Can Ownership Restrictions Enhance Security Value? Evidence from a Natural Experiment
This paper examines the role of ownership restrictions in raising capital from niche clienteles. Extant literature suggests that limiting availability of securities to only certain classes of investors constricts demand, and hence decreases prices. We argue that ownership restrictions can have positive implications for prices when viewed in the overall context of security design. We provide empirical evidence through an in-depth analysis of a natural experiment: multiple events of capital raising by an emerging market company with ownership restrictions, namely $4.2 billion and $5.5 billion of bonds offered by India's largest bank, State Bank of India exclusively to Indians living abroad at approximately 150 basis points below comparable benchmarks leading to a bottom line savings of $1.08 billion. This is an intriguing issue because it raises the question, how can an emerging market issuer with junk bond ratings obtain such yields? We argue that ownership restrictions can lead to value enhancement as well as value transfer from holders of other securities. Ownership restrictions can enhance value by circumventing the deadweight costs of prolonged negotiations, particularly when a security is restricted to a homogenous clientele that values the underlying collateral higher than other investors. Restricting the ownership further ensures that investment is limited to a homogenous class of investors that the issuer cares about. It thus serves as a precommitment to ensuring an efficient ex-post renegotiation in the potential default states, resulting in a lower ex-ante offering yield (and a higher offer price). This can result in an implicit seniority of holders of these restricted bonds vis-a-vis holders of unrestricted bonds. We empirically test and find support for both value enhancement as well as for value transfer from ownership restrictions. In particular, we find evidence of a transfer of wealth from existing holders of foreign currency denominated bonds of other Indian firms. However, the implicit seniority accounts for some but not all the difference in yields suggesting that ownership restrictions also enhance value through other avenues such as higher collateral valuation and lower renegotiation costs. Overall, our results suggest that firms with niche clienteles can benefit from designing securities with ownership restrictions, by offering new securities exclusively to investors who value them the most.
SMU Cox: Finance (Topic)