IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 1

Research Proposal Draft

Impact of Corporate Bond (Debenture) Issuance on Stock PRICE

Submitted by:

Ramraj Sharma

BBA Year IV Semester II

Kathmandu University School of Management (KUSOM)

Pinchhe Tole, Gwarko, Lalitpur

Submitted to:

Prof. Dr Achyut Wagle

IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 2

Table of Contents

PART I: INTRODUCTION ............................................................................................... 3

1.1 Background of Study ........................................................................................................... 3
1.2 Statement of problem .......................................................................................................... 4
1.3 Rationale .............................................................................................................................. 5
1.4 Research Objectives............................................................................................................. 7
1.5 Research Questions.............................................................................................................. 7
PART II: LITERATURE DESIGN ................................................................................... 7
2.1 Literature Review ................................................................................................................ 7
2.2 Theoretical Framework ....................................................................................................... 9
2.3 Research Hypothesis .......................................................................................................... 10
2.4 Definition of financial terms .............................................................................................. 11
PART III Research Methodology .................................................................................... 12
3.1 Purpose of the Study .......................................................................................................... 12
3.2 Type of Investigation ......................................................................................................... 12
3.3 Study Setting..................................................................................................................... 13
3.4 Time Horizon ..................................................................................................................... 13
3.5 Data Collection .................................................................................................................. 14
3.6 Study Population ............................................................................................................... 14
3.7 Sampling Design ................................................................................................................ 14
3.8 Sampling ............................................................................................................................ 15
3.9 Data Analysis ..................................................................................................................... 15
3.9.1 Regression Variables...................................................................................................... 16
3.9.2 Regression Model ............................................................................................................ 16
PART IV: REFERENCES .............................................................................................. 17
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 3

PART I: INTRODUCTION

1.1 Background of Study

The Nepalese debt market is relatively small and has not done effective work in the

security market for years. Security market is a platform created to facilitate the exchange of

financial securities or assets by bringing together buyers and sellers of securities. It provides

an effective way of procuring long-term funds by issuing shares and debentures or bonds for

corporate enterprises and government and at the same time provide an investment opportunity

for individuals and institutions. When an investor thinks of an investment strategy, most of the

time it turns out to be purchase of some securities. These securities are tradable investment

assets such as stocks, bonds, and all of the assets which have monetary value. Nepal Stock

Exchange (NEPSE) is the only trading floor in Nepal that trades mainly shares and

comparatively low numbers of development bonds in the country.

The Nepalese bond market is not well developed and the investors and borrowers still

prefer bank loans against the bonds. Even within the bond market, the government bond

composes higher proportion than that of corporate sector. The corporate sectors, public

regulatory sector (NRB), brokers and other experts hold different views regarding the lack of

incentive for bond market growth and development. This study attempts to discuss the concept

of effects on debentures on the stock market of issuing company and further aims to analyze

the performance of Nepalese securities market. Similarly, the variables such as trading

turnovers, paid up values, market capitalization and stock price are analyzed for the secondary

market. Since, in Nepal corporate sectors have been issuing debentures as debt instrument and
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 4

bond issuance events are found only in case of NRB, debentures have been treated as corporate

bonds based on their availability and treatments by issuing companies in their financial reports.

1.2 Statement of problem

Any company that issues debt is bounded to make regular and fixed set of cash

payments over the maturity period. Inability to make such payments can lead to adverse

impacts on issuing company. Addition of huge debt to a company’s capital structure can cause

higher expected future cash flows (Barclay and Smith, 2005). So, events of debt issuance

signals that the company is well aware that it can pay its debt (coupons) obligations.

By present value models, incase of debt issuance, debt having higher interest (coupons)

payments (viz higher discount rates) , other things being equal, cause stock prices to fall; a fall

in expected discount rates should have the opposite effect on both. Putting the same point in

simpler terms, an increase in expected long-term bond yields would seem to make long-term

bonds a more attractive investment, and so stock prices would have to fall to induce people to

hold stocks. That argument might be right, if certain implicit assumptions about stochastic

properties of relevant variables are valid, but need not be. The problem with the argument is

that the dividend stream that is discounted for stocks is radically different than the stream of

coupons that is discounted for bonds. The implied differences in their stochastic properties can

be relevant for the problem of the relations between the two assets from at least two

perspectives.

First, the dividend stream on stocks is relatively stable in real terms, while the dividend

stream on debentures is in nominal terms. If there is substantial inflation, then these two streams

can be dramatically different in ways that are correlated with the (nominal) discount rates.

Therefore, if changes in nominal debenture yields reflect primarily inflationary expectations,

IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 5

then these changes should perhaps have little effect on stock prices. Second, movements in l

interest rates might also be related to information about the future dividend stream on stocks.

Empirical studies of stock market reactions to bond announcements come to conflicting

results. In the case of announcements of bond issuance, there are no any statistically significant

stock market reaction (Haug, 2017). Besides solely analyzing straight bonds, Eckbo/Masulis

(1995) also look at the issue of convertible bonds and here the authors find negative effects on

stock market prices, which is due to the fact that convertible bonds have debt and equity

components. Eckbo/Masulis (1995) find that the stock market reaction is most negative for

common stock issues, less negative for convertible bonds and zero for straight debt issues

(Eckbo/Masulis 1995, p. 1042). Most studies carried out on the U.S. market find these negative

effects when convertible bonds are issued. Similarly, Machel (2013) conducted a study on the

effects of debt issues on the stock price performance of companies listed at the Nairobi

Securities Exchange and came to a conclusion that bond issues do not have a significantly

positive effect on the stock prices of issuing firms.

Since the findings are conflicting, this study of impact of corporate bond issuance on

stock price has further scope for research as it helps managers to understand how different

capital change decisions, more specifically the decision of debt issuance, affect the company

value.

1.3 Rationale

Along their expansion path, corporations finance investments by retained earnings as

well as by raising additional funds. The new capital received can be seen as an advance on

future growth as the money can be used for investments that optimally increase the company
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 6

value. Firms that need additional funds can draw from a list of many possibilities of how they

want to raise new capital, ranging from equity offerings to different debt instruments.

Nepal has witnessed the frequent turn arounds of excess or minimum liquidity in the

financial markets. These turn arounds have stirred the financial institutions to issue bond and

raise capital and ensure a shield against the frequent changes in liquidity. Since, the capital

raised comes from the investors who seek to grab higher returns through high interest rates

offered by the financial institutions, there have been a shift of investors in capital market (stock

exchange) towards investment in bonds with an expectation to make a low risk and sure profit.

Corporate bond issuance can lead to changing patterns of demand and supply of stocks of

companies listed in the exchange and can also signal different expectation regarding company

performance in long run which could create drastic changes in the wealth of investors. Such

changing patterns has made it very essential to deduce the relationship between bond issuance

and the prices of stocks. This paper tries to identify how such debt instrument viz Bond

Issuance changes the prices of stocks listed on the stock market. In brief the research addresses

very practical issue that helps to understand the effect of corporate bond issuance on the stock

index.

The large body of empirical literature on the market reactions to bond issuances

motivated many researchers to develop theories about how the stock market movements can

be explained. Based on these theories, this paper formulates hypotheses that will be tested for

a sample of Nepalese stock market share prices of debenture issuing companies for a period

of 6 years between January 2013 and September 2019. Applying the event study methodology,

this paper aims at contributing to our understanding of why stock index behaves the way we

observe it.
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 7

1.4 Research Objectives

• To identify the effects of debenture issuance in the stock price performance.

• To identify if bond issuance affects stock market index.

1.5 Research Questions

• Does the Stock price fluctuate with corporate bond issuance?

• Does the bond issuance affect stock market index?

PART II: LITERATURE DESIGN

2.1 Literature Review

The returns quoted by newly issued bonds can have impact on price of stocks. If the

expected returns of any underlying stock asset is less than the return promised by any newly

issued bond then there are high chances that investors shift their investment preferences to bond

and then sell their current stock holdings. This could lead to higher selling preferences of stocks

leading to decreased stock price. Considering the present value models, an increase in expected

future discount rates (viz bond yields) should, other things being equal, cause both stock prices

to fall and long-term interest rates to rise; a fall in expected discount rates should have the

opposite effect on both. Putting the same point in simpler terms, an increase in expected long-

term bond yields would seem to make long-term bonds a more attractive investment, and so

stock prices would have to fall to induce people to sell stocks. On the other hand, if the newly

issued bond has relatively lower returns than the stocks, it is more likely that the value of the

bond will decrease making the demand of the stocks higher. This argument claims there should

be a simple inverse relation between bond issuance with high returns and stock price.

According to Premchand, (1989), whenever a company issues debentures or bonds , the risk

perception of the equity holders increases, as debenture holders have to be paid interest, before

paying any amounts to the other beneficiaries of the company. So, the company has to increase

the dividend payout ratio, in order to create a balance and retain its existing shareholders and
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 8

keep them satisfied, even after the issue of debentures. Similarly, according Richardo Kolodny

and Diane Rizzuto Suhler (1998) debt issuance can signal equity investors about the kind of

investment companies will have through the issued funds and investments with higher potential

in cash flows can lead to expectations of increasing value of firms affecting stock market

positively.

However, though this has been the fundamental explanation on the relation between

bonds yields and stock price, this hasn't always been the case and we can see contradictory

results from different reports on this subject. Studies of stock market reactions to bond

announcements have seen to come with conflicting results. Antweiler and Frank (2006) come

to the result that for their sample of U.S. firms, announcements of straight bond issues do not

affect the stock price of the issuing firm. These results of Antweiler and Frank (2006) are

confirmed by Shyam-Sunder (1991) as well as by Eckbo and Masulis (1995) who also found

neither positive nor negative effects on the stock market when straight bonds were issued.

Similarly, Shyam Sunder (1991) studied bond ratings, but could not find statistically significant

effect of ratings on the stock market effects (Shyam-Sunder 1991). Gebhardt et al (2005), in

their study, indicated that bonds and stocks have the similar underlying cash flows and they are

affected by the company fundamentals. Their study shows that over a ninety day period, any

abnormal returns on a company’s share matched by better performance of short term notes with

floating interest rates. Therefore, bonds cannot evolve independently of equities.

A more recent investigation by Chin and Abdullah (2013) studies abnormal returns in

response to straight bond issues in Malaysia as well as the company characteristics that

influence that effect. Based on the sample of 100 bond issuers between 2000 and 2007, the

authors report a positive and significant cumulative average abnormal return for the 21 days
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 9

that surround the event. In this case, if we consider firm characteristics, we can find an

insignificant relationship of the control variables on the abnormal returns, Max Hung (2016)

In addition to solely analyzing straight bonds, Eckbo and Masulis (1995) also studies

at the issue of convertible bonds and the authors found negative effects on stock market prices,

which is due to the fact that convertible bonds have debt and equity components. Eckbo and

Masulis (1995) find that the stock market reaction is most negative for common stock issues,

less negative for convertible bonds and zero for straight debt issues (Eckbo and Masulis 1995).

The study conducted by Ammann et al. (2006) in the period 1996 – 2003 found results

similar to Eckbo and Masulis (1995). The authors report that the announcement of convertible

bonds leads to significant negative return of -2.43% for the German sub-sample in the two-day

event window (Ammann et al. 2006). Similarly, in another study by Burlacu (2000) 141 issues

of convertible bonds in France between 1981 and 1998 were analyzed. The research showed

that, on average, there is a negative stock market response to convertible bond issues in France

and the reaction is more negative, the higher the equity component in the convertible bond is

(Burlacu 2000`).

In another research by Robert J Shiller and Andrea E Beltratti (1992), the nature of the

variability of discount rates and dividends in relation to information available in advance of

this variability, there should indeed be generally a slight negative correlation between changes

in real stock prices and changes in long-term interest rates. Robert J Shiller and Andrea E

Beltratti (1992) found that excess returns in the stock market correlate too much with excess

returns in the bond market.

2.2 Theoretical Framework

Given the profound findings of mixed impacts in stock price from corporate bond

issuance the question of impact of bond issuance on stock price serves as a benchmark in terms
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 10

of understanding the interrelation of different tools applied in capital market. For this study

theoretical framework has been formulated from the literature review. Here, the independent

variable is bond issuance (event, which is dummy variable) and the dependent variables are

stock price of issuing company and transaction volume of same company. Also

For this research, the NEPSE price for banks and financial institutions will be taken as

the indicator of stock market index. The movement of the prices will be tracked over a 361

estimate period which is 180 days before and 180 days after the bond issuance opening date.

A regression analysis will be run for these two variables.

Stock Market

Bond Issuance

Transaction Volume

Fig. Conceptual Framework

2.3 Research Hypothesis

H1: Bond issuance affects stock price of issuing company.

H2: The Stock transaction volume fluctuates with Bond Issuance.

IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 11

2.4 Definition of financial terms

• Bond: A bond, also known as a fixed-income security, is a debt instrument created for

the purpose of raising capital. They are essentially loan agreements between the

bond issuer and an investor, in which the bond issuer is obligated to pay a specified amount

of money at specified future dates. Usually bonds are backed by collateral.

• Debenture: A debenture, also known as a fixed-income security, is a debt instrument

created for the purpose of raising capital. They are essentially loan agreements between the

bond issuer and an investor, in which the bond issuer is obligated to pay a specified amount

of money at specified future dates. Since, debentures are issued by financially stable and

company with good reputation no collateral is required.

• Stock: It is a type of security that gives stakeholders a share of ownership in a

company.

• Stock market index: A stock market index measures the change in the prices of stocks

of the index’s components.

• Bond yields: It is a return that an investor realizes on a bond.

• Coupon rates: It is the interest rate that the issuer of the bond promises to pay the

bondholder.

• Convertible bond: It is a fixed-income debt security that yields interest payments, but

can be converted into a predetermined number of common stock or equity shares. The

conversion from the bond to stock can be done at certain times during the bond's life and is

usually at the discretion of the bondholder.

• Discount rates: It refers to either the interest rate that the bank charges for short term

loans or the rate used to discount future cash flows in discounted cash flow analysis.
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 12

• Discounted cash flow analysis: It is a valuation method used to estimate the value of

an investment based on its future cash flows.

• Dividend payout ratio: It is the ratio of the total amount of dividends paid out to

shareholders relative to the net income of the company. It is the percentage of earnings paid to

shareholders in dividends.

• Stock valuation: It is the method of determining the intrinsic value of a stock. By

knowing a stock’s intrinsic value, an investor may determine whether the stock is undervalued

or overvalued at its current market prices.

• Free cash flows: It is the cash left over after a company pays for its operating

expenses and capital expenditures.

PART III Research Methodology

This part of the study deals with the research strategies, research methods, methods of

data collection, selection of sample, the research process, including the type of data analysis.

3.1 Purpose of the Study

The trend of issuing debentures by banks and financial institutions has seen livelier in

recent years. While we see increasing trend of issuing debenture to cope up with the present

problem of liquidity, now investors have more options to choose among investment sectors,

some corporate bonds providing them with abnormally high interest rates. This research aims

to deduce the impacts of bond issuance to the stock market index of Nepal, with the help of

literature and empirical evidences from past researches, while understanding the impacts in

other nations. This study aspires to seek the link between bond issuance and the price

fluctuation of stocks in stock exchange leading to the changes in market index.

3.2 Type of Investigation

This study has employed the event study methodology to determine the effect of

debenture issuance on stock prices. This methodology has been used with an understanding
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 13

that stock prices represent the discounted value of issuing firms’ future stream of profits. The

changes in equity value of firms that have been affected by their event (issuance of corporate

bond or debenture ) can be taken as a measure of discounted (or additional) value of stocks

expected to accrue as a result of that event.

The study analyses the correlation between issuance of bonds and their impacts on the

stock market index. The returns offered by debentures can be related to the investors preference

of buying bonds to investing in stocks. Further, past results show that there is a negative

correlation between the change in actual real log stock prices and the change in actual long-

term interest rates (Shiller and Beltrati, 1992). So, considering these factors correlation

investigation has been used for the study.

3.3 Study Setting

This research is aimed to understand the real relationship between debenture issuance

and stock market prices, which clearly makes it to have real time data and real market

participants in stock and capital market. So, considering these facts, the non-contrived study

setting will be applied, where the phenomenon will be analyzed while they occur naturally.

The relationship between the stock market and the bond issuance will not be tampered with in

any way by any exogenous factors so in that regards the study setting will be that of a non-

contrived one.

3.4 Time Horizon

The study has been conducted within the time frame of 6 years (January 2013 to Februry

2020) which includes both bull and bear cycle in Nepse. The study critically analyses all the

debenture issuances and debenture issue announcements during this period and the changes in

the stock prices at the same time period. Hence, longitudinal time frame has been used.
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 14

The Data Collection in this research will all be done which is a much greater time frame

than what this study seeks to evaluate hence making the data collection aspect simpler.

3.5 Data Collection

Due to the fact that this research evaluates the effect of bond issuance on stock market,

the primary data collection methods like questionnaire and interview are not necessary. The

data for the bond issuance will be collected through the Nepal Rastra Bank (NRB) website and

its publication along with websites www.sharesansar.com. Because our study deals with the

impact of Bond Issuance on the Stock Market prices, the stock market index data is available

in Nepal Stock Exchange and data have been extracted from the same. Nepal has only one

stock market and the data for 125 days of past index is available in it’s website. However,

because this study seeks to evaluate the effect of bond issuance on the stock price for a period

of six years, the software Share Sansar Pro (SSPRO) has been referred which will enable us to

have a data reference of six years.

3.6 Study Population

Numerous amounts of bonds and Debentures have been issued in Nepal from

government bonds to corporate bonds since the first bond was issued in 1964 (Shrestha, 2038).

Most of these government as well as corporate bonds are listed in the securities market NEPSE.

The study population includes the companies that have issued debentures in the security market

and the stock market (NEPSE) in the given time frame. However, any company issuing

debenture more than once in given time frame is not included.

3.7 Sampling Design

The ideal scenario for any research would be the study of the entire population. And in

most of the cases it is unfeasible to conduct due to which certain sample is taken. Sample is a

part of the population, that generally is representative of the entire population (Mugo Fridah

W., 2002).
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 15

For the purpose of this study purposive sampling technique, a non-probabilistic

sampling technique, is selected. Purposive sampling technique relies on the judgement of the

researcher on selecting the units to be studied and they can provide researchers with the

justification to make generalizations from the sample that is being studied, whether such

generalizations are theoretical, analytic and logical in nature (Gaganpreet Sharma, 2017).

3.8 Sampling

For the purpose of this study under the purposive sampling technique typical case

sampling has been selected. Typical case sampling helps us to identify the ongoing

phenomenon, have an in-depth understanding and relate it to the research objective. Typical

case sampling also allows the researcher to select a sample where the study subject is more

frequent (Palys, 2008). This complements our study since, our study aims to illustrate the effect

of bond issuance on the stock price.

The corporate bonds that have been issued since Jan, 2013 to Dec, 2018 will be

analyzed. This sample has been selected on the basis that complete amount of data is available

in the market and the consequences of selecting the greater sample would be gap in the research

due to lack of accurate and reliable data (Robinson, K.A., Saldanha, I.J., & Mckoy, 2011). And

this sample should be sufficient enough to get insight of the phenomenon of the stock index

after the issuance of bonds if any.

3.9 Data Analysis

Firstly, expected return was calculated by taking 180 days prior and 180 days after

issuance. Similarly, window period of 60 days prior and 60 days after was calculated to

calculate abnormal return which is the difference of expected and actual price. The calculated

indicators will then be used for panel regression, and the resulting analysis will be the

conclusion of the study.

IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 16

3.9.1 Regression Variables

Dependent Variables:

• Abnormal return

Independent Variables:

• Event (Issuance of Bond)

• Transaction Volume

3.9.2 Regression Model

The paper employs the market-adjusted model, also called the beta-one model. This

market model calculates the returns of each stock based on the firm’s historical stock return

and the historical market return. Here the paper also clarifies whether the market model or the

market-adjusted model is more suitable in determining abnormal returns.

Yit = b0i + b1 X1it+ +b2X2it+ uit

where,

Y=expected returns of stocks

X1=event of bond issuance

X2= transaction volume of issuing company

i= entity (firm)

t= time
IMPACT OF CORPORATE BOND ISSUANCE ON STOCK PRICE 17

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