In comparison to bank financing, public debt market may allow firms to more readily match maturity and risk structures between their assets and liabilities. We test whether new issuers on the European corporate bond markets experience a change in their interest rate sensitivity upon their bond issuance. We find that stock returns have become significantly less sensitive to interest rate fluctuations for firms that enter the publicly traded bond market. Our findings support the notion that firms manage their interest rate risk with new debt issues.

Introduction

While interest rate risk management is mostly studied within banking industry, non-financial firms also view interest rate exposures and hedging of them to be of utmost importance (Graham and Harvey, 2001; Bodnar et al., 2013). Fast growth ofthe European corporate bond markets since the euro introduction has provided European firms with an expanded set of opportunities to manage their interest rate exposures (Korkeamaki, 2011). We study whether European firms’ interest rate sensitivity changes when they enter the corporate bond market. Banks have traditionally been the dominant source of debt financing for European non-financial firms. In a bank-dominated financial market, firms’ access to fixed rate funding tends to be limited, as bank financing comes predominantly in floating rate (Altman et al., 2010; Vickery, 2008; Faulkender, 2005).1 Limited access to fixed rate financing complicates firms’ efforts to match the interest rate sensitivity of their liabilities with that of their assets. Our work is related to the literature regarding the choice between bank financing and arm’s length financing via public markets. Diamond (1991) and Bolton and Freixas (2000) emphasize the monitoring role of bank lenders. Both papers predictthat high quality firms choose to use arm’s length debt, whereas lower-quality firms use bank debt due to its monitoring benefits. In a more recent paper, Rauh and Sufi (2010) explore the parallel use of bank debt and public debt. Their results provide further supportfor the importance of bank monitoring. They find that firms with public debt access continue to use bank debt. However, bank lending may also change its character when banks face increased competition from public marketlending. Boot and Thakor (2000) model suggests that with increased competition from the public capital market, banks reduce their investment in information acquisition. Part of that may be driven by banks’ need to cut costs as they face pressure to lower the cost of their lending, due to capital market competition (Hale and Santos, 2009) Boot and Thakor (2000) even question whether relationship-based European banking model will survive the growth in corporate bond market. Korkeamaki (2011) reports a significant change in interest rate sensitivity at the market level in Europe following the euro introduction, and he attributes the observation to the corporate bond market. We explore this issue further. Whereas Korkeamaki (2011) studies interest rate sensitivity of the European market indices and notes that a reduction in their interest rate sensitivity coincides with growth of European corporate bond issuance, our main contribution is that we use an identification strategy that specifically relates changes in interest rate sensitivity to bond IPOs at the firm level.