Constanta Maritime University Annals Year IX, Vol

Constanta Maritime University Annals Year IX, Vol. 11

EMPIRICAL PERSPECTIVE ON SOVEREIGN CEILING PHENOMENON WITHIN EAST EUROPEAN EMERGING COUNTRIES

PHD Candidate Cristina Maria Triandafil

PHD Professor Petre Brezeanu

Academy of Economic Studies, Bucharest

ABSTRACT

This paper focuses on developed versus emerging markets arbitrage in terms of investors’ perception. We first perform a literature review on the topic, highlighting out both disconnection and transmission belt theories. Then we conduct a deep comparative analysis on the East-European corporate versus government spread bonds evolution during the last 10 years, 1997 being precisely the year when Basel II sovereign ceiling requirement was softened. Thus, we are interested especially in the way investors perceived East-European emerging countries afterwards. Conclusions are worthwhile in the context of the actual financial crisis from many perspectives: emerging markets attraction to foreign investors, corporate and sovereign rating interconnectivity for the countries in the sample (Romania, Bulgaria, Poland and Hungary) and corporate finance decision approach within East-European emerging countries.

Keywords: sovereign ceiling, corporate rating, sovereign spreads, emerging

INTRODUCTION

Sovereign rating is a key element for emerging countries. Macroeconomic volatility will impact corporate segment profitability. It has been pointed out that company cash-flow is deeply correlated with the economic cycle. From the perspective of the sovereign default theory exerted by the ,,spillover effect’’, a financial distress occurred at the macroeconomic level will extend also at the level of the corporations. Moreover, a high country risk premium will determine equity cost increase within the financing operations made on the international capital market.

Until 1997, based on the sovereign ceiling policy, rating agencies have never rated companies higher than the countries they were located into. This policy has been relaxed by Standard and Poor’s once there has been agreed on the fact that deeply ,,dollarized’’ economies (Latin America countries) are less affected by potential exchange controls exerted in case of sovereign default. First, Moody’s has adopted a clear opposition to the ,,lite’’ sovereign ceiling policy; then it began applying it although during the Argentine crises all the companies which have been rated higher than the countries they were located into have defaulted.

In this context, sovereign ceiling phenomenon became a very important research area. There have been conducted many studies, especially in the case of Latin American countries in order to highlight a potential impact of the sovereign rating on the corporate one.

Theories generally rallied around two divergent approaches: disconnection and transmission belt principles.

From the perspective of the disconnection theory, sovereign spreads do not have any impact on the corporate spreads. This theory was validated especially at the level of the developed countries (Li – Gang Liu, Giovanni Ferri, 2001).

EMPIRICAL PERSPECTIVE ON SOVEREIGN CEILING PHENOMENON WITHIN EAST EUROPEAN EMERGING COUNTRIES

Transmission belt theories assume a deep correlation between these two variables, especially from the perspective of the low significant information reflected into the corporate rating assigned to the companies located into emerging countries. The lack of transparency and reliability in terms of accurate financial information strengthen the idea of sovereign rating extension at the level of the individual corporations (Chan-Lee, Ahn, 2001).

This paper focuses on the sovereign ceiling phenomenon within East European emerging countries. There will be performed a deep analysis of the correlation between corporate and sovereign spreads in order to highlight out a potential impact of the sovereign spreads on the corporate one. The paper is structured as follows: section two includes literature review, section three which is divided into four parts is dedicated to the case study and section four contains the conclusions.

Section 2

3.1 DATABASE AND METHODOLOGY DESCRIPTION

The most recent theories regarding the sovereign ceiling assume a certain differentiation across countries. It has been pointed out that emerging countries imply a deep correlation between country and corporate rating while as for developed countries, the correlation is not validated to the same extent. This study focuses on revealing if this impact can be validated at the level of the East European emerging countries. The innovative element consists of highlighting out a potential impact of the country rating on the corporate rating having as reference the arbitrage between country risk and corporate risk. East European emerging countries imply an assembley of characteristics in terms of corporate finance decision making process: high degree of macroeconomic volatility, illiquid underdeveloped capital market, limited access to finance resources and high reluctancy to leverage. These characteristics derive precisely from the fact that emerging countries corporate sector profitability depends to a high degree on the macroeconomic environment. National currency fluctuations as well as inflation impact deeply corporate profitability.

The topic of this case-study is related to the one of Cavallo and Valenzuella and also to the one of Huang and Kongor Peter and Grandes which studied the relationship between corporate and sovereign spreads having as point of reference the corporate default premium limited to the case of publicly traded firms. This study is more closed to the work of Borensztein who analyzed this correlation at the level of the credit-rating, but we propose to be more analytical in terms of rationale which lays out behind the relationship between sovereign and corporate spreads.

The deep analysis will be performed in terms of descriptive statistics corresponding to the sovereign and corporate spreads both at the global and individual country level.

There have been built up two series, one containing the evolution of the East European country sovereign spreads, the other one containing the dynamic of the corporate bonds spreads issued by East Emerging countries Stock Exchanges listed enterprises.

The global perspective will integrate corporate and sovereign spread comparative analysis based on the data consolidation at the level of the whole assemble of countries (Romania, Poland, Slovakia, Hungary) while the individual approach will be made at the level of every country.

The sources the information was obtained from were the following:

and sites in order to get information on sovereign spreads;
East European Stock exchanges sites in order to get an insight on the corporate bond spreads.

There have not been made a differentiation at the level of the corporate and government bonds spreads because of a previous own research which pointed out that there have not been a clear difference between the two variables; as for the East European emerging countries, spreads both on corporate and government bonds have followed up the same pathway during 1997-2007.

As for the methodology, analysis of the descriptive statistics and of correlation matrix of corporate and sovereign spread is the most frequently used tool in order to highlight out the

EMPIRICAL PERSPECTIVE ON SOVEREIGN CEILING PHENOMENON WITHIN EAST EUROPEAN EMERGING COUNTRIES

3.2 DESCRIPTIVE STATISTICS ANALYSIS OF THE GLOBAL PERSPECTIVE ON THE CORPORATE AND SOVEREIGN SPREADS CORRELATION

In order to highlight out the correlation between the two variables, descriptive statistics will be analyzed both at individual and global level.

The global perspective points out that sovereign spread outperforms corporate bonds spread in terms of mean and minimum value while corporate spreads outperform sovereign spreads in terms of maximum level.

Corporate spread is more volatile than the sovereign spread and more right skewed.

These findings are in line with the assumption that a sovereign rating modification impacts to a higher extent corporate spreads no matter if it is positive or negative.

The higher corporate spread volatility reflects a deep connection between corporate environment and macroeconomic context.

Table 1 . Sovereign spreads descriptive statistics

Mean / Confid. - 95% / Confid. +95%
0.077859 / 0.064146 / 0.091571
Variance / Std.Dev. / Maximum / Minimum
0.001006 / 0.03171 / 0.16 / 0.057
Kurtosis / Std.Err. Kurtosis / Skewness / Std.Err. Skewness
1.206184 / 0.934764 / 1.647729 / 0.481337

Source: own processing

Table 2 . Corporate spreads descriptive statistics

Mean / Confid. - 95% / Confid. +95%
0.057319 / 0.054307 / 0.060331
Variance / Std.Dev. / Maximum / Minimum
0.001714 / 0.041396 / 0.56 / -0.0041
Kurtosis / Std.Err. Kurtosis / Skewness / Std.Err. Skewness
28.6249 / 0.18095 / 2.648005 / 0.090598

Source: own processing

The descriptive statistics of the two variables reflect a relationship between the two of them; there are not significant level gaps/differences and the overall perception could be the one of a corporate spread linking to sovereign spread.

This idea is not validated at the level of the correlation matrix. The correlation coefficient (-0.1117) is a very low one indicating the non-existence of a relationship between the two variables.

This contradictory situation could be explained by the low degree of development of the bond market within East European emerging countries which impacts negatively the set up of an extended database which should allow the illustration of a relation between the two variables.

Moreover, the graph associated to the spread distribution indicates an opposite causality. Within the existing literature, there have been agreed on an influence exerted by the macroeconomic context on the corporate sector profitability. As for the global East European countries perspective, the direction is that of an impact deriving from corporate spread towards sovereign spreads which points out that corporations’ economic performance has a strong contribution on the country risk level; macroeconomic welfare/stability depends to a high extent on the enterprises capacity to generate cash-flow and profitability.

EMPIRICAL PERSPECTIVE ON SOVEREIGN CEILING PHENOMENON WITHIN EAST EUROPEAN EMERGING COUNTRIES

Table 3. Corporate and sovereign spreads

correlation matrix

VAR1 / VAR2
VAR1 / 1 / -0.1117
VAR2 / -0.1117 / 1

Source: own processing

3.3 DESCRIPTIVE STATISTICS ANALYSIS OF THE INDIVIDUAL- COUNTRY LEVEL PERSPECTIVE ON THE CORPORATE AND SOVEREIGN SPREADS CORRELATION

In order to refine the perspective on sovereign/corporate spreads correlation, there has been performed analysis of the descriptive statistics at the level of every East European emerging country.

First there have been computed both corporate and sovereign spreads descriptive statistics; then the focus has been oriented towards the correlation matrix.

As for Poland, the corporate spreads are superior to the sovereign spreads in terms of maximum and mean

Table 4. Descriptive statistics of theEast European corporate spreads

Poland / Romania / Hungary / Slovakia
Mean / 0.0845045 / 0,138791 / 0,04054 / 0,070669231
Variance / 0,000734595 / 0,019981 / 0,001197 / 0,060%
Kurtosis / -0,80961937 / 10,32355 / -0,2139562 / -0,1609
Std.Err. Kurtosis / 0,324475 / 1,279416 / 0,2294214 / 0,500303
Confid. +95% / 0,088081 / 0,233755 / 0,0437422 / 0,075774077
Std.Dev. / 0,027103 / 0,141355 / 0,0346043 / 2,451%
Maximum / 0,15 / 0,56 / 0,2 / 13,500%
Minimum / 0,043 / 0,065 / -0,0041 / 3,000%
Confid. - 95% / 0,080928 / 0,043827 / 0,0373377 / 0,07
Skewness / 0,441356419 / 3,177782 / 0,7920327 / 65,548%
Std.Err. Skewness / 0,162940925 / 0,660687 / 0,114960816 / 0,252676

Source: own processing

EMPIRICAL PERSPECTIVE ON SOVEREIGN CEILING PHENOMENON WITHIN EAST EUROPEAN EMERGING COUNTRIES

Table 5. Descriptive statistics of theEast European sovereign spreads

Poland / Romania / Hungary / Slovakia
Mean / 0,06325 / 0,13506 / 0,061143 / 6,118%
Variance / 8,2358E-06 / 0,000275 / 0,00% / 0,000%
Kurtosis / -1,39876825 / 0,112947 / -25,10% / -5,6131
Std.Err. Kurtosis / 1,587451 / 2 / 158,75% / 2,618615
Confid. +95% / 0,065904 / 0,155632 / 0,0636359 / 6,372%
Std.Dev. / 0,00287 / 0,016568 / 0,27% / 0,001598
Maximum / 0,0671 / 0,16 / 6,46% / 6,265%
Minimum / 0,06 / 0,12 / 5,70% / 5,960%
Confid. - 95% / 0,060596 / 0,114488 / 0,0586499 / 5,863%
Skewness / 0,630820974 / 0,813275 / 10,90% / -0,04042
Std.Err. Skewness / 0,793725393 / 0,912871 / 79,37% / 1,014185

Source: own processing

values. Concerning the minimum values, it seems that corporate spreads are lower than sovereign spreads.

Corporate spreads are also more volatile than sovereign ones, but less right skewed.

As for the correlation between the two variables, the coefficient is a high one (0,8289739), reflecting a deep relationship.

The quartiles gap levels between corporate and sovereign spreads are not significant. We could say that corporate bonds spreads are mapped to a high extent to the sovereign spreads, since both dynamics are almost equivalent.

The only significant gap is recorded in the case of the volatility which validates the idea that corporate spreads are more fluctuating than sovereign ones.

Hungarian corporate spreads are lower than the sovereign ones. Both maximum and minimum levels are inferior in the case of the corporate spreads, but the volatility is higher.

The correlation coefficient is a lower one than in the case of Poland, but it still reflects a deep relationship because it is superior to 50%.

The higher volatility associated to the corporate spread correlation coefficient is a lower one than in the case of Poland, but it still reflects a deep relationship because it is superior to 50%.

Table 6 Corporate and sovereign spreads correlation coefficient

Poland / Romania / Hungary / Slovakia
Correlation coefficient / 0,828973892 / 0,162098 / 0,66942 / 0,622402078

Source: own processing

The highest gap between the two variables is remarked in the Slovakia case. The corporate spreads are superior to the sovereign ones and the associated volatility is a superior one too.

Within the analysis performed at the country level there is the first time that it is encountered a negative correlation between the two variables.

This negative correlation appears exactly in the case where sovereign spreads have the lowest volatility. During the analyzed period, Slovakia and Hungary are the only countries that do not have real fluctuations at the level of the sovereign spreads.

Thus, certain stability at the level of the sovereign spreads does not necessarily trigger the lack of corporate spreads volatility.

In the previous cases, corporate spreads have higher volatility than the sovereign ones; this time the lack of volatility at the level of the sovereign spreads is accompanied by the existence of a corporate spread volatility quite similar to the previous ones, which is in line with the assumption that even in the case of a sovereign spread non-dynamic, investors perceive corporations as risky.

The lowest correlation between the two variables is encountered in the Romanian case.

EMPIRICAL PERSPECTIVE ON SOVEREIGN CEILING PHENOMENON WITHIN EAST EUROPEAN EMERGING COUNTRIES

Within the group of analyzed countries, Romania is the riskiest one since it has the highest country risk premium.

As for the maximum, minimum and volatility parameters, Romania corporate and sovereign spreads follow-up the same principles as in the previous cases.

4. CONCLUSIONS

This study contains a research on the sovereign ceiling phenomenon within East European emerging countries.

There have been performed analysis especially in terms of correlation matrix at the level of every country in order to highlight a potential impact of the sovereign risk on the corporate bonds spreads.

Analysis revealed the fact that overall we can not establish a clear correlation between sovereign and corporate spreads. In some cases such as Poland and Slovakia, since corporate spreads have been superior to the sovereign ones, we can conclude that despite the fact that a clear correlation could not be highlighted out, investors integrated country risk premium into the corporate spreads.

In other cases, corporate spreads have been lower than the sovereign ones (Hungary), but the associated volatility was higher.

A general conclusion can be determined at the level of the volatility. It has been pointed out that corporate spreads are more volatile than the sovereign ones.

The lowest correlations have been remarked in the case of the least developed capital markets (Romania).

Overall since correlation matrices highlighted out weak relationships, investors perceived East European corporations as less risky than the countries they are located into. This assumption is based on the huge inflows of foreign investments that have been directed towards the East European emerging countries. The high gain potential vanished to a certain extent the macroeconomic risk reflected into the sovereign spread.

Future research will keen on a more detailed corporate spreads analysis in terms of business profile. There will be followed up an analysis at the individual business profile level in opposition with the actual global one in order to underline potential differences in terms of sovereign ceiling phenomenon.

REFERENCES

Cantor R., Packer F., (1996), ,,Determinants and Impact of Sovereign Credit Ratings’’, Federal Reserve bank of New York Economic Policy Review (October), pp. 1-15

Cohen, D., (2007), Incorporating default risk into Hamada’s Equation for application to capital structure, MPRA Press,

Cornell, B. Landsman, W., Shapiro A, (1989), ,,Cross sectional regularities in the response of stock prices to bond rating changes, Journal of Accounting, Auditing and Finance, Vol.4 pp. 460-479

Dangl T., Zechner J., (2006), Credit risk and Dynamic Capital Structure Choice, Vienna Univesity Press,

Davydenko, S., (2005), When do firms default? A study on the default boundary, London Business School Press,

Durbin, E., D. Ng, (2001) ,,Macroeconomic Risk and Expropriation Risk in Emerging Market Corporate Bonds’’, CornelUniversity working paper