Information and Liquidity of Over-the-Counter Securities: Evidence from Public Registration of Private Debt Song Han Federal Reserve Board [email protected]Alan G. Huang University of Waterloo [email protected]Madhu Kalimipalli Wilfrid Laurier University [email protected]Ke Wang Federal Reserve Board [email protected]This version: June 10, 2017 Preliminary. Comments Welcome. Abstract The Rule 144A private debt represents a significant and growing segment of the U.S. bond market. A large fraction of 144A bond issues carry registration rights and are subsequently publicly registered. We examine the market liquidity effects of enhanced information induced by the public registration of private debt. Using the regulatory version of TRACE data for the period 2002-2013, we find that following public registration of 144A bond, liquidity cost of trading these bonds measured by dealer-specific effective bid-ask spreads narrow. The spread reduction is larger for issues with higher ex-ante information asymmetry. Our results are consistent with existing theories that financial transparency reduces information risk and thus improves market liquidity. Keywords: Rule 144A bond, broker-dealers, public registration, liquidity, information disclosure JEL Classifications: G12, G14 The views expressed herein are completely our own and do not necessarily reflect the views of the Federal Reserve Board or its staff. We acknowledge discussants and participants at the Third Ontario Universities Accounting and Finance Symposium, 2017 Annual Meeting of the Mid-West Finance Association, and 2017 Annual Fixed Income and Financial Institutions Conference, University of South Carolina for their helpful comments. (Accepted for presentation at the 2017 European Finance Association Meetings, Mannheim, and Summer School on Liquidity in Financial Markets and Institutions, Washington University in St. Louis)
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Information and Liquidity of Over-the-Counter Securities:
The Rule 144A private debt represents a significant and growing segment of the U.S. bond market.
A large fraction of 144A bond issues carry registration rights and are subsequently publicly
registered. We examine the market liquidity effects of enhanced information induced by the public
registration of private debt. Using the regulatory version of TRACE data for the period 2002-2013,
we find that following public registration of 144A bond, liquidity cost of trading these bonds
measured by dealer-specific effective bid-ask spreads narrow. The spread reduction is larger for
issues with higher ex-ante information asymmetry. Our results are consistent with existing
theories that financial transparency reduces information risk and thus improves market
liquidity.
Keywords: Rule 144A bond, broker-dealers, public registration, liquidity, information disclosure
JEL Classifications: G12, G14
The views expressed herein are completely our own and do not necessarily reflect the views of the Federal Reserve
Board or its staff. We acknowledge discussants and participants at the Third Ontario Universities Accounting and
Finance Symposium, 2017 Annual Meeting of the Mid-West Finance Association, and 2017 Annual Fixed Income
and Financial Institutions Conference, University of South Carolina for their helpful comments. (Accepted for
presentation at the 2017 European Finance Association Meetings, Mannheim, and Summer School on Liquidity in Financial Markets and Institutions, Washington University in St. Louis)
A wide range of corporate securities and derivatives are traded in the over-the-counter
(OTC) market, where market-makers and investors search for trading counterparties and bargain
over trade terms. Theories show that asymmetric information among traders about issuer’s
financial conditions is one of major factors contributing to search frictions and market liquidity in
trading these securities (e.g., Duffie 2012). In practice, the extreme cases of Iliquidity episodes
include trading halts of specific securities due to lack of information, for example, when a firm
fails tofile periodic public reports. Trading conditions may also deteriorate sharply across the broad
market when the information risk becomes too high, as occurred during the recent financial crisis.
In this paper, we provide a quantitative analysis of how asymmetric information in
corporate finance impacts the trading liquidity in the market for corporate bonds—an OTC market
that has received a great deal of attention in recent years. Our focus on the informational effect
contributes to this growing literature, because most existing studies examine the impact on bond
liquidity of opacity in trading activities and market fragmentation.1 Our premise is the following.
The standard OTC theory implies that greater public disclosures of an issuer’s financial conditions
should improve the market liquidity of the issuer’s bonds, because public disclosure reduces the
extent of information asymmetry among traders (see, for example, Diamond and Verrecchia, 1991,
Easley, Hvidkjaer, and O’Hara 2002, Greenstone, Oyer, and Vissing-Jorgensen 2006).
We examine the liquidity effect on OTC securities of information disclosure in the context
of the public registration of the Rule 144A corporate bonds. Adopted in 1990, the Rule 144A
provided a safe harbor from the public registration requirements of the Securities Act (1933) for
resales of restricted securities to “qualified institutional buyers” (or QIBs), which generally are
large financial institutions and other accredited investors.2 Interestingly, while the Rule 144A
bonds are issued at “dark exclusively to QIBs,” many of them carry registration rights and are
1 Typical for an OTC market, corporate bond trading is generally opaque. Several studies find that trading costs have
declined after increased post-trade transparency on transaction information (Bessembinder, Maxwell, and
Venkataraman (2006), Edwards, Harris and Piwowar (2007), Goldstein and Hotchkiss (2007), and Goldstein,
Hotchkiss and Sirri (2007)). A large literature has examined the role of information asymmetry among traders in the
market liquidity of equity trading. See, for example, Glosten and Milgrom (1985), Glosten and Harris (1988),
Madhavan, Richardson, and Roomans (1997), and Huang and Stoll (1997). 2 Specifically, QIBs are the following financial entities: 1) an institution (e.g., an insurance company, investment
company or pension plan) that owns or invests at least $100 million in securities of non-affiliates; 2) a bank or savings
and loan (S&L) association that meets condition 1) and also has an audited net worth of at least $25 million; 3) a
broker or dealer registered under the Exchange Act, acting for its own account or for that of QIBs that own and invest
at least $10 million in securities of non-affiliates; or 4) an entity whose equity holders are all QIBs.
3
subsequently publicly registered.3 As required by the securities law, issuers need to disclose their
financial conditions as part of the public registration. Importantly, public registrations generally
entail an offer of new public bonds to exchange for the target Rule 144A bonds, where the terms
of the new bonds are mostly identical to those of the exchanged ones. As such, the 144A public
registrations don’t accompany changes in the issuer’s fundamentals such as leverage, allowing us
to better identify the informational effects on OTC trading liquidity.
Assessing the liquidity effect of the Rule 144A public registration can help shed light on
the informational effects for the broad bond markets. First, since its inception, Rule 144A corporate
bonds have quickly become an important source of corporate financing. For example, according
to the Fixed Income Securities Database (FISD), between 1990 and 2013, Rule 144A bonds
account for 20 percent of the total corporate bonds issued by U.S. firms, with the growth
particularly strong since the recent financial crisis.4 Second, secondary market volumes of 144A
bonds are also sizable, representing nearly 20 percent of the average trading volumes of all
corporate bonds (FINRA,,2014).5 To the best of our knowledge, we provide a first comprehensive
study on the market liquidity effects of Rule 144A public registration, which sheds light on the
general issue of the information effects on OTC trading.
We find that liquidity improves following public registration of 144A bonds and that the
improvement is larger for issues with higher ex-ante information asymmetry. Our analysis takes
advantage of the comprehensive version of the Trade Reporting and Compliance Engine (TRACE)
data for the period 2002-2013. The data contain transactions of all bonds reported to the Finance
Industry Regulatory Authority (FINRA), including those that previously were not disseminated to
the public, among which are Rule 144A bonds.6
To begin, we examine the change of trading costs following the public registration. Our
main measure for trading costs is the round-trip costs of trading (RTC). Following, for example,
3 Extant literature provides a wide range of estimates on the extent of exercises of these registration rights. Depending
on the sample used, over 30-90% of the 144A bonds are publicly registered in the few months following issuance.
See, e.g., Livingston and Zhou (2002), Huang and Ramirez (2010), and Craig (2012). 4 Specifically, out of the total $20.7 trillion of corporate debt issued during 1990-2013, $4.1 trillion was Rule 144A
debt. Also, 144A bond issuance as a share of total U.S. corporate bond issuance rose from 23.40 percent during pre-
crisis period ( 1999-2006) to 37.62 percent in post-crisis period (2010-2013). 5 Dan Caplinger, “How Rule 144A Created a Shadow Financial Market.” Motley Fool, 7/3/2015
(https://www.fool.com/investing/brokerage/2015/07/03/how-rule-144a-created-a-shadow-financial-market.aspx). 6 This regulatory data for this study is provided by FINRA to the Federal Reserve Board under a data sharing
agreement. Note that FINRA phased in public disseminations of non-Rule 144A from July 2002 to February 2005,
and started to disseminate Rule 144A transactions to the public on June 30, 2014, with 18 months of time lag.
4
Goldstein, Hotchkiss, and Sirri (2007), the RTC measure is the difference of transaction prices
between a dealer’s sale to a customer and a dealer’s purchase from another customer for the same
security on the same day. Since we observe the identification of the broker-dealers intermediating
each trade, we are able to compute dealer-bond specific RTC, which is closer to the true dealer-
specific effective bid-ask spread. OTC markets such as the Rule 144A market are often
characterized by sporadic trading and traders’ specific portfolio needs, making trade size-based
measures such as Amihud’s (1989) price impact measure less desirable. Using RTC as the liquidity
measure avoids such pitfall.
We search 144A bond registrations by matching bond specific attributes, combined with
validation of registration-key words in bond prospectuses. A Rule 144A bond becomes registered
mostly through an exchange offer in which the debtor issues registered public securities to tender
for the 144A bond. For every 144A bond, we search the FISD database to locate a public bond
subsequently issued that matches key characteristics of the 144A bond. We then validate the
matching by searching exchange offer-related key words in the prospectus of the public bond. Our
results show that on average, registration reduces RTC by 3.3 (5.0) basis points 100 (30) days
around the registration, or about 12 (19) percent of its pre-registration level.
We then conduct three sets of difference-in-difference (DID) analysis to address the
identification concern that the changes in trading liquidity around the public registration may be
attributable to factors other than changes in information environment regarding the 144A issuer’s
financial conditions. We take comfort in that 144A public registrations are not associated with
capital structure and funding changes, because the new public bond offered to replace the existing
144A bonds is identical to the tendered bond except the security legend. Even so, other factors, such
as market conditions, may change around the registrations and in turn affect bond liquidity.
Addressing this concern, we contrast the change in trading liquidity of bonds that are more likely
to experience changes in information environment with that of other control bonds. The premise is
that if the information disclosure matters for trading liquidity, then the public registration effects
should be stronger among issuers with greater information risk pre-registration.
The three sets of DID analysis are as follows. Firstly, focusing on the 144A bonds
experiencing public registrations, we contrast those issued by firms with public equities with those
by private firms. Because public firms disclose regularly their financial conditions, public
registration of their 144A bonds may have relatively less information content, when compared to
5
to 144A registrations of private firms. Secondly, we use an issue-specific proxy for the extent of
possible changes in information risk. Specifically, following the recent literature of SEC filing
analysis (e.g., Li 2008, Loughran and McDonald 2013, Ertugrul et al. 2015), we use three metrics
from bond prospectus to measure ex-ante information asymmetry of a public issue: total word
count, count of uncertainty words, and file size. This school of literature finds evidence for
“information obfuscation,” where issuers tend to hide adverse information through lengthy filings
(Bloomfield 2002). Lastly, we construct a matched sample of public (non-144A) bonds as our
control group. We expect the 144A debt registration for public firms to informationally less
prominent. For each 144A bonds experiencing public registration, we find a set of public bonds
with same industry, credit rating, callability, remaining bond maturity, and bond issue size. We
compare the changes in RTC between the 144A bond and its matched public bond around the
registration event. Overall, these three sets of DID analysis find that the RTC measure of bid-ask
spreads decreases post registration, and it is more so for firms with high information asymmetry
pre-public registrations. These findings suggest that increased corporate information disclosure
associated with public registration improve the market liquidity of OTC securities.
Measuring the impact of registration on bond pricing, we find that yields on average
decrease by 16 basis points and daily returns decrease by 3 basis points following registration,
consistent with previous empirical studies on 144A bonds. We also find that trading activities are
subdued following public registration, based on both trading volume and frequency of trading,
regardless of more retail investors entering the market; and that bond dealers tend to reduce their
net positions following public registration of 144A bonds. Since registration is an expected event,
some institutional traders may have reasons to trade 144A bonds ahead of registration time more
actively. Although post- registration, retail investors can enter the market, as they might behave
more like “busy-and-hold” investors, we tend to observe less active trading activity. However, if
we measure liquidity in terms of trading costs such as effective bid-ask spread, we still conclude
liquidity improves after registration. In a public bond market setting, Goldstein, Hotchkiss and
Sirri (2007) finds that enhanced transparency is not associated with greater trading volume, which
is consistent with our findings.
Overall, this paper contributes to the empirical literature showing that public disclosure
reduces liquidity costs for OTC securities. Following public registration of 144A bond, bid-ask
spreads narrow, and more so for firms with higher ex-ante information asymmetry. We believe
6
our paper is the first to identify the relationship between financial information asymmetry and
liquidity cost based on bond transaction data. It also complements empirical studies on bond
liquidity with detailed examination on Rule 144A bonds, which are often omitted in earlier
literature using TRACE database since the dissemination of this type of bonds is only recent
and our regulatory version of data contains all 144A bond transactions reported in TRACE but
not disseminated before.7 The rest of the paper is organized as follows. Section 2 discusses our
contributions to the literature. Section 3 describes our data, sample construction, and liquidity
measures. Section 4 presents our main empirical results on the impact of registration to liquidity
and trading activity. Section 5 provides additional robustness tests and other findings regarding to
yields and trading activities. Section 6 concludes.
2. Related Work
Our paper contributes to three related strands of literature that are summarized below.
2.1 Studies on Public Disclosure, Liquidity and Asset Pricing in OTC Markets
Our paper contributes to the broad literature on the effect of corporate information
disclosure on market liquidity and asset prices. A key insight of this literature, including standard
market microstructure theory, is that the market liquidity of traded securities reflects the risk of
asymmetric information about the issuer’s financial health (e.g., Glosten and Milgram 1985,
Diamond and Verrecchia 1991, and many others).
More specifically, our paper is more closely related to the strand of literature of how public
disclosure of corporate information in OTC markets affects liquidity and asset prices. Most of these
studies focus on OTC stocks. In particular, studies have found that market liquidity and asset prices
in the OTC stocks improve following mandatory disclosure requirements, because higher quality
financial reporting and better disclosure can reduce information asymmetry (e.g., Healy, Hutton,
and Palepu 1999, and Leuz and Verrecchia 2000, Easley, Hvidkjaer, and O’Hara 2002, Greenstone,
Oyer, and Vissing-Jorgensen 2006, Brüggemann, Kaul, Leuz, and Werner 2016).8 White (2016)
7 As of June 2014, FINRA (Financial Industry Regulatory Authority) started releasing 144A transaction data on
TRACE . 8 For example, Greenstone, Oyer, and Vissing-Jorgensen (2006) analyze the effects of mandatory disclosure
requirement using 1964 Securities Acts Amendments in U. S. equity markets and find the Amendments created $3.2
7
using a proprietary database of transaction-level OTC shows that the typical OTC investment
return is severely negative and that investor outcomes worsen for OTC stocks that have weaker
disclosure-related eligibility requirements. A number of recent studies also examine liquidity of
OTC equities per se and have similar findings on information effects. For example, different market
tiers of information disclosure are related to liquidity in both the OTC markets (Davis, Van Ness
and Van Ness 2016) and the Pink Sheet markets (Jiang, Petroni and Wang 2016). Ang, Shatuber
and Tetlock (2013) find that there is an illiquidity premium among OTC stocks and that the
premium is largest among stocks held predominantly by retail investors and those not disclosing
financial information in the OTC stocks.
Our paper is also related to the impact of corporate disclosure in the bond market. Duffie
and Lando (2001) theorize that imperfect accounting information due to infrequent accounting
disclosure contributes to the relatively elevated yield spreads of short-term corporate bonds, an
aspect that has been found puzzling for some time in studies of the term structure of corporate bond
yield spreads. Examining only corporate bond prices, Yu (2005) empirically verifies the prediction
of Duffie and Lando (2001) that firms with better information disclosure rankings tend to have
lower credit spreads, and that the transparency effect is especially large among short-term bonds.
Tang (2012) examines how proprietary costs of mandatory disclosure influence the decision to
exclude registration rights in private debt placements, and finds that, at the industry level,
industries dominated by players with “product differentiation strategy” have a larger proportion of
private placements without registration rights than product markets dominated by players with
“low cost strategy.”
A number of studies, also mostly on equity trading, assess the quantitative importance of
information risk on market liquidity by estimating the information component in bid-ask spreads—
a common measure for trading cost. For example, it is documented that the adverse selection risk
associated with information asymmetry among market participants about issuers’ financial
conditions leads to higher bid-ask spread (e.g., Huang and Stoll, 1987; Glosten and Harris, 1988;
Madhavan, Richardson, and Roomans,1997). An exception to these equity studies, Han and Zhou
(2014) estimate the information asymmetric components of corporate bond trading bid-ask spreads
to $6.2 billion of value for shareholders of the OTC firms in their sample. Brüggemann, Kaul, Leuz, and Werner
(2016) analyze a comprehensive sample of more than 10,000 U.S. OTC stocks and find that OTC firms that are subject
to stricter regulatory regimes and disclosure requirements have higher market quality (higher liquidity and lower crash
risk).
8
and examine the pricing implications of informed trading and its ability to predict corporate
defaults. They find that microstructure measures of information asymmetry seem to capture adverse
selection in corporate bond trading reasonably well.
Rule 144A debt has peculiarities. Bolton, Santos, and Scheinkman (2012) argue that the
disclosure exemption in the “dark” markets such as 144A allows informed “qualified” institutional
investors to exploit their information advantage. They explain that shadow financial sector exists
because they prevent dissemination of valuable information about asset values, and hence cream-
skim most valuable assets away from public, transparent, exchanges in turn leading to reduced
access of retail investors to the most lucrative investments. In terms of improving the post-
registration transparency, 144A debt registration can also be resemble “going public” exercise
using debt. However, the major difference of the 144A registration is that it doesn’t involve any
effective changes in firm’s funding or leverage. This factor helps our identification, separating our
study from previous studies on the information effects of bond IPOs (e.g., Datta, Datta and Patel
1997, 1999, 2000; Cai, Helwege and Warga 2007; Datta, Datta and Raman 2000).
Overall, our finding of positive effects of public disclosure on the corporate bond liquidity
is consistent with previous empirical evidence that information transparency generally improves
market liquidity.
2.2 Studies on Corporate Bond Market Liquidity
Our study also brings a new empirical angle toward the understanding of the corporate
bond market liquidity, a research area that has drawn growing attention in recent years. Previous
studies have examined the role of trading opacity and market fragmentation in the corporate bond
market liquidity. For example, in terms of trading opacity, studies find that TRACE dissemination
of transaction information results in lower transaction costs (e.g., Bessembinder, Maxwell, and
Venkataraman 2006, Edwards, Harris and Piwowar 2007, Goldstein and Hotchkiss 2007, and
Goldstein, Hotchkiss and Sirri 2007).9 Similarly, Green, Hollifield, and Schurhoff (2007a, 2007b)
and Green, Li and Schurhoff (2011) find positive effects of trade dissemination on transaction
9 Specifically, Bessembinder, Maxwell and Venkataraman (2006) report a 50% reduction in institutional trade
execution costs upon introduction of TRACE for bonds eligible for TRACE transaction reporting, in addition to a
liquidity externality of another 20% reduction of trade execution costs for non-TRACE bonds. Goldstein, Hotchkiss
and Sirri (2007) finds that enhanced transparency is not associated with greater trading volume, which is consistent
with our findings.
9
information in the municipal bond market. In terms of market fragmentation, Huang, Sun, Yao
and Yu (2015) show that liquidity clienteles affect corporate bond prices, and specifically, both
the level and volatility of liquidity premia are substantially attenuated among corporate bonds
heavily held by investors with a weak preference for liquidity. Recent studies also debate on
whether bond market liquidity increases or not in recent years following the recent financial crisis
and post-crisis regulations including the Volcker Rule and Dodd-Frank Act (e.g., Adrian, Fleming,
Shachar and Vogt 2105, Trebbi and Xiao 2015, Bao, O’Hara and Zhou 2016, Dick-Nielsen and
Rossi 2016, Anderson and Stulz 2017).
2.3 Studies on 144A securities
Our paper also complements existing studies on 144A securities by focusing on the
liquidity effects of information transparency on corporate financial conditions brought by public
registration of private debt. Previous studies on 144A corporate bonds generally examine their
yield premium compared to public bonds. For example, in an earlier study, Fenn (2000) documents
that among high-yield issuers between 1996 and 1997, yield premium for 144A bonds relative to
their public counterparts vanishes over time before registration so that registration does not have
much information value. Follow-up studies expand the data to include investment-grade issues and
draw different conclusions regarding yield premium of private issues. These studies find that Rule
144A debt on average has higher yield than their public counterparts (e.g., Livingston and Zhou
2002, Chaplinsky and Ramchand 2004, Craig 2012).
The majority of above studies conjecture that investors in 144A bonds generally require
higher yield because of lower liquidity and higher degree of information opaqueness in the private
debt market. Our paper is the first to provide direct evidence on the liquidity factor. Because our
liquidity measure is based on intra-day transaction data at the dealer-bond level, we provide a more
accurate proxy for trading cost. In addition, our DID approach better helps identify the information
disclosure effects from other factors that may potentially be associated with the changes in
liquidity conditions.
Our paper also relates to corporate finance studies on the 144A securities market examining
the choice between public bonds and 144A private issuance. These include, for example, the 144A
debt issuance by foreign firms where 144A market is fast replacing the public debt market for high
yield and non-rated international issues (e.g., Miller and Puthenpurackal 2002, Huang and Ramirez
10
2010, Gao 2011, Huang, Kalimipalli, Nayak and Ramchand 2016), and the role of corporate
governance, market timing, and market competition in the decision of public vs. private debt or
equity financing (Arena and Howe 2009, Barry, Mann, Mihov, and Rodríguez 2008). The
empirical evidence is broadly consistent with the notion that costs associated with mandatory
disclosure regulation have an economically significant impact on the financing choice between
public and private financing.
Our paper complements a recent study on 144A securitized (collateralized) securities by
Hollifield, Neklyudov and Spatt (2014), who also examine market liquidity using transaction data.
Their focus is the role of dealers in a network setting in liquidity provision, and they find that
central dealers receive relatively lower spreads than peripheral dealers, with the centrality discount
stronger for 144A securitizations.
3. Data and Sampling
3.1 Rule 144A Bonds in TRACE and FISD
Our study focuses on the 144A bond issues that are subsequently registered as public
bonds. We use Mergent’s Fixed Income Securities Database (FISD) and the Trade Reporting and
Compliance Engine (TRACE) to construct our initial sample. To start, we use FISD’s 144A
indicator to extract the corporate 144A bonds issued from 1990 (the inception of Rule 144A bonds)
to 2013. We then examine 144A bond trading using transaction level data provided by the FINRA
using the regulatory version of the TRACE data. Our TRACE data covers the period of July, 2002
to February, 2013, and contains corporate bond transactions for both publicly and non-publicly
disseminated bonds; the latter include144A bonds which were issued to QIBs.10
We follow Dick-Nielsen (2009) and Dick-Nielsen et al. (2012) to filter the raw TRACE
data for cancelled trades, erroneous entries, reversals, duplicated reports, as well as trades with
non-positive prices or non-positive volumes. We present the summary statistics of the final 144A
TRACE data in Table 1. Panel A of Table I lists the number of bond issues classified into 144A
10 FINRA began to release to the public Rule 144A transactions on June 30, 2014. However, the public version of
TRACE has a very limited coverage of Rule 144A transactions for earlier years as of 2015. In addition, the regulatory
version of TRACE contains dealer ids which are necessary to construct our liquidity measures. To ensure accuracy,
we double check the TRACE 144A bonds with those from FISD.
11
and non-144A categories using the 144A flag in the TRACE data. We observe that during the 2002
to 2013 sample period, 12% to 23% of bonds traded each year in the market are 144A bonds. In
our entire secondary trading sample of TRACE data, there are 26,716 unique issues, or 16% of all
bonds, that are issued as 144A bonds. Panel A of Table 1 indicates that 144A bonds is a significant
portion of the bond universe in TRACE.
[Table I about here.]
We rely on FISD for bond characteristics. Intersecting FISD with TRACE bonds in Panel
A of Table I based on issue CUSIP and restricting bond issuers to be corporations domiciling in
U.S. leaves us with 11,443 Rule 144A bond issues from 3,528 issuers. Panel B of Table I lists the
number of these bonds by their origination year. We observe that 144A bonds with reported trades
in TRACE during 2002-2013 are mostly issued during those years or slightly prior to year 2002.
Panel C of Table I shows the primary market bond characteristics of the TRACE-FISD
Rule 144A bonds. While most bonds are non-convertible, non-puttable and non-secured, more
than half of the issues are callable. The average offering maturity of these bonds is 7.57 years, or
medium to long-term.
3.2 Public Registration of Ru1e 144A Bonds
Previous studies, such as Livingston and Zhou (2002) and Huang and Ramirez (2010),
search company filings in EDGAR to identify subsequent registration of 144A bonds. We instead
mainly use a matching sample approach to identify 144A registration events. The information on
the 144A registration rights clause or the exercise of the rights is not readily available. However,
Rule 144A securities become registered mostly through an exchange offer in which the debtor
issues registered public securities (with a new CUSIP) to tender for the 144A securities.11 The
prospectus for the 144A issues typically states that the new bonds issued pursuant to such an offer
will be substantially identical to the 144A bonds for which they may be exchanged in several
attributes, such as coupon rate, maturity date, security (collateral), and restrictive covenants.
Therefore, for every 144A bond, we search the FISD database to see if we can find a public bond
that matches key characteristics of the 144A bond, and we treat the matched bond as the
11 An alternative, but seldom used, procedure is to register the 144A bonds using a shelf registration. Comparing to
the exchange offer approach, the shelf registration can be more burdensome to the issuers because the likely holders
of securities at the future date of the registration must be included in the prospectus—a requirement that makes it
onerous for a broader investor base in the longer run.
12
corresponding registered bonds and its issuance date as the registration date.
Specifically, our matching criteria are as follows: (i) the public bond is issued by the same
borrower zero day to five years (inclusive) after the date of the 144A issuance; (ii) the difference
in the dates of maturity of the two bonds is no greater than 30 days; iii) the difference in the offering
amount of the two bonds is no greater than 5 percent; (iv) the two bonds have the same coupon
rate and same coupon type (fixed or variable);12 (v) the two bonds have the same security condition
(secured or not); and (vi) the two bonds have the same “straight” characteristic (straight bond or
not, where straight bond is defined as non-convertible, non-puttable, and non-callable). From Panel
C of Table I, we note that 10% of the 144A bonds are secured and 41% of the 144A bonds are
straight.
The matching process yields 2,749 bonds for the universe of 11,443 bonds in Panel B of
Table I, i.e., about 25% of the TRACE-FISD 144A bonds are subsequently registered. This
percentage is in line with 30% reported in Craig (2012) and 40% of investment grade bonds
reported in Livingston and Zhou (2002), who, unlike us, rely on Thompson SDC, EDGAR filings,
and Bloomberg data to identify registration.13
Panel A of Table II provides the characteristics of the registration. More than 99% of the
matched pairs have exactly the same maturity, and more than 75% (90%) of the matched pairs
have exactly the same (less than 0.1% difference in) the offering amount. The slight differences in
the offering amount in the right tail of the distribution may be due to early payment such as sinking
fund. More than half the registrations take place within half a year of 144A issuance, and more
than 95% of the registrations take place within a year. Even though we allow for five years to
search for potential registration, these results indicate that the registration, if any, takes place
quickly.
[Table II about here.]
Figure 1 shows the number of registrations by year. Before 1996, registrations were scant
(partly due to the lack of Rule 144A bonds). The number of registrations increased steadily since
12 We impose condition iv) because maintaining the same coupon rate is one motivation for Rule 144A bonds to be
registered. Livingston and Zhou (2002) document that for Rule 144A bonds with the registration-rights clause, a
failure to register would in most cases result in an increase in the coupon rate, and hence issuers are motivated to
register the bond to avoid the increase of coupon rate when a registration-rights clause exists. 13 Some authors report that for subsets of 144A bonds, the registration rate is much higher. For example, Huang and
Ramirez (2000) document that the registration rate for all 144A convertible debt issues is about 88% for the sample
period of 1996 to 2004. Note that in Panel C of Table I we identify that convertible debt issues only consists of 10%
of all domestic 144A debt issues for our sample period.
13
1996, only to peak in 2003 to reach 412 registrations. The recent financial crisis only deterred
registration briefly in 2008, and registration activities since 2009 returned to normal level
comparable with previous periods. We also note that there are far fewer registration events before
the TRACE availability year of 2002. There are 2,487 or 90% of the registrations on or after 2002.
Therefore, it is suitable to use TRACE data to examine the effect of registration.
[Figure 1 about here.]
We provide further validation of the registration events identified above by examining the
EDGAR filings of the registered bonds. Specifically, we employ machine searching of bond
prospectuses to ensure that the matched procedure that we used above indeed produces registered
bonds of 144As. In registering a public bond for the 144A bond, the issuer makes an exchange
offer. To prepare key words for machine reading, we first read a number of bond prospectuses. We
note that the following four phrases appear frequently in the exchange-offer prospectuses: “offer
to exchange”, “exchange offer”, “exchange note”, “to exchange.” We hence count the number of
appearance of these phrases in bond prospectuses to verify that the pairs that we identified in Table
II are indeed 144As and their exchange offers.
Out of the 2,749 matched bond pairs, we are able to download 1,150 prospectuses from the
SEC’s EDGAR website for those issues that we can calculate the bid-ask spread measure of round-
trip cost (to be elaborated in the next section).14 Panel B of Table II provides the summary statistics
of the above key words in these prospectuses. 98.2% (99.7%) of the prospectuses contains at least
fifty (five) occurrences of the aforementioned exchange-related phrases; and the minimum number
of occurrences of those key words in a prospectus is four times. Out of the four key phrases,
perhaps not surprisingly, “exchange offer” and “exchange note” make the most frequent
appearance, each appearing on average 100 or more times in a prospectus. These results suggest
that our filtering of 144A registration is highly effective. We keep all of the matched pairs in our
sample, but note that our results are robust to excluding the registered issues whose prospectuses
have fewer than fifty occurrences of the exchange-related phrases.
In untabulated results, we also investigate whether there is a change of registration
activities after 2008 (inclusive), since year 2008 witnessed not only the financial crisis, but also a
regulatory reform on Rule 144A debt. Prior to 2008, non-affiliate QIBs (i.e., QIBs that are not in
a relationship of control with the issuer) can freely trade 144As after a two-year holding period
14 These prospectuses appear in the form of 424 or S-4.
14
when the bond issuers meet certain public-information disclosure requirement. After 2008, the
SEC halved the holding period to one year, and all the disclosure requirements are lifted. In other
words, after 2008 non-affiliate QIBs only need to hold 144A bonds for a year before they can
freely resell the bond to anyone. Such regulatory change may also affect how market accepts 144A
bonds. In our sample, post 2008, there are 2,887 144A offerings; out of which, 855, or 29.6% of
144As are subsequently registered. Out of that sample, time to registration has a higher median
value of 0.56 years. Hence, there is no discernible difference in the registration rate before and
after 2008.
3.3 Liquidity Cost Measures
Our research goal is to investigate the impact of financial information disclosure of bond
issues on the liquidity cost of trading as these bonds transfer from 144A to public bonds. Among
the prevailing bond trading liquidity measures, the most relevant and suited to our empirical
enquiry is DRT (dealer round-trip) liquidity measure used in Goldstein et al. (2007). The DRT
metric is based on transaction prices of opposite sides of trades matched by the same dealer and
the same trading volume.Hence we construct a “round-trip cost” measure of liquidity (RTC) as
follows and develop our main results of liquidity cost comparison before and after 144A bonds’
public registration based on this RTC measure. We will discuss results using other bond trading
liquidity measures in Section 5 under further robustness checks.
For each bond in our sample, we search for matched trading pairs within the same day for
the same dealer15 and the same trading volume at the opposite trading sides, taking only dealer to
customer trades into consideration. That is, for each trade in which a customer sells (buys) a bond
to a dealer, we attempt to find a subsequent trade in which the same dealer sells (buys) the bond
with the same amount to another customer within the same day. If we find such a pair, we estimate
the bid-ask spread that the dealer charges to the customers as the difference between the pair of
buy-sell prices.16 Formally, we define this “round-trip cost” (RTC), for each pair of trades as:
𝑅𝑇𝐶 =𝑃𝑎𝑠𝑘 − 𝑃𝑏𝑖𝑑
100
15 To construct such dealer-specific liquidity cost measure, we need dealer ID information for each trades, which is
provided by FINRA to Federal Reserve as part of the regulatory version of TRACE data. 16 In case there are multiple trades that match the original trade in terms of trading volume, trading parties (dealer),
trading sides, and trading day, we select the trade with the closest transaction time.
15
where 𝑃𝑎𝑠𝑘 (𝑃𝑏𝑖𝑑) is the ask (bid) price per $100 par. We define normalized version of liquidity
cost RCT_pct as 𝑃𝑎𝑠𝑘−𝑃𝑏𝑖𝑑
(𝑃𝑎𝑠𝑘+𝑃𝑏𝑖𝑑)/2 . This round-trip cost measure is essentially the bid-ask spread
charged by the same dealer implied from the buy and sell transactions intermediated by the specific
dealer at a specific trading volume. Larger RTC indicates worse liquidity, or equivalently, larger
transaction cost for trading the bond.
We take simple average to aggregate the RTC measures by trading day, bond, and/or
dealer. For example, for each bond and dealer pair, we calculate daily RTC as the average of the
RTCs of all pairs of trades we could identify for the dealer. Daily RTC for each bond is then
averaged across dealers and used as the sample liquidity measure. Clearly, the availability of RTC
depends on whether there exist at least two opposite-side trades on the same bond with the same
volume intermediated by the same dealer on the same day. Although in calculating RTC we do not
cover all of the transactions by disregarding trades without following off-setting same-day trades
by the same dealer, it is known common practice in bond market that dealers do cover the trades
within a short-time period if they are pure market makers.17
Using RTC has advantages in our setting. One advantage of using RTC measure is that we
can separate transactions with different trading volumes while calculating liquidity costs of trade.
As well-documented in bond liquidity literature, unlike stock trading, large trading size is most
likely associated with small transaction cost. With 144A bonds’ public registration, retail investors
begin to trade these bonds, so naturally the average trading size will become smaller after
registration, causing larger transaction costs per trade, if we do not control away the trading size
change. Figure 2 shows histogram of trading size distribution before and after registration. Clearly
after registration, larger percentage of trades have transaction size lower than $1mil. We also
observe such change is more significant since 2010, may be due to some regulation changes that
affect bond trading. In contrast to RTC which requires two sides of trade must have the same
trading volume, some other common liquidity measures, such as Roll’s measure, and measures
based on price dispersion such as half-spreads or min-max spreads, all pool transactions with
different trading volumes together while calculating liquidity. The price impact measure of
liquidity, Amihud measure, although commonly used in equity market hasbeen criticized for
17 Roll’s measure, requiring at least three trades on the same bond within the day, is another widely used liquidity
measure. In contrast, RTC requires at minimum two trades.
16
measuring bond liquidity, as it employs trading size as the denominator. So these other measures
of liquidity have potential to overestimate the illiquidity costs post-registration due to subdued
trading activity arising from small transactions, rendering them less suitable for our study.
[Figure 2 about here.]
Another advantage of choosing RTC as the liquidity measure is that in general, it is less
contaminated by intra-day price volatility although during very volatile days, fundamental price
movements may also affect RTC. The impact of volatility on RTC measured is likely to be smaller
compared to other liquidity measures.
3.4 Sample Correlations
We use 100 trading days around registration as our primary event window. For the 2,487
matched registered bonds after 2002, we are able to calculate the round-trip-cost of 1,734 bond
pairs, or more than two thirds of the sample. Table III shows the correlations among the major
variables used in the paper. The registration indicator variable, post, which takes the value of zero
(one) for the transaction time before (post and including) registration, is negatively correlated with
RTC. The variable post is also negatively correlated with yield. The table also reports that,
consistent with conventional wisdom, RTC is negatively correlated with bond offering amount,
firm size, and whether the issuing firm is a public firm or not, and is positively correlated with
firm’s leverage and stock return volatility. These results suggest that dealers provide liquidity to
high information asymmetry issues.
[Table III about here.]
4. Empirical Analysis on 144A Bond Liquidity Around Registration
4.1 Overview of Liquidity Change around Registration
We first examine RTC changes around registration by applying traditional mean-of-mean
approach in event studies. For example, in the comparison of RTC liquidity measures, we take the
mean values of the RTC for each bond-pair, respectively, during specific window periods before
and after the registration, and then average over the mean values of all bonds. This way, each bond
has an equal weight regardless of its trading frequency. Panel A of Table IV offers the comparison
of RTC pre- and post-registration. It shows that RTC decreases after registration regardless of event
17
time window. From windows 30 to 100 days, the differences of RTC and RCT_pct pre- and post-
registration are all significant, and the reduction of RTC ranges from 12 to24%, which is
economically significant.
[Table IV about here.]
The last columns of Panel A of Table IV compares the trade size before and after the
registration, and shows that the average trade size drops after registration, echoing the trading size
distribution in Figure 2. This prompts us to examine the change in RTC conditional on trade size.
Based on trading volume and prevalent bond credit ratings, we partition transactions into three size
groups: Large, Medium, and Small. Transactions with par-value volume larger or equal to $5
million ($1 million) of an investment grade (high-yield or non-rated) bond belong to the “Large”
group; transactions with volume smaller than $100,000 belong to the “Small” group; and the rest
of the transactions are classified into the “Medium” group. After the partition, within each size
group, we re-calculate the RTC liquidity measures as we do for the full sample. Panel B of Table
IV shows that large trades dominate the sample, accounting for around two thirds of the trade
observations. Small trades account for less than 10% of the trades. Noticeably, the reduction of
RTC post-registration occurs mostly for the large trade-size group, and less conspicuously for the
medium trade-size group.
Figure 3 visualizes the decrease of RTC after registration by plotting the average RTC
measures across bonds along [-100,100] trading day window around the registration date, using
only the “Large” transactions in the sample. Plots of other liquidity measures that we checked,
such as Roll’s measure, half-spreads, also demonstrate similar patterns within the “Large”
transaction group, but no obvious change is identified for “Small” transaction group, as transaction
size may intervene with liquidity cost reduction.
[Figure 3 about here.]
4.2 Baseline Regressions of RTC
We then test the univariate results above in regressions that control for both bond cross-
sectional characteristics variables and time-varying macroeconomic variables. In examining the
change of RTC following the public registration, we employ the following baseline regression
specification based on the extant bond liquidity literature:
Table IV: Event Study on RTC Measures around Registration
A 144A issue and its exchange issue must appear both before and after registration to be included in the comparison. In the comparison, for each bond-pair, we take the mean
values of the RTC liquidity measures, respectively, before and after the registration, and then average over the mean values of all bonds to arrive at the number reported in
the table. In Panel B, we partition the transactions into three size groups: Large, Medium, and Small, according to their trading volume and bond credit ratings. Transactions
with volume larger or equal to $5 million ($1 million) at par value for an investment grade (high-yield or non-rated) bond belong to the “Large” group; transactions with
volume smaller than $100,000 belong to the “Small” group; and the rest of the transactions are classified into the “Medium” group. After the partition, within each size group,
we re-calculate the RTC liquidity measures as we do for the full sample. ***, **, and * indicate significance at 1, 5, and 10 percent levels, respectively.
Panel A: RTC and Trade Size around Registration
Trading days # of RTC RTC_pct (%) Trade Size ($1,000)
around
registration
bond
pairs Before After Diff. Before After Diff. Before After Diff.