Monitoring Costs of Public Debt: Evidence from a Natural Experiment in Israel

10/10/2021 |  Kedmi Itay, Lakan Guy
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The Financial Markets and Financial Stability
Abstract:

The incentive for creditors to monitor borrowers is influenced, in part, by the extent to which the creditor is concentrated in a specific debt, a factor underscored by the differences between the public debt market and the private debt market. In this study, we examine how the investment decisions made by institutional investors were influenced by the implementation of Hodak Committee recommendations. This committee imposed substantial monitoring costs in the public debt market, costs that are borne exclusively by institutional investors. After the recommendations entered into force, the institutional investors redirected their investments to private loans at the expense of public bonds. Using the Difference-in-Differences methodology, we find that the price difference between the two debt instruments diminished significantly. Actually, those findings suggest that following the Hodak Committee, the institutional investors changed their investment preferences in corporate debt.