To withstand credit market shocks, diversify your company’s bonds

The corporate bond market has become an increasingly important source of capital for the U.S. economy. 

Issuance of corporate bonds rose 30.2% in 2024 from the previous year, according to the Securities Industry and Financial Markets Association. “It’s a market that has increased tremendously since the financial crisis,” said Lira Mota, assistant professor of finance at MIT Sloan. “It has doubled in size from 2008 to today.”

When companies want to expand their operations or fund new business ventures, they turn to the corporate bond market and issue bonds to investors. Doing so has advantages over borrowing from banks. “It’s a way to access a broader and wider range of investors” and diversify a company’s funding base, Mota said. 

Companies usually issue bonds that match the profile of their business. For example, for a long-term project, you might choose to issue a long-term bond. “That might help you in terms of the interest rate management” as it relates to maturity, Mota said. Generally, companies opt for long-term bonds for long-term projects because the cost to borrow is generally favorable and allows the company to lock in a (hopefully low) interest rate for the duration of the project. 

However, Mota and Kerry Siani, an assistant professor of finance at MIT Sloan and a former bond underwriter at Morgan Stanley, identified a somewhat contradictory situation. In analyzing 22,966 bonds issued by 2,558 firms from 2003 through 2023, they were struck by the range of bonds that companies issued to investors; firms in their sample had, on average, 12 bonds outstanding with varying characteristics.

The pair wondered why companies are doing this. “Why are they entering such complex debt structures?” Mota said. “We think [it] might be costly for them to have that many types of bonds outstanding. Why would that be beneficial for the firm?”

Their research, available at SSRN, identifies one major reason why businesses are diversifying bonds: because doing so can increase companies’ resilience to credit market shocks. Having access to a wider variety of institutional investors allows companies to better maintain access to capital in times of distress.

Inside the research

Mota and Siani’s data was taken from the Mergent Fixed Income Securities Database of U.S. bonds and from Compustat information extracted from companies’ financial statements. The dataset incorporated other information as well, such as data on bond pricing, bond investor holdings, and credit default swap pricing. 

To understand the complexity of firms’ bond portfolios, the researchers categorized corporate bonds into 72 distinct types based on key diversification characteristics, including credit rating, time to maturity, size, redemption options, and covenants. They then mapped that complexity to investor composition and prices. 

Finally, they computed a measure of a company’s exposure to funding risk — that is, how exposed a company is to a potential shock from idiosyncratic investor demand for bonds — and then aggregated that measure of risk to the firm level based on what bonds the firm has outstanding.

Their results showed that when firms had more bond types outstanding, their funding risk was lower. “Companies that have more diverse funding sources — basically [those] that borrow from many different kinds of institutional investors — are more resilient to aggregate credit shocks,” Siani said. “That’s a benefit that firms can create for themselves by strategically issuing specific different kinds of bonds rather than just one bond.” 

For example, Mota noted that in March 2020, with the onset of the COVID-19 pandemic, the default probability went up for everyone, so the overall riskiness went up for every company. But if there were two similar firms with equal exposure to the pandemic shock, “the one that had a more diversified investor base was better able to surf the crisis than the other one,” she said. 

The extent to which companies were diversifying surprised the authors: Sixty percent of firms they studied had issued multiple bond types, and 24% had issued bonds through multiple subsidiaries as of 2023.

In addition, as of 2022, 

• 23% of all firms in the dataset had over five bond types outstanding.
• On average, 53% of firms had bond types in multiple maturity buckets.
• 37% of firms had bonds in buckets of varying sizes.

For example, in 2023, Exelon issued BBB-rated senior unsecured debt in five-, 10- and 30-year tranches at the coupon rates of 5.15%, 5.3%, and 5.6%, respectively, while three of its subsidiaries issued 10- and 30-year senior secured debt with ratings ranging from A- to AA-, at rates ranging from 4.9% to 5.4%. 

The authors found that companies with multiple bond types tended to be older, larger, and better-rated firms that had more bonds as a share of their overall debt. In addition, as firms matured, the number of bond types they issued increased. Companies in the utilities, transportation and warehousing, and finance and real estate industries tended to have the highest number of bond types. 

Firms are “leaving money on the table” when they fail to diversify

When funding their operations, companies generally try to find an optimal balance between debt and equity. It’s just as important, Mota said, for companies to diversify their credit supply and make sure to consider it when figuring out what their optimal capital structure is. 

She suggested that companies should think about their capital structure just as they consider portfolio optimization, especially as it relates to the trade-off between risk and returns. Mota said that companies should issue bonds that are in high demand so that they can get a high price in return, and they should do so when times are good so that they can maintain access to more lenders in times of distress. 

While Mota cautioned companies to consider the trade-off of borrowing from more investors, which usually implies more risk, “The takeaway here for firms is that there is money to be made by optimally choosing their capital structure,” she said. “There are firms out there that are leaving money on the table” by not diversifying their corporate bonds. 

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