Is Gradualism a Credible Commitment to Enhance Bond Market Discipline Toward State-Owned Enterprises in China?

This study investigates whether market discipline on Chinese state-owned enterprises (SOEs) improved after the default wave of SOE bonds in 2020. We use Flannery’s classical definition of two-side market discipline, market monitoring and market influencing, as the criteria to measure the credibility of the gradual marketization reform. Using secondary market corporate bond transactions' dynamic panel data with the SYS-GMM estimator, we find that investors actively monitored the risk profile of bond issuers before 2020, and the monitoring effect is enhanced as investors become more sensitive to the default risk of bond issuers. Our results reveal that bond market discipline is more pronounced in economically developed regions but less in systematically important industries. We also note that no-bailout cases of SOEs in a province surprisingly do not induce other SOEs in the province to take more risks, which suggests a lack of market discipline on the risk-taking of SOEs before the reform; the effect is reversed after 2020. Overall, the gradualism strategy of the Chinese central government has improved market discipline towards SOEs in some respects. Our findings support several policy implications for further enhancing market discipline and regulating risk-taking by SOEs.