The effects of manager’s over-investment on bond market: Focusing on bond spread in Korea

This study is toinvestigate whether over investing activities of bond issuing firm affect the cost of capital in the Korean bond market. Managers have an opportunistic incentive to over-invest resource of the firm and then, the over investing behavior leads to inefficient performance of investment. Generally, bond investors consider financial conditions, operation results and investing activities of bond issuing firm, in the process of pricing the bond. Thus bond investors, negatively, response to over investing behavior of issuer, so bond price is discounted. This study analyzes how the over-investing of managers was responded to by the bond market to affect the bond prices. The response of the bond market to inefficient investment that does not lead to corporate value but is driven by opportunistic incentives was similar to that shown by the stock market. That is, there was a negative response to the over-investment. Therefore this study implies that a high cost of capital for corporations must be borne by corporations since bond investors, just like their stock counterparts, show a negative reaction to inefficient over-investing.