When Is There a Strong Transfer Risk from the Sovereigns to the Corporates? Property Rights Gaps and CDS Spreads

When a sovereign faces the risk of debt default, it may be tempted to expropriate the private sector. This may be one reason for why international investment in private companies has to take into account the sovereign risk. But the likelihood of a transfer from the sovereign risk to corporate default risks may be mitigated by legal institutions that provide strong property rights protection. Using a novel credit default swaps (CDS) dataset covering both government and corporate entities across 30 countries, this paper studies both the average strength of the transfer risks and the role of institutions in mitigating such risks. We find that (1) sovereign risk on average has a statistically and economically significant influence on corporate credit risks. All else equal, a 100 basis points increase in the sovereign CDS spread leads to an increase in corporate CDS spreads by 71 basis points. (2) The sovereign-corporate relation varies across corporations, with state-owned companies exhibiting a stronger relation. (3) However, strong property rights institutions tend to weaken the connection. In contrast, contracting institutions (protection of creditor rights or minority shareholder rights) do not appear to matter much in this context.