Supply uncertainty of the bond investor base and the leverage of the firm

We examine the effect of the bond capital supply uncertainty of institutional investors (e.g., mutual bond funds and insurance companies) on the leverage of the firm using a novel data set. Our main finding is that the supply uncertainty of the firmʹs bond investor base — measured as (i) the average portfolio turnover, or (ii) the average flow volatility of investors holding the firmʹs bonds, or (iii) the prevalence of mutual funds among the firmʹs bondholders as opposed to insurance companies — has a negative and significant effect on the leverage of the firm. The supply uncertainty of the firmʹs bond investor base also has a negative and significant effect on the firmʹs probability of issuing bonds, and a positive and significant effect on the firmʹs probability of issuing equity and borrowing from banks. We take a multi-pronged approach to address potential endogeneity issues, including use of geography-based instruments and firm fixed effects, subsample analyses, and a placebo test. Our results highlight the fragility of access to the bond market for companies that depend on mutual funds with high turnover/ flow volatility as primary bond investors.