The Impact of Introducing a (Nearly) Redundant Security: Evidence from Malaysian Corporate Bonds

We examine the case of redundant securities in Malaysia, where traditional corporate bonds and non-conventional (NC) Islamic bonds are issued. Because religious investors only buy Islamic bonds and non-religious (NR) investors are indifferent between the two types of bonds, if the issuance costs are low enough, Malaysian firms might only choose to fund their projects via NC bonds. We present a model of the firm’s choice to issue one type or the other or both, and relate the decision to the demand for risky debt as well as to the bonds’ secondary market liquidity. We show theoretically that a firm may choose to issue both types of bonds when doing so reduces its overall funding costs and that the NC bonds may be purchased by both clienteles. In our empirical work, we find that mixed issuers exist throughout the sample period and that NR investors are active participants in both markets. Thus, while the Islamic bond market’s growth has outpaced that of traditional corporate bonds in Malaysia, the introduction of a redundant security has not squeezed out issuance of the existing security.