Too-big-to-fail: The value of government guarantee

• Published in: Pacific-Basin finance journal 2021-09, Vol.68, p.101313, Article 101313
• Main Authors: Tsafack, Georges, Li, Yifei, Beliaeva, Natalia
• Format: Article
• Language: English
• Subjects: Chinese SOEs; Contingent claim; Funding cost; Implicit guarantee; Too-big-to-fail
• ISSN: 0927-538X; 1879-0585
• DOI: 10.1016/j.pacfin.2020.101313

Following the 2008 financial crisis and the government bailout of troubled companies, Too-Big-to-Fail became a standard expression to name a free protection of Wall Street by tax-payers' money. What should have been the fair cost of this protection? We offer a novel approach to estimate the value of the implicit government guarantee by combining the contingent claim pricing with the likelihood of the government intervention. We find that the cost of this implicit protection can go beyond tens of billions of dollars with an average of about $13 million per company, per year, and it rises to about $24 million if the government is assumed to intervene with certainty. Moreover, we show that the spread of the funding costs of the large banks over the small banks is strongly inversely associated with the value of the implicit government guarantee, especially after the crisis. For the Chinese companies, we use the contingent claims approach to measure the government guarantee and find that the value of the guarantee for State-owned Enterprises (SOEs) is inversely related to their bond yield spreads. •We propose a novel way to measure the value of the implicit government guarantee.•We investigate the relationship between the implicit government guarantee and the funding costs of small and large banks.•We apply our framework to the Chinese market and examine the value of government guarantees of state-owned enterprises.