Abstract
We show that an increase in sovereign credit risk leads to higher corporate borrowing costs. This is demonstrated using the announcement of the first Greek bailout on April 11, 2010 that triggered a significant increase, rather than the expected decrease, in Greece's borrowing costs. The event represents an unexpected shift in the perception of sovereign risk across Europe. We estimate that a one percent increase in sovereign credit risk raises corporate borrowing costs by 0.1 percent after the bailout, reflecting a higher dependence between sovereign and corporate credit risk. Further results suggest more pronounced effects in countries that belong to the Eurozone, that are more financially distressed and that have weaker property rights. We also find that borrowing costs rise at least as much for non-financial companies as for financial companies. Non-financial companies that are more bank dependent and that have greater public ownership are relatively more affected by increased sovereign credit risk.