RFS Advance Access originally published online on March 2, 2009
Review of Financial Studies 2009 22(7):2873-2905; doi:10.1093/rfs/hhp010
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Corruption, Political Connections, and Municipal Finance
University of Texas at Dallas
University of Tennessee
University of Memphis
Send correspondence to Alexander W. Butler, Department of Finance, School of Management, SM 31, University of Texas at Dallas, Richardson, TX 75083; telephone: 972-883-5929; fax: 972-883-2799. E-mail: butler{at}utdallas.edu.
JEL Classification: D73, G20, G22, G24, H74
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Abstract |
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We show that state corruption and political connections have strong effects on municipal bond sales and underwriting. Higher state corruption is associated with greater credit risk and higher bond yields. Corrupt states can eliminate the corruption yield penalty by purchasing credit enhancements. Underwriting fees were significantly higher during an era when underwriters made political contributions to win underwriting business. This pay-to-play underwriting fee premium exists only for negotiated bid bonds where underwriting business can be allocated on the basis of political favoritism. Overall, our results show a strong impact of corruption and political connections on financial market outcomes.
We thank Arthur Allen, Gennaro Bernile, Jeff DeSimone, Donna Dudney, David Dwek, Rick Green, Bart Hildreth, Ayla Kayhan, Marc Lipson, Atif Mian (the AFA discussant), Adair Morse, Harold Mulherin, Jung Park, Natalia Reisel, Simone Silva, Matt Spiegel (the editor), and Frank Yu and seminar participants at Instituto de Empresa Business School, Wichita State University, Oklahoma State University, University of Nebraska, University of Texas at Dallas, Georgia State University, University of Georgia, University of Tennessee, the U.S. Securities and Exchange Commission, and the College of William and Mary's Batten Conference for their suggestions for improving the paper. For comments on an early draft, thanks go to Vladimir Atanasov, Ted Day, Chris Downing, Jeff Fleming, Angela Gore, Gustavo Grullon, Scott Hein, Erik Lie, Tomas Mantecon, David Robinson, Hong Wan, James Weston, and seminar participants at Rice University, Texas Tech University, University of Missouri, Wake Forest University, and University of South Florida. Bob Goke provided assistance with understanding some of the data. Special thanks go to Lee Ann Butler and Jim Napper of the Louisiana Department of the Treasury, Douglas Benton of Moody’s, and Chris Charles of Wulff Hansen for detailed and helpful conversations about the municipal bond offering process. Any remaining errors or infelicities belong solely to the authors.