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Tax-Subsidized Underpricing: Issuers and Underwriters in the Market for Build America Bonds


Dario Cestau


Carnegie Mellon University - David A. Tepper School of Business

Richard C. Green


Carnegie Mellon University - David A. Tepper School of Business

Norman Schürhoff


University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

October 15, 2012

Swiss Finance Institute Research Paper No. 12-32

Abstract:     
Build America Bonds (BABs) were issued by states and municipalities for twenty months as an alternative to tax-exempt bonds. The program was part of the 2009 fi scal stimulus package. The bonds are taxable to the holder, but the federal Treasury rebates 35% of the coupon payment to the issuer. The stated purpose of the program was to provide municipal issuers with access to a more liquid market by making them attractive to foreign, tax-exempt, and tax-deferred investors. We evaluate one aspect of the liquidity of the bonds|the underpricing when the bonds are issued. We show that the structure of the rebate creates additional incentives to underprice the bonds when they are issued, and that the underpricing is larger for BABs than for traditional municipals, controlling for characteristics such as size of the issue or the trade. This suggests that the bonds are not more liquid, contrary to the stated purpose of the program, or that issuers and underwriters are strategically underpricing the bonds to increase the tax subsidy, or both. Several findings point to strategic underpricing. There is a negative correlation between the underwriter's spread and the underpricing. The underpricing for BABs is quite evident for institutional and interdealer trades, while that for tax-exempts is primarily for smaller sales to customers. Counterfactuals for our estimated structural model also suggest strategic underpricing.

Number of Pages in PDF File: 49

Keywords: Underpricing, Build America Bonds, Municipal Finance, Financial Intermediation, Incentive Conflicts

JEL Classification: E44, E63, G23, H74

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Date posted: October 18, 2012 ; Last revised: November 27, 2012

Suggested Citation

Cestau, Dario and Green, Richard C. and Schürhoff, Norman, Tax-Subsidized Underpricing: Issuers and Underwriters in the Market for Build America Bonds (October 15, 2012). Swiss Finance Institute Research Paper No. 12-32. Available at SSRN: http://ssrn.com/abstract=2162960 or http://dx.doi.org/10.2139/ssrn.2162960

Contact Information

Dario Cestau
Carnegie Mellon University - David A. Tepper School of Business ( email )
5000 Forbes Avenue
Pittsburgh, PA 15213
United States
Richard C. Green
Carnegie Mellon University - David A. Tepper School of Business ( email )
315B Schenley Park
Pittsburgh, PA 15213-3890
United States
412-268-2302 (Phone)
412-268-7064 (Fax)
Norman Schürhoff (Contact Author)
University of Lausanne ( email )
Extranef 228
CH-1015 Lausanne
Switzerland
+41 (0)21 692 3447 (Phone)
+41 (0)21 692 3435 (Fax)
Swiss Finance Institute ( email )
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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