Political Connections and the Cost of Bank Loans

Abstract

This paper analyzes whether the political connections of listed firms in the United States affect the cost and terms of loan contracts. Using a hand-collected data set of the political connections of S&P 500 companies over the 2003-2008 time period, we find that the cost of bank loans is significantly lower for companies that have board members with political ties. This negative link between political connections and the costs of bank loans is more profound for firms with more government procurement dependence, less relationship lending, lower credit ratings, for firms facing stronger foreign competition and for firms during the recent financial crisis period. Moreover, focusing on the sample period from 2005 to 2007 and the firms that borrowed from banks both before and after the Democratic victories in the mid-term election of 2006, we find that firms connected to the Democratic Party experience a decrease in cost of borrowing after the election while firms connected to the Republican Party experience an increase in the loan spread after the election. We also find that political connection reduces the likelihood of a capital expenditure restriction or liquidity requirement commanded by banks at the origination of the loan. Taken together, our results suggest that political connections increase the value of U.S. companies and reduce monitoring costs and credit risks faced by banks and, in turn, reduce the borrower’s cost of debt.

Keywords: Political connection, cost of debt, loan contracting

JEL Classification: G21, G34, G38