Political Connections and the Cost of Bank Loans

52 Pages Posted: 18 Aug 2011 Last revised: 21 Feb 2012

Joel F. Houston

University of Florida - Department of Finance, Insurance and Real Estate

Liangliang Jiang

Hong Kong Polytechnic University

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

(马跃) Yue Ma

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Date Written: February 15, 2012

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

Suggested Citation

Houston, Joel F. and Jiang, Liangliang and Lin, Chen and Ma, (马跃) Yue, Political Connections and the Cost of Bank Loans (February 15, 2012). Available at SSRN: https://ssrn.com/abstract=1911760 or http://dx.doi.org/10.2139/ssrn.1911760

Joel F. Houston (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Liangliang Jiang

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Chen Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Yue Ma

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

HOME PAGE: http://www.cb.cityu.edu.hk/staff/yuema24

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