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

49 Pages Posted: 18 Oct 2012 Last revised: 27 Nov 2012

See all articles by Dario Cestau

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

Swiss Finance Institute - HEC Lausanne

Date Written: October 15, 2012

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.

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

JEL Classification: E44, E63, G23, H74

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: https://ssrn.com/abstract=2162960 or http://dx.doi.org/10.2139/ssrn.2162960

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)

Swiss Finance Institute - HEC Lausanne ( email )

Chavannes-près-Renens
Switzerland

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