Political Hazards and the Choice of Contracting: The Case of Municipal Bonds

Abstract

We study the impact of political contestability on the choice of rule-based contracts through the municipal bond market. We provide evidence that when the probability of losing office is high, mayors are more likely to issue expensive revenue bonds over cheaper general obligation bonds, and to choose procedural competitive bidding over flexible negotiated sales. This effect is stronger for elected mayors than for city managers, and as elections approach. We utilize two referenda---one failed and one succeeded---regarding the required supermajority to issue general obligation bonds in California to assess the causal relationship between political hazards and the choice of security type.

Keywords: Political Oversight, Strategic Behavior, Public Finance

JEL Classification: D72, D73, H57