Financial Reform and Public Good Provision: Municipal Bankruptcy Law and the Financing of Hospitals

Abstract

Does financial reform improve public good provision? We examine state-level adoption of municipal bankruptcy law. After reform, municipalities’ borrowing costs decrease and bonds’ issuance increase, particularly for bonds financing hospitals; hospitals’ investments increase, particularly when using such bonds; local firms’ investment and performance increase, particularly in the construction sector. Ex-ante, reform occurs earlier in states with weaker unions, stronger bondholders’ interests, and better courts. Similar factors explain congressional voting on municipal bankruptcy law. These results support the hypothesis that financial reform destroys labor union rents and expands investment, highlighting a novel spillover channel from public finance to the real economy.

Keywords: bankruptcy, Chapter 9, municipal bonds, hospitals

JEL Classification: D86, G33, G34, K22