Impact of Bankruptcy Eligibility Requirements and Statutory Liens on Borrowing Costs
27 Pages Posted: 5 Dec 2017
Date Written: Winter 2017
While bankruptcy protection remains an instrument of last resort, a recent wave of petitions has aroused the interest of key participants in the municipal bond market. To date, 12 states unconditionally authorize municipalities to file for bankruptcy protection, 15 states require that municipalities satisfy certain threshold requirements, while the remaining 23 states either explicitly prohibit or have not specifically provided this authority to municipal governments. As bankruptcy protection rules influence bondholder risk exposures, we empirically test the significance of the state‐specific bankruptcy eligibility requirements on borrowing costs. In a representative sample of general obligation bonds, empirical results suggest that municipalities eligible to file for bankruptcy protection pay a premium. The premium is higher if issuers are unconditionally authorized to file for bankruptcy protection, especially for debt with longer maturities. Findings also show that there are benefits associated with statutory liens; however, these benefits diminish with maturity.
Suggested Citation: Suggested Citation