Firm-level Political Risk and Credit Markets
63 Pages Posted: 12 Jun 2019 Last revised: 24 Mar 2020
Date Written: March 10, 2020
We examine the effect of firm-level political risk on debt markets. While prior research relies mainly on economy-wide proxies for political risk, Hassan et al. (2019) suggests that a substantial amount of political risk plays out at the firm-level. We use their measure to show that borrower-level political risk is reflected in the cost and liquidity of public debt, the cost of private debt, as well as in debt issuance decisions. We address challenges to a causal interpretation of these findings by using exogenous variation in the political risk of firms caused by the redrawing of electoral district boundaries after the decennial census of 2010. Furthermore, we show that lender-level political risk influences the supply of credit and of loan pricing. Taking advantage of the granularity of the political risk measure, we also show that lender-specific changes in political risk propagate to borrowers and co-lenders, suggesting the importance of network effects in amplifying the effects of political uncertainty. Finally, our evidence suggests that borrowers and lenders can mitigate the effects of political risk through political activism and through contract design.
Keywords: credit markets, political risk, financial institutions
JEL Classification: G21, G18, P16
Suggested Citation: Suggested Citation