Political Uncertainty and Private Debt Contracting: Evidence from the U.S. Gubernatorial Elections
44 Pages Posted: 31 Jul 2019 Last revised: 11 Feb 2020
Date Written: December 1, 2019
We investigate the effect of political uncertainty on private loan contracts by exploiting the U.S. gubernatorial elections as a source of variation in uncertainty. Our results show that lenders are more likely to impose financial covenants and state-contingent pricing grids on borrowers headquartered in the states in election years. The effect is more pronounced for performance-based pricing grids and covenants, consistent with lenders' intention to monitor borrowers more closely. Using the term limit status of incumbent governors as the instrument for closely-contested elections, we support the causal effect of political uncertainty on loan contracting outcomes. Although a direct effect of elections on loan spread appears absent, interest rate-increasing pricing grids become more common than rate-decreasing pricing grids. Moreover, the positive effect of election on rate-increasing pricing grids is pronounced for the firms whose operation is geographically concentrated. Overall our evidence suggests that the increased uncertainty during gubernatorial election years, albeit transitory, has significant impacts on debt contracts and the cost of private debt capital.
Keywords: political uncertainty, gubernatorial election, debt contract
JEL Classification: G30, G39
Suggested Citation: Suggested Citation