Conflicts of Interest in Municipal Bond Advising and Underwriting

Abstract

A regulation following from Dodd-Frank prohibits municipal financial advisors from simultaneously acting as municipal bond underwriters. Using a difference-in-differences approach, I test whether this reduction in advisor privileges affects financial advice and bond outcomes. Bonds with potential dual advisor-underwriters see financing costs fall by 11.4 basis points (5.3% of average yield) after the advisor is no longer allowed to underwrite. The decline is concentrated in opaque school district bonds and new money issues. Non-advisors compete for underwriting business more aggressively since they are less likely to face adverse selection after previously conflicted advisors encourage creditworthy borrowers to obtain credit ratings.

Keywords: Adverse Selection, Financial Regulation, Public Finance, Conflicts of Interest

JEL Classification: D44, D53, G12, G14, G28, H74