Conflicts of Interest in Municipal Bond Advising and Underwriting

Abstract

When can financial advisor conflicts of interest generate worse outcomes for clients? A regulation following from Dodd-Frank prohibits municipal advisors from simultaneously acting as bond underwriters. Using a difference-in-differences approach and 20,051 bond auctions, I test whether this reduction in advisor privileges affects financial advice and borrower outcomes. Bonds with potential dual advisor-underwriters see financing costs fall by 11.4 basis points after the advisor is no longer allowed to underwrite. The decline follows from increases in standardization, third party certification, and auction participation---consistent with limiting the adverse selection that arises due to advisors withholding information from the market.

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

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