Local Economic Freedom and The Cost of Corporate Borrowing: Evidence From The US States

Abstract

Using data on syndicated bank loans, we show that higher local (state-level) economic freedom reduces the cost of bank credit for US firms. A one standard deviation increase in local economic freedom, similar to the difference in economic freedom between Pennsylvania and Texas, decreases loan spreads by around 13 basis points (or $1.5 million interest for the average loan). We further show that freedom from government spending and taxation are the economic freedom components that drive this relationship. Labor market freedom also assists in reducing loan spreads for smaller firms and when the local economic growth potential is higher. We also find that economic freedom loosens non-price loan contract terms such as maturity, fees, and general covenants. These results denote that increased local economic freedom could assist the development of the local private sector from a bank credit standpoint.

Keywords: Economic freedom; Cost of bank loans; Nonprice loan terms

JEL Classification: G21, L11