The Effects of Tax Clientele on Disclosure: Evidence from the Municipal Bond Market

Abstract

The municipal bond market has been widely criticized for its lack of disclosure, which prior research has attributed to weak regulatory oversight. We propose the tax clientele for tax-exempt municipal bonds as another explanation and examine whether the taxability of municipal bonds is associated with issuers’ disclosure practices. Individual investors form a primary tax clientele for tax-exempt municipal bonds, whereas taxable municipal bonds attract institutional investors. Consistent with institutional investors demanding and monitoring disclosure, our analyses suggest that municipal bond issuers provide more continuing disclosures in years with taxable bonds outstanding relative to years without. We also observe that issuers previously without taxable bonds increase continuing disclosures after issuing a taxable bond, consistent with the differing tax clientele for taxable bonds shaping municipality’s continuing disclosure. Our analyses can inform regulators of the municipal bond market and tax policymakers examining the costs and benefits of the tax-exempt status afforded to municipal bonds.

Keywords: municipal bonds, tax clientele, continuing disclosure

JEL Classification: H20, H74, M41