Corruption, Political Connections, and Municipal Finance

48 Pages Posted: 22 Mar 2007 Last revised: 29 Aug 2008

See all articles by Alexander W. Butler

Alexander W. Butler

Rice University - Jesse H. Jones Graduate School of Business

Larry Fauver

University of Tennessee, Knoxville - Department of Finance; University of Tennessee

Sandra Mortal

University of Alabama - Culverhouse College of Commerce & Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: August 25, 2008

Abstract

We exploit unique features of the U.S. municipal bond underwriting market to assess how political integrity affects primary financial market outcomes. We show that state corruption and political connections have strong effects on several aspects of municipal bond sales and underwriting. Specifically, we find that higher state corruption is associated with greater credit risk, higher bond yields, greater use of external credit enhancement, and use of lower quality underwriters. States that are more corrupt can eliminate the corruption yield penalty by purchasing credit enhancements, effectively selling integrity-related default risk to an independent financial intermediary. Underwriting fees do not vary with cross-state corruption, but were significantly higher during an era when under writers routinely made political campaign contributions to win underwriting business. Furthermore, this pay-to-play underwriting fee premium exists only for negotiated bid bonds where underwriting business can be allocated on the basis of political favoritism. Overall, our results show a strong impact of state corruption and political connections on economic and financial outcomes.

Keywords: Political integrity, Corruption, Pay to play, Municipal finance

JEL Classification: D73, G20, G22, G24, H74

Suggested Citation

Butler, Alexander W. and Fauver, Larry and Mortal, Sandra, Corruption, Political Connections, and Municipal Finance (August 25, 2008). AFA 2008 New Orleans Meetings Paper. Available at SSRN: https://ssrn.com/abstract=972471 or http://dx.doi.org/10.2139/ssrn.972471

Alexander W. Butler (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

MS 531
Houston, TX 77005
United States
713-348-6341 (Phone)

HOME PAGE: http://www.owlnet.rice.edu/~awbutler/

Larry Fauver

University of Tennessee, Knoxville - Department of Finance ( email )

424 Stokely Management Center
Knoxville, TN 37996
United States

University of Tennessee ( email )

424 Stokely Management Center
Department of Finance
Knoxville, TN 37996-0540
United States
865-974-1722 (Phone)
865-974-1716 (Fax)

Sandra Mortal

University of Alabama - Culverhouse College of Commerce & Business Administration ( email )

Culverhouse College of Business
Tuscaloosa, AL 35487-0223
United States

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