Political Bonds: Political Hazards and the Choice of Municipal Financial Instruments
We study the link between the choice of rule-based public contracts and political hazards using the municipal bond market. While general obligation bonds are serviced from all municipal revenue streams and offer elected officials financial flexibility, revenue bonds limit the discretion that political agents have in repaying debt as well as the use of revenues from the projects financed by the debt. We predict that public officials choose revenue bonds when elections are very contested to signal trustworthiness and transparency in contracting to the voter. We test this hypothesis on municipal finance data that includes 6,500 bond issuances nationwide as well as election data on over 400 cities over 20 years. We provide evidence that in politically contested cities, mayors are more likely to issue revenue bonds. The correlation is economically significant: a close victory margin of winning candidates and more partisan swings increases the probability of debt being issued as a revenue bond by 3–15% and the probability of issuing bonds through competitive bids by 7%. We test a few additional hypotheses that strengthen the argument that the choice of revenue bonds is a political risk adaptation of public agents so as to signal commitment and lower the likelihood of successful political challenges of misuse of funds.
Data from Bloomberg Financial is gratefully acknowledged. We are grateful to Fernando Ferreira and Joseph Gyorko for sharing their municipal election data and Mosche Barache for his assistance needed to link the bond and election data. We are also thankful to Kenneth Ayotte, Richard Boylan, David Schleicher, and Eric Singer for extensive and helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.