Political Hazards and the Choice of Contracting: The Case of Municipal Bonds

We study the impact of political competition on the choice of rule-based contracts through the municipal bond market. We provide evidence that when the probability of losing office is high, mayors are more likely to issue... [ view full abstract ]

We study the impact of political competition on the choice of rule-based contracts through the municipal bond market. We provide evidence that when the probability of losing office is high, mayors are more likely to issue revenue bonds over general obligation bonds, and to choose competitive bidding over negotiated sales. Narrowing victory margins by one quintile increases the probability of debt being issued as a revenue bond by4.2 percent, while an additional partisan swing in the last three electoral cycles increases the likelihood of using a revenue bond by 8.2 percent. Likewise, narrowing of victory margins by one quintile increases the probability of issuing bonds through competitive bids by 2.5 percent, while an additional partisan swing in the last three electoral cycles increases the likelihood of using a competitive sale procedure by 6.1 percent. The impact of political hazards is stronger for elected mayors than for city managers, and closer to the next elections. We utilize two referenda---one failed and one succeeded---regarding changes in the required supermajority to issue general obligation bonds in California to implement a double difference-in-differences approach as a way to assess the causal relationship between political hazards and the choice of security type.