Political sensitivity and government oversight in the US corporate bond market: evidence from federal contractors

Abstract

Purpose This paper aims to investigate the political cost hypothesis and the effects of political sensitivity-induced governance in the US bond market by using yield spreads from bonds issued by a diverse sample of US government contractors. Design/methodology/approach Fixed effects regression analysis is used to test the relation between the political sensitivity of government contractor firms and their cost of debt. Findings Results illustrated that government contractors with greater political sensitivity are associated with larger yield spreads, indicating that bondholders require a premium when firms endure the costs of increased political oversight and the threat of outside intervention, reducing the certainty of future income. However, despite the overall positive impact of political sensitivity on bond yield spreads on average, the authors found that the additional government oversight is associated with lower spreads when the firm is facing greater repayment risk. Practical implications Despite the benefits of winning a government contract, this paper identifies a direct financial cost of increased political sensitivity because of additional firm oversight and potential intervention. Importantly, it also finds that this governance is valued by bondholders when faced with increased risk. Firms must balance their desire for government receipts with the costs and benefits of dependence on those expenditures. Originality/value This paper contributes to the literature in its exploration of political sensitivity as an important determinant of the cost of debt for corporate government contractors. Specifically, the authors document a significant risk premium in bond pricing because of the joint effects of the visibility and importance of government contracts to the firm.

Corporate transparency among government suppliers: Implications for firm valuation

“…Yet, despite these transparency efforts, they are not always rewarded by capital markets that set higher transparency benchmarks for them. Investors view political costs as an additional risk factor, often demanding a premium to offset uncertainties like those associated with stringent political oversight, which can cloud future cash flow projections (Craig & Hadley, 2020). For instance, politically sensitive firms bear additional costs – be they excess federal taxation (Mills et al., 2013), self‐imposed CEO compensation caps (Hadley, 2019), profit recognition avoidance during high‐risk periods (Boland & Godsell, 2020) or overspending (Redmayne et al., 2010) – to safeguard government contract revenues.…”

“…For instance, politically sensitive firms bear additional costs – be they excess federal taxation (Mills et al., 2013), self‐imposed CEO compensation caps (Hadley, 2019), profit recognition avoidance during high‐risk periods (Boland & Godsell, 2020) or overspending (Redmayne et al., 2010) – to safeguard government contract revenues. These firms often do not reap extra benefits, merely maintaining their current revenue streams and thereby incurring what is termed a ‘political cost’ (Craig & Hadley, 2020).…”