Public Corruption in the U.S. States and Its Impact on Public Debt Pricing

Abstract

Summary This study evaluates the levels of public corruption in the American states and their impact on the prices of public debt sold by underwriting banks to retail investors. Results suggest that the markups paid by retail investors to underwriters decrease significantly with the incidence of public corruption. The relationship remains significant even when existing anti‐corruption enforcement efforts are taken into consideration. Extant literature shows that the issuers of public debt from relatively more corrupt jurisdictions receive lower prices from underwriting banks in wholesale transactions. We develop and empirically show the mechanism through which this can occur. We offer the first evidence that the public debt market exerts disciplining pressures on the American states with greater levels of public corruption. When purchasing state‐issued public debt, retail buyers appear to demand narrower markups by factoring in public corruption. This, we argue, is an important reason why underwriting banks offer lower prices when dealing with less disciplined fiscal sovereigns.

Corruption and Tax Structure in American States

“…Kaufmann (2010) provocatively asks “whether corruption may adversely affect public finances in industrialized countries?” An abundant literature has focused on corruption impacts in developing and transition countries (Fjeldstad & Tungodden, 2003; Ghura, 1998; Grimes & Wängnerud, 2010; Moloney & Chu, 2016; Ohemeng & Owusu, 2015; Tanzi & Davoodi, 1997; Themudo, 2014) and a new literature is finding impacts of corruption on American state finances (Bayoumi, Goldstein, & Woglom, 1995; Butler, Fauver, & Mortal, 2009; Depken & LaFountain, 2006; Liu, Moldogaziev, & Mikesell, 2017; Maher, Deller, Stallmann, & Park, 2016; Moldogaziev, Liu, & Luby, 2017). This article extends this examination of corruption impacts by considering whether corruption in American states might impact the structures used to raise tax revenue.…”

Fiscal Governance, Information Capacity, and Subnational Capital Finance

“…This finding is consistent with evidence in existing studies that, when left unchecked, greater levels of corruption and substandard levels of the rule of law result in economic losses in a number of areas of capital market activity. These losses are linked to deterioration of SNG credit quality, increasing borrowing costs, and overall levels of indebtedness (Depken and LaFountain 2006; Butler, Fauver, and Mortal 2009; Moldogaziev, Liu, and Luby 2017; C. Liu, Moldogaziev, and Mikesell 2017).…”

“…The legal environment addresses the extent to which legal norms are upheld and the capacity in the system to enforce the rules. Excessive disregard for rules or outright corruption are found to have a detrimental impact on SNG borrowers (Butler, Fauver, and Mortal 2009; Depken and LaFountain 2006; Moldogaziev, Liu, and Luby 2017; C. Liu, Moldogaziev, and Mikesell 2017).…”

Control of Corruption and Luxury Goods Consumption

“…Their results confirm that increased corruption and a larger shadow economy lead to an increase in public debt. In the same vein, Moldogaziev et al () show that there is a corruption penalty for the public debt of US states that have greater incidences of public corruption. They argue that state level corruption weakens credit ratings of local governments and increases their borrowing costs.…”