Political connections and the cost of bank loans

Joel F. HOUSTON, Liangliang JIANG, Chen LIN, Yue MA

Research output: Journal PublicationsJournal Article (refereed)

150 Citations (Scopus)

Abstract

This paper analyzes whether the political connections of listed firms in the United States affect the cost and terms of loan contracts. Using a hand-collected data set of the political connections of SandP 500 companies over the 2003–2008 time period, we find that the cost of bank loans is significantly lower for companies that have board members with political ties. We consider two possible explanations for these findings: a Borrower Channel in which lenders charge lower rates because they recognize that connections enhance the borrower's credit worthiness and a Bank Channel in which banks assign greater value to connected loans to enhance their own relationships with key politicians. After employing a series of tests to distinguish between these two channels, we find strong support for the Borrower Channel but no direct evidence supporting the Bank Channel. Finally, we demonstrate that political connections reduce the likelihood of a capital expenditure restriction or liquidity requirement commanded by banks at the origination of the loan. Taken together, our results suggest that political connections increase the value of U.S. companies and reduce monitoring costs and credit risk faced by banks, which, in turn, reduces the borrower's cost of debt.
Original languageEnglish
Pages (from-to)193-243
Number of pages51
JournalJournal of Accounting Research
Volume52
Issue number1
Early online date31 Dec 2013
DOIs
Publication statusPublished - Mar 2014

Bibliographical note

The authors acknowledge the financial support from the HKSAR Government (RGC Earmarked Competitive Research Grant, 147810) and the University of Florida.

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