Corruption is Expensive, But Who Pays the Bills?

Mar 25, 2008

One often must look no further than today’s headlines to find examples of personal failure, corporate financial woes and political corruption. But how does political integrity affect the bottom line? A University of Missouri researcher has found that state corruption and political connections have strong effects on the economy and that higher state corruption is associated with greater credit risk, higher bond yields, increased use of external credit enhancements (such as bond insurance) and the utilization of lower quality underwriters.

“Corruption is expensive,” said Sandra Mortal, assistant professor of finance in MU’s Robert J. Trulaske, Sr. College of Business. “Corruption affects the cost of finance. To avoid or decrease the effects of corruption, issuers are paying for credit enhancement, such as bond insurance. Who’s paying for the higher yields and the underwriter’s fees? It may eventually be the taxpayer.”

The study supports the bulk of theory and evidence that indicate corruption is costly because it impedes transactions, hinders trade and retards financial and economic growth and development. Mortal’s research examined how political integrity, and lack thereof, affects the interactions among governments, financial intermediaries and financial markets—specifically how corruption and political connections affect primary security market transactions and the issuance of municipal bonds.

In the study, researchers measured corruption using actual per-capita federal corruption convictions and the amount of municipal bond underwriting that involved “pay-to-play.” Pay-to-play is a practice whereby investment banks seek to win underwriting business by making campaign contributions to legislators who are involved in the process of selecting underwriters for municipal bonds.

Mortal found that less corruption is associated with better bond ratings, corrupt states pay significantly higher yields on municipal securities and issuers in corrupt states use lower quality underwriters. She also found that the issuers in corrupt states were more likely to use bond insurance to improve credit ratings and reduce yields.

“Our findings should be of interest to financial economists because we show issuers can outsource corruption-induced default risk to institutions that provide credit enhancement,” Mortal said. “Our findings also should be of interest to development economists because we identify a way to mitigate the damaging effects of corruption even if or when corruption itself cannot be completely eliminated.”

Mortal, with researchers Alex Butler (University of Texas at Dallas) and Larry Fauver (University of Tennessee), presented the paper “Corruption, Political Connections and Municipal Finance” at the 2008 American Finance Association meeting in New Orleans. The paper also was named “Best Paper in Fixed Income Research” by the Financial Management Association.

Source: University of Missouri

Explore further: Report: Dangerous lab fires show lack of training

add to favorites email to friend print save as pdf

Related Stories

Hackers leap from dark basements to world stage

Oct 10, 2014

Hackers are shaking off their reputations as nerdy, loner basement dwellers and rebranding themselves on the world stage as members of Internet age tribes with offbeat codes of conduct and capricious goals.

Disease burden links ecology to economic growth

Dec 27, 2012

A new study, published December 27 in the open access journal PLOS Biology, finds that vector-borne and parasitic diseases have substantial effects on economic development across the globe, and are major drivers of differ ...

Recommended for you

Prophet's ancient seal provides insights from antiquity

5 hours ago

When a personal artifact of a religious leader is discovered nearly 1,700 years after its use, the object provides invaluable historical insights. Zsuzsanna Gulacsi, professor of Comparative Cultural Studies, ...

Billionaires' $10m gift to Yale stirs debate in China

9 hours ago

A Chinese billionaire couple's $10 million gift to Yale University sparked controversy among the country's Internet users Thursday, with some arguing that the money would be better spent on schools in China.

User comments : 0

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.