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

Abstract

PurposeThis 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/approachFixed effects regression analysis is used to test the relation between the political sensitivity of government contractor firms and their cost of debt.FindingsResults 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 implicationsDespite 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/valueThis 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.