Recent years have seen a heightened level of partisan conflict in the U.S. Both academic research and anecdotal evidence suggest that partisanship generates profound influence on individuals’ beliefs, leading them to selectively incorporate information that is favorable to their own political orientation. In particular, partisanship appears to play a role in influencing individuals’ perceptions of the economy. People whose political beliefs are in agreement with the party ruling the White House tend to hold a more optimistic view than those misaligned with the party in power.
In our recent working paper, we study whether partisan beliefs distort security prices and firms’ cost of capital. We focus on the U.S. syndicated loan market, a market operated by professional bankers making high-stakes lending decisions. We define a “misaligned” banker as one who is affiliated with a different party from the one represented by the sitting President (for example, a banker who is a registered Republican under a Democratic president). Similarly, we define “aligned” bankers to be those affiliated with the same party as the President. If political beliefs do in fact matter, misaligned bankers should be more pessimistic about future economic conditions than aligned bankers. In our empirical analysis, we find that misaligned bankers indeed charge higher interest rates for the loans they issue than aligned bankers.
Our empirical study
We compile a unique dataset that tracks corporate bankers’ political affiliation and the contract terms of the loans they originate. We identify the bankers in charge of underwriting syndicated loans using SEC filings and manually search for each banker’s political party affiliation based on their public voting records. Our study covers 2,974 loans with a total value of $2.46 trillion, originated by 1,199 bankers during the period of May 1998 through August 2019.
We find that politically misaligned bankers charge significantly higher loan spreads compared to aligned bankers. Specifically, misaligned bankers charge 7% higher spreads than aligned bankers. The average rate for the loans in the sample is roughly 210-basis points over Libor, therefore this estimate translates into misaligned bankers charging around 14-basis point more than aligned bankers. Given that the average syndicated loan in our sample has a face value of over a billion dollars, our result indicates that political partisanship generates a sizable effect on firms’ cost of capital and access to credit.
Our approach helps us rule out various alternative explanations. In our approach, we fix a banker and track his/her pricing tendency over time. This allows us to see how a banker’s price-setting behavior changes following a party-switching election. Such a change does not reflect the banker’s innate characteristics. At the same time, we fix the borrower’s characteristics, such as industry, growth potential, and credit quality. This allows us to compare the pricing of a politically misaligned banker with that of an aligned banker for loans extended to similar firms.
Through additional analysis, we also rule out several other potential explanations that might influence the banker partisanship-spread relation that we document. These alternative stories include politically misaligned bankers selecting riskier borrowers, borrowers of misaligned bankers demanding more or less credit than the borrowers of aligned bankers, and misaligned bankers being employed by banks with more stringent lending policies. These stories do not seem to explain the partisanship-spread relation that we find.
Group identity and partisanship
How do bankers form partisanship bias and how does such bias persist? We try to understand this question by investigating the role of social groups. Social identity theory argues that people with similar beliefs tend to form groups and share opinions. Such homogeneous groups become an “echo chamber” and further strengthen the beliefs of group members. We find evidence in support of this idea. Our tests show that the partisan effect on pricing is stronger when bankers live in areas where the overwhelming majority of the residents vote for their party. We also find that bankers with the same political affiliation tend to form a lending syndicate (i.e., a group of lenders that assemble capital and issue a loan together). Inside a politically homogenous lending syndicate, bankers partisan bias generates a stronger effect on lending terms. These results represent the first attempt to uncover how homophily could amplify bankers’ political bias and, in turn, affect credit market outcomes.
Personal belief and partisanship bias
What type of borrowers are most affected by partisanship bias? We find that firms with more opaque assets and speculative credit ratings are more subject to the banker partisanship effect than other firms. This suggests that bankers’ personal beliefs generate a stronger effect on hard-to-value firms. For those borrowers, bankers have to rely more on their intuition to set loan terms and in that process, their partisanship could kick in and make them more optimistic and pessimistic. At the same time, we also find firms with fewer outside borrowing options are more affected by banker partisanship. This is because these firms have “nowhere else to go.” They are held-up in the relationship with their current bankers and are thus fully exposed to the impact of those bankers’ pessimism/optimism. Taken together, our analyses provide textured evidence revealing the channels through which partisanship can influence bankers’ beliefs regarding borrower credit quality, which in turn affects their pricing decisions.
Partisanship and performance
If politically misaligned bankers issue more highly priced loans, are they able to generate a higher revenue than aligned bankers? We compare this performance metric between aligned and misaligned bankers in the closing of our analyses. Corporate bankers are rewarded for achieving a high origination volume and punished for credit risk exposure. We thus examine whether misaligned bankers have lower lending volume and face higher default rates. We find that, despite them charging higher interest rates, misaligned lenders also appear to underwrite a smaller volume of loans. This makes it unlikely that misaligned lenders generate higher revenue than aligned lenders. Finally, we do not find that misaligned and aligned officers face different borrower default rates. Overall, our evidence indicates that the higher loan spreads charged by misaligned bankers do not make them more successful. The differences in loan spreads reflect the difference in bankers’ perception, but not an attempt to achieve higher profit or to compensate for different borrower risk.
Our paper provides the first evidence that investors’ political beliefs affect the cost of credit for large U.S. corporations. This finding contributes to the literature studying the effect of the political beliefs of households, managers, and investors. It suggests that partisan perceptions not only breed disagreement among investors, but such disagreement also influences prices. This study thus advances our understanding of the “real effects” of partisan perceptions on financial markets.
Ramona Dagostino is an Assistant Professor at University of Rochester Simon Business School.
Janet Gao is an Assistant Professor of Finance at Indiana University Kelley School of Business.
Pengfei Ma is a Ph.D student at Indiana University Kelley School of Business.
This post is adapted from their paper, “Partisanship in Loan Pricing,” available on SSRN.
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