No. 87: Firm-level political risk and credit markets

Abstract

We take advantage of a new measure of political risk (Hassan et al. (2019)) to study the effects of firmlevel political risk on private debt markets. First, we use panel data tests and exploit the redrawing of US congressional districts to uncover plausibly exogenous variation in firm-level political risk. We show that borrowers’ political risk is causally linked to interest rates set by lenders. Second, we test for the transmission of political risk from lenders to borrowers. We predict and find that lender-level political risk propagates to borrowers through lending relationships. Furthermore, we introduce new text-based methods to understand the distinct sources of political risk to lenders and borrowers and provide textual evidence of the transmission of political risk from lenders to borrowers. Our analysis allows for endogenous matching between lenders and borrowers and indicates the role of network effects in diffusing political risk throughout the economy.