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Journal of Business Ethics

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22-10-2016 | Original Paper

Social Capital and the Municipal Bond Market

Authors: Pei Li, Leo Tang, Bikki Jaggi

Published in: Journal of Business Ethics | Issue 2/2018

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Abstract

We examine the influence of social capital in the municipal bond market. Defined as the norms and networks that encourage cooperation, social capital is a social construct which captures a region’s level of altruism, trustworthiness, and propensity to honor obligations. We expect that municipalities with high social capital are more trustworthy and likely to honor their debt obligations, which will result in lower bond yields. Our findings confirm that the bonds issued by municipalities located in high social capital counties exhibit lower yields compared to the municipalities located in low social capital counties. Our findings are also supported by bond prices in the secondary market, which shows that bonds from the municipalities located in high social capital regions have higher prices. Additional tests reveal that the influence of social capital is stronger for general obligation bonds, suggesting that social capital matters more for bonds where the willingness of municipalities to pay taxes is an important factor. Lastly, we document that the bonds of municipalities in high social capital areas are less likely to have insurance, suggesting that social capital may act as a substitute for bond insurance.

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The municipal bond market is also important to understand because it represents approximately $3.7 trillion (as of 2010) in outstanding debt. As a source of funding for essential services for state and local governments, the municipal market has grown in size from 185 billion in bond issuances in 1996 to over 433 billion in 2010.

Recent work by Leventis et al. (2015) and Gul and Ng (2016) also finds that religiosity influences audit pricing.

From a high of 57 % insured before the crisis to 19 % in 2008, and to 3.5 % in 2012. http://www.bondbuyer.com/issues/123_83/bond-insurance-then-and-now-revival-of-industry-1062071-1.html.

In additional tests, we also examine the association between social capital and yield spreads and find similar results. Yield spreads are lower for municipal bonds issued in high social capital areas.

Similarly, Jaggi and Tang (2015) also find that distance influences corporate credit ratings and debt costs.

$9.02 billion in monetary defaults in 2014 compared with only $1.95 billion in 2012. http://www.bondbuyer.com/news/markets-buy-side/defaults-reached-record-in-2014-1069491-1.html.

While Moody’s only notes 71 listed defaults from 1970 to 2011, there were 2521 defaults during this same period for unrated municipal securities. http://libertystreeteconomics.newyorkfed.org/2012/08/the-untold-story-of-municipal-bond-defaults.html.

The index consists of 20 general obligation bonds that mature in 20 years. The average rating of the 20 bonds is roughly equivalent to Moody's Aa2 rating. The index represents theoretical yields rather than actual prices or yield quotations. Municipal bond traders are asked to estimate what a current-coupon bond for each issuer in the indexes would yield if the bond was sold at par value. The index is a simple average of the estimated yields of the bonds.

Due to large sample sizes, we find that the Pearson correlations between all variables are significant at the 1 percentile level. We discuss both economic and statistical significance in our multivariate regressions.

http://aese.psu.edu/nercrd/community/social-capital-resources/social-capital-variables-for-1997-2005-and-2009.

Cuny (2016) also indicates that the deterioration in credit quality of the major bond insurers increased demand for voluntary disclosures.

1−(exp (−0.024*0.322)/exp(−0.024*−0.998)) = 3.12 %.

The difference between the yield to worst for a callable bond and the yield for a noncallable bond is a function of the callable dates and duration. Given that this relationship may not be linear, we examine our results separately for callable and noncallable bonds and find that the association between social capital and bond yields is significant under both samples.

In separate tests, we only include either issue size or bond size and find similar results.

1−(exp (−0.050*0.322)/exp(−0.050*−0.998)) = 6.39 %.

1−(exp (−0.026*0.322)/exp(−0.026*−0.998)) = 3.37 %.

The results remain unchanged when the pre-downgrade period and the post-downgrade period are extended to two, three, and four years, respectively. In separate analysis, we also examine the interaction between social capital and the post-downgrade period and find consistent results.

Per the CRSP Treasury database guide, these issues are sorted by term type, which distinguishes the length of maturity. A valid issue that best represents each term is chosen at the end of each month for each of the above referenced fixed terms. A valid issue is one that is at least one half year prior to the target maturity date and is fully taxable. The selection process filters a representative bond from each of the fixed-term groups. The first selection criteria are a noncallable, nonflower bond that is closest to the target maturity of its group and fully taxable. If more than one issue remains, and/or none are available which fit the above criteria, they are then respectively filtered on the basis of flower bonds acceptable at par, and accrued interest if owned by descendent at time of death.

In alternative specifications, we winsorize yield spread at the 1 percent and 99 percent level and find similar results. To address the skewness in distribution, we also examine the log of yield and find similar results.

In additional analysis, we find that social capital is associated with bond yields for general obligation bonds with either a limited or unlimited pledge.

1−Exp(−0.104) = 0.0988.

1−Exp(−0.215) = 0.1935.

1−(exp(−0.032*1.264)/exp(−0.032*−0.446)) = 5.32 %.

We thank the referee for pointing this out and suggesting the use of granger causality tests.

We also examine lags of only 1 year and find similar results.

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Title: Social Capital and the Municipal Bond Market
Authors: Pei Li
Leo Tang
Bikki Jaggi
Publication date: 22-10-2016
Publisher: Springer Netherlands
Published in: Journal of Business Ethics / Issue 2/2018
Print ISSN: 0167-4544
Electronic ISSN: 1573-0697
DOI: https://doi.org/10.1007/s10551-016-3355-8

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