The political economy of competitive and negotiated sales in the municipal bond market

The use of negotiated sales of municipal debt by state and local government issuers has increased dramatically over the past two decades. While there are several reasons for this increase, it is commonly believed that it is partly due to the rise of pay to play , where elected officials use negotiated sales to reward campaign contributors from the investment banking industry. Ordinary least squares and two-stage regression techniques designed to correct for selectivity bias and facilitate identification were used to evaluate the relative cost of competitive and negotiated sales for 41 large U.S. cities between the years of 1980 and 1993 and to examine the associations between the choice of issuance procedure and a set of variables describing the political climate at the time of debt issuance. Negotiated sales had a statistically significant higher net interest cost than competitive sales, although the differential has decreased substantially since the passage of the Tax Act of 1986. Variables associated with a higher probability of a negotiated sale included a mayor/council structure of government, close primary election and percent black population. The results provide support for current efforts by the SEC and MSRB to curb campaign finance abuses in the municipal bond market