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Tax-Subsidized Underpricing: Issuers and Underwriters in the Market for Build America Bonds

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  • Cestau, Dario
  • Green, Richard
  • Schürhoff, Norman

Abstract

Build America Bonds (BABs) were issued by states and municipalities for twenty months as an alternative to tax-exempt bonds. The program was part of the 2009 fiscal stimulus package. The bonds are taxable to the holder, but the federal Treasury rebates 35% of the coupon payment to the issuer. The stated purpose of the program was to provide municipal issuers with access to a more liquid market by making them attractive to foreign, tax-exempt, and tax-deferred investors. We evaluate one aspect of the liquidity of the bonds---the underpricing when the bonds are issued. We show that the structure of the rebate creates additional incentives to underprice the bonds when they are issued, and that the underpricing is larger for BABs than for traditional municipals, controlling for characteristics such as size of the issue or the trade. This suggests that the bonds are not more liquid, contrary to the stated purpose of the program, or that issuers and underwriters are strategically underpricing the bonds to increase the tax subsidy, or both. Several findings point to strategic underpricing. There is a negative correlation between the underwriter's spread and the underpricing. The underpricing for BABs is quite evident for institutional and interdealer trades, while that for tax-exempts is primarily for smaller sales to customers. Counterfactuals for our estimated structural model also suggest strategic underpricing.

Suggested Citation

  • Cestau, Dario & Green, Richard & Schürhoff, Norman, 2012. "Tax-Subsidized Underpricing: Issuers and Underwriters in the Market for Build America Bonds," CEPR Discussion Papers 9186, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:9186
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    Keywords

    Build America bonds; financial intermediation; incentive conflicts; municipal finance; underpricing;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing

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