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Political capital and moral hazard

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  • Kostovetsky, Leonard

Abstract

This paper examines how political connections affect risk exposure of financial institutions. Using a geography-based measure, I find that politically connected firms have higher leverage and their stocks have higher volatility and beta. Furthermore, prior to the 2008 financial crisis, politically-connected financial firms had higher leverage and were more likely to increase their leverage during the housing bubble in response to local growth in median housing prices. During the crisis, higher leverage was associated with worse performance but being in a state with a US Senator on the Banking Committee was correlated with weakly improved stock returns and reduced bankruptcy probability, highlighting the value of political connections for financial firms.

Suggested Citation

  • Kostovetsky, Leonard, 2015. "Political capital and moral hazard," Journal of Financial Economics, Elsevier, vol. 116(1), pages 144-159.
    • Handle: RePEc:eee:jfinec:v:116:y:2015:i:1:p:144-159
    DOI: 10.1016/j.jfineco.2014.12.003
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    More about this item

    Keywords

    Moral hazard; Financial crisis; Bank leverage; Political connections; Risk taking;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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