Impact Of Bankruptcy Eligibility Requirements And Statutory Liens On Borrowing Costs

• In Event: Government Reporting and Financial Distress

Abstract

While filing for bankruptcy protection remains an instrument of last resort, the recent wave of petitions has aroused the interest of key participants in the municipal bond market. To date, 12 states unconditionally authorize municipalities to file for bankruptcy protection, 15 states require municipalities satisfy threshold requirements, while the remaining 23 states either explicitly prohibit or have not specifically provided the authority to municipal governments. Since a petition in federal bankruptcy court could result in losses for bondholders, we empirically test the relevance and significance of the state-specific bankruptcy eligibility requirements on borrowing costs. Using a representative sample of general obligation bonds, our analysis finds municipalities eligible to file for bankruptcy protection pay a premium and that premium is larger if the issuer is unconditionally authorized to file for bankruptcy protection. Our study also finds there were benefits associated with statutory liens, however the economic value diminishes if the issuer is also subject to a tax limit.

Author

• Sharon Kioko, Syracuse University