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

Dario Cestau, Richard Green and Norman Schürhoff
Authors registered in the RePEc Author Service: Norman Schuerhoff ()

No 9186, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Build America bonds; financial intermediation; incentive conflicts; municipal finance; underpricing (search for similar items in EconPapers)
JEL-codes: E44 E63 G23 H74 (search for similar items in EconPapers)
Date: 2012-10
New Economics Papers: this item is included in nep-fmk, nep-mac and nep-pbe
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