Political Connections, Government Procurement Contracts, and the Cost of Debt

Abstract

This paper shows that while a firm’s percent of sales to the government is positively related to the firm’s costs of debt, firms are able to offset this effect through political connections. Politically connected government contractors have lower costs of debt than non-connected contractors. Capital expenditure, R&D expense, and volatility of cash flows are all underlying explanatory mechanisms. Our results thus indicate that the documented benefits that accrue to shareholders of connected firms transfer to bondholders as well. Our results contribute to a better understanding of the overall effects of political connections and the determinants of the cost of debt.

Keywords: government contracting, political connections, cost of debt

JEL Classification: G38, G18, G31