Daniel Garrett - Duke University

Conflicts of Interest in Municipal Bond Advising and Underwriting

Abstract:  This paper shows that conflicts of interest between financial advisors and municipalities prevent markets from delivering an efficient outcome. I study a regulation that prohibits financial advisors from simultaneously acting as underwriters. Using a difference-in-differences approach, I compare bond issues with dual advisor-underwriters to other bond issues with independent advisors using within municipality variation. I find that bonds with dual advisors see interest costs fall by 8.15 basis points (3.7% on average) after the advisor is no longer allowed to serve as underwriter. Even though this policy limits competition from the advisor, I find an overall increase in competition for these bonds. I show that this increase in competition can be explained by the fact that, prior to the reform, non-advisors were subject to a winner’s curse. As an unintended consequence of the regulation, limiting asymmetric information between underwriters increases competition and improves market outcomes.