Political Uncertainty and Bank Loan Contracts: Does Government Quality Matter?
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Political Uncertainty and Bank Loan Contracts: Does Government Quality Matter? Yin-Siang Huang 1 & Iftekhar Hasan 2 & Ying-Chen Huang 3 & Chih-Yung Lin 4 Received: 31 March 2019 / Revised: 24 August 2020 / Accepted: 22 September 2020 # Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract
We investigate the relation between political uncertainty and bank loan spreads using a sample of loan contracts for the G20 firms during the period from 1982 to 2015. We find that banks charge firms higher loan spreads and require more covenants during election years when domestic political risks are elevated. Greater differences in the support ratios of opinion polls on candidates lead to the lower cost of bank loans. This political effect also lessens when the government quality of the borrower’s country is better than that of the lender’s country. Better quality government can lower the political risk component of bank loan spreads. Keywords Political uncertainty . Bank loans . Loan spreads . Loan covenants . Opinion poll . Government quality . Elections JEL G32 . G33 . G34
1 Introduction Recently, Baker et al. (2016) have developed a policy uncertainty index and have found that this uncertainty is associated with greater stock price volatility and reduced investment and Chih-Yung Lin appreciates the financial support from Taiwan Ministry of Science and Technology (MOST1082636-H-009-001). Any remaining errors are ours.
* Chih-Yung Lin [email protected] Yin-Siang Huang [email protected] Iftekhar Hasan [email protected] Ying-Chen Huang [email protected] Extended author information available on the last page of the article
Journal of Financial Services Research
employment in policy-sensitive sectors. Furthermore, this association is greater during national elections that are plausibly greater exogenous shocks to political uncertainty. Thus, they are useful laboratories to examine the role of political uncertainty (Julio and Yook 2012, 2016). National elections represent a change in a country’s leader and the ruling party that can lead to a change in government policies. Thus, these changes can cause instability due to political uncertainty that subsequently, affects the decisions and performances of firms. Thus, this study identifies one part of policy uncertainty—national elections—and addresses their effect on the financing costs in the loan market. In particular, we use the national elections between 1982 and 2015 in the Group of Twenty (or G20) countries to examine the relation between political uncertainty and firms’ borrowing costs. Our main hypothesis is straightforward. For domestic loan contracts, firms face different degrees of political uncertainty that depend on their nation’s election results. If an election changes the ruling party, then the economic policies and investors’ expectations might also change, and thus firms face greater political uncertainty. We propose that banks charge higher loan spreads during election years to compensate for the domestic political risks th
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