Does Corruption Lead to Lower Subnational Credit Ratings? Fiscal Dependence, Market Reputation, and the Cost of Debt

Maciej Sychowiec,Nicholas Charron,Monika Bauhr

doi:10.1017/bap.2020.22

Abstract

AbstractWhile studies show a consistent negative relationship between the level of corruption and range indicators of national-level economic performance, including sovereign credit ratings, we know less about the relationship between corruption and subnational credit ratings. This study suggests that federal transfers allow states with higher levels of corruption to retain good credit ratings, despite the negative economic implications of corruption more broadly, which also allows them to continue to borrow at low costs. Using data on corruption conviction in US states and credit ratings between 2001 and 2015, we show that corruption does not directly reduce credit ratings on average. We find, however, heterogeneous effects, in that there is a negative effect of corruption on credit ratings only in states that have a comparatively low level of fiscal dependence on federal transfers. This suggest that while less dependent states are punished by international assessors when seen as more corrupt, corruption does not affect the ratings of states with higher levels of fiscal dependence on federal revenue.

Highlights

During the last few decades, international organizations, policy makers, and experts have expressed an increased concern about the negative economic effect of corruption
While fiscal guarantees may not be expected in all situations, we suggest that maintaining a high level of fiscal transfers despite higher levels of corruption or economic mismanagement can send a strong signal to rating agencies about
We find no evidence of a direct effect of corruption on state-level credit ratings, which supports our H1

Summary

Introduction

During the last few decades, international organizations, policy makers, and experts have expressed an increased concern about the negative economic effect of corruption. The effects of corruption on subnational credit ratings are, heterogeneous, and vary depending on a state’s level of fiscal dependence on the central government.

Results

Conclusion