As discussed in this PubCo post, we’ve lately been witnessing a profusion of state and local legislation targeting companies that express public positions or adopt policies on sociopolitical issues or conduct their businesses in a manner disfavored by the government in power. Bloomberg observes that, while “companies usually faced mainly reputational damage for their social actions, politicians are increasingly eager to craft legislation that can be used as a cudgel against businesses that don’t share their social views.” And many of these state actions are aimed, not just at expressed political positions, but rather at environmental and social measures that companies may view as strictly responsive to investor or employee concerns, shareholder proposals, current or anticipated governmental regulation, identified business risks or even business opportunities. These laws are presumably detrimental to the targeted companies, but are there any adverse consequences for the state or locality adopting this legislation and its citizens? To better understand the phenomenon and its impact on financial market outcomes, this paper from authors at the University of Pennsylvania and the Federal Reserve Bank of Chicago looked at the impact of one example of this type of legislation—a law recently adopted in Texas that blocks banks from government contracts in the state if the banks restrict funding to oil and gas companies or gun manufacturers. The authors concluded that the Texas legislation has had, and is expected to continue to have, a “large negative impact on the ability for local governments to access external finance. Our results suggest that if economies around the world that are heavily reliant on fossil fuels attempt to undo ESG policies by imposing restrictions on the financial sector, local borrowers are likely to face significant adverse consequences such as decreased credit access and poor financial markets outcomes.”
According to Reuters, some “states have unleashed a policy push to punish Wall Street for taking stances on gun control, climate change, diversity and other social issues, in a warning for companies that have waded in to fractious social debates.” For example, Reuters reports, last year, states passed legislation sidelining companies “that ‘boycott’ energy companies or ‘discriminate’ against the firearms industry from doing new business with the state,” contending that the “policies of such companies deprive legitimate businesses of capital.” Bloomberg reports that several states have “passed legislation that requires financial firms to say whether they have policies that limit doing business with oil, gas and coal companies, a common practice for firms that have made pledges to reduce their own carbon footprint. Banks that demur could lose their licenses in those states. Another 12 states are considering similar measures.” According to a new Reuters analysis, in 2022, there were at least 44 bills or new laws in 17 states “penalizing such company policies, compared with roughly a dozen such measures in 2021….The growing restrictions show how America’s culture wars are creating new risks for some of the most high-profile U.S. companies, forcing them to balance pressure from workers and investors to take stances on hot-button issues with potential backlash from conservative policymakers.” Some state officials accuse the targeted companies of “using the power of their capital to push their ideas and ideology down onto the rest of us.”
Not that these measures come solely from one side of the political spectrum—Bloomberg reports that some politicians have taken aim at tax breaks for companies that oppose workers’ union-organizing activities, offering a bill that “would propose that employers’ spending on anti-union activities qualifies as political speech under the tax code, barring those companies from deducting the costs on their taxes.” In addition, some states are reportedly considering actions such as a “climate resiliency fee” for institutions that fund fossil fuel projects or a prohibition against state pension plan investment in fossil fuel companies. Still, Reuters indicates that states favoring ESG policies are “not pursuing as many punitive measures, according to the review and sources.” Of course, that could change. And the review conducted by Reuters showed that it’s not just states that are sitting clearly on one side of the culture line or the other that are adopting these types of measures; some “swing” or purple states are also getting into the mix.
These new prohibitions can create serious impediments to companies’ ability to conduct state business, implicating billions of dollars. In addition, Reuters reports, the “issues such measures target are also mushrooming. Guns and energy were the focus of the roughly dozen state laws and bills last year and of at least 30 legislative measures this year. But this year there were also more than a dozen bills relating to social and other issues,” including many divisive concepts, such as mandatory COVID-19 vaccines.
To examine the effect of this type of targeted legislation, the authors conducted a study looking at the impact of “a significant and unexpected regulatory change” in Texas, implemented in September 2021, that barred some of the largest banks from government contracts in the state if the banks restricted funding to oil and gas or firearms companies. The laws “led to the abrupt exit of five of the largest municipal bond underwriters from Texas.” The study looked at how this legislation affected borrower behavior and outcomes.
The authors found that, after the state adopted its prohibition, issuers that had relied on the targeted banks prior to the legislation were more likely to negotiate pricing in subsequent bond financings than to conduct an auction, received fewer competitive bids from underwriters, raised less financing and incurred higher borrowing costs. According to the paper, “borrowing costs increase because there are fewer municipal underwriters competing for the state’s municipal bonds, and because issuers no longer have access to the national bond placement networks of the major banks.” More specifically, they found that borrowing costs increased by approximately 10 basis points for some issuers (those with an additional 22% higher bond dollar volume underwritten by exiting banks), and by up to 45 basis points for issuers that had previously raised the majority of bond financing through the exiting underwriters. The study also found that, among remaining competitive offerings, the number of underwriting bidders “declines sharply, the variance among remaining bids increases, and the winning bid in terms of yield to maturity increases after the implementation of the Texas laws for issuers with previous reliance on the exiting banks. These results suggest that the exit of the targeted underwriters from the Texas market has significant impact on underwriter competition and that the remaining banks may enjoy increased market power due to barring banks with certain social and environmental policies from the market.”
Placement of municipal bonds with investors also changed substantially as issuers lost direct access to the distribution networks of the five exited large banks. The authors note that the “large underwriters targeted by the new Texas laws typically have national distribution networks and may be better able to place municipal bonds with a wider array of investors than regional underwriters.” Because Texas municipal bonds are widely held out of state (as a result of the absence of Texas state income tax), the availability of wide distribution was “especially important.”
The study also examined the efficiency of bond placement by comparing the underpricing of new issues before and after implementation of the Texas laws. Although the authors concluded that, on average, underpricing of the municipal bonds was similar both before and after implementation of the laws, they found that “issuers previously reliant on the targeted banks for the majority of underwriting activity face increases in underpricing of about 14 basis points.” The authors also found changes in placement patterns consistent with more costly placement, implying a “higher direct participation of retail investor trades and less dealer intermediation,” and suggesting that issuers substituted the “national intermediation of municipal bonds provided by the exiting banks with a more local placement at higher average costs.”
The authors estimated that Texas entities will pay an additional $303 to $532 million in interest on the $32 billion in borrowing during the first eight months following implementation of the Texas laws. “Assuming no other banks leave the state,” the authors concluded, “Texas taxpayers can expect these bills to cost them about $445 million a year in additional borrowing costs. If more banks leave, these costs will go up.”
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