Research on HBCUs and racial bias in the bond market receives award

University of Notre Dame research that found historically black colleges and universities (HBCUs) pay higher fees to issue tax-exempt bonds than non-HBCUs was recently recognized as a “best paper” by the Journal of Financial Economics (JFE).

Pengjie (Paul) Gao, Finance

Pengjie (Paul) Gao, a finance professor at Notre Dame’s Mendoza College of Business, received first place in the prestigious JFE-sponsored Jensen Prizes for Corporate Finance and Organizations. Gao and co-authors Casey Dougal of Florida State University, William J. Mayew of Duke University and Christopher A. Parsons of the University of Washington were recognized for their paper, “What’s in a (School) Name? Racial Discrimination in Higher Education Bond Markets” (Volume 134, Issue 3, December 2019, Pages 570-590).

The research tests the theory originally put forward in Milton Friedman’s book, “Capitalism and Freedom” that “economic development deters the expression of discrimination, racial or otherwise.” Therefore, it should be unlikely that a “product” such as the municipal bond market would exhibit signs of racial discrimination.

The researchers discovered evidence to the contrary.

They collected information from a 23-year (1988-2010) sample of 4,145 tax-exempt municipal bond issues, totaling approximately $150 billion. Of the 965 colleges and universities involved, 102 were HBCUs.

After examining the underwriting fees — the fees that underwriters charge a school to bring a bond offering to investors — Gao and his co-authors found that HBCU issuance costs were about 20 percent higher than for non-HBCUs. A $30 million bond issuance would cost an HBCU about $290,000, compared to $242,000 for a non-HBCU. The difference appears to be due to the fact that it was more difficult for underwriters to find buyers for the HBCU bonds.

The papers considers numerous factors that could possibly explain the difference other than race, such as school attributes, credit ratings and state tax breaks. But Gao and colleagues ultimately conclude that racial animus was the primary driver. Further, the effect was even more pronounced in the Deep South states of Louisiana, Alabama and Mississippi, which rank highest in racial resentment and opposition to affirmative action as measured in the Cooperative Congressional Election Study survey and racially biased social media. The researchers found that HBCUs in those states were paying underwriters three times more to place their bonds relative to HBCUs in other states.

The paper presents several potential solutions to the problem, from lowering the price point for investors to enter this market, to making the associated state tax benefit transferable, to a federal law that designates HBCU bonds as triple tax exempt, applying to federal, state and local taxes.

The Jensen Prize is awarded annually to authors with the best corporate finance and organizations research papers published in the Journal of Financial Economics. The award is named after Michael Jensen, a co-founding advisory editor of the journal.