We examine the impact of policy uncertainty surrounding U.S. gubernatorial elections on loan contracting outcomes. Loans made to firms headquartered in election states are more likely to include contingency-pricing provisions and financial covenants. The effect is pro-nounced for cash flow-based pricing grids and covenants—vis-à-vis balance sheet-based ones—and is stronger when elections are closely contested. Consistent with efficiency of loan contracting under transitory uncertainty, we find no direct effect on loan spreads. How-ever, an important pricing effect is manifested through interest-rate contingencies in pricing grids. The use of rate-increasing grids increases significantly in election years for the firms with geographically concentrated operations and government contract-dependent ones. Our findings suggest that while the contingency-pricing feature curbs an explicit rise in the cost of loans for borrowers facing elections, loan contracts are designed to ensure compensation to lenders for uncertainty—via interest-rate contingencies—and to factor in increased monitoring demand.

Keywords: uncertainty, gubernatorial election, debt contract, contingency pricing, cost of capital