HBCUs pay higher fees to borrow money. Research links that premium to racism.

(Eugenio Hansen / Creative Commmons)

October 1, 2019

Historically black colleges and universities looking to raise money for major projects face higher fees than their non-HBCU counterparts, even when agencies that rate credit risk give HBCU-issued bonds their highest scores, according to research recently published in the Journal of Financial Economics.

There’s one big reason for the additional cost, according to the authors: racial discrimination.

Colleges and universities typically issue bonds to pay for big-ticket items, like a new dorm or athletic facility. Bonds are loans, paid back over time with interest. Multimillion dollar bonds are usually split across different investors, but schools don’t track down those investors. Instead, they pay underwriters. An underwriter buys an entire bond and then finds investors to buy chunks of it.

Out of the pool of bonds the authors studied, non-HBCUs pay on average 81 cents of every $100 raised to underwriters. For a $10 million non-HBCU bond, that’s $81,000 in fees going to an underwriter.

But HBCUs pay on average 92 cents per $100 raised to underwriters — about 14% more, the paper finds.

That’s $92,000 in underwriting fees on a $10 million HBCU bond. HBCUs are higher education institutions founded before 1964 primarily to educate black students, many of whom were barred from predominantly white institutions.

“The underlying notion is it’s harder for an [HBCU] underwriter to find a buyer and they pass the cost on to the schools,” says Bill Mayew, professor of accounting at Duke University and one of the paper’s authors. “That’s where the difference comes from.”

The financial premium is even higher for HBCUs in Alabama, Louisiana and Mississippi, where racial animus runs higher than in other states, according to data the authors analyze. In those three states, the cost to HBCUs for bond underwriting is 106 cents per $100 raised. That’s $106,000 going to an underwriter on a $10 million HBCU bond.

Understanding two types of discrimination

Economists point to two things that typically underlie actions a reasonable person could perceive as racist: statistical discrimination and taste-based discrimination.

Statistical discrimination happens when people take actual or perceived aggregate information and apply it to a specific situation. This happens sometimes in labor markets. A hiring manager considering two candidates from two different demographic groups might believe people from one group are less productive on average than people from the other. The hiring manager might argue they are not being racist in relying on stereotypes. They might say they are simply considering the company’s bottom line productivity.

Taste-based discrimination is discrimination based on personal taste. Someone, “simply has a preference for working with one type over the other,” as economists William Neilson and Shanshan Ying wrote in 2016 in a paper on the relationship between these types of discrimination. The hiring manager’s decision is based purely on distaste or preference for a candidate’s skin color.

“When you think of the notion of race discrimination, that’s a taste-based preference,” Mayew says.

Differentiating between statistical and taste-based discrimination is difficult to do, but important toward understanding why people make decisions that might appear discriminatory.

Credit ratings and insurance: disentangling HBCU discrimination

The authors look at a sample of 4,145 tax-exempt bonds issued from 1988 to 2010 from 965 four-year colleges totaling $150 billion. HBCUs, both public and private, issued 102 of those bonds.

Creditworthiness scores make it possible to parse the two types of discrimination. Ratings agencies like Moody’s and Standard & Poor’s rate higher education institutions’ credit risk. They provide a score that tells investors how likely the school is to default on its bond payments. A triple-A rating, the highest possible, means the college or university is practically assured to make their payments on time.

“You might say it’s not that buyers of bonds are racist, it’s they think those bonds are more likely to default,” Mayew says. “It’s really hard in most settings to disentangle those indications. But in the bond market, we can measure that really well with the credit rating so we can dig into and isolate race effects.”

Insurance is another way the authors rule out statistical discrimination. Universities can get bond insurance, so if they default the bond financer still gets paid back. Credit ratings and bond insurance give financers a sense of an institution’s likelihood of defaulting.

Still, the authors find that “identical [fee] differences are observed between HBCU and non-HBCUs with AAA ratings or when insured by the same company, even before the 2007–2009 financial crisis.”

HBCU bonds also take longer and cost more to offload in secondary markets. Those are markets where investors trade bonds that have already been financed. The authors find that HBCU bonds are 20% pricier than non-HBCU bonds to trade in secondary markets. Larger bonds — those over $50,000 — face a 60% premium. HBCU bonds overall linger 25% longer on secondary markets.

“If you’re going to say you’re talking about race discrimination you’ve got to provide a lot of evidence to make that case,” Mayew says. “That’s a tough piece of evidence to refute.”

Premiums are much higher in parts of the Deep South

If racism were the main driving factor behind higher HBCU bond fees, then HBCUs in states that are more racist should face even higher fees, according to the authors. Broadly capturing racism is not necessarily straightforward. The authors try to do it using a variety of data to rank racial animosity in the 50 states plus the District of Columbia.

They use survey responses capturing resentment and opposition to affirmative action from the Cooperative Congressional Election Study, a large yearly survey of American adults by county. They also turn to state-level data on racist Google searches, and the percentage of white voters in each state who voted for Barack Obama in 2008 compared with the share of white voters who chose John Kerry in 2004. And they consider geocoded racist tweets just after Obama was reelected in 2012.

Alabama, Louisiana and Mississippi scored highest for racial animosity. Georgia was next, but with a sharp drop-off. Those top-three states for racial animosity account for 4.7% of all bond issuances in the sample studied — but 26% of HBCU issuances. In those states, HBCUs pay about three times as much in bond underwriting fees as non-HBCUs, the authors find.

Tax exemptions limit the size of the market

The U.S. municipal bond market is worth almost $4 trillion. Though higher education bonds are a fraction of the total, that submarket is still big enough that taste-based discrimination shouldn’t matter. Anyone can finance a university bond issuance. If a racist investor doesn’t want to finance an HBCU project, there should be plenty of other investors to pony up capital.

But tax exemptions tend to limit university bond markets to the state a school is in. Interest payments are tax exempt if the bond is issued by an entity in the state where the financer is based. Someone living in Louisiana would receive tax-free interest payments by financing a Xavier University of Louisiana bond but not an Alabama State University bond.

The authors argue that a triple tax exemption — with interest payments on university bonds exempt from federal, state and local taxes — could take racism out of the equation. Triple tax exemption would allow HBCUs to, “tap into a larger market where racial preferences are different,” Mayew says.

Barriers to bonds

There’s no good way to quantify how much higher education institutions pay insurers and credit rating agencies, Mayew says, but those entities need to be paid in addition to underwriters. So there are costs to entering bond markets — and when it comes to underwriting, those costs are higher for HBCUs. That may mean some HBCUs pass up raising money through bonds, potentially forgoing major campus improvements.

“Bond markets should be one of the cheapest forms of capital,” Mayew says. “It’s many individual investors, and schools should be able to raise lots of money. And maybe 25 years ago, an HBCU passed up renovating a dorm. These are the opportunity costs schools face.”


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Citation: Casey Dougal, Pengjie Gao, William J. Mayew and Christopher A. Parsons. “What’s in a (school) name? Racial discrimination in higher education bond markets,” Journal of Financial Economics, May 2019, doi:10.1016/j.jfineco.2019.05.010.