| Summary: | Do political connections increase banks' risks, or do they serve as a financial safety net ex post? Using a data set of lobbying activities undertaken by U.S. financial institutions, this paper reveals lobbying efforts are negatively associated with banks' risks under the presence of government bailouts. First, I find lobbying banks experienced greater reductions in their credit default swap (CDS) spreads after major bailout announcements in 2008 than non-lobbying peers. Next, I reveal lobbying expenses are positively associated with banks' default risks through their effect on the cost structure of bank risk taking (fundamental channel). Lobbying expenses, however, are negatively correlated with banks' default risks through their effect on bank stakeholders' beliefs about the likelihood of default (equilibrium-selection channel) under the presence of bailouts. I show the equilibrium-selection channel has dominated the fundamental channel since bank stakeholders factored in the presence of bailouts in 2008.
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