There are currently no national standards for financial reporting among cities, counties, and states.
This creates significant risk, and there is evidence that the lack of transparency has been exploited.
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Voluntary Disclosure Incentives: Evidence from the Municipal Bond Market
After Ambac’s bankruptcy, issuers of insured debt increase disclosure relative to issuers of uninsured debt. After local per capita income declines or expenditures increase, issuers, particularly those with strong electoral incentives and weak voter oversight, reduce disclosure.
I find that issuers that either suffer a decline in local per capita income or increase spending reduce the quantity and quality of public disclosure. Issuers in counties that experience a negative change in per capita income file 7 percent fewer financial statements and are 33 percent less likely to separately file a budget in the following year than issuers that do not experience a negative change in per capita income. Issuers that increase spending are 4 percent less likely to file financial statements, file 11 percent fewer financial statements and are 22 percent less likely to file a budget in the following year than issuers that do not increase spending. These reductions suggests that, on balance, the desire to capture personal political success tends to outweigh the capital market based motive to provide transparency.
Issuers with relatively strong ex-ante electoral incentives are particularly likely to suppress negative information. By contrast, issuers that are subject to relatively strong voter oversight are less likely to suppress negative information.
Internal Control Deficiencies and Municipal Borrowing Costs
There is some evidence that internal controls tend to be stronger in local governments with effective audit committees (Matkin 2010; Rich and Zhang 2014). There is also evidence that governments often do not properly monitor and assess internal controls after they are created (Roberts and Candreva 2006). And, smaller governments are thought to be more susceptible to financial reporting problems like internal control problems (Modlin 2012).
Municipal bond issuers with material weaknesses are estimated to pay 13–18 basis points more in all four models, compared to clean audits. The impact of having a significant deficiency is not statistically significant in Models 3 and 4.
, from 2005 through 2012;
We find that the total effect of a material weakness is a 17 basis point increase in borrowing costs
Financial Disclosure and Municipal Market Dynamics: What the Research Tells Us
Borrowing costs in GAAP-regulated states are, on average, 15-25 basis points less than in non GAAP-regulated states (Baber and Gore 2008).
• In 15 states, state law requires local governments to comply with GAAP created by the Governmental Accounting Standards Board (GASB) • In 10 states, local government compliance is �unregulated" • In the other 25, local governments follow a state-wide �chart of accounts" that may or may not correspond to GASB standards
Municipal borrowing costs increase by 6 basis points ($319,800 for a typical issue) for every 100 days of audit delay (Edmonds, et. al. 2016)
Non-pro�t hospitals that produce quarterly, unaudited �nancial reports borrow at 10-12 basis points less than those that don't (Marlowe 2016)
When transparency pays: The moderating effect of disclosure quality on changes in the cost of debt
We find that among issuers with the same beginning credit rating in the same local house price change decile, a one-standard deviation improvement in disclosure quality lowers the odds of downgrade by 47 percent and raises the odds of upgrade by 28 percent. This relation is pronounced for issuers in the two most negative house price change deciles for two consecutive years.
##Further work:
When Knowledge Is Power: Evidence from the Municipal Bond Market
I investigate whether access to fundamental information enhances retail investors’ bargaining power, reducing the premium that small municipal bond investors pay over large investors. I find a reduction in this small trade premium after the introduction of an online disclosure repository that lowers retail investors’ information acquisition costs. This finding is limited to issuers whose disclosures are disseminated through the repository. The finding is pronounced for issuers that impose high information acquisition costs on investors ex-ante and those that exhibit high disclosure quality ex-post. These results suggest that as investors’ information sets align, so does their bargaining power with dealers.
Government Financial Disclosures: The Timeliness of State Comprehensive Annual Financial Reports
Does timeliness of financial information matter in the governmental sector?
The effects of GAAP regulation and bond market interaction on local government disclosure