Download Municipal Market Measures and Reporting Practices: An Extension

Journal of Accounting Research
Vol. 20 No. 2 Pt. II Autumn 1982
Printed in U.SA.
Municipal Market Measures and
Reporting Practices: An Extension
ROBERT W. INGRAM* AND RONALD M. COPELANDf
In a recent paper, Wallace [1981] reported the results of her study on
the effects of accounting and auditing practices of municipal bond issuers
on their borrowing costs and bond ratings. The study concluded that
"interest costs reflect cross-sectional differences in accounting variables
and bond ratings reflect cross-sectional differences in auditors and audit
reports." However, the sample was constrained to municipal issues within
the state of Florida, so she was unable to generalize beyond this sample.
Our study provides an extension of Wallace's research by (1) exfmiining
a more representative sample of United States municipalities, (2) employing alternative meeisures of bond risk and return, and (3) focusing on
state-mandated accounting, auditing, and financial management practices. The magnitude of municipal bond risk and return measures is
hypothesized to be associated with state-mandated practices. Our findings
confirm those of Wallace in that we also found accounting and auditing
practices to be associated with the interest cost and risk of municipal
bonds. In particular, more stringent accounting and auditing requirements were associated with lower interest costs and risk measures.
Methodology
SAMPLE
We selected 122 municipalities for which we could obtain sufficient
observations on their general obligation bond yields and then financial
variables to perform the study. The sample was restricted to noncallable,
noninsured, general obligation issues in order to avoid compounding
problems due to differences in call features and default risk related to
' Associate Professor, University of Iowa; fProfessor, Northeastern University. [Accepted for publication March 1982.]
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Copyright ©, Institute of ProfeK.sional Accounting 1983
MUNICIPAL MARKET MEASURES
767
issue-specific attributes. Rating agencies assign one rating to all of the
generfil obligation bonds of each rated municipality since all general
obligation issues for a municipality share the risks associated with the
issuer's economic capacity.
DEPENDENT VARIABLES
The dependent variables selected for study were bond yield premiums,
changes in yield premiums, emd systematic risk (beta) measures.' Each of
these variables was derived from the offering yield-to-maturity data
published in the Blue List? As a result, they are based on pretransaction
observations in a secondary market,^ rather than on the new bond issue
data used by Wallace.
Since each municipality had a number of bond issues outstanding over
the period and the same issues were not always reported each period in
the Blue List, we had to perform a transfonnation to produce a time
series of yield observations that captured the risk-retiun attributes of
each municipality. This was achieved by calculating yield premiums for
each municipal issue relative to the yield of a corresponding Treasury
bond with equivalent maturity and coupon rate. In notation:
YTt = Yit - Yrt,
(1)
where Yft was the yield premium on security i in month t and Yi and Yr
were the yield to maturity on security i and Treasury bond T for the
same period. Bond yields for the last trading day of each month for the
period August 1976 to February 1979 (31 months) were used for a sample
municipality each month up to a maximum of six issues for each municipality.
The YT were obtained from Moody's Bond Record for each of the 31
months of the study. But since an equivalent maturity and/or coupon
rate was not available for each municipal issue, we had to model the term
structure of Treasury bond yields. The following regression model
achieved an average R^ oi .897:
YT = Yo + yi CT + Y2LMr,
(2)
' Wallace considered bond ratings of the Florida sample as measures of municipal bond
risk and found an inverse relationship between the ratings and the extent of accounting
requirements. In another study, we examined the relationship between general obligation
municipal bond ratings and accounting, auditing, and financial management practices for a
sample of 300 cities in the United States. This study also found an inverse relationship
between bond ratings and the intensiveness of state-mandated accounting practices. See
Ingram and Copeland [1982a].
^ The Blue List is published every business day by a subsidiary of Standard & Poor's
Corporation and contains data about the coupon rate, offering agent, offering yield to
maturity, quantity offered, and issue-specific descriptive information on select municipal
i8sues.
' See Ingram, Brooks, and Copeland [1983] for an extended discussion on the use of Blue
List data as surrogates for market-derived observations.
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JOURNAL OF ACCOUNTING RESEARCH, AUTUMN 1982, PT. II
where CT was the coupon rate for Treasury bond T, LMT was the baseten logarithm of the maturity (in months) of bond T, and y'a were
regression parameters.*
Our initial dependent variable was the average yield premium, computed for each of the 122 sample municipalities for 1977, or:
Y^*=i i Yl,
t-i
i-l
(3)
-
where Y^* is the average yield premium for municipality m and is
sununed over the average premiums for n monthly issues over 12 months
for 1977. The average percentage change in Y^"' for 1977 was also used as
a dependent variable, as follows:
fm = s [YL - y;!,.,-i)/Y*.,-,],
(4)
t-i
where fm is the sum of the first-order percentage changes in the average
monthly yield premiums on municipality m bonds for 1977. The average
percentage change in yield premium was used because the offering yields
obtained from the Blue List probably are biased upward firom actual
yields. While this bias would not affect the results using Ym* if the bias
were systematic across issues for aU cities, the use of the percentage
premium change only requires that the bias be systematic for all issues
of a given city.
A third dependent variable examined was the systematic risk measure
for each sample municipality computed as:
fmt = am + Pm^Mt,
(5)
where fmt is the average change in yield premium on municipality m bond
issues for month t, a eind ^ are regression parameters (with /3 being
systematic risk), and fj^is the market portfolio in month t. The average
change in yield premium on all sample bond issues was used to construct
the market index.^ AU 31 months of data were used to calculate the
regression parameters.
INDEPENDENT VARIABLES
Independent variables used in the study consisted of measures of the
quality of local government accounting, auditing, and financial management practices; bond ratings; and 28 financial accounting ratios representing the economic performance attributes of the municipalities.
'* Approximately 20 observations were used in estimating coefficients for the YT model
each month. The maturity variable was stated in log form to correct for nonlinearity in the
function.
" Alternative indexes (e.g., Moody's Municipal Bond Index) were also employed without
a significant change in values. The index described has the advantage of containing a larger
number of issues than other indexes and demonstrates the same adjustments as the
individual municipal data.
MUNICIPAL MARKET MEASURES
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TABLE 1
Ordinal Measures of State-Mandated Accounting, Auditing, and Financial
Management Practices
Accounting Practices
0 = no accounting or reporting practices specified by state
1 = reporting guidelines or standardized report format specified by state
2 = uniform accounting principles and procedures required by state
3 = both uniform accounting and reporting guidelines and standardized report format
required by state
Auditing Practices
0 = no audit required by state
1 = audit by independent or state auditor required by state
2 = audit by independent auditor required by state
Financial Management Practices
0 = no state requirements associated with local bond financing
1 = state assists in collecting data on bonded debt
2 = state reviews municipal financial data
3 = state approves data before issuance of local securities or prescribes data to be reported
4 = state is actively involved in marketing local bonds
Accounting, auditing, and financial management measures were derivedfi-omPetersen, Cole, and Petrillo [1977], who identified stateregulated practices for each of the threefinancialreporting and disclosure
areas. We transformed the descriptions into ordinal measures to specify
the relative strength of reporting practices mandated by each state. A
description of the ordinal measures is provided in table 1.* The other
independent variables were included because previous research has
shown that bond ratings andfinemcialperformance attributes are important determinants of municipal risk and return.'
Since our primary concern is with the marginal contribution of statemandated accounting, auditing, and financial management practices to
risk-return attributes of municipal bond issues, we examined the intercorrelations between the state-mandated variables and the other independent veuiables. Minimal intercorrelations were observed.
HYPOTHESIS AND TESTS
Assuming state-mandated reporting practices are beneficieil, we tested
the following hypothesis:
Hi: Municipalities in states with more rigorous reporting requirements
demonstrate lower average yield premiums, smaller average yield premium changes, and lower systematic risk measures than those in states
with lessrigorousrequirements.
"See Ingram and Copeland [1982a] for a more complete discussion of the relationship
between state-mandated accounting, auditing, and financial management practices and
municipal bond risk measures.
' See Ingram and Copeland [1982a; 19826] for a list of these variables and for a discussion
of the rationale for their choice.
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R. W. INGRAM AND R. M. COPELAND
MUNICIPAL MARKET MEASURES
771
TABLE 3
Summary Statistics for Regression Models
Yield 1Premium
Dependent Variahle: Beta
Model:
Adjusted R^
F
f
SSE
F Improvement
p Improvement
Full
Reduced
.052
.230
1.02
2.83
.002
.416
177.12
134.22
16.62
<.O1
FuU
.339
6.78
.001
29.58
Reduced
.277
8.51
.001
35.30
10.25
<
Chan
Piremium
Full
Reduced
.267
.102
4.21
1.52
.001
.159
162.45
199.79
11.97
<.O1
The hypothesis was tested by stepwise regression analysis using data
from 1977. The test consisted of comparing the results from two sets of
models. The first was a "full" model developed for each dependent
variable, using the 32 independent variables (28 accounting ratios, bond
ratings, and 3 state-mandated measures) to the extent that additions
improved the adjusted R^. The second was a "reduced" model, which
included all of the significant independent variables from the "fuU" model
except the state-mandated variables. The significance of the state mandates for each dependent variable could then be assessed by measuring
the marginal reduction in unexplained error between the "fuU" and the
"reduced" models.
A procedure described by Neter and Wasserman [1974, pp. 262-64] was
used to determine the significance of the state-mandated variables. For
each dependent variable, an F-ratio was computed as follows:
SSE{R) - SSE{F) /SSE{F)
^
/
<^)
where SSE {R) and SSE {F) are the error sum of squares for the reduced
and full models respectively and N is the sample size.
Results
Coefficients and significance levels for independent variables contained
in the "full" models for each dependent variable appear in table 2.
Accounting regulations were significant for systematic risk and changes
in yield premiums, and auditing regulations were significant for yield
premiums and changes in yield premiums. Financial management regulations were significant only for yield premiums. The coefficients were
negative in all cases, indicating decreases in the respective risk or return
measures. These findings generally are consistent with those of Wallace
[1981].
Comparative results from the two models are shown in table 3. The
R^'a for the "full" models ranged fi-om .230 for the beta measure to .339
for yield premium. Each "full" model was significant at a = .01. The
"reduced" models resulted in a significantly lower explained variance in
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R. W. INGRAM AND R. M. COPELAND
each case, as shown by the F-ratio for model improvement. Hence, the
results are consistent with Hi.
Summary
Results of this study confirm thefindingsof Wallace [1981] that more
strenuous accounting and auditing requirements have a favorable impact
on the risk and return attributes of municipal bonds. This study extends
the findings to a larger set of municipalities and to a secondary market
environment using different risk and return measures than those used by
Wallace.
REFERENCES
COPELAND, R., AND R. INGRAM. "The Association Between Municipal Accounting Information and Bond Rating Changes." Journal of Accounting Research (Autumn 1982, pt.
I): 275-89.
INGRAM, R., AND R. COPELAND. "State Mandated Accounting, Auditing and Finance
Practices and Municipal Bond Ratings." Public Budgeting and Finance (FaU 1982a).
, AND R. COPELAND. "The Association Between Accounting Numbers and Market
Risk of Municipal Bonds." University of South Carolina Working paper. University of
South Carolina, 19826.
, L. BROOKS, AND R. COPELAND. "The Information Content of Bond Rating Changes.
Journal of Finance (1983).
NETER, J., AND W . WASSERMAN. Applied Linear Statistical Models. Homewood, 111.:
Richard D. Irwin, 1974.
PETERSEN, J., L. COLE, AND M . PETRILLO. Watching and Counting. Chicago: Municipal
Finance Officers Assn., 1977.
WALLACE, W. "The Association Between Municipal Market Measures and Selected Financial Reporting Practices.'' Journal of Accounting Research (Autunm 1981): 502-20.