An Examination of the Effects of Budgetary Control on Performance: Evidence from the Cities

Abstract

According to government statistics, at the end of June 2006, there was over $7 trillion of corporate, state, and local government, asset-backed structured finance bonds outstanding with much of it rated by only a (literal) handful of bond rating companies that establish creditworthiness of corporate entities and of governmental units. Linking bond ratings to performance is important particularly in a governmental setting where credit ratings remain a key feature of municipal debt management, and debt is the key source of capital. Yet we know little about the direct linkage between budgetary control and ultimate bond ratings in this setting. In this study, we examine whether budgetary control is associated with performance, using a sample of large U.S. cities over the 2003-04 timeframe. Subject to the same general legal and regulatory constraints, these cities exhibit tight budgetary control at the organizational level, in large part due to the balanced budget requirements. Within this unique context, we examine whether tightness of budgetary controls or effective level of budgetary control within the cities, as measured by budget variances, contribute to performance, as measured by bond rating. We find that the effective level of budgetary control is significantly and positively related to bond rating, refuting a common, but unfounded, assumption that tight budgetary control is the most effective level of budgetary control. This suggests that city mangers interested in maintaining or improving their municipal bond ratings to manage debt costs may consider paying closer attention to the effective level of budgetary control within the cities, as measured by budget variances.

Keywords: Budgetary Control, Bond Ratings, Public Sector

JEL Classification: H72, H74, M40, M46