An empirical evaluation of the relationship between accounting information and municipal bond net interest cost

The objective of this study was to test the association between the surplus/deficit of selected Minnesota municipalities and the net interest cost of the general obligation bonds issued by these municipalities. The effect on net interest cost of the surplus/deficit was tested by employing a pooled time-series cross-sectional design. After modeling the primary determinants of net interest cost, a test of the reaction of net interest cost to changes in the expectation of the surplus/deficit became feasible.

The sample was dichotomized into two groups: those municipalities with positive forecast errors and those municipali ties with negative forecast errors. A two-way analysis of variance was employed to determine if there was a significant difference in the effect on net interest cost between positive and negative forecast errors.

To enhance the validity of this study, an additional test was performed that employed the criteria developed by Standard & Poor's to evaluate the financial condition of municipalities. According to Standard & Poor's, two consecutive years of deficits may indicate fiscal stress. This study employed this criterion in comparing the effect on net interest cost of the bonds of municipalities with two consecutive years of surpluses and municipalities with two consecutive years of deficits.

The ANOVA results of both tests indicate that the surplus/ deficit is not correlated with increases/decreases in the net interest cost of the bonds issued by a municipality. The results were unaffected by the exclusion of bond ratings as an independent variable.