Você está na página 1de 29

Managerial Auditing Journal

Auditors and early signals of financial distress in Local Governments


Sandra Cohen Antonella Costanzo Francesca Manes-Rossi
Article information:
To cite this document:
Sandra Cohen Antonella Costanzo Francesca Manes-Rossi , (2017)," Auditors and early signals of financial distress in Local
Governments ", Managerial Auditing Journal, Vol. 32 Iss 3 pp. -
Permanent link to this document:
http://dx.doi.org/10.1108/MAJ-05-2016-1371
Downloaded on: 24 January 2017, At: 11:28 (PT)
References: this document contains references to 0 other documents.
To copy this document: permissions@emeraldinsight.com
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

Access to this document was granted through an Emerald subscription provided by emerald-srm:173272 []
For Authors
If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service
information about how to choose which publication to write for and submission guidelines are available for all. Please
visit www.emeraldinsight.com/authors for more information.
About Emerald www.emeraldinsight.com
Emerald is a global publisher linking research and practice to the benefit of society. The company manages a portfolio of
more than 290 journals and over 2,350 books and book series volumes, as well as providing an extensive range of online
products and additional customer resources and services.
Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee on Publication
Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation.

*Related content and download information correct at time of download.


Auditors and early signals of financial distress in Local Governments

Purpose: The study analyzes whether and how a set of financial ratios calculated on the basis
of financial statement information would allow auditors of Italian Local Governments (ILGs)
to get an indication of LGs financial distress risk and, hence, to support politicians and
managers in promptly detecting financial distress.

Design: A model comprising a set of financial indicators that would distinguish distressed
from non-distressed LGs through a logistic regression approach has been estimated and
applied to Italian LGs. The model is built on the basis of information pertaining to 44
distressed and 53 non-distressed LGs for up to five years prior to bankruptcy and covers the
period 2003-2012.

Findings: The model reveals that the percentage of personnel expenses over revenues, the
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

turnover ratio of short-term liabilities over current revenues and the reliance on subsidies
(calculated as subsidies per capita) are factors discriminating non-distressed LGs from the
distressed ones.

Practical implications: The model could have political and practical implications. The
possible use of this model as a complementary tool in auditing activities might be helpful for
auditors in detecting financial distress promptly, thus potentially enabling politicians and
managers to search for different ways to manage public resources in order to avoid the
detrimental consequences related to the declaration of distress.

Originality/value: This model, contrary to existing models that use accrual accounting data,
applicable to LGs that adopt a modified cash accounting basis.

Keywords:

financial distress; auditing; role of auditors; Local Governments; logistic regression;


accounting; financial distress prediction models, Italy

Article Classification: Research article

1
1. Introduction
All over the world local governments (LGs) are experiencing financial difficulties due to the

global financial crisis; at the same time their citizens ask for the sustainability of basic

services provision and the improvement of their efficiency and effectiveness. The eroding tax

bases and transfer reductions from central governments to LGs have contributed in several

LGs becoming financially distressed. In some countries, like Italy, the introduction of a

decentralized system of public finances, accompanied by fiscal federalism and a reduction of

central government transfers, has shifted the responsibility of managing financial resources
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

from central government to local authorities. Also, the focus of control has changed from the

correct use of governmental grants to the efficient and effective use of citizens' local taxes

(Caperchione and Mussari, 2000). Having New Public Management (NPM) approach as a

starting point which emphasizes private sector management styles coupled with output

controls (Hood, 1995), higher levels of accountability have been progressively required and as

a result the importance of the audit function has been stressed in the public sector (Gendron et

al., 2007). In particular, legislators and standard setters both at national and international level

as well as citizens, taxpayers and other external stakeholders have started paying increasing

attention to financial reporting as a primary medium to enhance public accountability (Ryan et

al., 2002; Steccolini, 2004). Consequently, provided that financial reporting is a tool used by

stakeholders to evaluate how politicians and managers administer public resources, the role of

auditors becomes fundamental in ensuring that reported financial information is accurate,

reliable and relevant (Gendron et al., 2007). Moreover, the financial audit performed by

auditors would unravel signals of financial distress.

Researchers and practitioners have largely investigated the factors affecting the financial

position of LGs and they have provided empirical evidence that this is the outcome of a

combination of internal and external factors (Brown, 1993; Carmeli and Cohen,

2001;Carmeli, 2007; García-Sánchez et al., 2012; Justice and Scorsone, 2012;Navarro-Galera


2
et al., 2015a; 2015b). Therefore, the financial situation of LGs is shaped by a complex and

often unpredictable interaction of environmental and organizational factors. Undoubtedly,

when financial distress occurs, both citizens and the entire local community have to endure a

detrimental impact. Also, the future development of the LG is compromised (Pagano and

Moore, 1985; Watson et al., 2005; Carmeli, 2008).

The aim of this study is to analyze whether and how a set of financial ratios calculated on

the basis of financial statement information would allow auditors of LGs to get an indication

of LGs financial distress risk and, hence, to support politicians and managers in promptly
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

detecting financial distress. Therefore in this study a model based on accounting data having

the power to discriminate LGs which are bankruptcy prone from the healthy ones has been

developed through a logistic regression approach.

Scholars and practitioners have developed so far a large set of models that assess the

financial condition of LGs aiming at getting early signals of possible future financial distress

(e.g. Kloha et al. 2005; Murray and Dollery, 2005; Zafra-Gomez et al., 2009; Cohen et al.

2012; Doumpos and Cohen, 2014; Garcia-Sanchez et al., 2012; Navarro-Galera et al., 2015b).

However, no study so far, to the best of our knowledge, has considered how these models

could be adopted by auditors. Professional auditors are ‘naturally’ prone to adopt tools for

rating the financial condition of LGs. This is highly related to a going concern assessment.

Moreover, in some countries, auditors are specifically requested to give an opinion on local

finances (e.g. the UK and Italy) and sometimes their role in LGs overcomes the typical

borders of accounting auditing, as they are required to support politicians and managers in

getting the most out of the scarce resources available. Therefore a tool providing signals of

financial distress could facilitate them in their work. The distinctiveness of the proposed

approach lies in the possibility of exploiting financial performance indicators of LGs derived

from modified cash-basis financial data rather than from accrual accounting data as most of

3
the models already developed. This is an interesting issue as in several European countries

accounting data are still recorded following modified cash accounting (Brusca et al., 2015),

and so the model can be applied in different contexts.

In this paper, a model comprising a set of financial indicators that would distinguish

distressed from non-distressed LGs through a logistic regression approach has been created

and applied to Italian Local Governments (ILGs, henceforth). ILGs are an interesting and

unusual case in which budgetary accounting (i.e. modified cash accounting) is adopted both

for budget and for accounting purposes during the year, while measurements under the
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

accrual basis only occur for preparing financial statements and for reporting purposes at the

end of the year. Thus, accrual accounting information is not available during the year but is

calculated only as a snapshot. Moreover, auditing is significant in Italy as the Italian law asks

auditors to be highly involved in the financial reporting process. The law mandates the

performance of audits by professional auditors with a high level of experience who are totally

independent of politicians. At the same time, however, auditors should support politicians to

make better use of public resources. In this context, a model able to estimate the probability of

an ILG to become financially distressed built by using information prior to this incidence

would be undoubtedly useful both for auditors, managers and politicians.

To carry out the study a panel of 97 Italian LGs split into two groups according to their

financial status has been considered. In particular, information pertaining to 44 distressed and

53 non-distressed LGs for up to five years prior to bankruptcy have been extracted from the

database provided by the Ministry of Interior for the period 2003-2012

(http://finanzalocale.interno.it). The time period chosen for the collection of LGs information

is relevant to the research question as from year 2003 due to a change in the regime regarding

the treatment of financial costs related to the repayment of the debt of the distressed entities

there was a drastic reduction in the number of entities declaring financial distress. This change

4
motivated several LGs to try to hide their financial difficulties by reporting improper data

(Cortedei Conti, 2014; Anessi Pessina et al., 2008).In this context the importance of the audit

opinion on the true representation of the financial reports and the going concern of the LG

became even more important.

The paper has the following structure: the next section provides a literature review on

financial distress and refers to models developed to identify financial crises in LGs. In the

third section, the role played by auditors as well as features and legislation regulating ILGs

are presented. Section 4 sketches the main assumptions of the proposed model in light of the
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

available data. Section 5 discusses the main results of the analysis. Conclusions, future

developments of the research and possible implications are presented in the last section.

2. Literature Review

Financial distress in the public sector has captured the attention of scholars and

practitioners in the ’70s when some major metropolitan areas in the United States declared

their financial distress (the most famous one was New York in 1975). The concept of

financial distress has also been captured under the terms fiscal crisis, fiscal distress, financial

risk or fiscal strain that are commonly used as synonymous.

Since then, a vast literature has developed, aiming to individuate what causes financial

distress. For instance, some authors considered the imbalance between revenue capacity and

expenditure needs as the critical condition (Pagano and Moore, 1985; Inman, 1995). Others

have pinpointed problems related to the short-run solvency (i.e. the ability to pay current

liabilities) as well as the long-run solvency (i.e. the ability of future resources to face long-

term obligations) (Groves et al., 2003; Padovani and Scorsone, 2012). In any case, solvency

has been related to the tax base (Kloha et al., 2005). Wilson (1984) has detected some signs

which could preannounce financial stress: current expenditures exceeding current revenues by

5
a significant amount; continuous deficit spending by small amounts; and current liabilities

exceeding current assets on the financial statements of LGs. Bradbury (1982) analyses fiscal

distress as budgetary fiscal distress and citizen fiscal distress: the former occurs when

municipalities encounter difficulties in balancing their budgets, the latter occurs when citizens

have levied high taxes and fees for municipal services or when the quality of municipal

services is low.

Part of the literature has focused on local management and political context by considering

financial decline as a consequence of financial mismanagement, poor economic conditions


Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

and dishonesty by the municipal leadership (Martin, 1982; Park, 2004; Landry, 2007; Spiotto,

2008). Also,, exogenous factors have been largely considered by literature, as possible factors

dictating LG financial decisions recognizing in this way that the appropriate fiscal structure

for a government is contingent upon its environment (Howell and Stamm 1979; Skidmore and

Scorsone, 2011). In this realm, some studies on the relationship between the measures of

fiscal distress and local responses strategies have been conducted (Pammer, 1990; Maher and

Deller, 2007). Finally, intergovernmental dynamics between multiple levels of government

have also been investigated as potential source of fiscal stress in LGs (Honadle, 2003;

McDougall and O’Connor, 2005; Jones and Walker, 2007).

Therefore, it is possible to detect two main strands already considered in the literature: a

‘socioeconomic-decline approach’ when scholars pinpoint external factor as the main causes

of financial distress, and a ‘local-management approach’ when they consider that the

management and the political approach prevail (Kihmi, 2008).

Scholars and practitioners have developed so far a large set of models to control for

financial equilibrium and to avoid bankruptcy: Brown (1993) proposed the famous 10-point

test, later updated by Maher and Nollenberg (2009). Hendrick (2004) views governments as

an ‘open system’ identifying three different dimensions of fiscal health: properties of the

6
government’s environment; balance of fiscal structure with the environment; and properties of

the government’s fiscal structure. Other scholars (Honadle, 2003; Kloha et al., 2005) have

based their models on accounting information accompanied by information emanating from

audit reports, while others seem to prefer statistical modeling approaches (Murray and

Dollery, 2005). Practitioners have largely adopted the ICMA Financial Trend Monitoring

System, developed by the City Management Association to support American LGs in

monitoring their financial condition. The fil rouge which links all these models is the attempt

to forecast, therefore, prevent financial distress by presenting early signals that would trigger
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

timely government action (Maher and Deller, 2011). Nevertheless, which are the best

indicators suitable for this purpose and how they should be employed is an empirical question

still open.

The majority of relevant studies until recently has been almost limited to the United States

and Australia (Kloha et al. 2005; Murray and Dollery, 2005). Nevertheless, especially thanks

to the financial crisis started in 2008, studies aiming at developing adequate tools to assess the

relationship between financial indicators and local response strategies started to be also

performed in Europe. However, European studies based on statistical modeling are still quite

scanty, and they are related to LGs adopting accrual accounting systems (Zafra-Gomez et al.,

2009; Cohen et al., 2012; Garcia-Sanchez et al., 2012; Cabaleiro et al., 2013; Navarro-Galera,

2015a). It is worth noting the increasing attention put on possible models based on financial

indicators attuned to prevent financial distress.

3. Italian Local Governments

Italy is a country with a long tradition in the public sector, where the State used to have for

more than a century a strong role in the country’s socio-economic life. This tradition has been

radically changed from the early 1990s when the financial and political crisis, coupled with

the pressure exercised both by the European Union and by the citizens started pushing

7
towards more effective and efficient public administration. These pressures have caused a

shift towards federalization and an increasing trend towards the distinction between political

choices and administrative ones, despite the culture of governance remained highly legalistic

(Ongaro and Vallotti, 2008; Turrini et al., 2010). In Italy, there are 8,147 LGs (8,047

municipalities and 110 Provinces) spread in 20 Regions. ILGs, as forerunners of a large

reform process, have gained the power to levy taxes - even if in most of the cases under a

predetermined range set by the central government - and they have an obligation to provide a

certain array of public services. The Italian central government typically requires ILGs to
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

follow accounting rules defined by law. The annual budget should be balanced, and its

development and follow-up should follow recommended cash and debt management

procedures. At the end of each financial year, ILGs are required to publish a report which

included three documents: the Financial Statement prepared according to the modified cash

accounting basis, and the Assets and Liability Statement plus the Income statement, prepared

by reclassifying financial data in accordance with the accrual accounting principles. All

accounting documents should be audited. Moreover, auditors are requested to answer to a

questionnaire prepared by the National Audit Court in which, among other assertions, they

have to certify the financial health of the local government based on a set of ten indicators, as

discussed below. Additionally, auditors have the duty to signal to the City Council whenever

conditions of financial distress occur.

3.1 Financial Distress in Italian LG

The declaration of distress in ILGs is governed by D.Lgs. 267 issued in 1989. According to

art.244 financial distress occurs when the entity, municipality or province, is no longer able

to perform its essential functions and deliver due services, or when it is no longer able to meet

debt with third parties through the ordinary means of restoring fiscal balance or after

recognizing the debts that have not been included in the balance sheet. The City Council is

8
responsible to officially declare that the LG has entered in a condition of financial distress.

This produces a separation of functions. More specifically, an Extraordinary Board is

appointed by the central government (based on suggestions from the Ministry of the Interior).

Board's task is to prepare a plan to repay overdue debt. At the same time, the municipality’s

institutional bodies have to act towards achieving a stable financial condition by removing the

‘structural causes’ of financial destabilization. In addition, the financial condition of the ILG

is kept under observation by three public institutions: the Ministry of Interior, the National

Audit Court and the State General Accounting Department (which belongs to the Ministry of
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

Economy).

The year 2003 signaled a change on LGs' distress declaration. There was a change in the

regime regarding the treatment of financial costs related to the repayment of the debt of the

distressed entities. While before that law, the financial costs related to loans were assumed by

the central government, the new legislation obliged ILGs to repay on their own and in full, all

costs related to financial distress. The new regulation while drastically reduced the number of

entities declaring financial distress at the same time gave rise to an unanticipated result; many

LGs started to try to hide their financial difficulties by reporting improper data (Corte dei

Conti, 2014; Anessi Pessina et al., 2008).

Moreover, since 2011 a different procedure has been introduced. In case the National

Audit Court identifies any financial difficulties or irregularities, and the LG does not proceed

in any measure to overcome these shortcomings, the Court officially asks for the adoption of

actions necessary to recover the financial equilibrium. In case the situation persists, and the

conditions required by the law are met (the aforementioned art. 244), the Council of the entity

should declare distress within a strict deadline of 20 days. If the described procedure is not

attended, the Council is dissolved and a special Commissioner is appointed directly by the

Ministry of the Interior.

9
Finally, a further possibility has been recently introduced by the Italian law, the so-called

pluriannual financial re-equilibrium procedure. Under this provision, the Council would start

working in order to regain the financial equilibrium avoiding that the National Audit Court

declares that the LG is in financial distress. Nevertheless, the Council needs to obtain the

positive judgment of the National Audit Court before starting this procedure.

The declaration of financial distress has a strong impact on the local community. Tax and

services fees have to be raised to the maximum levels allowed by the Italian law while

managers and politicians are required to cut off expenses and to proceed in all actions
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

necessary to remove the causes of insolvency. Financial distress has effects on municipal

employees as well. The number of employees must be reduced to certain levels defined by

law and new recruitments are not allowed before the complete restoration of the financial

equilibrium.

The Ministry of the Interior in order to periodically assess the financial health of LGs has

developed with the cooperation of the LGs’ association a set of ten financial indicators (which

have to be updated every three years) to identify whether the LGs are showing any signals of

financial distress. The last such set was issued in February 2013 and has no material

differences compared to the previous one. In case the values of more than the half of these ten

parameters of a given ILG are out of the ranges provided by the law, the LG is included in a

‘watching list’. As a result of that, the LG is found under the close supervision of the Ministry

of Interior and it has to increase its local taxes and tariffs for public services.

The criteria chosen by the Ministry of Interior to monitor the financial condition of the ILGs

are the following. Exceeding the defined threshold per criterion means failure in meeting it.

1) Negative financial results up to2.5% of the current revenues where financial results

stand for the algebraic sum of cash, receivables and payables at the year-end;

10
2) Unpaid operating expenses of the current year up to 50% of the ascertainment of

operating expenses;

3) Total amount of expenses for employees higher than 38% of the current revenues;

4) Financial debts up to 160% of the current revenue for entities presenting positive

financial result (up to 140% of the current revenue for entities presenting negative

financial result);

5) Unrecorded debts up to 1% ascertained current revenues in all the last three financial

years;
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

6) Ascertainment of unpaid anticipation by Treasury up to 5% of current revenues;

7) The total amount due for forced execution procedures of payment up to 0.5% of

operating expenses;

8) The total amount of assets to be sold or the use of financial results up to 5% of the

current expenses for covering financial unbalance.

The model developed in this study albeit aiming at predicting LGs financial failure does

not use any of the predictors listed above for two main reasons. Firstly, as the ILGs know that

they are assessed against these benchmarks, they are expected to try to keep their scores

within the eligible ranges at least for a significant number of them. Secondly, LGs reporting a

negative operating result are more likely to declare bankruptcy by definition. Therefore,

including this variable in a bankruptcy prediction model dominates all others.

Since 1989 and until 2013, 495 ILG (Corte dei Conti, 2014) declared financial distress.

The majority of the financial distressed ILGs are located in the south of Italy, which is the less

economically developed area of the country (Tabellini, 2010). Actually, 239 distressed

municipalities which constitute the 55% out of the total cases are located in two Italian

southern regions (Campania and Calabria). Small ILGs are more failure-prone: in fact, 318

ILGs of the total failed have less than 5,000 inhabitants, while only 5 LGs have more than

11
60,000 inhabitants. Data highlights how reduced financial resources and poor management in

money collection and payments (Manes Rossi, 2011) coupled with difficulties in attracting

new financial resources or adopt structural changes do not allow small LGs to cope with

extraordinary events and as a result push them towards financial distress. Figure 1 shows the

number of ILGs failed per year starting from 2003 up to the year 2012.

[FIGURE 1 ALMOST HERE]

3.2 The role of auditors in ILGs

Since 1990 in all ILGs an independent audit board composed of professionals has to be
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

appointed. In particular, one auditor is required in entities with less than 15,000 inhabitants

while a committee of three auditors is necessary for municipalities with more than 15,000

inhabitants. Their duty is to audit the accounting data during the year, the budget and all other

documents that are part of the financial reports. Auditors have to prepare an Audit Report that

is annexed to the Statement of Accounts, in which they make remarks and proposals aiming at

the improvement of LGs' efficiency as well as productivity and performances (Bisogno et al.,

2014). The legislation referring to the auditors was updated in 2000 (D. Lgs. 267, art. 234-

241), and it requires auditors to closely cooperate with the City’s Council, according to the

City’s Statute and internal rules, in order to support the ILGs’ Council in attempting the goals

of efficiency, effectiveness and good performances in LGs' management. Also, the Board of

Auditors has to control for both reliability and adequacy of revenues during the year, as well

as for the consistency of expenses, in order to ensure financial equilibrium. Quarterly audits

on cash are also compulsory. Last, but not least, auditors, while supervising the management

of the ILGs, should signal to the City Council serious irregularities. By the same token, City

Councils have to abide by the suggestions postulated by the auditors. In this framework, it is

obvious that the auditors in the ILGs have increased responsibilities that go beyond the

traditional financial audit of the published financial statements. They are supposed to act as

12
objective watchdogs of good financial governance providing indications of financial distress

and giving advice and guidance to management.

The role of auditors concerning the declaration of financial distress is even important. They

are involved just from the beginning in the process as they are entrusted with the task to

indicate whenever the declaration of distress is unavoidable and whether it cannot be

postponed. They also get active immediately after the declaration of distress, as they are

supposed to provide the necessary support to politicians and managers in regaining LGs'

financial equilibrium. In this setting, having a reliable model able to characterize the tendency
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

of LGs towards financial distress would be useful not only to support managers and

politicians in the adoption of appropriate strategies to regain financial equilibrium but also to

help auditors in playing their role as gatekeepers of LGs financial health.

4. Data and research design

The present study aims at developing a model that could support auditors to promptly

recognize whether there are signals of LGs bankruptcy. The ratios selected are based on both

Italian practice on assessing financial condition of ILGs ( i.e. the Rating system of the Bureau

van Dick for the Italian Local Governments (https://aidapa.bvdinfo.com/)) and international

literature (Zafra-Gómez et al., 2009, Cabaleiro et al., 2013; Cohen et al., 2012; Brusca et al.,

2015; Navarro-Galera et al. 2015a). They account for solvency (i.e. the capability to respond

to obligations) the ability to cover expenses for which the LG is committed to (e.g. personnel

expenses) (Groves et al., 2003), financial autonomy that decreases the possibility of default

(Cabaleiro et al., 2013) as well as financial and economic equilibrium. All ratios are measured

on the basis of modified cash accounting information. Following a theoretical reasoning, it is

possible to expect that the increase of current revenues in relation to both financial liabilities

and operating expenses would lead to a lower uncertainty in LGs financial conditions because

13
of their relative stability during the medium term, which would support financial

sustainability. Furthermore, since own revenues are directly dependent upon decisions taken

by LGs, they can be maintained over the years, thus reducing the risk of default.

Table 1reports the calculation and the description of the indicators exploited in this study to

analyze the ILGs risk of financial failure. In Table 1 the column referring to the expected sign

for each indicator corresponds to the expected relation with the default risk predicted by the

estimated logit model (see Section 5).

(INSERT TABLE 1)
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

The study covers the period 2003-2012. The time period is relevant to the research

question as from the year 2003 the law N.289/2002 changed the regime regarding the

repayment of the debt of distressed entities. Before that law, the financial costs related to

loans were assumed by the central government while the new legislation obliged ILGs to

repay on their own and in full, all costs related to financial distress. The new regulation had,

as a result, the number of entities declaring financial distress to reduce. However, it gave rise

to the phenomenon of LGs trying to hide their financial difficulties by reporting improper data

(Corte dei Conti, 2014; Anessi Pessina et al., 2008).

Collecting information about all the 58 distressed LGs in the period 2003-2012 has not been

possible due to the lack of available data. Thus, the final sample is a panel of 97 ILGs divided

in 44 distressed (out of the population of 58 distressed), and another 53 non-distressed ILGs

covering the period 2003-2012. For each ILG financial information have been collected for up

to five years prior to the declaration of distress. The total sample is 485 ILG observations. To

reduce differences as a source of variation, the non-distressed LGs have been matched from

the population of LGs on the basis of some covariate values one year prior to bankruptcy. In

particular, the geographical region (provinces) was considered as the matching covariate for

the non-distressed group (Heckman et al., 1998) as it condenses many dimensions of interest.

14
In fact, as regards the Italian context, the geographical location tends to incorporate

information about migration, history, socio-economic characteristics, climate, topography,

neighboring areas and so on (Goff et al., 2008). Our matching criterion approach is based on

selecting all contiguous pairs of non-distressed LGs that share a common geographic

relationship within the interquartile range of population size1 and within the interquartile

range of per-capita GDP of the distressed group. In this process, 290 unique paired non-

distressed LGs were obtained among which 44 observations have been randomly selected.

Table 2 reports group statistics of the financial indicators exploited in this study.
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

(INSERT TABLE 2)

The main summaries confirm the expected direction of the indicators' values for distressed

and non-distressed LGs. More specifically, distressed LGs have a higher contribution of

personnel cost to total revenues (meand = 0.376 and meannd = 0.329), they pay more interest

as a proportion of their revenues (meand = 0.066 and meannd = 0.052). Also, short term

liabilities for distressed municipalities correspond to a higher percentage of their revenues

(meand = 0.8808 and meannd = 0.485) while their operating expenses are higher than operating

revenues, a phenomenon that is not encountered in the non-distressed group (meand = 1.025

and meannd = 0.934). Similarly, the higher average value assumed by the SUB_P indicator for

distressed LGs compared to the non-distressed group confirms our theoretical reasoning that

the proportion of LGs operating in a poor environment are granted with higher subsidies

(meand = 959.46 and meannd = 270.35). The former group of LGs might be facing difficulties

in obtaining own revenues which raises the probability of default. On the contrary, the

average value of the indicator CR_FL is larger for non-distressed LGs indicating that their

financial burden as a percentage of their revenues compared to the distressed group is lower

than non-distressed LGs (meand = 1.265 and meannd = 1.810).


1
LGs have been divided into ‘small’ LGs (<15000 inhabitants equal to 40 non distressed and 34 distressed ) and
non-small LGs (>15000 inhabitants equal to 13 non distressed and 10 distressed). Notice that in the examined
sample the number of small LGs is larger than the non-small LGs subgroup.

15
4.1 Methodology
In this study, a logistic regression (LR, henceforth) approach has been exploited in order to

predict the LGs risk of financial distress. The generic form of the model can be expressed as

follows:

 = ( ,  ;
) (1)

where = 1, … , ,  is the vector of the continuous financial indicators reported in Table 1

considered as explanatory variables for the  LG;


is the vector of parameters to be
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

estimated and  is i.i.d. (independent and identically distributed) and logistically distributed.

The response variable  is dichotomous coded 1 for distress condition and 0 otherwise.

Differently from other parametric classification methods (e.g. discriminant analysis, DA), LR

does not have requirements for data normality and equal dispersion of covariance matrices of

groups (James et al., 2013).

Following Altman (1968) the logit function has been estimated on the training set consisting

of LGs data referring to one year prior the declaration of distress. On the other hand, to

evaluate the long-range predictive power of the estimated model LGs data from the second up

to the fifth year prior bankruptcy has been considered as a validation set. The analysis was

carried out in steps. Starting from the training sample, the probability of bankruptcy has been

estimated. In order to attain the “best” set of bankruptcy predictors, stepwise analysis has

been exploited as a criterion for ranking importance. The significance of each coefficient was

tested using the Wald statistic, while the overall significance of the logistic regression was

assessed by the likelihood ratio test (Long, 1997).

The predictive ability of the estimated model is tested by using data up to five years prior to

LGs financial distress. In this framework, the resulting LGs probabilities of failure might be

16
considered as a measure of the management effectiveness on a yearly basis providing auditors

with a complementary tool to investigate and prevent the risk of financial failure.

5. Empirical findings and classification accuracy

The final logit model is reported in Table 3. It illustrates the estimated coefficients, Coef (),

their standard errors, . , and the associated p-values. The variables RPER and SUB_P

appear statistically significant in affecting the probability of financial distress at 5%

significant level (p-value < 0.05,  = 5%) while the variable STL_CR is statistically
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

significant at 1% (p-value < 0.000,  = 1%). The other variables are not statistically

significant.

(INSERT TABLE 3)

The correlation matrix in Table 4 illustrates the relationships among the involved financial

predictors. While the association between the variables SAT and CR_FL and OP_CR and

RPER is not negligible. Overall, the estimates provided by the model can be considered

reliable for assessing the risk of LGs' financial distress.

(INSERT TABLE 4)

In logistic regression, the estimated coefficients give the change in the log odds of the

outcome for a one-unit increase in the predictor variable (Scott, 2005). In such a case, for one

unit increase in RPER, the log odds of going bankrupt increases by about 6.8, while for one

unit increase in STL_CR the log odds of being distressed increases by about 2.6. The variable

SUB_P seems to be not particularly important regarding the effect on the probability of

financial failure. This is a variable associated with subsidies received to compensate poor or

disadvantaged economic condition affecting the entity; but, it is worth noting that in

accordance with the progressive federalism adopted by the Italian Government, subsidies are

going to be progressively reduced.

17
Besides, in order to determine whether a particular exposure is a risk factor for LGs

bankruptcy, and to compare the magnitude of various risk factors on the financial distress

conditions the results are presented in terms of odd ratios, Exp ().

In this case, the model suggests that for one unit increase in the value of STL_CR the risk of

being distressed increases by a factor of 14%. The results confirm previous researches

undertaken in different countries estimating the effect of short and long-term liabilities on the

likelihood of default (Cabaleiro et al., 2013; Navarro Galera et al., 2015a). On the other hand,

the risk of distress increases enormously as the value of RPER indicator increases by one. The
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

findings are consistent with results reported by research already undertaken in the public

sector (Hájek P. and Olej, 2008; Puntillo, 2012).

The predictive ability of the estimated model has been tested through the sensitivity and the

specificity coefficients reported, as percentages, in the main diagonal of Table 5.

(INSERT TABLE 5)

The fitted model correctly predicted 75% of all distressed LGs and 77.1% of all non-

distressed observations. The secondary diagonal illustrates the miss-rate (i.e. the percentage of

false positive LGs of all distressed LGs) and the fall-out rate (i.e. the percentage of false

negative LGs of all non-distressed units), respectively. The fall-out rate is about 25% while

the miss rate is about 23%. The overall predictive accuracy of the model is about 77%.

Lastly, the long range predictive power of the estimated model has been estimated by

exploiting data collected up to five years prior the bankruptcy (test set) and via bootstrapping

procedures2of the training sample. The prediction accuracy of the estimated model is

illustrated in Table 6.

(INSERT TABLE 6)
2
Five replications of the analysis on five bootstrap sampling from the training set. The predictive ability along
time appears not so different from the results reported in Table 4. Results not tabulated as they are
qualitatively the same to the ones reported in Table 6.

18
As expected, the overall predictive power decreases as long as data from two to five years

before the declaration of financial distress are considered. Notwithstanding, the model appears

more suitable to correctly detect non-distressed LGs rather than distressed ones. In other

words, it preserves a better sensitivity (i.e. correctly categorizing non-distressed LGs as non-

distressed ones) than specificity (i.e. correctly categorizing distressed LGs as distressed ones),

while its power slightly decreases, as expected, throughout time.

Therefore, the application of the model would provide auditors with early signals about the
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

possibility of a LG to run bankrupt in the short run. On the other hand, the model would

provide supportive evidence in favor of LGs that do not exhibit signs of future distress.

6. Final Remarks

ILGs face several critical situations which can result in a distress condition: improper

management of resources, delay in the payment of debts, high level of personnel expenses,

difficulties in cashing receivables (especially those related to tax), to name a few. Moreover,

the coexistence of those factors, coupled with other environmental factors such as the

federalization of taxes and services which have reduced governmental grants for ILGs, often

lead LGs to financial distress conditions.

Literature has already highlighted that financial distress is a multidimensional concept and

that financial dimensions are related to each other (Wang et al., 2007). Some studies

performed by rating agencies (e.g. Fitch, Moody’s, Standards & Poor’s) as well as scholars

(Capaldo et al. 2011, Navarro-Galera et al., 2015b) have related economic and social

conditions to financial distress. We also acknowledge that financial distress does not evolve

only for one single reason. LGs’ financial vulnerability is affected by diverse and interacting

factors, acting simultaneously. However, in this study we follow a "local-management

approach" which focuses on the actions of internal management of LGs which is reflected on

the financial statements as the origin of financial decline.

19
More specifically, the present study – aiming at developing a model which could be used by

auditors in order to assist them in supporting LGs in preventing financial distress - belongs to

the strand of literature which measures financial condition solely on the basis of accounting

data. Therefore the model is strictly constrained to accounting data availability (Altman,

1968; Zafra-Gomez et al., 2009; Cohen et al., 2012; Padovani and Scorsone, 2012). We

consider this to be a merit of the model as it is self-sufficient and it does not depend on

exogenous data to provide assessment results.


Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

ILGs provide an excellent sample to assess bankruptcy prediction models, as LGs in Italy

actually declare bankruptcy in contrary to LGs in other European countries. The proposed

model, based on logistic regression approach, allows asserting that a set of indicators built on

the basis of accounting data (measured under modified cash basis information) can assist

auditors in Italian LGs in detecting financial distress promptly, thus potentially enabling

politicians and managers to search for different ways to manage public resources in order to

avoid the detrimental consequences related to the declaration of distress. The model revealed

that the percentage of personnel expenses over revenues, the turnover ratio of short-term

liabilities over current revenues and the reliance on subsidies (calculated as subsidies per

capita) are factors discriminating non-distressed ILS from the distressed ones.

Nevertheless, there are some limitations in our study. Firstly, the model progressively loses its

predictive power in the medium term. However, this is a limitation inherent in all predictive

models. Second, the model is solely based on accounting data. This makes the model easy to

apply but on the other hand, it cannot encapsulate information about the quality of municipal

services. Thirdly, the sample size is rather small because it aimed at covering a homogeneous

period regarding bankruptcy policy. However, it includes the 75% of the bankrupt ILGs for

the period in question (it covers 44 out of the 58 bankrupt ILGs).

20
The model developed could also be applied to other countries where modified cash

accounting is adopted, and it provides an easy tool to monitor and signal financial distress.

Nevertheless, our research does not offer an exhaustive set of measures detecting financial

distress. It would be rather considered as a useful starting point for future analysis aiming at

supporting auditors to early diagnose LGs in financial distress. Further studies would add to

the financial distress detection models indicators related to outcomes that would be useful to

policy makers and financial stakeholders to assess the financial condition of LGs. Moreover,

the models could be enhanced by the inclusion of other demographic and socioeconomic
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

factors such as population density, immigration and unemployment rates. From another point

of view, investigating the reasons why LGs go bankrupt despite the application of monitoring

tools enforced by law aiming at preventing this exact event, could help auditors and, in turn,

politicians and managers to understand the roots of this failure.

REFERENCES

Abdesselam, R. (2006), "Mixed principal component analysis", in Nadif, M. and Jollois, F.X. (Ed.), Actes des
XIIIe`mes Rencontres SFC-2006, Metz, France, pp. 27-31.
Agresti, A. (1996),An introduction to categorical data analysis, John Wiley, New York.
Altman, E.I. (1968), Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The
Journal of Finance, Vol 23, No. 4, pp. 589-609.
Anessi Pessina, E., Nasi, G. and Steccolini I. (2008), "Accounting reforms: determinants of local governments’
choices." Financial Accountability& Management, Vol. 24, No. 3 pp. 321-342.
Bisogno, M., Manes Rossi, F. and Tartaglia Polcini, P. (2014), “ La qualità della revisione negli enti locali
italiani”, Azienda Pubblica, No. 3, pp.278-294.
Bradbury, K.L (1982),“Fiscal Distress in large U.S.”, New England Economic Review, (January /February), pp.
33-43.
Brown, K. W (1993),“The 10-Point Test of Financial Condition: Toward an Easy-to-Use Assessment Tool for
Smaller Cities”, Government Finance Review,Vol. 9, No. 6, pp. 21–26.
Brusca I., Caperchione E., Cohen S. and Manes Rossi F. (2015), Public Sector Accounting and Auditing in
Europe. The Challenge of Harmonization. Palgrave Macmillan, Hampshire, England.
Brusca, I., Manes Rossi, F. and Aversano, N. (2015), Drivers for the financial condition of Local Government: a
comparative study between Italy and Spain”,LexLocalis, Vol. 13, No.2, pp.161-184.
Cabaleiro R, Buch E. andVaamonde A. (2013), “ Developing a method to assessing the municipal financial
health”, The American Review of Public Administration, Vol. 43, No. 6, pp. 729–751.
Capaldo, E., Grossi, G. Ianni, L. and ,Sargiacomo, M. (2011) Financial Distress in the Italian Local
Governments in Yearbook of Swiss Society of Administrative Sciences, SGVW,Zurich,pp.81-92.
Caperchione, E. and Mussari, R. (2000),Comparative issues in LG accounting, Kluwer Academic Publishers,
Norwell, Massachussets.
Carmeli, A. (2007), “The Effect of Fiscal Conditions of LG Authorities on Their Economic
Development”,Economic Development Quarterly, Vol. 21, pp. 1-8.
Carmeli, A. (2008), “The fiscal distress of LG in Israel”, Administration & Society, Vol. 30, No. 8, pp. 984-1007.

21
Carmeli, A., and Cohen, A. (2001), “The financial crisis of the local authorities in Israel: A resource-based
analysis”, Public Administration, Vol. 79, No. 4, pp. 893–913.
Cohen, S.,Doumpos, M., Neofytou, E., and Zopounidis, C. (2012), “Assessing financial distress where
bankruptcy is not an option: An alternative approach for local municipalities”, European Journal of
Operational Research, Vol. 218, No. 1, pp. 270-279.
Corte dei Conti (2013), Relazione sulla gestione finanziaria degli Enti Locali - esercizi 2011 – 2012.
Corte dei Conti (2014),Audizione sul D.D.L. disposizioni urgenti in materia di finanza
locale,availableathttp://www.corteconti.it/export/sites/portalecdc/_documenti/controllo/sez_autonomie/201
4/audizione_21_marzo_2014.pdf (last visit20/03/2016)
Doumpos, M. and S. Cohen (2014), “Applying data envelopment analysis on accounting data to assess and
optimize the efficiency of Greek local governments”, Omega, Vol. 46, pp. 74-85.
García-Sánchez, I.M., Cuadrado-Ballesteros, B., Frías-Aceituno, J.V.andMordan, N. (2012),“A New Predictor of
Local Financial Distress”, International Journal of Public Administration, Vol. 35, No. 11, pp.739-748.
Gendron, Y., D. J. Cooper and B. Townley, (2007), The Construction of Auditing Expertise in Measuring
Government Performance. Accounting, Organizations and Society, Vol. 32, No. 1, pp. 101-129.
Groves, S.M. and Valente, M.G. (2003),Evaluatingfinancial Condition: a handbook for LG, 4th ed., International
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

City/Country Manager Association (ICMA),Washington DC.


Hájek P. and Olej V. (2008), “Municipal Creditworthiness Modelling by Kohonen’s Self-organizing Feature
Maps and LVQ Neural Networks, Artificial Intelligence and Soft Computing”, In ICAISC 2008 Lecture
Notes in Computer Science 5097, pp. 52-61.
Heckman J., Ichimura J and P. Todd (1998), “Matching as an Econometric Evaluation Estimator”, Review of
Economic Studies, Vol. 65, No. 2, pp. 261-294.
Hendrick, R. (2004), “Assessing and Measuring the Fiscal Heath of LG: Focus on Chicago Suburban
Municipalities”, Urban Affairs Review, Vol. 40, No. 1, pp. 78-114,
Honadle, B. W. (2003), “The states’ role in U.S. LG fiscal crises”, International Journal of Public
Administration, Vol. 26, No. 1, pp. 1431–1472.
Hood, C.A. (1995),“The NPM in the 1980s: Variations on a Theme”,Accounting, Organizations and Society,
Vol. 20,No. 2/3, pp. 93-109.
Howell, J. M. and Stamm, C. F. (1979),Urban fiscal stress: A comparative analysis of 66U.S. cities.,MA:
Lexington Books,Lexington.
ICMA (2003),Evaluating Financial Condition: A Handbook for Local Government, The International
City/County Management Association.
Inman, R.P. (1995),“How to have a fiscal crisis: lessons from Philadelphia”. American Economic Review, 85 (2),
378-383.
James G, Witten D., Trevor H.& R. Tibshirani (2013),An Introduction to Statistical Learning. Springer
Jones, S. & Walker, G. (2007),“Explanators of LG Distress”,Abacus,Vol. 63, No. 3, pp. 396-418.
Justice,J. B., & Scorsone, E. A (2012), “Measuring and predicting local government fiscal stress: Theory and
practice”. In Levine, Justice J. B &Scorsone E. A (ed.) Handbook of local government fiscal health, Jones
&Bartlett Burlington, MA, pp. 43-74.
Kihmi, O, (2008), "Reviving Cities: Legal Remedies to Municipal Financial Crisis, Boston Univeristy Law
Reivew, Vol. 88, pp. 633-684.
Kloha, P., Weissert, C. S. and Kleine, R. (2005),“Developing and testing a composite model to predict local
fiscal distress”. Public Administration Review, Vol. 65, No, 3, pp. 313-323.
Landry, R. (2007), “Causal factors leading to municipal bankruptcies: A comparative case study”, Municipal
Finance Journal, Vol. 28, No. 1, pp.19-36.
Long, S. (1997), Regression Models for Categorical and Limited Dependent Variables. Sage Publications, Inc.
Maher, C. S. and Nollenberger, K. (2009), “Revisiting Kenneth Brown's 10-Point Test”, Government Finance
Review, Vol. 25, No. 5, pp. 61-66.
Maher, C.S. and Deller S.C. (2011), “Measuring Municipal Fiscal Condition: Do Objective Measures of Fiscal
Health Relate to Subjective Measures?”, Journal of Public Budgeting Accounting and Financial
Management, Vol. 23, No. 3, pp. 427-450.

22
Maher, C.S. and Déller, S. C. (2007), “Municipal Responses to Fiscal Stress”, International Journal of Public
Administration, Vol.30, pp.1549-1572.
Manes Rossi, F. (2011), “Analysis of solvency in Italian LG: the impact of Basel II”, The IUP Journal of
Financial Risk Management –The Icfai University Press. Vol. 8, No. 3, pp. 17-42.
Martin, J. K. (1982), Urban financial stress – Why cities go broke, Auburn House Publishing CompanyBoston,
Massachusetts.
McDougall, A. and O’Connor, K., (2005), “The Importance of Proximity in Economic Competitiveness:
Rethinking the Role of Clusters in Local Economic Development Policy”, Australasian Journal of
Regional Studies, Vol. 11, No. 1, pp. 3-24.
Murray, D. and Dollery, B. (2005),“Local council performance monitoring in New South Wales: Are ‘at risk’
councils really at risk?”, Economic Papers, Vol. 24, pp. 332–345.
Navarro-Galera, A., Lara-Rubio, J., Buendía-Carrillo, D., and Rayo-Cantón, S. (2015a), "What can increase the
default risk in local governments?",International Review of Administrative Sciences, 0020852315586308 -
first published on 29 December 2016.
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

Navarro-Galera, A., Rayo-Cantón, S., Lara-Rubio, J. and Buendía-Carrillo, D., (2015b), "Loan price modelling
for local governments using risk premium analysis", Applied Economics, Vol. 47:58, pp 6257-6276.
Ongaro, E. and Valotti, G. (2008), “Public management reform in Italy: explaining the implementation gap”,
International Journal of Public Sector Management, Vol. 21, No. 2, pp.174-204.
Padovani, E. and Scorsone, E. (2012), “Measuring financial health of LG: a comparative framework”,
Management of crisis situations by the state and the administration- The Swiss society of administrative
sciences yearbook.
Pagano, M. and Moore, R. J. T., (1985), Cities and fiscal choices: a new model of urban public investment,
Duke University Press, Durham.
Pammer, W. J. (1990), Managing Fiscal Strain in Major American Cities: Understanding Retrenchment in the
Public Sector. Greenwood Press,New York.
Park, K. (2004),“To file or not to file: the causes of municipal bankruptcy in the United States”, Journal of
Public Budgeting, Accounting and Financial Management, Vol.16, No. 2, pp.228-256.
Puntillo P. (2012), “Predictive models of default risk in LG. A logistic regression”, In Financial Reporting
Workshop, Naples (Italy), 14-15 June 2012.
Ryan, C., Dunstan, K. and Brown, J., (2002),“The value of public sector annual reports and annual reporting
awards in organizational legitimacy”,Accounting, Accountability and Performance,Vol. 8, No. 1, pp. 61-76.
Skidmore, M. and Scorsone, E. (2011),“Causes and consequences of fiscal stress in Michigan Cities”,Regional
Science and Urban Economics, Vol. 41, No. 4, pp. 360-371.
Spiotto, J.E. (2008),“Chapter 9: The last resort for financially distressed municipalities”, in Feldstein S.G.,
Fabozzi F.J., The Handbook of Municipal Bonds, John Wiley & Sons.
Steccolini, I. (2004),“Is the Annual Report an Accountability Medium? An Empirical Investigation into Italian
LG”, Financial Accountability & Management, Vol. 20, pp. 327–350.
Tabachnick, B.G. and Fidell, L.S. (1996),Using Multivariate Statistics. Harper Collins College Publishers.
Tabellini, G. (2010), “Culture and institutions: economic development in the regions of Europe”, Journal of the
European Economic Association, Vol. 8, No. 4, pp. 677-716.
Turrini A., Cristofoli, D., Nasi, G. &Soscia, I., (2010), “Lifting the veil of Maya: Measuring the implementation
gap of public management reforms in Italy”, International Journal of Public Sector Management, Vol. 23,
No. 1, pp. 5 – 21.
Wang, X., Dennis, L. &Tu, Y. S. (2007), “Measuring Financial Condition: A Study of U.S. States”, Public
Budgeting & Finance, Vol. 27, No. 2, pp. 1–21.
Watson, D. J., Handley, D.M. and Hassett, W.L. (2005), “Financial distress and municipal bankruptcy: The case
of Prichard, Alabama”, Journal of Public Budgeting, Accounting and Financial Management, Vol. 17, No.
2, pp.129-150.

23
Wilson, R.A. (1984),Allocating and reallocating financial resources in an environment of fiscal stress,
University of Arizona, Center for Study of Higher Education, Tucson, Arizona.
Wilson, S. (1978), “Choosing between Logistic Regression and Discriminant Analysis”, Journal of the American
Statistical Association, Vol.73, No. 364, pp. 699-705.
Zafra-Gómez, J. L., López-Hernández, L. M., and Hernández-Bastida, A. (2009), “Developing a Model to
Measure Financial Condition in LG: Evaluating Service Quality and Minimizing the Effects of the
Socioeconomic Environment: An Application to Spanish Municipalities”, The American Review of Public
Administration, Vol. 39, No. 4, pp. 425-449.

Biographical Details (if applicable):

Francesca Manes Rossi is Associate Professor in the Department of Management and Information Technology
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

at the University of Salerno where she teaches, researches and consults on public accounting, auditing and
performance measurement in public entities. Her research work has been published in several ranked journals
and has been presented in several international conferences.

Antonella Costanzo is Ph.D.in Economics and Quantitative Methods at the University of Cassino and Southern
Lazio. She works as jr. Researcher (CTER) at National Institute for the Evaluation of the Education and Training
(INVALSI). She researches on statistical modelling, applied statistics in economics and educational fields.

Sandra Cohen is an Associate Professor of Accounting in the Department of Business Administration at Athens
University of Economics and Business. Her research interests lie in the fields of "Public Sector Accounting",
"Management accounting" and “Intellectual Capital”. Her research work has been published in several ranked
journals and has been presented in several international conferences.

24
Auditors and early signals of financial distress in Local Governments

Figure 1.Number of ILGs failed in the period 2003 to 2013.


Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

Source: Corte dei Conti 2014

0
Table 1.Description of the ratios selected for the model

Indicator Calculation Expected Explanation


sign
RPER Personnel expenses + The higher the proportion of personnel expenses to
/Current Revenues revenues, the lower the available resources of LG to
devote to other operating expenses. Thus, this would
contribute to financial strain as salary expenses are rather
inflexible
SAT Interest + Interest bearing debt is a typical source of insolvency. The
Expenses/Current larger the proportion of revenues that has to be devoted to
Revenues the coverage of interest obligation the higher the risk of
bankruptcy
CR_FL Current - When a LG is not heavily indebted compared to its yearly
Revenues/Financial generation of revenues is less likely to get bankrupt. The
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

Liabilities amount of financial debts should be proportionated to the


ability to obtain revenues from current operation
STL_CR Short term Liabilities/ + The higher the size of the outstanding liabilities compared
Current Revenues to the yearly generated revenues the higher the bankruptcy
risk . This is a turnover ratio that refers to how many times
short term liabilities are sufficient to cover LGs' own
revenues Short term liabilities correspond to short term
bank loans as well as short term debts to suppliers,
contractors, and other accounts payable
OP_CR Operating + When yearly revenues are not able to cover yearly
Expenses/Current operating expenses this is a signal of a non-balanced
Revenues budget that ends up in an operating deficit. The higher the
value of this ratio the more reliant is a municipality on
subsidies in order to have a sound financial condition.
SUB_P Subsidies per Citizen + The larger the value of subsidies per citizen the more
dependent a LG is on central government; thus it is more
vulnerable with respect to central government policy
changes. It is indicative of LG's financial autonomy and
easiness to overcome financing problems when central
government faces difficulties in providing subsidies.

Table 2:Main summaries for the selected financial indicators

Distressed LGs Not Distressed LGs


Variable Mean Median St. Dev Mean Median St. Dev
RPER 0.376 0.355 0.118 0.329 0.315 0.074
SAT 0.0664 0.056 0.041 0.052 0.0450 0.030
CR_FL 1.265 0.875 1.247 1.810 1.076 2.004
STL_CR 0.880 0.715 0.575 0.485 0.400 0.336
OP_CR 1.025 0.968 0.304 0.934 0.948 0.110
SUB_P 959.467 258.159 3386.813 270.354 276.192 203.011

1
Table 3. ILGs bankruptcy status: estimates

CI 95% for Exp(ࢼ)


Variable Coef.(ࢼ) Std.Err Exp(ࢼ) Lower Upper
RPER 6.808** 3.082 905.409 1.010 13.266
SAT 6.77 9.426 871.198 11.005 26.186
CR_FL -0.139 0.181 0.871 -0.535 0.199
STL_CR 2.624*** 0.698 13.790 1.361 4.133
OP_CR 2.515 3.431 12.369 -2.857 9.791
SUB_P 0.002** 0.001 1.002 0.000 0.003
Constant -7.432** 3.239 0.001 -14.546 -2.556
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

ᇱ ଶ ሺ1973ሻ
‫ܴ݋݀ݑ݁ݏܲݏ ݊݁݀݀ܽܨܿܯ‬ = 0.28, ݂݀ = 7;
Sign. Code *** p<0.001, ** p<0.01, *p<0.05, ‘p<0.1

Table 4. Correlation matrix

RPER SAT CR_FL STL_CR OP_CR SUB_P


RPER 1.000
SAT 0.124 1.000
CR_FL 0.054 -0.458 1.000
STL_CR -0.096 0.222 -0.2063 1.000
OP_CR 0.461 0.412 -0.081 0.287 1.000
SUB_P 0.148 -0.132 0.071 -0.048 -0.049 1.000

2
Table 5. Predictive power of the estimated model

Predicted default status


Non Bankruptcy Bankruptcy
True default status
Non Bankruptcy 77.1% 22.8%
Bankruptcy 25.0% 75.0%
Overall predictive power 77%, cut-off=0.5
Downloaded by University of Newcastle At 11:28 24 January 2017 (PT)

Table 6.Long range predictive accuracy


Prediction accuracy

Year prior to bankruptcy Size (N) % Specificity % Sensitivity % Total


2 year 97 68 70 69.07
3 year 97 65 78 68.04
4 year 97 63 71 65.00
5 year 97 62 78 64.94

Você também pode gostar