Effects of GAAP Regulation and Bond Market Interaction On Local Government Disclosure

Journal of Accounting and Public Policy 23 (2004) 23–52
www.elsevier.com/locate/jaccpubpol
The effects of GAAP regulation

and bond market interaction on
local government disclosure
Angela K. Gore *
Department of Accounting, Lundquist College of Business, University of Oregon, Room 1208,

Eugene, OR 97403, USA
Abstract
This study examines the effects of disclosure regulation on municipal managersÕ
incentives to disclose financial report information to the bond market. I compare dis-
closure levels of municipal governments in Michigan, which requires GAAP, with those
in Pennsylvania, which has unregulated disclosure. In the absence of disclosure regu-
lation I find that managers have bond market-induced incentives to disclose informa-
tion. Controlling for other incentives to disclose, the evidence implies that regulation
induces additional disclosures for low-debt governments, and is not binding for high-
debt governments.
Ó 2003 Elsevier Inc. All rights reserved.
Keywords: Regulation; Disclosure; Bond market; Local governments
1. Introduction
Although financial reporting and disclosure have been regulated for over 60
years, relatively few studies have evaluated the effects of these regulations. The
lack of research critically evaluating the effects of disclosure regulation is
surprising given the impact that this regulation has had on the accounting
*
Tel.: +1-541-346-3329; fax: +1-541-346-3341.
E-mail address: agore@oregon.uoregon.edu (A.K. Gore).
0278-4254/$ - see front matter Ó 2003 Elsevier Inc. All rights reserved.
doi:10.1016/j.jaccpubpol.2003.11.002
24 A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52
profession (Healy and Palepu, 2001). Disclosure regulation research is espe-

cially critical in light of recent calls for increased regulation due to the cor-
porate accounting scandals. Regulation proponents assert that market failures
necessitate mandatory disclosure, and that in the absence of regulation,
organizations lack incentives to voluntarily disclose adequate levels of infor-
mation. Critics argue that market forces produce optimal levels of disclosure,
and provide arguments against the efficacy of market failures. 1 Empirical
evidence on disclosure regulation is extremely limited, however, primarily due
to data constraints (Healy and Palepu, 2001).
The purpose of my paper is to provide further empirical evidence about the
effects of disclosure regulation on information production. I do so in the
context of the municipal bond market, for two reasons. First, governmental
GAAP is being made mandatory in many states at substantial cost. Second,
because not all states require GAAP, municipalities allow an examination of
disclosure regulation in a relatively controlled experiment.
I first examine disclosure in an unregulated case, and hypothesize that
bond market incentives are sufficient to induce disclosure. I next examine
the influence of regulation on disclosure and hypothesize that for any given
level of regulation, mandated disclosure induces information production
for low-debt municipalities, and is non-binding for the rest. My empiri-
cal tests compare municipal disclosure levels in a state that requires GAAP
(Michigan) with those in a state with unregulated disclosure (Pennsylva-
nia). 2
My analysis indicates two main results. First, in the unregulated state, I
find a significant positive association between disclosure levels and proxies
for bond market interaction. This evidence suggests that in the absence of
regulation, municipal managers disclose financial information in response
to bond market incentives. This result is interesting because prior studies
have had conflicting results about the relation between disclosure and
proxies for debt. For example, studies such as Robbins and Austin (1986)
and Evans and Patton (1987) find positive relations, while others such as
Evans and Patton (1983), Ingram and DeJong (1987) and Copley (1991)
find either no statistically significant relation or report mixed results. It is
also interesting because it shows municipal managers act rationally in re-
sponse to capital market incentives, opening an avenue to future disclosure
regulation research with implications that extend beyond the municipal
sector.
1
For summaries of the arguments for and against disclosure regulation, see Easterbrook and
Fischel (1991), Watts and Zimmerman (1986), and Leftwich (1980).
2
I define ‘‘regulated’’ disclosure as requiring GAAP regulations, and ‘‘unregulated’’ disclosure
as requiring neither GAAP nor other, state-mandated disclosure regulations.
A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52 25
Second, I find that GAAP disclosure levels are significantly higher in the
regulated state than in the unregulated state. The difference in disclosure levels
is significantly smaller among those governments with higher debt, however,
which implies two things. First, this evidence suggests that regulation is not
binding for governments with high debt levels. 3 In other words, regulated
governments with high debt levels are required to disclose GAAP information
that they would have voluntarily disclosed in the absence of regulation. Sec-
ond, it implies that regulation induces the production of information, or is
binding, for governments with low debt levels, indicating that these govern-
ments may incur costs by being forced to disclose more information than the
market requires. These results are interesting given that prior governmental
research (e.g., Ingram and DeJong, 1987; Copley, 1991) does not find a sig-
nificant difference in disclosure level between states that require GAAP and
states with unregulated disclosure.
The evidence presented in this paper is relevant for evaluating the impli-
cations of the recent trend of increasing GAAP disclosure requirements (Barth
and Murphy, 1994). For example, the GASB recently enacted a new disclosure
standard for governments that expands the level of required disclosures
(GASB Statement No. 34). Opposition has been strong, due to the costs of
implementing and monitoring this standard, and due to questions about
whether there is demand for the information (Copley et al., 1997). My results
suggest there is an economic basis for governmentsÕ choice to voluntarily
provide financial information. Mandating more information imposes costs on
governments with lower bond market interaction, and ultimately the taxpay-
ers, while conferring benefits to public accountants by increasing monitoring
costs.
One caveat needs to be considered when interpreting my results, however.
My analysis focuses on disclosure incentives in the context of bond markets.
Therefore, I do not consider alternative perspectives addressed in prior studies,
such as disclosure incentives derived from political markets (Baber, 1990).
However, as discussed later in the paper, there is a growing body of evidence
that indicates capital market participants are the primary users of the financial
reports, while voters rarely use them. In addition, while I do not focus on
political incentives to disclose, I do use control variables to represent them in
the empirical analysis.
The remainder of the paper is organized as follows. In Section 2, I discuss
the governmental accounting environment, and in Section 3, the theory and
hypothesis development. Section 4 describes the research design, Section 5
discusses the results, while Section 6 concludes.
3
The term ‘‘binding’’ refers to a binding constraint, applying the standard definition found
in most microeconomic theory texts.
2. Governmental accounting environment
2.1. Governmental accounting regulatory environment
In this paper, the term ‘‘GAAP’’ refers to standards issued by the Gov-
ernmental Accounting Standards Board (GASB), the governmental equivalent
of the Financial Accounting Standards Board (FASB). The GASB prescribes
the minimum GAAP requirement for financial reports as a set of general
purpose financial statements, which are comprised of combined financial
statements and footnote disclosures. Some governments choose to prepare a
more comprehensive report known as the comprehensive annual financial re-
port (CAFR), however. In addition, I use the term ‘‘non-GAAP’’ disclosure to
refer to financial report disclosures that are not required under GAAP or state-
specific regulations. 4
Although the GASB issues GAAP standards, the level of disclosure required
of local governments is regulated by the states in which they are located. States
may require that local governmentsÕ financial report disclosures follow GAAP,
state-specific regulations, or may be unregulated. Approximately 27 states re-
quire that local governments follow GAAP, 14 have state-specific disclosure
regulations, and the remaining nine have unregulated disclosure (NASACT,
1996). 5
2.2. The primary user group––the bond market
The remainder of my paper examines the costs and benefits of disclosing

financial report information. The determination of whether the disclosure of
information is a net cost or benefit depends in part upon which financial
statement userÕs perspective is adopted (Beaver, 1998). Although the GASB
identifies three potential user groups, which are voters, regulators, and the
bond market, I take the position that the primary users of local government
financial reports are members of the bond market. This position is supported
by both focus groups commissioned by the GASB (AAA, 1996), and by prior
literature (Gaffney, 1986; Jones et al., 1985; Copley et al., 1997).
4
The traditional term for disclosure outside of the set of GAAP disclosures is ‘‘voluntary
disclosure’’ (see Core, 2001). However, because all disclosure is voluntary in Pennsylvania, it
renders the term ‘‘voluntary’’ confusing in my study.
5
The State of Michigan adopted GAAP in 1968. An examination of news articles from this time
period did not reveal the reasons why State officials decided to adopt GAAP. However, discussions
with State of Michigan Treasury Department officials indicate that GAAP was most likely adopted
because Michigan had recently re-convened the state constitutional convention, and at that time
enacted mandatory audit requirements. When new GAAP and auditing regulations came out in
1968, they were automatically adopted because it was in the state constitution.
In the GASB focus group sessions, user groups representing voters and
regulators indicate that the two primary sources of financial information are
the budget; and conversations with individuals employed by the government.
The majority of these user groups do not use the annual financial reports.
Evidence in the literature also supports the proposition that bond market
participants commonly use the annual financial reports, while voters and
regulators do not. Empirical research, discussed in detail in Ingram and
Robbins (1987), shows that bond market representatives use governmental
financial reports to assess default risk. Other studies such as Zimmerman
(1977), Gaffney (1986), Jones et al. (1985), and Copley et al. (1997) suggest that
citizens rarely use governmental reports.
Although a growing body of evidence indicates that bond market partici-
pants use financial reports, the literature has had inconsistent results about the
relation between debt proxies and disclosure levels. Some studies such as
Robbins and Austin (1986) and Evans and Patton (1987) find positive rela-
tions, while others such as Evans and Patton (1983), Ingram and DeJong
(1987) and Copley (1991) find either an insignificant relation or report mixed
results. However, these studies confine their analyses to large municipalities,
do not distinguish between GAAP and non-GAAP disclosures, and most
do not consider differences in statesÕ regulatory environments.
2.3. Disclosure regulation
While theory supports the proposition that disclosure regulation results in

higher disclosure levels, municipal disclosure studies have not found such a
relation. For example, Ingram and DeJong (1987) examine whether the pres-
ence of a state requirement mandating GAAP compliance affects citiesÕ dis-
closure levels, and find no significant difference in disclosure levels between
GAAP-regulated and unregulated disclosure states. Two issues potentially af-
fect a straightforward interpretation of their evidence, however. First, their
sample is drawn from across all states without controlling for differences in
regulatory environments that potentially affect the role of financial information
in the bond market. For example, Colorado only permits the issuance of rev-
enue bonds, which require covenants. In contrast, Massachusetts only permits
general obligation bonds, which are backed by the full faith and credit of the
governments issuing them. Creditors in Colorado may therefore have relatively
greater incentives to monitor local governments through financial reporting. 6
Second, Ingram and DeJong only study large cities, with a mean population
of 143,000. Gore et al. (2004) finds that large cities tend to disclose more
6
For example, FSA, a municipal bond insurer, states on their website that revenue bonds
typically require more analysis than do general obligation bonds.
information because they are more likely to access the bond market. Therefore,
the finding of no difference in disclosure between large cities in GAAP-regu-
lated and unregulated disclosure states is not surprising.
In another study, Copley (1991) uses a dummy variable to control for
whether municipalities are in GAAP-regulated states, and finds this vari-
able is insignificant. However, CopleyÕs measure of disclosure includes both
GAAP and non-GAAP disclosures. The inclusion of non-GAAP disclosures
could cause the lack of significance because municipalities can voluntarily
disclose information regardless of whether the state requires GAAP. In addi-
tion, their analysis is again restricted to large cities, with a mean population
of 177,000.
In contrast to these studies, I employ a research design that restricts the
sample to two states in order to minimize the potentially confounding effects of
state-specific regulations, and also include smaller municipalities. In addition,
my disclosure measures distinguish between GAAP and non-GAAP disclo-
sures.
3. Theory and hypothesis development
3.1. Basic theoretical framework of municipal disclosure
My focus is on the relation between disclosure and the bond market. In so

doing, I expand ZimmermanÕs (1977) positive theory analysis, which focuses on
political incentives for disclosure, to explicitly consider the effects of regulation
and bond market incentives on disclosure. In order to develop the theory, I
need two assumptions. First, I assume that municipal managersÕ primary
motivation for financial disclosure is in response to bond market incentives,
and that municipal managers have incentives to lower municipal debt costs.
For example, ceteris paribus, if lower debt costs lead to lower property taxes,
which translate into more votes for municipal officials, then municipal officials
will want to lower borrowing costs. Second, I assume the bond market is
competitive, which implies that bond issuers fully bear transaction and infor-
mation costs in the form of higher debt costs.
Given asymmetric information whereby investors are unable to fully deter-
mine the default risk characteristics of issuers, managers use increased disclo-
sure to reduce the cost of capital in two ways. First, to reduce the costs
associated with the information asymmetry component of the cost of capital,
such as those due to transaction costs. Managers issuing debt therefore have
incentives to voluntarily disclose information to reduce the information asym-
metry problem, thus reducing the cost of financing (Myers and Majluf, 1984).
Second, managers use disclosure to reduce costs associated with investorsÕ
information risk. Barry and Brown (1985) argue that when disclosure is not
perfect, investors bear risks in forecasting their investmentsÕ future payoff. 7 If

this risk is not diversifiable, investors will demand an incremental return for
bearing the information risk. Managers therefore have incentives to voluntarily
disclose information to reduce investorsÕ information risk, and hence lower their
cost of capital. The results of empirical studies are consistent with theory,
showing that public financial disclosure reduces bond yields for both corporate
and government issuers (see Sengupta, 1998; Benson et al., 1991, respectively).
Municipalities that have a high level of bond market interaction stand to
gain relatively more benefits by disclosing information. This leads to the fol-
lowing hypothesis:
H1: Ceteris paribus, within a state that has unregulated disclosure, there is a
positive association between disclosure level and debt.
3.2. Disclosure regulation
When disclosure is mandated by regulation, it creates a minimum level of

disclosure. Assuming there is a positive association between disclosure and
debt, municipalities can have three general forms of disclosure equilibrium
levels (see Fig. 1). For some governments, the mandated disclosure level is set
above the municipalitiesÕ optimal level in the unregulated environment, and is
therefore binding (see Region 1 of Fig. 1). 8 This level of regulation unam-
biguously induces the production of information, imposing additional non-
productive costs on municipalities and their taxpayers.
For other governments, the equilibrium level is equal to the level set by
regulation, and so includes the set of required GAAP disclosures. This second
scenario is not likely because it is unlikely that regulators can determine an
optimum level of disclosure for all governments. Because GAAP is designed to
fit all state and local governments, including 35,000 counties, cities, towns, and
villages ranging in population from less than 1,000 to several million, it is
unlikely to be optimal for many of them.
7
One may conjecture that investors merely need to examine bond ratings in order to assess risk.
In the case of municipal bonds, however, many issues are not rated by ratings agencies, and for
these unrated issues, public disclosure is especially important to help resolve information
asymmetry. Empirical research such as Fairchild and Koch (1998) finds the decrease in debt costs
from public disclosure is greater for unrated issues. Even when bonds are rated, however, the
ratings alone are not sufficient for investors to forecast risk. Bond ratings only represent a range for
the probability of default, not the probability of recovery, and the ratings agencies do not assess
the liquidity of the underlying assets.
8
The term ‘‘optimal’’ refers to optimal disclosure for the municipal government, rather than
financial statement users. As such, I implicitly assume that the level of state regulation is exogenous.
I acknowledge that there may be additional cost–benefit concerns involved with statesÕ decisions
to mandate GAAP, however, I consider them outside the scope of this study.
Fig. 1. Hypothesized relation between total disclosure and bond market interaction.
Note: This figure shows the relation between disclosure and debt, and does not consider other
incentives for disclosure. ‘‘GAAP’’ represents the level of disclosure required under GAAP regu-
lations. ‘‘Regulated GovernmentsÕ Disclosure’’ represents the relation between debt and disclosure
for governments required to comply with GAAP. Note that Regulated Governments in Region 1
(low debt) disclose at levels required by GAAP; while Regulated Governments in Region 2 (high
debt) voluntarily disclose above the levels required under GAAP. ‘‘Unregulated GovernmentsÕ
Disclosure’’ represents the relation between debt and disclosure for governments that do not have
to comply with disclosure regulations.
Still other governments have equilibrium levels of disclosure above the re-
quired level (see Region 2 of Fig. 1). In this case, the mandated disclosure level
is below that which is optimal for governments, and is not binding.
Assuming municipalities are faced with varying demands for and quantities
of debt capital, then the benefits of information production will vary across
governments. Absent regulation, governments with little bond market inter-
action lack incentives to disclose information. In a GAAP-regulated state,
however, governments with low bond market interaction are required to dis-
close more information than they would in the absence of regulation. There-
fore, consistent with Fig. 1, for the subset of governments with low debt, the
level of GAAP disclosures will be higher in the GAAP-regulated state than it is
in the unregulated disclosure state. In other words, regulation will be binding
for low-debt governments, which leads to the following hypothesis:
H2A: Ceteris paribus, for the subset of governments with low debt, the level
of GAAP disclosures is higher in a state that requires GAAP than it is
for governments in a state that has unregulated disclosure.
Governments with a relatively higher level of bond market interaction will

voluntarily comply with GAAP if compliance results in lower borrowing costs,
as suggested by some of the literature discussed previously. In this case, the
level of GAAP disclosures should be the same regardless of whether the state
requires GAAP. In other words, for high-debt governments, regulation will not
be binding. This leads to the following hypothesis:
H2B: Ceteris paribus, for the subset of governments with high debt, the level
of GAAP disclosures is the same in a state that requires GAAP as it is
for governments in a state that has unregulated disclosure.
The combination of H2A and H2B represents a joint test of the effects of
regulation and bond market interaction on information production. Theoret-
ically, there should be a large difference in GAAP disclosure between regulated
and unregulated disclosure states for low-debt governments, and a relatively
smaller, or no difference between the two states for the high-debt governments,
consistent with Fig. 1. In addition, note that I confine my analysis of H2 to
GAAP disclosure because a priori, it is unknown how GAAP regulation affects
non-GAAP disclosure.
4. Research design and tests of hypotheses
4.1. Sample selection
I employ data from Michigan, which requires GAAP, and Pennsylvania,

which has unregulated disclosure (NASACT, 1996). 9 Michigan is chosen be-
cause it is a state that both requires and enforces the use of GAAP. 10 I confine
my analysis to two states to ensure that the municipalities in the sample are as
much alike as possible, with respect to non-disclosure regulatory and legal
constraints. Michigan and Pennsylvania are chosen because they closely match
each other in many ways other than the level of disclosure regulation. This is
important because my analysis relies on the assumption that, absent the
requirement of GAAP disclosure, governments in the regulated state would
disclose information at a level similar to those in the unregulated state.
9
An alternative research design would encompass the examination of governments in one state,
before and after the enactment of GAAP disclosure requirements. This is not feasible in part due to
the lack of data availability.
10
Discussions with State of Michigan regulators reveal that they routinely test GAAP
compliance by examining a sample of municipal financial reports in detail. If they find that a
financial report is not in compliance with GAAP, then the municipality must re-submit revised
reports within a specified time frame.
However, because there are only nine states that have unregulated disclosure, I
control for the differences that are most likely to affect the level of financial
report disclosure.
Michigan and Pennsylvania are similar in the following respects. Both states
have city and township governments that do not have overlapping boundaries,
to ensure that the financial reporting relation is clear. This criteria ensures that
municipalities only record transactions (such as debt) for that specific munic-
ipality, rather than for other entities as well (for example, school districts). 11
The states are also similar with regards to the types of bonded debt allowed,
both general obligation and revenue bonds, as well as the restrictions on the
amount of debt, in that both allow cities to issue debt directly. I use these
requirements because regulations affecting incentives to issue debt can indi-
rectly cause variation in disclosure. 12 Finally, both states require local gov-
ernments to be audited, however, Pennsylvania allows the choice of either an
external or an internal auditor. 13 I use this last requirement because mandated
audits potentially influence the level of GAAP disclosures.
Table 1, Panel A describes the selection criteria for the Michigan sample.
Similar to Zimmerman (1977), I select those governments with populations
greater than 10,000, for a total of 166 observations. Note that the use of this
restriction effectively biases against finding results because smaller governments
are less likely to have interaction with the capital markets (Gore et al., 2004).
From these, I collected financial reports for 88 municipalities from the Mich-
igan Department of Treasury for 1995. 14 I limit the analysis to one year be-
cause disclosure policies appear to remain relatively constant over time
(Botosan, 1997), and due to the availability of data.
Financial report data for the Pennsylvania municipalities are obtained in a
similar manner. I randomly selected 92 financial reports from those govern-
ments with populations greater than 10,000, roughly equivalent to the number
gathered from Michigan (see Table 1, Panel B). I collected a total of 87 reports,
11
Note that this does not refer to component units, but rather, organizations that are not
normally considered component units, such as school districts.
12
I hypothesize that there is a positive relation between debt and disclosure. If a state restricts
the amount of debt issued, then it is possible that I could find no relation between debt and
disclosure, which effectively biases against finding results.
13
Internal auditors are defined as auditors that agree to perform one municipal audit per year,
and may or may not be Certified Public Accountants. The audits performed by internal auditors are
in accordance with GAAP standards. However, I am unable to assess the impact the use of internal
auditors may have on audit quality.
14
Local governments are required to submit two copies of their financial reports to the
Michigan Department of Treasury on an annual basis. The Department of Treasury contributed
the ‘‘second copy’’ of the financial reports to this study for approximately one half of the cities and
townships with populations in excess of 10,000. This sample cannot be construed as random,
however, there is no known bias in the selection of individual financial reports.
Table 1
Summary of financial report selection procedures
Panel A: Michigan sample
Total local governments in Michigan 1,800
Less governments with population <10,000 and 1;634
governments other than cities and townships
Total Michigan cities and townships with populations 166
>10,000
Financial reports randomly eliminated 78
Final sample, collected from Michigan Department 88
of Treasury
Panel B: Pennsylvania sample
Total local governments in Pennsylvania 2,498
Less governments with population <10,000 and 2;288
governments other than cities and townships
Total Pennsylvania cities and townships with 201
populations >10,000
Randomly selected 92
Financial reports collected directly from municipalities 65
Financial reports collected from Pennsylvania Depart- 22
ment of Community and Economic Development
Financial reports not available 05
Total financial reports 90
Final sample 87
Michigan Pennsylvania Total
Panel C: Total sample
Cities 44 21 65
Townships 44 66 110
Total 88 87 175
through a combination of requests to the municipalities and the Department of

Community and Economic Development in Pennsylvania. The sample selec-
tion procedures yield a total sample of 175 governments (see Table 1, Panel C).
4.2. Tests of hypotheses
4.2.1. Regression specification for H1

I use the following regression specification to test my first hypothesis:
DISCLOSUREit ¼ ai þ b1i POPit þ b2i CITYit þ b3i AUDITSit
þ b4i DEBTit þ eit ð1Þ
where
DISCLOSUREit is the value of the GAAP, non-GAAP, or TOTAL disclo-

sure index in year t for government i,
AUDITSit is the number of municipal audits performed in year t by govern-

ment iÕs auditor,
POPit is the log of total population in year t for government i,
CITYit is a dummy variable where 1 indicates the city form of government
and 0 indicates the township form of government,
DEBTit is total debt/population in year t for government i.
The dependent variable is measured alternately using GAAP, non-GAAP,

or TOTAL (the sum of the two) disclosure indices, described in detail below.
Each disclosure index measures the number of items satisfied by the financial
report. H1 examines whether DEBT is positive and significant within Penn-
sylvania, the unregulated disclosure state.
4.2.1.1. Disclosure indices. I measure disclosure with two disclosure indices, one
measuring the extent of GAAP disclosure, and the other measuring the extent
of non-GAAP disclosure. The GAAP index is comprised of GAAP disclosures
identified on a checklist provided by the Michigan Department of Treasury, the
entity that oversees local governments in Michigan. The checklist, which only
contains GAAP disclosures, is used to determine whether municipalitiesÕ
financial reports are in compliance with GAAP. When compiling the GAAP
index, I retain all disclosures on the checklist that apply to all municipalities. 15
Otherwise, the index could proxy for complexity, as larger and more complex
governments would tend to score higher. 16 The non-GAAP disclosure index
includes those disclosures identified through the prior literature and through
Standard & PoorÕs (1986) as useful to bond market representatives.
I compile the two indices from disclosures contained within the annual
financial reports. The GAAP disclosures are drawn from elements contained
within the basic financial statements, as well as from the footnotes. Non-GAAP
disclosures are from the basic financial statements, footnotes, and supplementary
statistical information. Each disclosure is counted as part of the disclosure index
if it is present, and for the GAAP index, appears to be substantially in compli-
15
For example, commitments and contingencies are required to be disclosed under GAAP, and
this disclosure is listed on the checklist. However, many municipalities do not have contingencies.
I therefore exclude this disclosure, since it is likely to proxy for complexity.
16
Prior studies vary as to disclosure index construction. Some studies such as Robbins and
Austin (1986) use indices comprised of disclosures found useful to the bond market. The use of such
an index would be biased against finding evidence consistent with my hypotheses if some of the
disclosures required by GAAP are not useful to creditors. Rather than using one of these indices, I
use the checklist because it is a broad measure of GAAP, is somewhat more objective than those
used in prior studies, and also because it references recent disclosures. For example, studies such as
Copley (1991), Ingram and DeJong (1987), and Ingram (1984) use disclosures available in the mid-
1980s, and so do not include recent GASB pronouncements such as the investment disclosure.
ance with GAAP requirements. No attempt is made to assess the quality of

particular disclosures. The GAAP index contains 18 disclosure elements that are
required by GAAP (see Appendix A), while the non-GAAP disclosure index is
comprised of thirteen disclosures that are not required by GAAP (see Appendix
B). Equal-weighted index scores can therefore range between 0 and 18 for the
GAAP index, and between 0 and 13 for the non-GAAP disclosure index. 17
4.2.1.2. Debt. The debt variable represents current and future incentives to re-
duce the costs of issuing debt. For current debt, the disclosure of information
reduces the enforcement and monitoring costs of existing contracts. It also re-
duces the costs of future forays into the debt market. The bond market incentives
should increase as the amount of debt, and therefore, the level of interaction with
the bond market, increases, and as such is expected to be positively associated
with disclosure. I use the total debt per capita as the proxy for the debt level. 18
Total debt is comprised of all debt, including general obligation bonds, revenue
bonds, and other debt such as bank notes payable. I use this ratio to be consistent
with prior studies such as Ingram and DeJong (1987) and Copley (1991).
4.2.1.3. Control variables. I include three control variables found significant in

prior studies, audit quality, population, and government type, in the empirical
tests that follow. 19 Audit quality is postulated to be associated with disclosure
level in part because auditors often prepare the financial statements and
footnotes for their clients. One measure of audit quality is that of industry
specialization. OÕKeefe et al. (1994) find that the auditorÕs level of industry
knowledge is positively associated with audit quality, and Gore et al. (2004)
finds it is positively associated with GAAP disclosure. The proxy used for a
given observation is the number of governmental audits performed by the CPA
firm or auditor who audited that government. Population is included because
17
The use of an equally-weighted index is supported by Robbins and Austin (1986).
18
In Michigan, debt issued on behalf of local governments at the county or state level, called
overlapping debt, is recognized on the local governmentsÕ financial statements. In Pennsylvania,
local governments are required to include overlapping debt in calculations of the borrowing base,
which makes it likely that they include it in their financial reports. It is also likely to be included
because their financial reports are audited. However, because disclosure is not regulated in
Pennsylvania, it is also possible that they do not include it. Therefore, the debt variable may
understate the bond market incentives in Pennsylvania, which effectively biases against finding
results for my first hypothesis.
19
An additional variable commonly used in disclosure studies is a proxy for funding sources, the
ratio of intergovernmental revenues to total revenues. In this study, part of the sample is drawn
from the state of Michigan, where most of the intergovernmental revenue is comprised of state-
shared revenue allocated based upon population. I therefore do not include this variable because it
does not adequately represent a governmentÕs reliance on non-capital market sources of revenue.
prior studies such as Robbins and Austin (1986), Evans and Patton (1983), and
Copley (1991) find it positively associated with disclosure.
Government type is included as a control because Gore et al. (2004) finds
that for a sample of Michigan governments, the township government type is
negatively associated with the level of GAAP disclosure compliance. 20 The
negative relation is potentially attributable to restrictions in debt issuance
imposed by the state of Michigan, or because townships in general have fewer
incentives to comply with GAAP. 21 Alternatively, this could be due to the
more fundamental issue of why a government chooses to operate as a city
versus a township. Because the effect of government type on financial report
disclosure is unclear, this variable is included as a control. A dummy variable is
used to indicate the city government type.
With the exception of the audit quality and population variables, all data are
obtained directly from the financial reports. Data for the audit quality vari-
ables are hand-collected from the Michigan Department of Treasury and the
Pennsylvania Department of Community and Economic Development. I verify
the accuracy of the lists by comparing auditors on the lists with those in a
random sample of financial reports. Population data are from the 1990 census.
4.2.2. Regression specification for H2

My second hypothesis examines whether there is a significant difference in
disclosure levels for governments with low bond market interaction, and a rel-
atively lower (or insignificant) difference in disclosure levels for governments with
high bond market interaction. I therefore partition the sample into three groups
based upon the level of debt, with the top, middle, and bottom third of the sample
designated as high, medium, and low debt, respectively. This test utilizes the total
sample of Pennsylvania and Michigan municipalities, and dummy variables to
indicate the state (MI or PA) and the debt level (HIGHDEBT, MEDDEBT, or
LOWDEBT). I use the following regression specification to test H2 :
20
It is also common for disclosure studies to include a dummy variable indicating the city
manager form of government. Prior studies show that the presence of the city manager form of
government is positively associated with citiesÕ disclosure level. Studies such as Zimmerman (1977)
commonly describe this variable in terms of reducing agency costs that exist between city councils
and appointed city managers. However, in this study, both townships and cities are included in the
sample, and a control variable is included to measure differences in disclosure due to government
type. Because this variable is highly correlated with the city manager dummy variable, the latter
is not included in the regression. When I include the city manager variable, however, the results
remain consistent with those presented.
21
The State of Michigan does not allow townships to directly issue debt for bond issues greater
than $1,000,000. Instead, the county in which the township resides issues the debt, which the
township in turn must repay to the C ounty. This may reduce townshipsÕ incentives to issue debt
relative to cities. However, anecdotal evidence reveals that townships respond by issuing several
small issues, each under $1,000,000, in order to circumvent this regulation.
GAAPit ¼ ai þ b1i POPit þ b2i CITYit þ b3i AUDITSit

þ b4i HIGHDEBT; MIit þ b5i HIGHDEBT; PAit
þ b6i MEDDEBT; MIit þ b7i MEDDEBT; PAit
þ b8i LOWDEBT; MIit þ eit ð2Þ
where HIGHDEBT,MI, MEDDEBT,MI and LOWDEBT,MI indicates the
top, middle, and bottom 1/3 of the sample for Michigan municipalities, and
HIGHDEBT,PA and MEDDEBT,PA indicates the top and middle 1/3 of the
sample for Pennsylvania municipalities, ranked by debt per capita. The low-
debt partition for Pennsylvania is represented by the intercept term, and the
remaining variables are as described above. H2A tests whether LOWDEBT,MI
is positive and significant, while H2B tests whether (HIGHDEBT,
MI ) HIGHDEBT,PA) is not significantly different from zero. I use ordinary
least squares to facilitate comparison with previous studies. However, I also
use multinomial logit (not reported) in the sensitivity analysis due to the dis-
crete nature of the dependent variables, with the results qualitatively similar to
those reported.
5. Results
5.1. Descriptive statistics
Table 2 describes the total sample (Panel A), the subset of Pennsylvania and
Michigan governments (Panel B), and partitions based upon the level of debt
(Panel C). I assess the reasonableness of comparing Michigan and Pennsyl-
vania municipalities through non-parametric statistical tests in Table 2, Panel
B. These comparisons indicate there are no significant differences in population
or debt, however, differences between CITY and AUDITS are statistically
significant at the 0.01 level. Half of the Michigan sample is comprised of cities,
while only 24% of the Pennsylvania sample consists of cities. Also, Michigan
auditors perform a significantly higher number of governmental audits on
average than do Pennsylvania auditors (median 57 for Michigan versus median
4 for Pennsylvania). The difference in the number of audits performed is
probably due to PennsylvaniaÕs use of internal auditors, who are restricted by
law to one municipal audit per year. I do not consider this a problem that will
impact the hypothesis tests because the two variables are control variables in
the multivariate specifications.
Panel B of Table 2 reveals that Michigan municipalitiesÕ median score for
GAAP is 17 out of a possible 18, indicating that there is not full compliance
with GAAP. This effectively biases against finding results for H2 , however. In
addition, the non-parametric tests in Panel B show a significant difference
Table 2
Descriptive statistics and tests of significance from non-parametric tests of differences between
Michigan and Pennsylvania
Variable Mean Median Std. dev.
Panel A: Total sample (n ¼ 175)
POP 3.065 2.90 0.701
CITY 0.371 0.00 0.485
AUDITS 30.503 9.00 38.700
DEBT 578.979 393.68 757.501
STATE 0.503 1.00 0.501
GAAP 14.006 15.00 4.390
NONGAAP 2.935 1.00 3.888
Pennsylvania (n ¼ 87) Michigan (n ¼ 88) Mann–
Whitney
Mean Median Std. dev. Mean Median Std. dev.
p-values*
Panel B: Subset of Pennsylvania and Michigan governments
POP 3.095 2.90 0.772 3.035 2.895 0.627 0.542
CITY 0.241 0.00 0.430 0.500 0.000 0.503 0.003
AUDITS 7.149 4.00 6.681 53.591 57.000 43.205 0.000
DEBT 584.337 324.54 715.237 573.683 408.158 801.170 0.833
GAAP 11.552 13.00 4.810 16.432 17.000 1.923 0.000
NONGAAP 2.756 2.00 3.226 3.102 1.000 4.428 0.238
Low debt (n ¼ 58)a High debt (n ¼ 58)b
Mean Median Std. dev. Mean Median Std. dev.
Panel C: Subset of governments partitioned by debt
POP 2.858 2.73 0.450 3.258 2.924 0.909
CITY 0.259 0.00 0.442 0.517 1.000 0.504
AUDITS 25.086 8.50 35.968 33.707 9.000 41.267
DEBT 108.469 118.48 66.159 1252.437 956.247 1003.721
STATE 0.517 1.00 0.504 0.500 0.500 0.504
GAAP 12.328 14.00 4.673 15.793 17.000 3.259
NONGAAP 1.618 1.00 2.423 4.193 2.000 4.756
*Indicates the two-sided statistical significance levels for a test of differences between Pennsylvania
and Michigan.
This table presents descriptive statistics for the total sample (Panel A), and the subset of Michigan
and Pennsylvania governments (Panel B). Panel C shows the total sample partitioned into three
groups based on the total debt per capita, with the top and bottom third of the total sample
designated as high debt and low debt. Variable descriptions are as follows: POPit is the log of
population in year t for government i; CITYit is a dummy variable where 1 indicates the city form
of government and 0 indicates the township form of government; AUDITSit is the number of
municipal audits performed in year t by government iÕs auditor; DEBTit is the total debt per capita
in year t for government i; STATE is a dummy variable where 1 indicates Michigan (GAAP
disclosure state) and 0 indicates Pennsylvania (unregulated disclosure state); GAAPit is an index of
GAAP disclosures in year t for government i; and NONGAAPit is an index of voluntary disclosures
in year t for government i.
a
n ¼ 30 Michigan, 28 Pennsylvania.
b
n ¼ 29 Michigan, 29 Pennsylvania.
between the two states for GAAP disclosure, but no significant difference in
non-GAAP disclosure. The latter indicates that it is appropriate to compare
the two states, because in the absence of disclosure regulation, municipalities
voluntarily disclose information at similar levels.
Table 3 reports correlation matrices for the total sample (Panel A), the
subset of Pennsylvania governments (Panel B), and for partitions based on the
level of debt (Panels C and D). For the total sample and some of the partitions,
the correlation between STATE and variables such as AUDITS is high (0.54). I
therefore test for multicollinearity by computing condition indices following
the procedure outlined in Belsley et al. (1980). In each case the condition index
is below 10, which indicates that multicollinearity is not severe.
Table 3
Correlation matrices
POP CITY AUDITS DEBT STATE
Panel A: Total sample (n ¼ 175)
POP 1.000
CITY 0.238* 1.000
AUDITS )0.009 0.154* 1.000
DEBT 0.212** 0.290** 0.057 1.000
STATE )0.046 0.270** 0.540** 0.016 1.000
Panel B: Subset of Pennsylvania governments (n ¼ 87)
POP 1.000
CITY 0.242* 1.000
AUDITS )0.037 )0.158 1.000
DEBT 0.347* 0.287** )0.090 1.000
Panel C: Subset of high debt governments (n ¼ 58)

POP 1.000
CITY 0.299* 1.000
AUDITS )0.145 0.189 1.000
DEBT 0.072 0.381** )0.106 1.000
STATE )0.160 0.207 0.710** )0.077 1.000
Panel D: Subset of low debt governments (n ¼ 58)
POP 1.000
CITY 0.279* 1.000
AUDITS )0.076 0.264* 1.000
DEBT 0.118 0.201 0.000 1.000
STATE 0.016 0.255* 0.450** 0.064 1.000
*Significant at p < 0:05.
**Significant at p < 0:01.
Note: see Table 2 for variable definitions. This table shows the Spearman rank correlation matrices
for the total sample in Panel A, and for the subset of Pennsylvania governments in Panel B. The
total sample is also partitioned into three groups based on the total debt per capita, with the top
and bottom third of the total sample designated as high debt (Panel C) and low debt (Panel D),
respectively.
5.2. Tests of hypotheses
I first perform a Wald test to determine whether it is appropriate to pool the

cities and townships into one sample. 22 The results of this test indicate that the
Wald statistic has a value of 0.93, which is significantly close to zero, thus
allowing the cities and townships to be pooled into one sample.
Table 4 reports results for tests of my first hypothesis using Pennsylvania
governments, and presents evidence of the relation between bond market
interaction and disclosure. Disclosure is represented by the GAAP, non-
GAAP, and Total disclosure indices, with the latter being the sum of the two.
DEBT is positive and significant for all three models, consistent with H1 , and
shows that in the absence of disclosure regulation, municipal managers have
incentives to disclose information to the bond market. Interestingly, AUDIT is
positive and significant for GAAP disclosure, but not significant for non-
GAAP disclosure, consistent with practitionersÕ conjecture that auditors pre-
paring financial information for their clients are more focused on GAAP
compliance.
Prior to testing my second hypothesis, I first examine whether there is a
significant difference in disclosure between municipalities in GAAP-regulated
and unregulated disclosure states, similar to Ingram and DeJong (1987). The
results of this test, presented in Table 5, indicate that STATE is positive and
significant (p < 0:01). I include an interaction term, D E B T S T A T E , because I
expect there to be an interaction between the state and the level of debt. The
findings reveal that the level of GAAP disclosure is significantly higher in the
regulated state, in contrast to the insignificant difference found by Ingram and
DeJong (1987). 23
22
The Wald test is used because it does not rely on the assumption of constant variances across
samples, as does the Chow test. Preliminary analysis of the data indicated that the variances of the
cities could be different from the variances of the townships. The test statistic used is found in
Greene (1993), and is as follows:
W ¼ ðh1 h2 Þ0 ðV1 þ V2 Þ1 ðh1 h2 Þ
where h1 , and h2 are two normally distributed estimators of a parameter based upon independent
samples (cities and townships), with variances V1 and V2 . The variance estimates are obtained from
separate OLS regressions of the cities and townships. The Wald statistic has a chi-squared distri-
bution with K degrees of freedom, and tests whether the differences between the parameters are
significantly close to zero.
23
Interpretations of my results need to allow for the possibility that fundamental differences
between the states could lead to differences in disclosure regulation. For example, there could be
differences in the underlying incentives to borrow that lead to why Michigan requires GAAP, while
Pennsylvania does not. However, analyses in Poterba and Rueben (1997) show that the fiscal
institutions (e.g. the level of debt restrictions, balanced budget and spending limits) of the two
states are very similar. I consider any remaining differences outside the scope of this study.
Table 4
OLS results for a test of the relation between disclosure level and debt in Pennsylvania, the
unregulated disclosure state (H1 )
Model: DISCLOSUREit ¼ ai þ b1i POPit þ b2i CITYit þ b3i AUDITSit þ b4i DEBTit þ eit
Variable Expected Dependent variable:
sign
GAAPa (n ¼ 87) Non-GAAPa Totala (n ¼ 87)
(n ¼ 87)
Coeffi- t-statistic Coeffi- t-statistic Coeffi- t-statistic
cient cient cient
Intercept 3.194 1.46 )0.850 )0.55 1.832 0.60
POP + 1.841 2.37** 0.712 1.31 2.740 2.53**
CITY + 1.011 0.90 )1.199 )1.55 )0.145 0.09
AUDITS + 0.198 3.00** 0.060 1.25 0.247 2.68**
DEBT + 0.002 2.01* 0.000 3.53** 0.004 3.11**
Adjusted 0.30 0.27 0.36
R2
F -statistic 10.20 8.45 13.2
(p-value) (<0.0001) (<0.0001) (<0.0001)
*Significant at p < 0:05; based on two-tailed tests.
**Significant at p < 0:01; based on two-tailed tests.
Note: Variable descriptions are as follows: POPit is the log of population in year t for government i;
CITYit is a dummy variable where 1 indicates the city form of government and 0 indicates the
township form of government; AUDITSit is the number of municipal audits performed in year t by
government iÕs auditor; DEBTit is the total debt per capita in year t for government i; GAAPit is an
index of GAAP disclosures in year t for government i, described in Appendix A; and Non-GAAPit
is an index of voluntary disclosures in year t for government i, described in Appendix B; and Total
is the sum of the GAAP and Non-GAAP disclosure indices.
a
WhiteÕs t-statistics. All regression results have been checked for the presence of influential data
points using CookÕs D statistic; no influential data points were detected. All models have also been
estimated using multinomial logit with the results generally consistent with those presented here.
Table 6 reports results for my second hypotheses (H2A and H2B ). Results for
H2A show that the difference in disclosure between low-debt governments in
Michigan and Pennsylvania is significant (p < 0:01), represented by the vari-
able LOWDEBT,MI. Consistent with H2A and Fig. 1, for the subset of low-
debt governments, the level of GAAP disclosures is significantly higher in the
regulated state. This result is consistent with regulation inducing the disclosure
of information for governments with little bond market interaction.
H2B tests whether the difference in disclosure between high-debt govern-
ments in Michigan and Pennsylvania are not significantly different from zero,
or ðb4i b5i Þ is not significant. I find that high-debt municipalities in Michigan
disclose significantly more information, inconsistent with H2B . However, this
result appears to be sensitive to my selection of the debt proxy, because when I
use alternate debt proxies (see sensitivity analysis below), I consistently find
no significant difference in disclosure among the high-debt governments.
Table 5
OLS results for a test of the relation between the GAAP disclosure level and the state
GAAPit ¼ ai þ b1i POPit þ b2i CITYit þ b3i AUDITSit þ b4i DEBTit þ b5i DEBTit STATEit
þ b6i STATEit þ eit
Variable Expected sign Total sample (n ¼ 175)
Coefficient t-statistica
Intercept 6.714 5.63**
POP + 1.072 2.72**
CITY + 1.018 3.06**
AUDITS + 0.014 2.42*
DEBT + 0.002 2.89**
DEBT STATE ) )0.002 )2.21*
STATE + 4.957 7.38**
Adjusted R2 0.47
*Significant at p < 0:05; based on two-tailed tests, two-tailed otherwise.
**Significant at p < 0:01; based on two-tailed tests, two-tailed otherwise.
Note: Variable descriptions are as follows: POPit is the log of population in year t for government i;
CITYit is a dummy variable where 1 indicates the city form of government and 0 indicates the
township form of government; AUDITSit is the number of municipal audits performed in year t by
government iÕs auditor; DEBTit is the total debt per capita in year t for government i; STATE is a
dummy variable where 1 indicates Michigan (GAAP disclosure state) and 0 indicates Pennsylvania
(unregulated disclosure state); and GAAPit is an index of GAAP disclosures in year t for gov-
ernment i, described in Appendix A.
a
WhiteÕs t-statistics. All regression results have been checked for the presence of influential
data points using CookÕs D statistic; no influential data points were detected. All models have also
been estimated using multinomial logit with the results generally consistent with those presented
here.
I also test whether the difference in disclosure between the low-debt gov-
ernments is significantly greater than the difference in disclosure between high-
debt governments, or b8i ðb4i b5i Þ > 0, consistent with Fig. 1. The results of
this test, reported in Table 6, show that the difference is significant (p ¼ 0:003).
The results of this test are consistent with regulation being binding for low-debt
governments, and not binding for high-debt governments.
5.3. Sensitivity analysis
Sensitivity analysis establishes that my results are robust to alternative

specifications and measures of debt. First, I assess the sensitivity of the results
to model specification by estimating an alternate regression specification using
multinomial logit and ordered probit because of the discrete nature of the
dependent variables. The results of these specifications, not reported in the
tables, do not differ significantly from those reported.
Second, I use three alternative measures of debt because the use of debt
per capita may not accurately reflect the current level of bond market
Table 6
OLS results for tests of the relation between regulation and disclosure (H2 )a
GAAPit ¼ ai þ b1i POPit þ b2i CITYit þ b3i AUDITSit þ b4i HIGHDEBT; MIit
þ b5i HIGHDEBT; PAit þ b6i MEDDEBT; MIit þ b7i MEDDEBT; PAit
þ b8i LOWDEBT; MIit þ eit
Variable Expected Total Sample (n ¼ 175)
sign
Coefficient t-statisticb
Intercept 4.764 4.11**
POP + 1.357 4.53**
CITY + 1.007 2.40*
AUDITS + 0.013 2.76**
HIGHDEBT,MI + 6.909 7.74**
HIGHDEBT,PA + 4.406 4.22**
MEDDEBT,MI + 6.184 6.78**
MEDDEBT,PA + 2.278 2.09*
LOWDEBT,MI + 6.003 7.22**
Adjusted R2 0.51
Test of equality of coefficients
F -statistic for difference in coefficients:
HIGHDEBT,MI ) HIGHDEBT,PAc 7.04
(p-value) (0.0088)
LOWDEBT,MI ) (HIGHDEBT,MI ) 9.00
HIGHDEBT,PA)
(p-value) (0.0031)
*Significant at p < 0:05; based on two-tailed tests, two-tailed otherwise.
**Significant at p < 0:01; based on two-tailed tests, two-tailed otherwise.
Note: See Table 2 for variable definitions.
a
The total sample is ranked by the total debt per capita, with the bottom third designated as low
debt (LOWDEBT) governments, the top third designated as high debt (HIGHDEBT) govern-
ments, and the middle third as medium debt (MEDDEBT) governments. MI designates Michigan
governments, and PA denotes Pennsylvania governments.
b
WhiteÕs t-statistics. All regression results have been checked for the presence of influential data
points using CookÕs D statistic; no influential data points were detected. The model has also been
estimated using multinomial logit with the results generally consistent with those presented here.
c
The p-value of this test is insignificant (p ¼ 0:19) when multinomial logit is used.
interaction. Therefore, I also use the log of total debt, the ratio of total debt/
total revenue, and the number of new bond issues in the last five years, to
measure debt. The latter variable represents the frequency of recent forays
into the bond market. The results from these analyses are consistent with my
tests of H1 . However, for my test of H2B , I now find that for the alternate
measures of debt, there is no significant difference in disclosure level among
high-debt governments, or ðb4i b5i Þ is not significant, consistent with H2B .
Because my original specification with debt per capita as the debt proxy
includes population as a deflator and again as a separate control variable, it
is possible that this caused an econometric problem. This is plausible because
when total revenue is used as an alternate size deflator (in the ratio of total
debt/total revenue), I find no significant difference in disclosure between high-
debt municipalities in Pennsylvania and Michigan. In addition, when I use
multinomial logit for the specification that includes debt per capita, I again
find that there is no significant difference in disclosure between high-debt
governments.
Third, I assess the sensitivity of the results to the disclosure index measure
by using two alternative disclosure indices, the first based on Copley (1991) and
the second on Ingram and DeJong (1987). I chose these two indices because
both purport to represent measures of GAAP disclosure. A comparison of the
content of these alternate indices with the current studyÕs is provided in
Appendices A and B. Although I separate the GAAP and non-GAAP com-
ponents into two separate indices in the appendices to facilitate comparison,
for the purpose of this sensitivity test, I combine the indices in the same manner
as that used by the two aforementioned studies. The results of this specification
do not differ significantly from those reported, and as such, my results are not
likely due to index design.
Fourth, I assess the effect of the point of sample partition in the test of H2B ,
which uses the upper and lower third of the total sample to represent high and
low debt, by instead using the upper and lower quarter of the total sample. The
results from this analysis are again consistent with those presented. In partic-
ular, when I use this alternative partition point, the coefficient estimates for the
low-debt subset are slightly larger, and for the high-debt subset slightly smaller,
than the partition that divides the sample into thirdÕs.
6. Conclusion
The purpose of this paper is to examine the effects of disclosure regulation

and bond market interaction on information production, using data from the
governmental sector. I compare disclosure in Michigan, a state that requires
GAAP, with that of Pennsylvania, a state with unregulated disclosure.
My analysis indicates two main results. First, within the unregulated
disclosure state, I find a significant positive association between disclosure
level and proxies for the level of bond market interaction. This result sug-
gests that in the absence of regulation, municipal managers disclose financial
report information because they have bond market-induced incentives to do
so.
Second, I find that the level of GAAP disclosure is significantly higher in the
regulated state than in the unregulated state. The difference in disclosure levels
between states is significantly smaller among those governments with higher
debt, however, which implies two things. First, although somewhat mixed, this
evidence suggests that regulation is not binding for governments with high
debt levels. In other words, regulated governments with high debt levels are
required to disclose GAAP information that they would have voluntarily
disclosed in the absence of regulation. Second, it implies that regulation in-
duces the production of information, or is binding, for governments with low
debt levels. The latter result suggests that mandating GAAP information im-
poses costs on governments with lower bond market interaction, and ulti-
mately the taxpayers, while conferring benefits to public accountants through
monitoring costs.
My study examines disclosure levels for the governmental sector for one
year. This focus enables a more precise analysis of some of the consequences of
accounting regulation. However, it also means the results may not be gen-
eralized to the corporate sector and/or other time periods. This issue could be
addressed in future studies by applying a similar methodology to research areas
where corporate disclosure is differentially regulated, for example, in interna-
tional research.
Another limitation is that because some of the tests examine whether the
difference in disclosure between the two states is not significantly different from
zero, it is possible that the insignificance is due to model misspecification. A
final limitation of this study is that it necessarily restricts the examination of
disclosure to a bond market perspective. However, as discussed previously,
both focus groups commissioned by the GASB as well as prior academic re-
search indicate that bond market participants are the primary users of muni-
cipal financial reports. An additional benefit of the bond market focus is that it
allows analysis of non-political incentives to disclose, an area of the govern-
mental literature not extensively explored.
Acknowledgements
I would like to thank my dissertation committee, Bob Hagerman, Susan

Hamlen, Mike Rozeff, and P.K. Sen, for their guidance and support. This
paper has also benefited from the comments and suggestions of Bill Baber,
Ray King, Steve Matsunaga, Wayne Mikkelson, Dale Morse, Terry OÕKeefe,
Megan Partch, Kevin Sachs, Mike Stein, two anonymous reviewers, and by the
workshop participants at the American Accounting Association 2001 annual
meeting, Boston University, the University of Oregon, SUNY at Buffalo, and
the joint conference of the Universities of British Columbia, Oregon, and
Washington (UBCOW). I would also like to thank Dick Balderman and the
Michigan Department of Treasury Local Audit staff, as well as Ken Johnson
and the Pennsylvania Department of Community and Economic Development
staff, for the use of their financial reports. Financial support from the AAA
government and non-profit section is appreciated.
Appendix A. A GAAP disclosure index
46
This table presents the GAAP disclosure index used in regressions. The index is compiled directly from disclosures
contained within the governmentsÕ annual financial reports, and is drawn from both the basic financial statements and
the footnotes. The GAAP index contains 18 disclosure elements that are required by GAAP. Thus, governments can
A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52

attain an equally-weighted index score of between 0 and 18. The frequency of occurrence columns indicate the total
number of times each individual item is disclosed, and is shown for the total sample partitioned by state and debt per
capita. High denotes a high debt level, whereas Low denotes a low debt level
No. Copley Ingram Disclosure practice Frequency of occurrence
(1991) and Total sample partitioned by
DeJong
(1987) State Debt
MI PA High Low
(n ¼ 88) (n ¼ 87) (n ¼ 58) (n ¼ 58)
Basic financial statements
1 A3 Combined balance sheet 88 72 58 49
2 A2, B1 Combined statement of revenues, expendi- 88 70 57 48
tures, and changes in fund balance––all
governmental fund types and expendable
trust funds
3 A1 1, 7 Combined statement of revenues, expendi- 76 56 53 36
tures, and changes in fund balance––budget
and actual––all governmental fund types and
expendable trust funds
4 A8 Combined statement of revenues, expenses, 82 54 50 40
and changes in retained earnings––all pro-
prietary fund types and similar trust funds
5 A7 Combined statement of cash flows––all pro- 82 51 55 36
prietary fund types and similar trust funds
Footnotes
6 A10 8 Basis of accounting––governmental funds 88 59 52 46

use modified accrual
7 8 Basis of accounting––expendable trust, 88 43 51 40
agency funds use modified accrual
8 8 Basis of accounting––non-expendable trust, 88 50 52 38
pension, proprietary funds use accrual
9 B5 Budgetary basis of accounting, budgetary 86 75 57 51
policies
10 B6 Basis of accounting––revenue and expense 88 74 57 50
recognition
11 Property tax calendar: lien, levy, and due 58 35 38 24
dates
12 Cash deposits with financial institutions: 75 57 47 40
carrying amount of total deposits, and total
bank balance classified into three risk
categories
13 Investments: investments classified into three 65 37 38 32
risk categories; disclosed carrying amount
and market value in total and for each
investment type; and briefly describe types
of investments authorized by legal or
contractual provisions
14 B4 2 Fixed assets: statement of changes in general 78 47 49 35
fixed assets; and method of recording general
47
fixed assets
48
Appendix A (continued)

DeJong
(1987) State Debt
MI PA High Low
(n ¼ 88) (n ¼ 87) (n ¼ 58) (n ¼ 58)
15 A6 10 Accrued sick and vacation pay (compensated 72 57 49 39
absences) recorded in F/S or footnote
16 All 4 Long-term debt: debt service requirements 75 56 50 36
to maturity; and changes in general
long-term debt
17 B7 Interfund receivables/payables footnote 83 35 45 37
18 B2 5 Amount of pension expenditure pursuant 86 76 56 53
to an actuarial determination
B3 9 Commitments and contingencies are
discloseda
A5 Unfunded pension liabilitiesa
A9 Lease and purchase commitmentsa
a
Items proxy for the level of complexity, as only those that have this particular activity are required to disclose it.
Appendix B. Non-GAAP disclosure index
This table presents the non-GAAP disclosure index, comprised of seven disclosure elements that are not required by
GAAP. Thus, governments can attain a non-GAAP index score of between 0 and 7. The non-GAAP disclosure elements
are drawn from the basic financial statements, footnotes, and supplementary statistical information. The frequency of

occurrence columns indicate the total number of times each individual item was disclosed for the total sample parti-
tioned by state
DeJong
(1987) State Debt
MI PA High Low
(n ¼ 88) (n ¼ 87) (n ¼ 58) (n ¼ 58)
1 General governmental expenditures by 22 17 19 4
source and function
2 A12 Percentage of property taxes collected 24 30 24 10
3 A13 Legal tax limits 11 11 10 4
4 B9 Assessed value of taxable property 40 41 32 20
5 B10 Legal debt limits and unused debt 22 15 20 3
margins
6 B11 Property tax rates 43 56 35 30
7 B12 Schedule of direct and overlapping debt 21 16 19 4
8 Principal taxpayers 22 17 20 4
9 Demographic statistics––population 17 6 15 2
(10-year trends)
10 Demographic statistics––per capita 11 7 14 2
income (10-year trends)
49
50
Appendix B (continued)

DeJong
(1987) State Debt
MI PA High Low
(n ¼ 88) (n ¼ 87) (n ¼ 58) (n ¼ 58)
11 Demographic statistics––unemploy- 15 4 11 2
ment rate (10-year trends)
12 Demographic statistics––school enroll- 16 5 13 2
ment (10-year trends)
13 Demographic statistics––median age 10 1 7 1
(10-year trends)
3 Current liabilities are reported separate
from long-term liabilities
6 Encumbrances are reported as a reserve
of fund balance at year-end
B8 Disclosure that legal bond requirements
have been met
A4 Revenues and expenditures by source
and function
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Effects of GAAP Regulation and Bond Market Interaction On Local Government Disclosure

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Journal of Accounting and Public Policy 23 (2004) 23–52

The eﬀects of GAAP regulation

Department of Accounting, Lundquist College of Business, University of Oregon, Room 1208,

Keywords: Regulation; Disclosure; Bond market; Local governments

profession (Healy and Palepu, 2001). Disclosure regulation research is espe-

2. Governmental accounting environment

2.1. Governmental accounting regulatory environment

2.2. The primary user group––the bond market

The remainder of my paper examines the costs and beneﬁts of disclosing

2.3. Disclosure regulation

While theory supports the proposition that disclosure regulation results in

3. Theory and hypothesis development

3.1. Basic theoretical framework of municipal disclosure

My focus is on the relation between disclosure and the bond market. In so

perfect, investors bear risks in forecasting their investmentsÕ future payoﬀ. 7 If

3.2. Disclosure regulation

When disclosure is mandated by regulation, it creates a minimum level of

Governments with a relatively higher level of bond market interaction will

4. Research design and tests of hypotheses

4.1. Sample selection

I employ data from Michigan, which requires GAAP, and Pennsylvania,

through a combination of requests to the municipalities and the Department of

4.2. Tests of hypotheses

4.2.1. Regression speciﬁcation for H1

DISCLOSUREit is the value of the GAAP, non-GAAP, or TOTAL disclo-

AUDITSit is the number of municipal audits performed in year t by govern-

The dependent variable is measured alternately using GAAP, non-GAAP,

ance with GAAP requirements. No attempt is made to assess the quality of

4.2.1.3. Control variables. I include three control variables found signiﬁcant in

4.2.2. Regression speciﬁcation for H2

GAAPit ¼ ai þ b1i POPit þ b2i CITYit þ b3i AUDITSit

5.1. Descriptive statistics

Panel C: Subset of high debt governments (n ¼ 58)

5.2. Tests of hypotheses

I ﬁrst perform a Wald test to determine whether it is appropriate to pool the

W ¼ ðh1 h2 Þ0 ðV1 þ V2 Þ1 ðh1 h2 Þ

5.3. Sensitivity analysis

Sensitivity analysis establishes that my results are robust to alternative

The purpose of this paper is to examine the eﬀects of disclosure regulation

I would like to thank my dissertation committee, Bob Hagerman, Susan

A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52

A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52

A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52

A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52

A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23–52

American Accounting Association (AAA) mid-year meeting, 1996. Report on governmental

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