An Examination of the Effects of Budgetary Control on

Performance: Evidence from Cities

Carolyn M. Callahan
Doris M. Cook Professor*
University of Arkansas-Fayetteville

Tammy R. Waymire
Ph.D. Candidate, Accounting
University of Arkansas-Fayetteville

Revised: November, 2007

*Corresponding Author, Sam M. Walton College of Business, Department of Accounting,

Business Building 401, University of Arkansas, Fayetteville, AR 72701-1201, email:
ccallahan@walton.uark.edu

We gratefully acknowledge support of this project by the Institute of Management Accountants.

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

Keywords: budgetary control; public sector; bond ratings; management control systems;
congruence.

Data Availability: Data in this study are derived from publicly available sources, including
websites of the cities in our sample, Moody’s website, and U.S. Census Bureau website.

2
 I. INTRODUCTION

Performance measurement and management control are critical components of improving

organizational performance. However, researchers have historically had little success in

determining the specific actions that lead to superior performance (e.g. Hirst, 1981, 1983;

Brownell, 1982, 1985; Govindarajan, 1984; and Govindarajan and Gupta, 1985). Exacerbating

this problem, researchers have had difficulty in agreeing on the performance metric that best

captures the concept of organizational performance (e.g. Otley, 1994; Malina and Selto, 2004;

Ittner and Larcker, 1997, 1998; Chenhall and Langfield-Smith, 2007). After several decades of

research in this area, we have few clear conclusions (Merchant and Otley, 2007). One area in

which researchers have provided some clarity in linking management controls to performance is

in the area of budgeting. For example, Abernethy and Brownell (1999) present a theoretical

model and examine the relationship between strategic change, style of budget and performance

in a nonprofit hospital setting.

The nonprofit setting is of interest as budgeting has been extensively used by

governmental entities and governmental accounting standards. Governmental reporting

standards require the presentation of budgetary comparison schedules as supplementary

information to financial statements. This requirement increases the level of accountability

associated with the budgeting process for these entities and its linkage to performance has the

potential to be informative to city managers who focus on budgetary control as an important

element of the management control system.

Broadly, management control systems serve as the foundation for decision-making in all

organizations. While the incentive structures in private sector and public sector organizations

may differ, management control systems provide the same structural support for the activities

and goals of the organization. Ultimately, organizations adopt management control systems with

3
the expectation that they will facilitate better decision-making and lead to improved

organizational performance. Over time, then, one would expect firms to adapt their management

control systems in an effort to maximize firm performance. To date, empirical research has not

fully examined the effects of management control systems on performance. Even within the

budgetary control literature which tends to dominate the management control literature, there is

scant evidence linking controls directly to performance, the focus of this paper.

In this study, we examine the effects of budgetary control on performance in a sample of

large U.S. cities, a unique setting that allows us to consider the differential effect of tight versus

effective budgetary control on organizational performance. We use bond ratings as a

performance metric as bond ratings have significant consequences for municipalities and the

public interest, largely because a low rating raises the cost of borrowing money for public capital

projects. Using budget-to-actual variances as a measure of budgetary control and bond rating as

a measure of performance, we find that tight budgetary control is not significantly associated

with performance. In contrast, we find that an effective level of budgetary control, i.e., one that

is reflective of the needs of the organization and that is meaningful to the analysts in their

evaluation of bond ratings, is positively and significantly associated with performance.

Previous research has tended to focus on the antecedents of budgetary control, rather than

the effects of budgetary control. For example, Simons (1987) found that a firm’s strategy was

related to its choice of control systems. More recently, Widener (2007) finds that, in certain

strategic conditions, information processing needs are such that firms use performance measures

both interactively and diagnostically suggesting multiple inter-dependent and complementary

relations among the control systems.

While this area of research is necessary in understanding how the degree of budgetary

control is established, it is also important to understand how budgetary control affects

4
organization performance. Because the primary source of financing for cities is debt, bond

ratings are a critical performance metric. Bond ratings represent the consideration of a myriad of

factors including a city’s ability to repay its debt, its operational effectiveness, and its economic

outlook. Bond ratings therefore represent a multi-faceted performance measure that has far-

reaching implications for city managers as well as taxpayers. In particular, bond ratings are

directly related to cost of debt (Reck et al., 2004) and also provide a signal to other stakeholders

about the operating performance of cities.

Perhaps the greatest barrier to the examination of the link between budgetary control and

performance is identifying, and controlling for, the contextual factors that influence this link.

Management accounting literature, as a whole, has relied heavily on contingency theory in

examining empirical questions, recognizing that contextual factors are of significant importance

in establishing models. Hartmann (2000) provides an extensive discussion of the construct

Reliance on Accounting Performance Measures (RAPM) and identifies the use and limitations of

the theoretical development of RAPM. He discusses the use of contingency theory and suggests

that consideration of the suitability of RAPM led to the inclusion of contextual variables in

research models. The underlying theme is that context matters. One would expect that context

matters in any discussion of the extent of budgetary controls in an organization.

In this study, we use a unique sample which overcomes much of the difficulty associated

with controlling for contextual factors that would otherwise influence the effect of budgetary

control on performance. In particular, we use a sample of large U.S. cities to examine whether

budgetary control, as measured by budget variances, is associated with performance, as

measured by bond rating. This context offers two differentiating characteristics from settings

used in previous research efforts and therefore provides control for operating characteristics

which would vary in most other research settings. First, Governmental Accounting Standards

5
Board (GASB) pronouncements require the use of budgets by governmental entities. Second,

governmental entities’ use of budgets is inextricably linked to their ability to obtain funding

through the appropriations process. These characteristics provide a setting of tight budgetary

control across all observations, at least at the organizational level. Furthermore, the cities in our

sample are generally subject to the same legal and reporting requirements, effectively controlling

for organizational differences that would be present in many other research settings.

In addition to the need to control for contextual factors, this research area has been made

more difficult by the general lack of agreement regarding the definition of “tight budgetary

control.” Van der Stede (2001) identifies inconsistency in the use of the term “tight budgetary

control.” He contributes to the literature by creating an instrument that can be used to measure

the degree of tight budgetary control. Of the five subcomponents, Van der Stede (2001) finds

that the order of importance of these items for establishing degree of tight budgetary control is:

low tolerance for interim budget deviations, detailed line-item follow-ups, intense discussions of

budgeting results, and more emphasis on meeting short-run budget targets. He finds no support

for level of tolerance for budget revisions during the year being indicative of tight budgetary

control. Further, he finds that his tight budgetary control construct is significantly and positively

correlated with budget goal difficulty, establishing an appropriate level of convergent validity.

Consistent with Van der Stede’s (2001) instrument, governmental entities, and

specifically the cities in our sample, operate under conditions of tight budgetary control at the

organizational level. GASB pronouncements require the use of budgets, the preparation of

budgetary comparison schedules required for the general fund and each special revenue fund,

and the discussion of significant variances in the management discussion and analysis (MD&A)

in the annual report. More importantly, governmental entities are generally subject to balanced

budget requirements, making it impossible from a practical standpoint to spend beyond the level

6
of appropriation. These mechanisms force governmental entities to monitor budget-to-actual

results closely throughout the year, creating the conditions described by Van der Stede (2001) as

indicative of tight budgetary control. However, because these conditions often lead to unused

appropriation and because the balanced budget requirement is generally imposed at the

organizational level, the opportunity exists for a significant amount of variation in budget-to-

actual results within the organization at the department or fund level. Furthermore, consistent

with Cavalluzzo & Ittner (2004), one would expect that the implementation of mandated

budgetary control systems may be somewhat superficial, also contributing to variation at the

department or fund level.

While Van der Stede’s (2001) instrument, if modified for use in the public sector, would

have been one possible way to measure budgetary control at deeper levels within the cities in our

study, we chose an alternate approach. As indicated by Van der Stede (2001), the most

important factor in the measure of tight budgetary control is low tolerance for budget deviations.

The second most important factor is detailed line item follow-ups, indicating that tight budgetary

control is concerned with variances at a line item level. Therefore, we used percentage variances

for revenues and expenditures in the general fund as a proxy the degree of budgetary control at

the fund level. Specifically, low budget variance percentages for revenues and expenditures

would be indicative of a high degree of tight budgetary control, while high budget variance

percentages for revenues and expenditures would be indicative of a low degree of tight budgetary

control.

The GASB and legislative bodies have assumed that tight budgetary control positively

affects performance and, accordingly, have often required the implementation of management

control systems that would provide for tight budgetary control in governmental entities. Despite

the general lack of empirical research examining whether budgetary control is associated with

7
performance and the weak findings in the studies that examine this question, tight budgetary

control is assumed to create accountability, and accountability is assumed to improve

performance. The GASB states in its Concepts Statement No. 1 that accountability is the

cornerstone of all financial reporting in government. In its codification of that statement, they

elaborate as follows:

Governmental accountability is based on the belief that the citizenry has a “right
to know,” a right to receive openly declared facts that may lead to public debate
by the citizens and their elected representatives. Financial reporting plays a major
role in fulfilling government’s duty to be publicly accountable in a democratic
society (GASB Concepts Statement No.1).

Within government organizations, accountability is created by the required use of annual

budgets. The GASB’s Budgeting, Budgetary Control, and Budgetary Reporting Principle

provides for the adoption of an annual budget by every government, an accounting system which

provides for an effective level of budgetary control, and the preparation of budget-to-actual

comparisons in the annual report of the reporting entity (Wilson, Kattelus, & Reck, 2007).

Similar assumptions regarding the link between tight budgetary control, accountability,

and performance are made in private sector firms. However, in that setting, there have been

considerable concerns about the perceived shortcomings of traditional budgeting, including the

dysfunctional behavior that is believed to be created by the budgeting process. Hansen et al.

(2003) examine practice developments in budgeting, presenting two approaches that have been

proposed to address problems within traditional budgeting. Both approaches are founded on the

assumption that traditional budgeting is flawed because of the manipulation involved and the

focus on incremental changes rather than value-creation. One approach would involve a radical

change to traditional budgeting, and the other approach advocates abandoning traditional

budgeting altogether. The advocates of the second approach consider the shortcomings of

budgeting to be so pervasive that any benefits of traditional budgeting are far outweighed.

8
 This study then informs the debate about the appropriate use of budgeting. By offering

evidence that the effective level of budgetary control is positively associated with performance,

we identify value in the budgeting process. While government organizations may differ

operationally from for-profit firms, there are some similarities that make our results at least

cautiously generalizable beyond the research setting. When adopted, budget systems serve at

least two of the same purposes whether an entity operates in the public or private sector. First,

budgets serve as a means of controlling costs and creating accountability. Second, budgets serve

as a means of improving revenue collection. Fundamentally, beyond required use in

governmental entities, the use of budgets then serves the same general purposes in all

organizations – to create accountability and control accounting results.

This study also has the potential to contribute to the efforts to address concerns regarding

the current state of government finance. According to the McKinsey Quarterly, one trend to

expect in 2006 is an increase in public-sector activities. This increase is expected largely

because of the aging of populations in developed countries. Consequently, it will be essential

that we understand and implement measures to create efficiencies in government and not-for-

profit organizations. Absent such measures, McKinsey predicts that, “the pension and health

care burden will drive taxes to stifling proportions (Davis & Stephenson, 2006).” It is therefore

becoming increasing important that decision-making in these organizations should be informed

about the relationship between control systems and performance.

In addition to the general growth of the public sector, cities face downward pressure in

budgeted and actual revenues from year to year. Declining tax base in many areas constrains

revenues while costs continue to grow. The National League of Cities (NLC) reports that cities

and towns are still experiencing financial distress in spite of economic rebound across the

country. In particular, NLC cites declining revenue conditions due to slow-growing or declining

9
sales tax, income tax, and tourism revenues. Municipal expenditures, primarily personnel costs

including health care costs and pensions, are increasing, and public safety concerns following

September 11, 2001 have strained security and police budgets. According to NLC, city officials

are faced with difficult decisions to reduce the municipal workforce and capital investments, to

increase fees and charges, and to draw down reserves (Pagano & Hoene, 2006). Given that most

cities require a balanced budget, the downward pressure on revenues and upward pressure on

expenditures provide a challenge to city officials. Linking budgets to performance creates

another challenge, namely an appropriate performance metric. The conceptual and technical

problems involved with valid and reliable performance measurement are numerous. Grenier

sums up the problems as follows:

Public sector performance measurement is, in effect, like putting a meter on a

black box: we have little knowledge of the mechanism inside and no theory
linking inputs, processes, outputs and outcomes to explain why a particular result
occurred or to prescribe what management organizational adjustments are needed
to improve performance.1

We focus on bond ratings as we wish to use a market metric that is objective as established by an

external party, bond rating agencies. This focus is consistent with statements by bond rating

agencies:

From larger cities to small towns, municipalities face the ongoing challenge of
issuing bonds for their municipal and school repairs and new construction. Karl
Jacob, Director of Public Finance Ratings for the bond rating firm of Standard &
Poor's, provides some perspective. "When we review a bond rating, we review the
general economy, city finances, their management and the amount of debt
outstanding," he said. "Then we blend those together and set the bond rating.

Municipal bond ratings, issued on request by Standard and Poor's Corporation or Moody's

Investors Service, hold implications for cities' financial management. Ultimately, the bond rating

1
For a detailed discussion, see John M. Grenier, 'Positioning Performance Measurement for the Twenty-First
Century' in Arie Halachmi and Geert Bouckaert (eds). Organizational Performance and Measurement in Public
Sector. Westport, Conn: Quorum Books, 1996, pp. 11-50.

10
assigned is a factor affecting the total cost of the bond issuance, related to the principal and

interest payments over the life of the debt. Hence, this makes cities or municipalities an

interesting and worthwhile setting to examine the impact of budgets on the performance of an

organization, as measured by bond rating. In this setting, we find that the effective level of

budgetary control is significantly and positively related to bond rating, refuting a common, but

unfounded, assumption that tight budgetary control is the most effective level of budgetary

control. This suggests that city mangers interested in maintaining or improving their municipal

bond ratings to manage debt costs may consider paying closer attention the effective level of

budgetary control within the cities, as measured by budget variances.

The remainder of this paper is organized as follows: Section II develops several testable

hypotheses; Section III describes the data and methodology; Section IV presents our results; and

Section V concludes.

II. HYPOTHESIS DEVELOPMENT

In forming our hypotheses, we considered the existing evidence that suggests that

budgetary control affects performance (Simons, 1987), as well as the evidence of compliance to

the exclusion of effective utilization of controls (Cavalluzzo and Ittner, 2004). Drawing on

institutional theory, we expect that tight budgetary controls, which exist at the organizational

level, are not necessarily present at deeper levels of the organization. Institutional theory

suggests that cities will comply with requirements to gain approval, or legitimacy, of external

observers, but that they will not implement controls at a more meaningful level. This

compliance to the exclusion of effective utilization provides the variation necessary to examine

the impact of budget variances, which proxies for level of budgetary control, on the bond rating

of the cities in our sample.

11
 In this research setting, it is important to consider the implications of evidence that

suggests that governmental entities comply with required systems or controls implementation,

but they may not effectively utilize those systems or controls (Cavalluzzo and Ittner, 2004). This

would suggest that, although balanced budgets are generally required at the city level, there may

be a surprising level of variation in the line item variances within funds. Whether this variation

negatively affects performance is the focus of this study.

While the extant literature would suggest that budgetary control is positively associated

with performance, the number of studies is limited, and the results have not been entirely

convincing. Simons (1987) finds that tight budgetary control is associated with performance for

all firms in his sample except those classified as larger defenders. Defenders are characterized

by Miles and Snow as operating in stable industries, offering limited products, and competing on

the basis of cost. Simons (1987) is unable to offer an explanation for why larger defenders

would not reflect performance improvement, as measured by return on investment (ROI), when

tight budgetary controls are in place. One would expect that defenders would stand to benefit

most from tight budgetary control, given their low cost strategy. The other categorized group of

firms in the Simons (1987) study was the prospectors. Prospector firms were characterized by

Miles and Snow as competing on the basis of differentiated products rather than price. One

would expect that these firms would require flexibility that would be indicated by looser control

in order to promote the innovation necessary to have a successful strategy. Simons’ (1987)

results then appear to be counterintuitive, suggesting the need for additional empirical

examination of this topic. In addition to Simon’s work, several other important studies also

establish a link between budgetary control and performance (e.g. Merchant 1981, Brownell and

Merchant 1990, Dunk 1992, Abernethy and Brownell 1999, Davila and Foster 2005). The first

12
hypothesis provides a foundational test for whether tight budgetary control is associated with

performance, and because we do not make a directional prediction, it is stated in the null form:

Hypothesis 1a: Tight budgetary control, as defined by small budget variances in

revenues and expenditures, will not be significantly associated with performance.

In contrast with Simons (1987), Ittner and Larcker (1997) examine whether a “match”

between strategy and control systems is directly related to performance. This represents a

competing hypothesis with the finding by Simons (1987) that tight budgetary control is generally

associated with performance. The congruence research that has followed Ittner and Larcker

(1997) has generally found that a match between control systems and the strategy or needs of the

organization are associated with economic performance (Bouillon et al. 2006; Pizzini 2006).

While the competing hypotheses are not mutually exclusive, the implication is that a system of

tight budgetary controls may not always provide the best match with the strategy of an

organization.

Degree of budgetary control can be measured with a results-oriented approach, meaning

that variances in revenues, expenditures, and the net of revenues and expenditures, can serve as a

measure of budgetary control, and is consistent with the factors that are most influential in Van

der Stede’s tight budgetary control survey. Whether the degree of budgetary control is effective

is more difficult to ascertain. From a practical standpoint, a city’s ability to manage its variances

with the flexibility of the budgetary slack that exists within the budget should contribute to the

city’s performance. Based on the downward pressure on revenues and upward pressure on

expenditures currently experienced by U.S. cities, bond rating analysts assigning bond ratings

may likely consider the net effect of variances, finding that variances close to zero are worthy of

higher bond rating and evidence of positive performance.

13
 We do not expect that tight budgetary controls will necessarily contribute to a city’s

performance, as measured by bond rating. Rather, we expect that the alignment of the needs of

the organization and the degree of budgetary control will positively affect performance. This

effective level of control may not constitute tight budgetary control. This prediction is consistent

with the management control systems literature regarding the benefits of the alignment of control

systems with the strategy of the firm. In other words, we expect that the tailoring of a system or

set of controls will most benefit an organization when the system or set of controls is created

with the entity’s strategy and unique needs in mind. Hypothesis 1b tests this competing

hypothesis that congruence between the budgetary control system and the strategy or needs of

the organization is the better predictor of performance, and is stated in the alternate form:

Hypothesis 1b: The effective level of budgetary control, as defined by small variances in
the net of the budget-to-actual revenue and expenditure variances, will be significantly
associated with performance.

Another consideration within this research setting is the legal constraints under which the

cities operate. Beyond the balanced budget requirement, cities obtain their funding through the

appropriations process. This process involves the competing of departments for funding and

limits the spending of a given line item to the amount appropriated. We would therefore expect

very few observations reflecting negative variances, as that would be indicative of overspending

of appropriated amounts which is prohibited and often not even administratively possible.

Larger variances, in either direction, are likely to have a negative effect on bond rating.

Large negative variances would suggest poor fiscal management, and perhaps even violations of

state or city law, resulting in an expected negative impact on bond rating. Large positive

variances would suggest that the city did not use the resources available to provide services to

the residents of the city. In its unique focus on performance measures other than the bottom line,

public sector entities are expected to use the resources available for the intended beneficiaries.

14
Furthermore, any excess of revenues over expenditures may not be available for the city in the

next fiscal year and could lead to future operating budget cuts. Therefore, while certainly not as

serious as the potential consequences of negative variances, we would expect large positive

variances to be penalized via the bond rating process. Overall, this would suggest that the

effective level of budgetary control for cities would result in small variances in the net of

revenues and expenditures for a given fund. This effective level of budgetary control is then

expected to be positively associated with performance. We therefore form the following

hypotheses:

Hypothesis 2: Negative variances in the net of the budget-to-actual revenue and

expenditure variances will have a more pronounced effect on bond rating than will large
positive variances.

III. METHODOLOGY

Sample

We selected a preliminary sample of twenty-six cities identified by the 2004 U.S. Census

to be among the 79 largest cities in the United States. We gathered bond rating data from

Moody’s on each of the cities for the period 2000 through 2006. Further, we gathered budget

and other financial data from each city’s comprehensive annual financial report (CAFR) obtained

from the cities’ websites, including the budgeted and actual revenues and expenditures, fund

balance in the general fund, and general obligation debt for the years 2003 and 2004. Our

preliminary sample represents a compilation of cities for which we could obtain both bond

ratings and for which comprehensive annual financial reports were available.

15
Dependent Variable

We use the Moody’s bond rating as our measure of performance.2 The bond rating we

used was the one issued the soonest after the end of a six-month window following the end of the

fiscal year covered by the CAFR. Most comprehensive annual financial reports are issued

within six months of the end of the fiscal year covered by the report. Therefore, the bond rating

we used was the one that issued closest to the end of the six-month window following the end of

the fiscal year covered by the CAFR. Furthermore, the bond ratings were measured at the

highest level of detail provided by Moody’s. The bond ratings were converted to an ordinal

ranking, as specified in Table 1, with the lowest bond rating reflecting a value of 1 and the

highest bond rating reflecting a value of 21. This provides for an easier interpretation of the

results.

The ratings agencies rely on historical financial information to some degree in evaluating

and assigning a bond rating. However, the agencies are focused on the long-term outlook in

establishing bond ratings. For example, Moody’s policy is to “focus on fundamental factors that

will drive each issuer’s long-term ability to meet debt payments, such as a change in

management strategy or regulatory trends. As a rule of thumb, we are looking through the next

economic cycle or longer (Moody's, 2004).” Because of this longer focus, it is appropriate to

examine the impact of budgeted information, and in particular, the comparison of budgeted to

actual results, on bond rating.

2
There are three major, independent bond rating agencies: Moody’s Investors Service (Moody’s), Standard and
Poor’s, and Fitch Ratings. We rely on Moody’s in this study for two distinct reasons. First, while it would have
been possible to use some average of the three agencies, the use of all three was determined to be both cumbersome
and possibly lacking in additional value as the rating services appear to provide similar rankings. Second, prior
accounting research has typically relied solely on Moody’s ratings, making our study consistent with past
accounting research practice.

16
 Moody’s (2004) indicates that a variety of factors is considered in its bond ratings and

identifies the factors can be distilled to five primary credit categories: legal security, local

economy, financial operations, debt profile, and management. The most significant factor is

debt, including general obligation debt, as well as capital leases, lease revenue debt and other

fixed obligations (Moody's Investors Service, 2004). The bond rating then is an appropriate

proxy for performance.

Independent Variables of Interest

All independent variables of interest are general fund budget-to-actual variances and are

calculated based on information provided in the cities’ CAFRs. The budgeting process,

including the steps and the timing, can vary significantly from city to city. However, almost all

cities require a balanced budget. Further, most cities have at least four stages to the budget

process: preparation, approval, implementation, and evaluation. The timing of these stages may

vary, but the conclusion generally is some approval by a city council or board and making the

approved budget public.

The budgeted revenues used in this study are those originally estimated by the cities. The

GASB has promulgated Statement No. 34, which provides, among other things, that cities must

publish in their Comprehensive Annual Financial Reports (CAFRs) the original and final

budgeted amounts. This appears to be in an effort to provide transparency to the reader of the

financial statements. In addition, Statement No. 34 requires Management Discussion and

Analysis (MD&A) that discusses significant differences between the original and final budget

amounts and significant differences between final budget amounts and actual results.

Specifically, GASB had some concern that governmental entities were revising the budget in an

effort to make their actual results appear to be closer to the budgeted amounts. In light of these

17
concerns and the recent promulgation, original budgeted amounts are the most appropriate and

interesting variables to include in this study.

The budgeted revenues and expenditures included in the study are not all in conformity

with generally accepted accounting principles (GAAP). Some cities use another basis of

accounting when preparing the budget. In these circumstances, actual revenues and expenditures

are reported on the same basis as the budgeted amounts. Consequently, we use some accounting

variables that are based on GAAP and some that are not. However, because financial variables

for a given city are reported on the same basis, we do not find this to be a problem.

Specifically, we operationalize budgetary control as the absolute value percentage

budget-to-actual variances in revenues, expenditures, and the net of revenues and expenditures.

Furthermore, we create binary variables to indicate whether revenue, expenditure, and net

variances were negative, small positive, or large positive. While our preference would have been

to categorize the variances as large positive, large negative, and small (either direction)

variances, there were not many large negative variances for either revenues or expenditures.

This is most likely the result of legal constraints which would preclude spending more than

amounts that are appropriated, as previously discussed. Therefore, we opted for an alternative

classification that provided for a more even distribution of the observations among the three

identified categories. Large positive variances are those variances which exceed five percent of

budgeted revenues or expenditures. Negative variances are those variances below zero percent

of budgeted revenues or expenditures. Finally, small positive variances are those variances that

range from zero to five percent of budgeted revenues or expenditures. To avoid linear

dependency, we coded binary variances for each observation as large positive and negative

variances, and omitted small positive variances.

18
 Finally, we interacted the binary variables with the absolute value percentage budget-to-

actual variances in revenues, expenditures, and net of revenues and expenditures, as appropriate.

Hanlon (2005) used a similar technique for isolating the effects of large positive and large

negative differences between book and tax income in a capital markets tax study. Similar to

Hanlon (2005), these interaction terms provided a means for comparing the effects of negative,

small positive, and large positive variances on bond rating.

Control Variables

We include four basic control variables in our study consistent with Raman (1981), Reck

et al. (2004), and anecdotal evidence. First, we included a variable to control for population.

Raman’s study and interview with city officials provided some basis for expecting that, ceteris

paribus, cities with larger populations would receive higher bond ratings. In fact, the city

finance officials that we interviewed indicated that a smaller city which performed well would

not be able to obtain as high a rating as a comparably performing larger city. The underlying

rationale is that bond rating analysts view larger cities as better able to adapt to some sudden

financial crisis, and that size might also be indicative that a city would not be too dependent on

any one business or industry for tax revenues. Population data was gathered from the U.S.

Census Bureau and reflects population estimates as of 2004. The control variable is calculated as

the natural log of those population estimates to control for the skewness in the populations and to

control for heteroskedasticity.

Second, we include geographic region of the country as a control variable. Related to the

inclusion of population as a control variable, certain areas have historically received higher bond

ratings. Geographic region was captured with a categorical variable which was transformed into

a series of binary variables for use in both regression equations. Table 2 depicts the region and

division of the country as defined by the U.S. Census Bureau. In this study, we use division as it

19
segments the U.S. into smaller areas than would the region variable. Further, of the nine

divisions of the country, only eight (two through nine) are represented in our sample of 25 cities.

In transforming the categorical variable into a series of binary variables, we omitted Division 2,

making the intercept for Division 2 equivalent to the intercept in the regression equation.

Therefore, these control variables are identified as DIV3 through DIV9.

Third, we include FINPOS, a variable used by Reck et al. (2004). This variable captures

the ratio of fund balance in the general fund to general fund revenues. The expected sign for this

variable is positive, consistent with prior literature. Fourth, we include LEVERAGE, another

variable used by Reck et al. (2004). This variable captures the ratio of general obligation debt to

general fund revenues. The expected sign for this variable is negative, consistent with prior

literature.

Model Development

We estimate four regression equations using OLS.3 The first two OLS regression

equations that we estimate are designed to test Hypothesis 1 and are as follows:

BRRANK = β 0 + β 1 ( REVVAR% _ ABS ) + β 2 ( EXPVAR% _ ABS ) + (1)

β 3thru12 {ControlVariables}

BRRANK = β 0 + β1 ( REVVAR% _ ABS ) + β 2 ( REVLPBAP) + β 3 ( REVNBAP)

+ β 4 ( REVLPBAP × REVVAR% _ ABS ) + β 5 ( REVNBAP × REVVAR% _ ABS )
(2)
+ β 6 ( EXPVAR% _ ABS ) + β 7 ( EXPLPBAP) + β 8 ( EXPNBAP) +
β 9 ( EXPLPBAP × EXPVAR% _ ABS ) + β 10 ( EXPNBAP × EXPVAR% _ ABS )
+ β 11thru 20 {ControlVariables}

Where:

3
We also considered the use of logistic regression given the ordered or ranking nature of the dependent variable in
both regression equations. However, at some point, OLS regression becomes appropriate when the number of
categories gets large. In this case, there are 21 rating categories, counting all the subcomponents. However, for the
sample used in this study, only ten of the ratings apply. The rest of the rating subcomponents are unused, at least
with respect to our sample. Even with ten possibilities for the dependent variable, logistic regression can be
considered to be unwieldy, making OLS regression more appropriate.

20
 BRRANK = the ranking associated with bond ratings as identified in Table 1

REVVAR%_ABS = the percentage variance between budgeted and actual revenues,

expressed as an absolute value percentage

REVLPBAP = binary variable indicating whether the revenue variance exceeds 5% of

the budgeted revenues

REVNBAP = binary variable indicating whether the revenue variance is less than 0% of

the budgeted revenues

EXPVAR%_ABS = the percentage variance between budgeted and actual expenditures,

expressed as an absolute value percentage

EXPLPBAP = binary variable indicating whether the expenditure variance exceeds 5%

of the budgeted revenues

EXPNBAP = binary variable indicating whether the expenditure variance is less than 0%

of the budgeted revenues

To support Hypothesis 1a, we expect to find that the coefficients of REVVAR%_ABS

and EXPVAR%_ABS in the first regression equation are statistically insignificant. In addition,

we expect to find that the coefficients of the four interaction terms (REVLPBAP*REV

VAR%_ABS, REVNBAP*REVVAR%_ABS, EXPLPBAP*EXPVAR%_ABS, and

EXPNBAP*EXPVAR%_ABS) to be statistically insignificant. This would indicate that an

increase in the absolute variance of budget-to-actual would not result in a lower bond rating and

would suggest that tight budgetary control adopted within the cities may not result in improved

performance.

We estimate two additional regression equations designed to test Hypothesis 1b. They

are as follows:
(3)
BRRANK = β 0 + β 1 ( NETVAR % _ ABS ) + β 2thru11{ControlVariables ]

21
 BRRANK = β 0 + β1 ( NETVAR % _ ABS ) + β 2 ( NETLPBAP ) + β 3 ( NETNBAP )
+ β 4 ( NETLPBAP × NETVAR % _ ABS ) + β 5 ( NETNBAP × NETVAR % _ ABS ) (4)
+ β 6thru15 {ControlVariables}

Where:

BRRANK = the ranking associated with bond ratings as identified in Table 1

NETVAR%_ABS = the net of the budget-to-actual revenue and expenditure variances,

expressed as an absolute value percentage in relation to total revenues

NETLPBAP = binary variable indicating whether the net budget-to-actual variance

exceeds 5% of the budgeted revenues

NETNBAP = binary variable indicating whether the net budget-to-actual variance is less

than 0% of the budgeted revenues

To support Hypothesis 1b, we expect to find that the coefficient of NETVAR%_ABS in

the third regression is negative and statistically significant, indicating that the greater the net of

revenue and expenditure variances, whether positive or negative, the lower the bond rating.

Given that a low NETVAR%_ABS is representative of an effective, but not necessarily high,

level of budgetary control, we would conclude that an effective level of budgetary control is

positively associated with performance. In the second regression equation, we expect to find the

coefficients of the two interaction terms (NETLPBAP*NETVAR%_ABS and

NETNBAP*NETVAR%_ABS) to be positive and statistically significant. Similar to our

expectations for the third regression equation, negative statistically significant coefficients would

suggest that an effective level of budgetary control is associated with city performance.

In addition, consistent with Hypothesis 2b, we expect the magnitude of the negative net

budget-to-actual percentage (NETNBAP*NETVAR%_ABS) to be greater than the magnitude of

22
the large positive net budget-to-actual percentage (NETLPBAP*NETVAR%_ABS). This would

suggest that cities are punished more for negative variances than large positive variances,

consistent with our discussion of legal constraints facing cities and the perception of

overspending versus underspending. Underspending would suggest that the cities might not

have utilized its available resources to meet the needs of its residents. Consequently, we would

expect a negative bond rating reaction. However, because overspending carries more serious

consequences, we would expect a more pronounced negative bond rating reaction in those

circumstances.

IV. RESULTS

Prior to examining the results of the regression equations, we performed standards tests

for multicollinearity, heteroskedasticity, and influential observations. While the correlation

matrix did not reflect correlations that would be suggestive of multicollinearity, we also

examined the variance inflation factors (VIFs) and condition indices. VIFs were all well below

10, and condition indices are all well below 20, alleviating any potential concern with

multicollinearity. To address skewness in the population numbers and prevent

heteroskedasticity, we used the natural log of population amounts (lnPOP) in our models as a

control variable rather than the raw population amounts. Further, we used White’s test for

heteroskedasticity and were unable to reject the null hypothesis of homoskedasticity. An

examination of the studentized residuals and Cook’s D statistics reflected any extreme data

points that should be considered for removal.

The results of the first and second regression analyses (Tables 4 and 5, respectively) do

not provide sufficient evidence to reject Hypothesis 1a. As expected REVVAR%_ABS and

EXPVAR%_ABS are statistically insignificant at conventional levels of significance in the first

regression equation. Also, as expected, the four interaction terms in the second regression

23
(REVLPBAP*REVVAR%_ABS, REVNBAP*REVVAR%_ABS,

EXPLPBAP*EXPVAR%_ABS, and EXPNBAP*EXPVAR%_ABS) were statistically

insignificant at conventional levels of significance. The adjusted R2 statistics are 0.4681 and

0.3935 for the first and second regression analyses, respectively. The explanatory power seems

to be driven by the inclusion of the control variables. These results suggest that tight budgetary

control is not always associated with performance, and, in the context of city government,

indicates that the effective level of budgetary control within the organization is something less

than what would be considered tight budgetary control

The purpose of the third and fourth regression analyses (Tables 6 and 7, respectively) was

to address whether an effective level of budgetary control, defined as low variances in the net of

the budget-to-actual variances in revenues and expenditures. The adjusted R2 statistics are

0.4964 and 0.5327 for the third and fourth regression analyses respectively. The explanatory

power of these models is improved over the first and second regression analyses. Consistent with

Hypothesis 1b, NETVAR%_ABS is negative, and it approaches but does not reach statistical

significance at the 0.10 level. The negative direction is consistent with the notion that the larger

the absolute percentage, the lower the bond rating. Assuming variance at this level of detail is an

adequate proxy for effective level of budgetary control, this evidence suggests that the alignment

of budgetary control with the needs and unique characteristics of organizations may have a

positive impact on the performance of the organization. In the fourth regression analysis, we

found, as expected and expressed in Hypothesis 1b, that both interaction terms would be negative

and statistically significant, suggesting that variance in the net of revenues and expenditures

would lead to lower bond rating. Furthermore, consistent with Hypothesis 2, we found that the

magnitude of the effect of positive variances (NETLPBAP*NETVAR%_ABS) was less than the

magnitude of the effect of negative variances (NETNBAP*NETVAR%_ABS), suggesting that

24
large positive variances are punished less severely than negative variances. This is consistent

with the expectation that both overspending and underspending are viewed negatively in

governmental entities, but overspending is considered more serious.

With respect to control variables, we found mixed results. Consistent with expectations,

the coefficient of LEVERAGE is negative and the coefficient of FINPOS is positive in all

regression results. However, while FINPOS is statistically significant at conventional levels in

all four models, LEVERAGE does not reflect statistical significance at conventional levels in

any of the four models. Reck et al. (2004) found that FINPOS was more influential than

LEVERAGE in bond pricing, consistent with our findings, although it is unclear why

LEVERAGE does not reflect statistical significance in any of the models.

The other two control variables included the natural logarithm of population (lnPOP) and

geographic division. We predicted that the coefficient of lnPOP would be positive, consistent

with previous research and anecdotal evidence. However, while we found the coefficient was

statistically significant at conventional levels of significance in all four models, the direction of

the sign was opposite of the predicition. One possible explanation for this result is the use of a

sample which consisted entirely of large cities. Had there been more variation in this variable,

the results could quite likely be different.

We made no prediction about the sign of the seven binary variables which capture

geographic region. However, the division we chose to omit from the coding of binary variables

was Division 2 which covers New Jersey, New York, and Pennsylvania. Of the twenty-six cities

in our sample, only two, comprising four observations of the total fifty-two, were from this

division, Philadelphia and Pittsburgh. These two cities have bond ratings that were the lowest

among the sample, quite likely for other operating characteristics than their geographic division.

25
The result is positive, statistically significant coefficients at the 0.05 level for each of the division

variables.

V. CONCLUSION

In this study, we examine the effects of budgetary control on performance in a sample of

large U.S. cities, a unique setting that allows us to consider the differential effect of tight versus

effective budgetary control on organizational performance. We use bond ratings as a

performance metric as bond ratings have significant cost consequences for municipalities. In a

shift from previous findings, our results are not consistent with prior research which suggests

that tight budgetary control is associated with performance for all firm types. However, our

results are consistent our hypotheses based on the theoretical development presented and our

unique setting. Consistent with most management accounting research, we would expect that

context matters in any evaluation of the effects of budgetary control on performance. Given that

Simons (1987) found results that are counterintuitive, it is possible that contextual factors were

omitted from his analysis, resulting in his unexpected findings. Consistent with the notion that

alignment of an entity’s level of budgetary control with its strategy and its needs, our findings

suggest that an effective level of budgetary control has a positive effect on performance. The

challenge in future research efforts to build on these results will be to establish effective level of

budgetary control so that its effects on performance can be examined.

Evidence was presented that suggests that the net budget variances are informative in the

bond rating process and have a significant impact on performance, whether the variance is

positive (favorable) or negative (unfavorable). This research setting offered the opportunity to

examine this question in a tight budgetary control environment, and to determine the effect of

budgetary control at deeper levels within the organization. Finding that the net variance, whether

positive or negative, was the most informative suggests that monitoring variances at the net level

26
may be the effective level of budgetary control for cities, and possibly other governmental

entities.

While our results are promising, like all preliminary studies, there are inherent limitations

that likely contributed to weaker results and the absence of statistically significant findings for

some of the control variables. First, our sample size of 52 (26 cities with two observations on

each) is very small, especially when our estimations techniques involved multiple sample

partitions among large positive, negative, and small positive differences between budgeted and

actual revenues. Furthermore, the number of independent variables used in the regression

analyses limits the degrees of freedom and impacts the power of our tests. This warrants

additional effort to increase sample size, despite the difficulty in obtaining the data. Second, the

cities in our sample were drawn from the 79 largest cities in the U.S. as identified by the U.S.

Census Bureau in 2004. Given the anecdotal evidence about larger cities receiving higher bond

ratings, including smaller cities in future research will be necessary to provide the necessary

variation in size.

Also important to note is that the categorization of size of variances followed an

alternative approach to the method we would have preferred. The lack of large negative

variances was prohibitive. Furthermore, this may be suggestive that cities build in budgetary

slack which would be inconsistent with the assumption of tight budgetary control. This also

warrants further investigation. Finally, our use of bond rating as a measure of performance could

also be improved and we are in the process of including interest costs or a bond yield to augment

our results.

Our work is an initial look at the impact of different levels of organizational budget

control and performance based on bond ratings in a non-profit setting. Future research might

consider short term performance effects associated with the capital markets. Researchers could

27
use an event study, specifically examining what precipitates a bond rating change for

municipalities. Furthermore, other organizational performance measures could be considered.

One possibility is the use of an efficiency score as a performance metric. This could be

accomplished with the use of Data Envelopment Analysis (DEA) or Stochastic Frontier

Estimation (SFE) procedures.

Our study represents the first which suggests that tight budgetary control may not be as

effective in improving performance as assumed both in public sector and private sector entities.

While it would be premature to conclude that tight budgetary control is not related to

performance, it can be concluded that the effective level of budgetary control will vary based on

contextual factors. In this study, it appears that the effective level of budgetary control is at the

net level for the funds within governmental entities. This area is in need of additional studies to

gain a better understanding of the effects of budgetary control on performance.

28
 APPENDIX A
EXECUTIVE SUMMARIES

The following summaries represent discussions of the accounting and budgetary control

systems for three of the cities in our sample – Los Angeles, Houston, and Philadelphia. These

discussions are excerpts from the comprehensive annual financial reports (CAFRs) of each of the

identified cities.

City of Los Angeles

The annual budget serves as the foundation for the City’s financial planning and control.
The City maintains budgetary controls to ensure that legal provisions embodied in the budget are
complied with and that expenditures do not exceed appropriated amounts. Expenditures and
appropriations are controlled at the line item level within each object by department, consistent
with the level set forth in the resolution adopting the annual operating budget. The City also
maintains an encumbrance accounting system that controls spending based on the expenditure
budget, appropriations, allotments, or a combination of them.
Annual appropriations unused and unencumbered lapse at year-end, except for non-
capital related continuing appropriations for certain Special Revenue and Capital Projects Funds,
which are carried forward to the next budget year. Capital related appropriations that are unused
and unencumbered at year-end are reappropriated during the subsequent budget year. Additional
information about the City’s budget process can be found in Note 3A in the Notes to the Basic
Financial Statements.
Budget-to-actual comparisons are provided in this report for each individual
governmental fund for which an appropriated annual budget has been adopted. For the General
Fund, Proposition A Local Transit Assistance Fund, Proposition C Anti-Gridlock Transit
Improvement Fund, Special Gas Tax Street Improvement Fund, and Community Development
Fund, the comparison is presented as part of the basic financial statements. For the other
budgeted nonmajor funds, the comparisons, as well as other supplemental budget-to-actual
schedules, are presented in the combining and individual fund financial statements and
schedules.

City of Houston
Under state law and the City Charter, the City is required to adopt a balanced budget each
year. Based upon recommendations by the Mayor, City Council adopts an annual budget for the
General Fund, Debt Service Fund, Special Revenue Funds, Internal Service Funds, and
Proprietary Funds. Exceptions are the Grant Revenue, Disaster Recovery, Health Special, and
Housing Special Revenue Funds, for which City Council adopts separate operating or program
budgets throughout the year. The City also does not budget capital projects and other capital
expenditures related to the General Fund. Instead, City Council authorizes these expenditures
through individual appropriation ordinances.
Proprietary Fund budgets (also called Enterprise Funds) exclude depreciation and
amortization expenses. These Proprietary Fund budgets include debt service and capital
equipment costs, but exclude buildings and improvements (with the exception of Aviation, which
budgets its current year expenses for these projects). As with General Fund capital projects,

29
approval of each Proprietary Fund capital project is accomplished through individual
appropriation ordinances. No City expenditures may be made without an appropriation. City
Council can legally appropriate only those amounts of money that the City Controller has
previously certified are, or will be, in the City treasury.
Although the legal level of budgetary control is at the departmental level within a fund,
the City maintains internal budgetary control at the expenditure category (i.e., Personnel
Services, Supplies, Other Services and Capital Outlay.) Budget control is primarily managed
using an automated encumbrance and accounts payable system.

City of Philadelphia
The City maintains budgetary controls to ensure compliance with legal provisions
embodied in the annual appropriated budget proposed by the Mayor and approved by City
Council for the fiscal year beginning July 1. Activities of the General Fund, City Related Special
Revenue Funds and the City Capital Improvement Fund are budgeted annually. The level of
budgetary control (that is, the level at which expenditures cannot legally exceed the appropriated
amount) is established by major class within an individual department and fund for the operating
funds and by project within department for the Capital Improvement Fund. The City also
maintains an encumbrance accounting system for control purposes. Encumbered amounts that
have not been expended at year-end are carried forward into the succeeding year and
appropriations that have not been expended or encumbered at year-end are lapsed.

30
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33
 FIGURE 1
THEORETICAL MODEL

Budgetary Control Performance

Budget Variances Bond Rating

Control Variables:
Population
Geographic Divisions
Leverage
Financial Position

34
 TABLE 1
BOND RATINGS CONVERTED TO RANKINGS FOR OLS REGRESSION

Bond Rating Bond Ranking

Aaa 21
Aa-1 20
Aa-2 19
Aa-3 18
A-1 17
A-2 16
A-3 15
Baa-1 14
Baa-2 13
Baa-3 12
Ba-1 11
Ba-2 10
Ba-3 9
B-1 8
B-2 7
B-3 6
Caa-1 5
Caa-2 4
Caa-3 3
Ca 2
C 1

Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic rating category from Aa
through Caa. The modifier 1 indicates that the issuer or obligation ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates a ranking in the lower end of that generic rating category.

35
 TABLE 2
U.S. CENSUS BUREAU REGIONS AND DIVISIONS

State Region Division

Connecticut 1 1
Maine 1 1
Massachusetts 1 1
New Hampshire 1 1
Rhode Island 1 1
Vermont 1 1
New Jersey 1 2
New York 1 2
Pennsylvania 1 2
Indiana 2 3
Illinois 2 3
Michigan 2 3
Ohio 2 3
Wisconsin 2 3
Iowa 2 4
Kansas 2 4
Minnesota 2 4
Missouri 2 4
Nebraska 2 4
North Dakota 2 4
South Dakota 2 4
Delaware 3 5
District of Columbia 3 5
Florida 3 5
Georgia 3 5
Maryland 3 5
North Carolina 3 5
South Carolina 3 5
Virginia 3 5
West Virginia 3 5
Alabama 3 6
Kentucky 3 6
Mississippi 3 6
Tennessee 3 6
Arkansas 3 7
Louisiana 3 7
Oklahoma 3 7
Texas 3 7
Arizona 4 8
Colorado 4 8
Idaho 4 8
New Mexico 4 8
Montana 4 8
Utah 4 8
Nevada 4 8
Wyoming 4 8
Alaska 4 9
California 4 9
Hawaii 4 9
Oregon 4 9
Washington 4 9

36
 TABLE 3
DESCRIPTIVE STATISTICS

Budget Budget
Revenue Expenditures
City Year DIV BRRANK Population (000's) REVVAR% (000's) EXPVAR% NETVAR NETVAR% LEVERAGE FINPOS
Los Angeles 2003 9 17 3,845,541 3,018,174 2.33% 3,419,999 -1.42% 21,730,000 0.72% 31.89% 22.08%
Los Angeles 2004 9 17 3,845,541 3,161,649 2.57% 3,514,151 -1.63% 23,885,000 0.76% 35.74% 19.42%
Houston 2003 7 18 2,012,626 1,428,913 -1.29% 1,428,862 2.85% 22,360,000 1.56% 143.56% 9.64%
Houston 2004 7 18 2,012,626 1,404,658 0.17% 1,406,440 0.39% 7,797,000 0.56% 147.26% 9.65%
Philadelphia 2003 2 14 1,470,151 3,023,724 2.05% 3,085,485 -2.19% -5,688,000 -0.19% 62.18% 7.55%
Philadelphia 2004 2 14 1,470,151 3,151,819 -1.87% 3,282,494 1.05% -24,710,000 -0.78% 66.34% 0.13%
Phoenix 2003 8 20 1,418,041 181,813 1.97% 772,722 10.05% 81,262,000 44.70% 523.23% 180.40%
Phoenix 2004 8 20 1,418,041 203,234 -0.87% 777,778 5.95% 44,533,000 21.91% 547.41% 150.75%
San Antonio 2003 7 18 1,236,249 577,843 5.44% 601,387 1.09% 37,961,090 6.57% 109.47% 13.40%
San Antonio 2004 7 17 1,236,249 591,311 6.15% 627,441 1.75% 47,342,689 8.01% 104.37% 15.69%
Detroit 2003 3 13 900,198 1,411,438 -2.23% 1,500,935 2.48% 5,778,825 0.41% 57.28% 10.17%
Detroit 2004 3 21 900,198 1,491,325 -7.80% 1,645,328 4.12% -48,491,044 -3.25% 60.17% 5.03%
Indianapolis 2003 3 21 784,242 370,200 -0.05% 377,817 1.91% 7,030,000 1.90% 68.66% 48.40%
Indianapolis 2004 3 21 784,242 363,833 -2.00% 370,936 -0.58% -9,424,000 -2.59% 66.40% 46.52%
San Francisco 2003 9 18 744,230 2,366,261 3.79% 2,366,261 4.97% 207,167,000 8.76% 35.00% 7.99%
San Francisco 2004 9 21 744,230 2,254,760 7.71% 2,254,760 2.17% 222,611,000 9.87% 34.77% 8.67%
Austin 2003 7 19 681,804 362,241 -2.21% 406,604 3.11% 4,626,000 1.28% 256.52% 26.31%
Austin 2004 7 15 681,804 363,490 3.47% 377,323 1.99% 20,115,000 5.53% 257.20% 28.26%
Baltimore 2003 5 17 636,251 977,659 1.22% 758,579 -0.07% 11,340,000 1.16% 57.36% 13.07%
Baltimore 2004 5 16 636,251 984,889 4.05% 960,013 -1.95% 21,172,000 2.15% 56.83% 13.63%
Denver 2003 8 16 556,835 736,332 -4.83% 708,570 3.93% -7,691,000 -1.04% 61.63% 21.88%
Denver 2004 8 20 556,835 694,144 2.13% 685,127 1.19% 22,974,000 3.31% 54.04% 23.41%
Nashville 2003 6 19 546,719 630,963 1.83% 620,660 1.90% 23,336,777 3.70% 172.57% 12.31%
Nashville 2004 6 19 546,719 620,645 1.55% 644,623 0.78% 14,668,949 2.36% 183.88% 5.74%
Portland 2003 9 21 533,492 319,651 -2.07% 337,490 10.53% 28,926,227 9.05% 24.50% 18.41%
Portland 2004 9 19 533,492 329,641 2.07% 343,737 5.16% 24,574,511 7.45% 25.29% 20.22%
Oklahoma City 2003 7 19 528,042 255,042 4.99% 228,029 4.61% 23,238,000 9.11% 131.00% 21.90%
Oklahoma City 2004 7 19 528,042 249,835 9.21% 225,554 1.96% 27,440,000 10.98% 126.36% 20.81%

37
 TABLE 3 (cont.)
DESCRIPTIVE STATISTICS

Budget Budget
Revenue Expenditures
City Year DIV BRRANK Population (000's) REVVAR% (000's) EXPVAR% NETVAR NETVAR% LEVERAGE FINPOS
Tucson 2003 8 17 512,023 408,289 -13.69% 363,532 13.70% -6,099,000 -1.49% 75.76% 15.96%
Tucson 2004 8 18 512,023 396,390 -5.58% 364,374 13.38% 26,614,995 6.71% 73.20% 19.60%
Cleveland 2003 3 16 458,684 474,671 -3.98% 482,967 -0.39% -20,785,000 -4.38% 78.31% 5.41%
Cleveland 2004 3 16 458,684 464,455 -1.10% 445,461 1.68% 2,407,000 0.52% 75.47% 7.54%
Albuquerque 2003 8 18 484,246 331,823 -1.82% 286,852 4.20% 6,016,959 1.81% 49.13% 13.24%
Albuquerque 2004 8 18 484,246 347,090 6.28% 300,941 0.76% 24,099,166 6.94% 71.19% 17.56%
Fresno 2003 9 21 457,719 259,759 2.70% 264,222 -0.79% 4,932,932 1.90% 77.93% 12.86%
Fresno 2004 9 21 457,719 277,129 5.07% 268,932 -3.31% 5,139,036 1.85% 70.09% 12.99%
Virginia Beach 2003 5 20 440,098 690,780 1.23% 683,607 -2.59% -9,242,439 -1.34% 78.53% 14.66%
Virginia Beach 2004 5 20 440,098 742,846 2.60% 736,883 -0.96% 12,212,238 1.64% 73.60% 15.83%
Atlanta 2003 5 18 419,122 373,288 9.55% 422,639 9.07% 73,989,000 19.82% 58.53% 28.84%
Atlanta 2004 5 18 419,122 424,959 12.08% 474,933 8.77% 92,960,000 21.88% 60.96% 33.11%
Minneapolis 2003 4 20 373,943 244,878 -5.09% 239,888 8.00% 6,744,000 2.75% 536.73% 23.04%
Minneapolis 2004 4 20 373,943 244,822 3.76% 234,708 3.23% 16,783,000 6.86% 511.33% 24.15%
Honolulu 2003 9 19 377,260 561,455 1.57% 502,817 5.01% 34,037,000 6.06% 287.50% 12.77%
Honolulu 2004 9 19 377,260 618,812 0.56% 517,658 3.61% 22,135,000 3.58% 288.05% 10.01%
Wichita 2003 4 19 353,823 158,118 -7.04% 164,871 14.31% 12,467,263 7.88% 149.24% 15.96%
Wichita 2004 4 19 353,823 154,718 1.52% 162,335 6.12% 12,275,342 7.93% 160.13% 16.35%
Pittsburgh 2003 2 11 322,450 386,396 -9.59% 386,396 0.60% -34,744,000 -8.99% 246.29% 10.07%
Pittsburgh 2004 2 12 322,450 388,831 -8.77% 388,831 3.43% -20,771,000 -5.34% 231.80% 4.10%
Arlington 2003 7 19 359,467 154,394 -2.95% 156,036 2.54% -599,000 -0.39% 173.44% 13.89%
Arlington 2004 7 19 359,467 157,292 -0.17% 160,668 2.28% 3,392,000 2.16% 165.94% 16.12%
Cincinnati 2003 3 20 314,154 307,615 1.22% 312,502 -0.70% 1,578,000 0.51% 125.99% 21.03%
Cincinnati 2004 3 20 314,154 313,949 0.38% 329,610 0.62% 3,219,000 1.03% 119.09% 19.49%

Mean 18.17 798,747 777,082 0.50% 815,015 3.05% 21,627,433 4.50% 141.14% 22.42%
Median 19.00 530,767 402,339 1.23% 460,197 2.08% 12,371,303 2.02% 78.12% 15.90%
Std. Dev. 2.35 740,904 827,896 4.93% 877,632 4.15% 46,530,471 8.27% 132.86% 30.48%
Coeff. Var. 0.13 0.93 1.07 9.79 1.08 1.36 2.15 1.84 0.94 1.36

38
 TABLE 4
FIRST REGRESSION RESULTS

BRRANK = β0 + β1REVVAR%_ABS + β2EXPVAR%_ABS + {CONTROL VARIABLES}+

ε1

Predicted
Variable Sign Coefficient t p-value

Intercept 27.7727 3.97 0.0003

REVVAR%_ABS - -7.63715 -0.81 0.4233
EXPVAR%_ABS - -3.47337 -0.36 0.7241
FINPOS + 3.6577 2.41 0.0207
LEVERAGE - -0.44844 -1.33 0.19
lnPOP + -1.04549 -2.11 0.0414
DIV3 ? 4.42441 3.72 0.0006
DIV4 ? 6.51615 4.46 <.0001
DIV5 ? 4.17993 3.37 0.0017
DIV6 ? 5.68482 3.72 0.0006
DIV7 ? 4.9698 4.80 <.0001
DIV8 ? 3.99728 3.16 0.003
DIV9 ? 5.93553 5.39 <.0001

Adjusted R2 0.4681

Where:
BRRANK = the ranking associated with bond ratings as identified in Table 1
REVVAR%_ABS = the percentage variance between budgeted and actual revenues,
expressed as an absolute value percentage
EXPVAR%_ABS = the percentage variance between budgeted and actual expenditures,
expressed as an absolute value percentage
FINPOS = the ratio of fund balance in the general fund to general fund revenues
LEVERAGE = the ratio of general obligation debt to general fund revenues
lnPOP = natural log of the population
DIV3 through DIV 9 = from Table 2, the geographic division of the U.S.
 

39
 
TABLE 5
SECOND REGRESSION RESULTS

BRRANK = β0 + β1REVVAR%_ABS + β2REVLPBAP + β3REVNBAP +

β4(REVLPBAP*REVVAR%_ABS) + β5(REVNBAP*REVVAR%_ABS)
+ β6EXPVAR%_ABS + β7EXPLPBAP + β8EXPNBAP +
β9(EXPLPBAP*EXPVAR%_ABS) + β10(EXPNBAP*EXPVAR%_ABS)
+ {CONTROL VARIABLES} + ε1
Predicted
Variable Sign Coefficient t p-value
Intercept 28.67089 3.75 0.0007
REVVAR%_ABS - -54.49826 -1.42 0.1668
REVLPBAP - -0.47576 -0.15 0.8819
REVNBAP - -0.76936 -0.65 0.523
REVLPBAP*REVVAR%_ABS - 49.81991 0.92 0.364
REVNBAP*REVVAR%_ABS - 40.72892 0.96 0.3421
EXPVAR%_ABS - 20.72856 0.57 0.5732
EXPLPBAP - -0.65248 -0.29 0.777
EXPNBAP - 0.61368 0.39 0.6994
EXPLPBAP*EXPVAR%_ABS - -11.88491 -0.3 0.7689
EXPNBAP*EXPVAR%_ABS - 11.17111 0.14 0.8859
FINPOS + 3.61513 1.84 0.0747
LEVERAGE - -0.35332 -0.86 0.3949
lnPOP + -1.08768 -2 0.0543
DIV3 ? 4.1874 3.08 0.0044
DIV4 ? 6.45151 3.48 0.0015
DIV5 ? 3.65728 2.23 0.0331
DIV6 ? 5.64676 3.15 0.0036
DIV7 ? 4.78638 3.58 0.0012
DIV8 ? 3.83598 2.62 0.0135
DIV9 ? 5.58837 3.79 0.0007
Adjusted R2 0.3935
Where:
BRRANK = the ranking associated with bond ratings as identified in Table 1
REVVAR%_ABS = the percentage variance between budgeted and actual revenues,
expressed as an absolute value percentage
REVLPBAP = binary variable indicating whether the revenue variance exceeds 5% of the budgeted revenues
REVNBAP = binary variable indicating whether the revenue variance is less than 0% of the budgeted revenues
EXPVAR%_ABS = the percentage variance between budgeted and actual expenditures,
expressed as an absolute value percentage
EXPLPBAP = binary variable indicating whether the expenditure variance exceeds 5% of the budgeted
expenditures
EXPNBAP = binary variable indicating whether the expenditure variance is less than 0% of the budgeted
expenditures
FINPOS = the ratio of fund balance in the general fund to general fund revenues
LEVERAGE = the ratio of general obligation debt to general fund revenues
lnPOP = natural log of the population
DIV3 through DIV 9 = from Table 2, the geographic division of the U.S.

40
 
TABLE 6
THIRD REGRESSION RESULTS

BRRANK = β0 + β1NETVAR%_ABS + {CONTROL VARIABLES}+ ε1

Predicted
Variable Sign Coefficient t p-value

Intercept 29.42494 4.24 0.0001

NETVAR%_ABS - -9.22215 -1.6 0.1178
FINPOS + 5.93837 2.87 0.0065
LEVERAGE - -0.51288 -1.56 0.1259
lnPOP + -1.1805 -2.39 0.0219
DIV3 ? 4.08126 3.4 0.0015
DIV4 ? 6.3371 4.98 <.0001
DIV5 ? 4.09613 3.4 0.0016
DIV6 ? 5.82911 4.01 0.0003
DIV7 ? 4.92749 4.92 <.0001
DIV8 ? 3.43796 2.76 0.0086
DIV9 ? 5.93425 5.76 <.0001

Adjusted R2 0.4964

Where:
BRRANK = the ranking associated with bond ratings as identified in Table 1
NETVAR%_ABS = the net of the budget-to-actual revenue and expenditure variances,
expressed as an absolute value percentage in relation to total revenues
FINPOS = the ratio of fund balance in the general fund to general fund revenues
LEVERAGE = the ratio of general obligation debt to general fund revenues
lnPOP = natural log of the population
DIV3 through DIV 9 = from Table 2, the geographic division of the U.S.
 

41
 TABLE 7
FOURTH REGRESSION RESULTS

BRRANK = β0 + β1NETVAR%_ABS + β2NETLPBAP + β3NETNBAP +

β4(NETLPBAP*NETVAR%_ABS) + β5(NETNBAP*NETVAR%_ABS) +
{CONTROL VARIABLES} + ε1

Predicted
Variable Sign Coefficient t p-value

Intercept 24.67895 3.29 0.0023

NETVAR%_ABS - 88.90663 1.89 0.0670
NETLPBAP - 1.47771 1.16 0.2535
NETNBAP - 2.52785 2.27 0.0290
NETLPBAP*REVVAR%_ABS - -94.00274 -1.99 0.0548
NETNBAP*REVVAR%_ABS - -129.53255 -2.53 0.0159
FINPOS + 4.98612 2.32 0.0259
LEVERAGE - -0.4482 -1.35 0.1858
lnPOP + -0.92953 -1.82 0.0775
DIV3 ? 4.56317 3.58 0.0010
DIV4 ? 5.82147 3.67 0.0008
DIV5 ? 3.76074 2.74 0.0094
DIV6 ? 4.2556 2.41 0.0213
DIV7 ? 4.63549 3.70 0.0007
DIV8 ? 2.91472 2.14 0.0390
DIV9 ? 5.5864 4.32 0.0001

Adjusted R2 0.5327

Where:
BRRANK = the ranking associated with bond ratings as identified in Table 1
NETVAR%_ABS = the net of the budget-to-actual revenue and expenditure variances, expressed as an absolute value
percentage in relation to total revenues
NETLPBAP = binary variable indicating whether the net budget-to-actual variance exceeds 5% of the budgeted
revenues
NETNBAP = binary variable indicating whether the net budget-to-actual variance is less than 0% of the budgeted
revenues
FINPOS = the ratio of fund balance in the general fund to general fund revenues
LEVERAGE = the ratio of general obligation debt to general fund revenues
lnPOP = natural log of the population
DIV3 through DIV 9 = from Table 2, the geographic division of the
U.S.

42