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

www.elsevier.com/locate/jaccpubpol

The efects of GAAP regulation and


bond market interaction on
local government disclosure
A

ngela
K.
Gore
Department of Accounting, Lundquist College of Business, University of Oregon, Room 1208,
Eugene, OR 97403, USA

Abstract
This study examines the efects of disclosure regulation on municipal managers
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.
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 efects of these regulations. The lack of
research critically evaluating the efects 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 2003 Elsevier Inc. All rights reserved.
doi:10.1016/j.jaccpubpol.2003.11.002

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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
efcacy 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 efects
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 sufcient to induce disclosure. I next examine the inuence 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 (Pennsylvania). 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 conicting 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.

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 diference 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 diference 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 governments
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.

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

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 statespecific 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 governments 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 users 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 (Gafney, 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 ofcials decided to adopt GAAP. However, discussions with State of Michigan
Treasury Department ofcials indicate that GAAP was most likely adopted because Michigan had recently reconvened 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.

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

27

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), Gafney (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 diferences in states 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 afects cities dis- closure levels, and find
no significant diference 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 diferences in regulatory environments that potentially afect 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

For example, FSA, a municipal bond insurer, states on their website that revenue bonds
typically require more analysis than do general obligation bonds.

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

information because they are more likely to access the bond market. Therefore, the
finding of no diference 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, Copleys 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 efects 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 Zimmermans (1977) positive theory analysis, which focuses on political
incentives for disclosure, to explicitly consider the efects of regulation and bond market
incentives on disclosure. In order to develop the theory, I need two assumptions. First,
I assume that municipal managers 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 ofcials, then
municipal ofcials will want to lower borrowing costs. Second, I assume the bond
market is competitive, which implies that bond issuers fully bear transaction and information 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 investors information risk. Barry and Brown (1985) argue that
when disclosure is not

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

29

perfect, investors bear risks in forecasting their investments future payof. 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 investors 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 following 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
municipalities 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.

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 sufcient 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 states decisions to mandate GAAP, however, I
consider them outside the scope of this study.

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

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
Governments 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 Governments 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.

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

31

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 H 2A and H2B represents a joint test of the efects of regulation
and bond market interaction on information production. Theoretically, there should be a large diference in GAAP disclosure between regulated and
unregulated disclosure states for low-debt governments, and a relatively smaller, or no
diference between the two states for the high-debt governments,
consistent with Fig. 1. In addition, note that I confine my analysis of H 2 to
GAAP disclosure because a priori, it is unknown how GAAP regulation afects
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.

32

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

However, because there are only nine states that have unregulated disclosure, I control
for the diferences that are most likely to afect 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 afecting 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 inuence 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 efectively 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 efectively
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.

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

33

Table 1
Summary of financial report selection procedures
Panel A: Michigan sample
Total local governments in Michigan
Less governments with population <10,000 and
governments other than cities and townships
Total Michigan cities and townships with populations
>10,000
Financial reports randomly eliminated
Final sample, collected from Michigan Department
of Treasury
Panel B: Pennsylvania sample
Total local governments in Pennsylvania
Less governments with population <10,000 and
governments other than cities and townships
Total Pennsylvania cities and townships with
populations >10,000
Randomly selected
Financial reports collected directly from municipalities
Financial reports collected from Pennsylvania Department of Community and Economic Development
Financial reports not available
Total financial reports
Final sample

Panel C: Total sample


Cities
Townships
Total

1,800
1;634
166
78
88

2,498
2;288
201
92
65
22
05
90
87
Michigan

Pennsylvania

Total

44
44
88

21
66
87

65
110
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 ai b1iPOPit b2iCITYit b3iAUDITSit
b4iDEBTit eit
1
where
DISCLOSUREit is the value of the GAAP, non-GAAP, or TOTAL disclosure index in year t for government i,
3
4

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

A
U
D
I
T
S

the number of municipal audits performed in year t by government is 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.

it

is 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 Pennsylvania, 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 nonGAAP 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 municipalities 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 & Poors (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.

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

35

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. OKeefe et al. (1994)
find that the auditors 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).


In Michigan, debt issued on behalf of local governments at the county or state level, called
overlapping debt, is recognized on the local governments 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 efectively 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
governments reliance on non-capital market sources of revenue.
18

36

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

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 efect 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 diference in
disclosure levels for governments with low bond market interaction, and a rel- atively
lower (or insignificant) diference 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 cities 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 diferences 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 County. This may reduce townships 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.
A.K. Gore / Journal of Accounting and Public Policy 23 (2004) 23-52

GAAPit ai b1iPOPit b2iCITYit b3iAUDITSit


b4iHIGHDEBT; MIit b5iHIGHDEBT; PAit
b6iMEDDEBT; MIit b7iMEDDEBT; PAit

b8iLOWDEBT;
MIit eit

37

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 H 2B tests whether (HIGHDEBT,
MI ) HIGHDEBT,PA) is not significantly diferent 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 diferences in population or debt, however,
diferences 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 diference in
the number of audits performed is probably due to Pennsylvanias 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 municipalities median score for GAAP
is 17 out of a possible 18, indicating that there is not full compliance
with GAAP. This efectively biases against finding results for H2, however. In
addition, the non-parametric tests in Panel B show a significant diference

38

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

Table 2
Descriptive statistics and tests of significance from non-parametric tests of diferences between
Michigan and Pennsylvania
Variable

Mean

Median

Panel A: Total
POP
CITY
AUDITS
DEBT
STATE
GAAP
NONGAAP

sample (n 175)
3.065
2.90
0.371
0.00
30.503
9.00
393.68
578.979
0.503
1.00
14.006
15.00
1.00
2.935

Std. dev.
0.701
0.485
38.700
757.501
0.501 4.390
3.888

Pennsylvania (n 87)
ean

Median

Michigan (n 88)
Std. dev.

Mean

Panel B: Subset of Pennsylvania and Michigan governments


POP
3.095
2.90
0.772
3.035
CITY
0.241
0.00
0.430
0.500
AUDITS
7.149
4.00
6.681
53.591
DEBT
584.337
324.54
715.237
573.683
GAAP
11.552
13.00
4.810
16.432
NONGAAP
2.756
2.00
3.226
3.102
Low debt (n 58)a
Mean

Median

Median

Std. dev.

2.895
0.000
57.000
408.158
17.000
1.000

0.627
0.503
43.205
801.170
1.923
4.428

MannWhitney
p-values*

0.542
0.003
0.000
0.833
0.000
0.238

High debt (n 58)b


Std. dev.

Panel C: Subset of governments partitioned by debt


POP
2.858
2.73
0.450
CITY
0.259
0.00
0.442
AUDITS
25.086
8.50
35.968
DEBT
108.469
118.48
66.159
STATE
0.517
1.00
0.504
GAAP
12.328
14.00
4.673
NONGAAP
1.618
1.00
2.423

Mean

Median

Std. dev.

3.258
0.517
33.707
1252.437
0.500
15.793
4.193

2.924
1.000
9.000
956.247
0.500
17.000
2.000

0.909
0.504
41.267
1003.721
0.504
3.259
4.756

*Indicates the two-sided statistical significance levels for a test of diferences 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: POP it 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; AUDITS it is the number of municipal audits
performed in year t by government is 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); GAAP it is an index of
GAAP disclosures in year t for government i; and NONGAAP it is an index of voluntary disclosures
in year t for government i.
a
n 30 Michigan, 28 Pennsylvania.
b
n 29 Michigan, 29 Pennsylvania.

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

39

between the two states for GAAP disclosure, but no significant diference in nonGAAP 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
Panel A: Total sample (n 175)
POP
1.000
CITY
0.238*
AUDITS
)0.009
DEBT
0.212**
STATE
)0.046

CITY

1.000
0.154*
0.290**
0.270**

AUDITS

DEBT

1.000
0.057
0.540**

1.000
0.016

Panel B: Subset of Pennsylvania governments (n 87)


POP
1.000
CITY
0.242*
1.000
AUDITS
)0.037
)0.158
1.000
DEBT
0.347*
0.287**
)0.090

STATE

1.000

1.000

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


POP
1.000
CITY
0.299*
1.000
AUDITS
)0.145
0.189
DEBT
0.072
0.381**
STATE
)0.160
0.207

1.000
)0.106
0.710**

1.000
)0.077

1.000

Panel D: Subset of low debt governments (n 58)


POP
1.000
CITY
0.279*
1.000
AUDITS
)0.076
0.264*
DEBT
0.118
0.201
STATE
0.016
0.255*

1.000
0.000
0.450**

1.000
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.

40

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

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 H 1, 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 practitioners 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
diference 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, DEBT STATE, 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 diference 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 diferent
from the variances of the townships. The test statistic used is found in
Greene (1993), and is as follows:
1

W h1 h20V1 V2 h1 h2
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 distribution with K degrees of freedom, and tests whether the diferences between the parameters are significantly
close to zero.
23
Interpretations of my results need to allow for the possibility that fundamental diferences between the
states could lead to diferences in disclosure regulation. For example, there could be diferences 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
diferences outside the scope of this study.

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

41

Table 4
OLS results for a test of the relation between disclosure level and debt in Pennsylvania, the
unregulated disclosure state (H1)
Model: DISCLOSURE it ai b1iPOPit b2iCITYit b3iAUDITSit b4iDEBTit eit
V
aria

Expected
sign

Dependent variable:
GAAPa (n 87)

Non-GAAPa
(n 87)

Coefcient

t-statistic

Coefcient

t-statistic

Coefcient

t-statistic

3.194
1.841
1.011
0.198
0.002

1.46
2.37**
0.90
3.00**
2.01*

)0.850
0.712
)1.199
0.060
0.000

)0.55
1.31
)1.55
1.25
3.53**

1.832
2.740
)0.145
0.247
0.004

0.60
2.53**
0.09
2.68**
3.11**

ble

Intercept
POP
CITY
AUDITS
DEBT
Adjusted
R2
F -statistic
(p-value)

+
+
+
+

Totala (n 87)

0.30

0.27

0.36

10.20
(<0.0001)

8.45
(<0.0001)

13.2
(<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 is auditor;
DEBTit is the total debt per capita in year t for government i; GAAP it is an index of GAAP disclosures in year t
for government i, described in Appendix A; and Non-GAAP it
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
Whites t-statistics. All regression results have been checked for the presence of inuential data points
using Cooks D statistic; no inuential 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 diference in disclosure between low-debt governments in
Michigan and Pennsylvania is significant (p < 0:01), represented by the variable LOWDEBT,MI. Consistent with H2A and Fig. 1, for the subset of lowdebt 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 diference in disclosure between high-debt governments in Michigan and Pennsylvania are not significantly diferent from zero,
or b4i b5i is not significant. I find that high-debt municipalities in Michigan
disclose significantly more information, inconsistent with H 2B. 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 diference in disclosure among the high-debt governments.

42

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

Table 5
OLS results for a test of the relation between the GAAP disclosure level and the state
GAAP it ai b1iPOPit b2iCITYit b3iAUDITSit b4iDEBTit b5iDEBTit STATEit
b6iSTATEit eit
V

Expected sign

ariable

Intercept
POP
CITY
AUDITS
DEBT
DEBT STATE
STATE
Adjusted R2

+
+
+
+
)
+

Total sample (n 175)


Coefcient

t-statistica

6.714
1.072
1.018
0.014
0.002
)0.002
4.957

5.63**
2.72**
3.06**
2.42*
2.89**
)2.21*
7.38**
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 is 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 GAAP it is an index of GAAP disclosures in year t for government i, described in Appendix A.
a
Whites t-statistics. All regression results have been checked for the presence of inuential data points
using Cooks D statistic; no inuential 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 diference in disclosure between the low-debt gov- ernments
is significantly greater than the diference in disclosure between highdebt governments, or b8i b4i b5i > 0, consistent with Fig. 1. The results of
this test, reported in Table 6, show that the diference is significant (p 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 difer significantly from
those reported.
Second, I use three alternative measures of debt because the use of debt per capita
may not accurately reect the current level of bond market

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

43

Table 6
OLS results for tests of the relation between regulation and disclosure (H 2)a
GAAP it ai b1iPOPit b2iCITYit b3iAUDITSit b4iHIGHDEBT; MIit
b5iHIGHDEBT; PAit b6iMEDDEBT; MIit b7iMEDDEBT; PAit
b8iLOWDEBT; MIit eit
Variable

Intercept
POP
CITY
AUDITS
HIGHDEBT,MI
HIGHDEBT,PA
MEDDEBT,MI
MEDDEBT,PA
LOWDEBT,MI
Adjusted R2
Test of equality of coefcients
F -statistic for diference in coefcients:
HIGHDEBT,MI ) HIGHDEBT,PAc
(p-value)
LOWDEBT,MI ) (HIGHDEBT,MI )
HIGHDEBT,PA)
(p-value)

Expected
sign

+
+
+
+
+
+
+
+

Total Sample (n 175)


Coefcient

t-statisticb

4.764
1.357
1.007
0.013
6.909
4.406
6.184
2.278
6.003
0.51

4.11**
4.53**
2.40*
2.76**
7.74**
4.22**
6.78**
2.09*
7.22**

7.04
(0.0088)
9.00
(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
Whites t-statistics. All regression results have been checked for the presence of inuential data points
using Cooks D statistic; no inuential 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 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 H 2B, I now find that for the alternate
measures of debt, there is no significant diference in disclosure level among
high-debt governments, or b4i b5i is not significant, consistent with H 2B.
Because my original specification with debt per capita as the debt proxy
includes population as a deator and again as a separate control variable, it is possible
that this caused an econometric problem. This is plausible because

44

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

when total revenue is used as an alternate size deator (in the ratio of total debt/total
revenue), I find no significant diference 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
diference 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 studys 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 difer significantly from those reported, and as
such, my results are not likely due to index design.
Fourth, I assess the efect of the point of sample partition in the test of H 2B,
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 coefcient 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 thirds.

6. Conclusion
The purpose of this paper is to examine the efects 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 diference 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

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

45

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 diferentially regulated, for example, in interna- tional research.
Another limitation is that because some of the tests examine whether the diference
in disclosure between the two states is not significantly diferent 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 Rozef, 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 OKeefe, 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 Bufalo, 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 staf, as well as
Ken Johnson and the Pennsylvania Department of Community and Economic
Development staf, 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

This table presents the GAAP disclosure index used in regressions. The index is compiled directly from disclosures contained
within the governments 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 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
N
o

Copley
(1991)

Ingram
and
DeJong

Disclosure practice

Total sample partitioned by

(1987)

A3
A2, B1

A1

A8

1, 7

Frequency of occurrence

State
Debt
MI
PA
High
Low
(n 88) (n 87) (n 58) (n 58)
Basic financial statements
Combined balance sheet
Combined statement of revenues, expenditures, and changes in fund balance--all
governmental fund types and expendable
trust funds
Combined statement of revenues, expenditures, and changes in fund balance--budget
and actual--all governmental fund types and
expendable trust funds
Combined statement of revenues, expenses,
and changes in retained earnings--all proprietary fund types and similar trust funds

88
88

72
70

58
57

49 2
48

76

56

53

36

82

54

50

40

A.
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or
e/
Jo
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d
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P
ol
ic
y
2

A7

A10

Combined statement of cash ows--all proprietary fund types and similar trust funds
8

B5

10

B6

11
12

13

14

B4

Footnotes
Basis of accounting--governmental funds
use modified accrual
Basis of accounting--expendable trust,
agency funds use modified accrual
Basis of accounting--non-expendable trust,
pension, proprietary funds use accrual
Budgetary basis of accounting, budgetary
policies
Basis of accounting--revenue and expense
recognition
Property tax calendar: lien, levy, and due
dates
Cash deposits with financial institutions:
carrying amount of total deposits, and total
bank balance classified into three risk
categories
Investments: investments classified into three
risk categories; disclosed carrying amount
and market value in total and for each
investment type; and briey describe types
of investments authorized by legal or
contractual provisions
Fixed assets: statement of changes in general
fixed assets; and method of recording general
fixed assets

82

51

55

36

88

59

52

46

88

43

51

40

88

50

52

38

86

75

57

51

88

74

57

50

58

35

38

24

75

57

47

40

65

37

38

32

78

47

49

35

A.
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or
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Jo
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P
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2

Appendix A (continued)
N
o

Copley
(1991)

Ingram
and
DeJong

Disclosure practice

(
1
9
8
7
)

Frequency of occurrence
Total sample partitioned by

State
MI

Debt
PA

High

Low

(n 88) (n 87) (n 58) (n 58)


15

A6

16

All

17
18

B7
B2
B3
A5
A9

10

Accrued sick and vacation pay (compensated


absences) recorded in F/S or footnote
4
Long-term debt: debt service requirements
to maturity; and changes in general
long-term debt
Interfund receivables/payables footnote
5
Amount of pension expenditure pursuant
to an actuarial determination
9
Commitments and contingencies are
discloseda
Unfunded pension liabilitiesa
Lease and purchase commitments a

72

57

49

39

75

56

50

36

83
86

35
76

45
56

37
53

Items proxy for the level of complexity, as only those that have this particular activity are required to disclose it.

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2

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 partitioned by state
N
o

Copley
(1991)

Ingram
and
DeJong

Disclosure practice

Total sample partitioned by

State

(1987)

1
2
3
4
5

A12
A13
B9
B10

6
7
8
9

B11
B12

10

Frequency of occurrence

General governmental expenditures by


source and function
Percentage of property taxes collected
Legal tax limits
Assessed value of taxable property
Legal debt limits and unused debt
margins
Property tax rates
Schedule of direct and overlapping debt
Principal taxpayers
Demographic statistics--population
(10-year trends)
Demographic statistics--per capita
income (10-year trends)

Debt

MI
(n 88)

PA
(n 87)

High
(n 58)

Low
(n 58)

22

17

19

24
11
40
22

30
11
41
15

24
10
32
20

10 4
20 3

43
21
22
17

56
16
17
6

35
19
20
15

11

14

30
44
2

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2

2
4

Appendix B (continued)
N
o

Copley
(1991)

Ingram
and
DeJong

Disclosure practice

Total sample partitioned by

(1987)

11
12
13
3
6
B8
A4

Frequency of occurrence

State

Demographic statistics--unemployment rate (10-year trends)


Demographic statistics--school enroll- 16
ment (10-year trends)
Demographic statistics--median age
(10-year trends)
Current liabilities are reported separate
from long-term liabilities
Encumbrances are reported as a reserve
of fund balance at year-end
Disclosure that legal bond requirements
have been met
Revenues and expenditures by source
and function

Debt

MI
(n 88)

PA
(n 87)

High
(n 58)

Low
(n 58)

15

11

13

10

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51

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