Assessing and ranking the financial risk of municipal governments

Abstract

The purpose of this study is to develop a model to assess and rank the financial risk of a municipal government (“municipality”). Financial risk is the likelihood that a municipality will experience financial distress. Logistic regression is used with financial indicators to assess the level of financial risk. Then, the municipalities are ranked according to their financial risk. As predictor variables for the regression model, indicators are used that were developed by a Pennsylvania state agency to monitor the financial condition of municipalities. Financial risk is positively associated with debt service, population, tax effort and public service on roadways, while negatively correlated with intergovernmental revenues, operating position, user charges, capital outlays, fund balances, and tax revenue concentration. The financial risk model is able to correctly classify up to 99 percent of municipalities as either at risk or not at risk of financial distress. The financial risk model was developed using data from one state in the United States. Further research is needed to test the model’s application to other states and countries. Financial risk is on the rise since the great recession. This study may be used by municipal managers, citizens, creditors, and regulators to assess and rank the financial risk of a municipality. This study provides a method of classifying municipalities as either at-risk or not at-risk of financial distress. Previous models of the financial condition of municipalities do not provide a method of assessing and ranking financial risk.