The Influence of Jurisdiction Size and Sale Type on Municipal Bond Interest Rates: An Empirical Analysis

The United Sates municipal bond market is very large, with $150 billion to $300 billion issued annually. The total municipal debt outstanding equals about 18 percent of the U.S. gross domestic product. Most local governments selling municipal bonds are small and sell infrequently. Two random sample surveys of municipal bond issues undertaken in the winter of 1996 showed the median population of governments issuing municipal bonds to be about 20,000 people (Simonsen and Kittredge 1996). (1) However, there has been very little research that focuses on small issuers. In this article we examine the determinants of municipal bond interest rates. Specifically, we explore two research questions: first, does management capacity influence municipal bond interest rates? As we will explain, the literature suggests that small communities typically have a smaller financial-management staff that is less sophisticated, frequently comprised of generalists, and often working part time. We proxy financial-management capacity using government population size and test whether this has an effect on interest rates. Second, does the method of sale affect municipal bond interest rates? We examine whether issuers experience an interest rate difference between bonds sold competitively versus those sold through negotiation (these are the two predominant ways in which municipal bonds are sold). We use data on bond sales in Oregon from 1994 to 1997 to answer these research questions. First, we look at the literature on management capacity and sale type. Second, we describe our methodology. Next, we report our research findings about the above two research questions. Finally, we discuss our research results and conclusions. Literature Review--Management Capacity and Population The management capacity of a local government revolves around managers' ability to know "whether they are doing the `right' thing programmatically, whether they are doing it `well', and whether they are doing `enough' or Bill Simonsen is an associate professor at the University of Connecticut in the Institute of Public Affairs and Department of Political Science. He is also the director of the MPA program. Email: simonsen@uconnvm.uconn.edu. `too much' of it." (Honadle and Howitt 1986, 2). Specifically, Honadle (1981) offers the following framework for capacity building: * Anticipate change * Make informed decisions about policy * Develop programs to implement policy * Attract and absorb resources * Manage resources * Evaluate performance to guide future actions. Financial management falls squarely in the "manage resources" category. According to Honadle (1981, 17) even if a community has the capacity to attract and retain resources, it must manage them effectively: "[W]ithout effective management of personnel, finances, time, information, and the other resources assigned to an organization, such resources will be dwindled away, and personnel will become demoralized by the lack of organization and direction." The research on financial-management capacity can be categorized into two broad categories, fiscal capacity and internal-management capacity. The research on fiscal capacity looks at the ability of governments to raise revenues and meet their expenditure needs. The book America's Ailing Cities (Ladd and Yinger 1989) is the most sophisticated look to date at the fiscal health of cities. Ladd and Yinger look at the influence of a range of outside factors on the fiscal health of 86 major U.S. cities to develop a standardized measure of fiscal health; they find it has worsened and call for federal and state policies to provide assistance to the neediest of cities. Other work in this area focuses on how to measure local government fiscal capacity (Berne and Schramm 1986; Clark 1994). Honadle and Lloyd-Jones (1998) apply fiscal-capacity tools to Swift County, Minnesota--specifically, three tools that test county financial condition. …