Wednesday, May 6, 2009

The Effects of Poor Financial Information Systems on the Long Term Sustainability of Local Public Services.

Abstract

In this paper we describe the existence of financial illusion in public accounting and we comment on its effects for the future sustainability of local public services. We relate these features to the lack of incentives amongst public managers for improving the financial reporting and thus management of public assets. Financial illusion pays off for politicians and managers since it allows for larger public expenditure increases and managerial slack, these being arguments in their utility functions. This preference is strengthen by the short time perspective of politically appointed public managers. Both factors run against public accountability. This hypothesis is tested for Spain by using an unique sample. We take data from around forty Catalan local authorities with population above 20,000 for the financial years 1993-98. We build this data basis from the Catalan Auditing Office Reports in a way that it can be linked to some other local social and economic variables in order to test our assumptions.

The results confirm that there is a statistical relationship between the financial illusion index (FI as constructed in the paper) and higher current expenditure. This reflects on important overruns and increases of the delay in paying suppliers, as well as on a higher difficulty to face capital finance. Mechanisms for FI creation have to do among other factors, with delays in paying suppliers (and thereafter higher future financial costs per unit of service), no adequate provision for bad debts and lack of appropriate capital funding either for reposition or for new equipments. For this, it is crucial to monitor the way in which capital transfers are accounted in local public sheet balances. As a result, for most of the Municipalities we analyse, the funds for guaranteeing continuity and sustainability of public services provision are today at risk.

Given managerial incentives at present in public institutions, we conclude that public regulation recently enforced for assuring better information systems in local public management may not be enough to change the current state of affairs

Introduction

In most of OECD countries over the last decades, conventional accounting information systems have been threat by the development of new Information Technologies. Potentials for better budget reporting have improved a lot (see P. Heller, 2003). The aim of improving public accountability through better information is indeed in the core of the new public management (Lopez et. al. 2003). Despite this, implementation depends on the incentives of managers and politicians and things are much less clear in this arena.

Under models of bureaucratic behaviour and fiscal illusion (Niskanen, 1971)1, it is plausible to assume that lack of transparency may be there to stay. As it helps to hide inefficiency, poor financial reporting may favour managerial slack against public interest.

Despite the fact that the former assumptions may be extended to public administration in general, our interest here is to test some particular propositions related to the creation of Financial Illusion (FI) at the local public sector level. Mayston et al (1992) have shown that this is an appropriate field of analysis given a larger diversity in the existing practices. We confront then the effects of FI on local public budgets, and the absence of incentives amongst public managers for a better financial information system to improve the management of publics assets, on a sample of forty two Catalan municipalities 2 along the 1993-98 period. Data are taken from the Sindicatura de Comptes de Catalunya (The Catalan Auditing Commission) on actual settled expenditure and revenues.

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