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We investigate the effects of state economic activity on the association of changes in the general fund (i.e., net revenue) and borrowing cost. Extant literature has established that net revenue is associated with municipal bond market metrics (e.g., true interest cost, bond yield spreads). Little is known, however, regarding the relationship between net revenue and borrowing cost when state economic activity is considered. Based on a sample of 1,970 general obligations bonds issued across 20 years by U.S. counties, we test whether the association between net revenue and borrowing cost is conditioned on state economic activity. We provide evidence that a state’s economic activity moderates the association between net revenue and borrowing cost among county governments.

Achieving minimum borrowing cost for municipal bonds is an ongoing concern. Apostolou, Apostolou, and Dorminey (2014) demonstrated that a fund accounting measure, spending rate magnitude (i.e., the absolute value of general fund revenues minus general fund expenditures) proxied for management's ability to balance revenues and expenditures. Their findings indicated that achieving balance at spending rate equilibrium (i.e., where general fund revenues equal general fund expenditures) was associated with minimum borrowing cost, and that the magnitude of departure from spending rate equilibrium was associated with higher borrowing cost. Little is known regarding the information content of spending rate in the years during and after the financial crisis that started in 2007. Given the crash of the housing bubble and severe reductions to property tax revenues, municipalities experienced a prolonged recovery that was characterized by a change to borrowing patterns and deficit spending. In this study, I extended from Apostolou et al. (2014) and examined whether the information content of spending rate was conditional to levels of economic activity. I accomplished this by using state leading indexes compiled by the Federal Reserve Bank to proxy for local economic activity. Based on a sample of 1,970 general obligations bonds that were issued by U. S. counties between 1995 through 2014, I tested three conditional hypotheses for significant interaction between economic activity and spending rate magnitude. Results indicated that the association between spending rate magnitude and borrowing cost was positively moderated by economic activity. Positive moderation was also significant for spending rate surpluses (i.e., where general fund revenues exceed general fund expenditures). These results suggest that departures from spending rate equilibrium are more severely assessed on borrowing cost when economic activity is positive, and less severely assessed on borrowing cost when economic activity is negative. Overall, my findings provide preliminary evidence that managerial competence over the balance of revenues and expenditures is evaluated more severely when economic conditions are goodnot when they are bad.

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