This chapter proposes nonlinear models using artificial neural network models to study the relationship between chief elected official (CEO) tenure and debt. Using Higher Order Neural Network (HONN) simulator, this study analyzes debt of the municipalities as a function of population and CEO tenure, and compares the results with that from SAS. The linear models show that CEO tenure and the amount of debt vary inversely. Specifically, a longer length of CEO tenure leads to a decrease in debt, while a shorter tenure leads to an increase in debt. This chapter shows nonlinear model generated from HONN out performs linear models by 1%. The results from both models reveal that CEO tenure is negatively associated with the level of debt in local governments.
Reducing debt costs through investment in financial control systems is important to the municipalities. Several theoretical and empirical studies examine the determinants of borrowing costs on tax-exempt bond issues (Benson 1979; Benson, Marks, and Raman 1991). In the early eighties and nineties of the last century, some early studies examine state imposed disclosure requirements. For example, Ingram and Copeland (1982), Benson, Mark, and Raman (1984), and Fairchild and Kock (1998) consider state imposed disclosure requirements in the context of municipal debt costs. Benson, Mark, and Raman (1991) estimate the magnitude of the interest cost savings on general obligation bonds as a potential benefit from differential GAAP compliance. Their study suggests that bond prices incorporate the effects of differential GAAP compliance.
More recently, Downing and Zhang (2004) posit municipal bond markets are less liquid. In addition, Harris and Piwowar (2004) show higher transaction costs are associated with municipal bond markets. Most recently, Baber and Gore (2005) compare municipal debt costs in states that mandate the adoption of GAAP disclosure with debt costs in states that do not regulate municipal accounting methods. The result shows that municipal debt costs in states that impose GAAP are lower by 15 basis points.
Several studies examine the effect of audit variables and accounting variables on the borrowing costs on new bond issues for local governments. Wallace (1981) suggests that lower interest costs and higher bond ratings are associated with compliance with GAAFR, hiring a national auditor, and having a clean audit report. Employing a national sample, Wilson and Howard (1984) find poorer financial operating performance and substandard reporting practices are associated with lower bond ratings and higher borrowing costs. Most existing studies in the government sector examine the determinants of cost of debt, determinants other than CEO tenure; an important goal for this chapter is to extend the current literature and shed light on the issue of debt in the nonprofit area.
Debt is studied extensively in the private sector. According to prior research, debt is associated with accounting methods and accounting conservatism (Beatty and Weber 2003; Ahmed et al. 2002). Beatty and Weber (2003) show that borrowers with bank debt contracts that allow accounting method changes to affect contract calculations are more likely to make income-increasing rather than income-decreasing changes. On the other side, accounting conservatism plays an important role in reducing firms’ debt costs. Ahmed et al. (2002) provide the evidence that accounting conservatism is associated with a lower cost of debt after controlling for other determinants of firms’ debt costs.