Association for Public Policy Analysis & Management

Slack is an important concept in many fields of disciplines. Researchers find that in the private sector, it is managers’ best interests as rational individuals to create slack (Cyert and March 1963). In the public sector, researchers find similar propensity that public officials build slack in their budgets intentionally through “conservative forecasting bias,” that is, to underestimate revenues and overestimate expenditures (Rose and Smith 2008). At the end of the fiscal year, the excess of actual revenues over actual expenditures becomes budgetary slack. Such slack is less visible to stakeholders until the GASB Statement No. 34 requires that governments should disclose the original budgets and report the budget-to- actual variances in their CAFRs. The budget-to- actual variances reflect (1) the volatility nature of a government’s budget structure, and (2) the management flexibility that a government responds to changing environment. Consistent unfavorable budget-to- actual variances (i.e. actual expenditures exceed budgeted expenditures, and actual revenues fall below revenue forecast) indicate poor financial management quality and deteriorating creditworthiness of a government. In contrast, favorable budget-to- actual variances (i.e. actual expenditures fall below budgeted expenditures, and actual revenues exceed revenue forecast) allows a government to gradually accumulate some budgetary slack which strengthens its financial position.

The intention of Statement No. 34’s requirement on budget-to- actual variance disclosure is to increase government financial transparency and further, to facilitate municipal securities market decision making. However, we are not quite clear how financial market perceives the value of such information; particularly, whether financial market information intermediary—credit rating agencies—incorporate the budget-to- variances into their assessment of governments’ creditworthiness. Using a panel dataset of 50 states from FY2010 to FY2015, I analyze how the direction and magnitude of budget-to- actual variances affect state general obligation bonds’ outlook.

Preliminary results show that favorable variances are associated with favorable credit outlook, suggesting the budget-to- actual variances are useful information, and greater transparency facilitates market decision-making.