Abstract
The local government (LG) sector plays an important role in the EU economies. Besides providing a vast range of public services, it accounts for over 8% of total investment. The crisis, which started in 2008, resulted in increased LG indebtedness and raised concerns over the sector’s debt repayment capacity. This paper proposes an alternative methodology of risk assessment of LGs to statutory debt limits, the Altman model and non-financial indicators. Firstly, it employs a corporate finance approach to evaluate the financial standing of individual entities. The measures are based on free operating cash flow and net debt. Next, Data Envelopment Analysis is used to derive the relative performance of LGs in debt utilization. The indicators used are available from the LG financial reports and also allow risk to be monitored on a quarterly basis. The proposed approach allows the ranking of the risk of individual LGs according to both their debt service capacity and long-term ability to manage costs and carry out a rational investment policy. The results obtained using the DEA method also enable the identification of LGs with persistently inferior risk profile. The quantitative analysis is conducted for the local governments in Poland for the period 2008–2015.
Highlights
Local governments (LGs) play an important role in national economies, providing public services and carrying out investment, especially in infrastructure
LGs in Poland have to comply with several statutory limits and related regulations implemented by Public Finance Law (PFL), and they are controlled by Regional Comptroller Offices (RIOs)
The LG sector performs an important function in the European Union (EU) economies, accounting for over 8% of all their investments
Summary
Local governments (LGs) play an important role in national economies, providing public services and carrying out investment, especially in infrastructure. The analysis showed that the probability of default rises in response to a fall in such factors as population density, dependent population, municipal income per capita and GDP growth and with the ideological alignment of the LG with the national government It rises with an increase in short-term borrowing and the market risk premium. This research develops a risk assessment methodology with the use of selected applicable financial indicators based on free operating cash flow and net debt as an alternative to the statutory limits on LG debt It combines these indicators with efficiency indicators for LGs using the Data Envelopment Analysis (DEA) method. As in the above-mentioned research, the focus in this analysis is on large municipalities (towns with county rights), which play a central role in the LG sector in Poland
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