The prediction of financial distress probability in East Java province governments

Rizky Aji Shiddiqy,Yeney Widya Prihatiningtias,Nurkholis Nurkholis

doi:10.20525/ijrbs.v11i1.1561

Rizky Aji Shiddiqy, Yeney Widya Prihatiningtias + Show 1 more

Open Access

https://doi.org/10.20525/ijrbs.v11i1.1561

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Abstract

Beginning in the mid-1970s, financial distress in local governments became big news when New York City nearly collapsed due to the energy crisis and high inflation. When local governments experience financial distress, the responsibility to provide services to the community both now and in the future cannot be fulfilled. Local governments can only maintain services to the community if they are able to avoid financial distress. If the financial distress condition is maintained, there will be a stagnation in the level of community welfare which will have an impact on regional economic growth because it is not supported by adequate public services. Some local governments like Pennsylvania, have implemented a measure to indicate financial distress as stipulated in the 1987 Financially Distressed City Act (UU 47). However, the local government in Indonesia does not yet have an absolute measure for this financial distress condition. For this reason, financial distress in this study will use a relative measure indicated by the probability value measured using a defined approach. The results of the study provide an overview of how the relevant values in local government financial statements are able to predict financial distress in local governments. The findings show that the variables intergovernmental revenue (IGR), financial independence (FIND), employee expenditure (EMPEX), capital expenditure (CAPEX), and operating position (OPPOS) have a significant effect and can be used as an alternative predictor of financial distress with more comprehensive suitability with the financial characteristics of local government in East Java Province.

Highlights

Government through Presidential Regulation no. 02 of 2015 concerning the National Medium-Term Development Plan (RJPMN) 2015-2019 has set an average target of capital expenditure for local governments of 30% of total regional spending
This study aims to obtain empirical evidence that financial ratios categorized based on income, expenditure, operating position, and debt structure have an influence and can be used in predicting the probability of financial distress in local governments in East Java Province
The results of model testing using binary logistic regression show that financial ratios in the income category are the intergovernmental revenue (IGR) variable which explains the level of intergovernmental income and financial independence (FIND) which explains the level of local government income from their own sources

Summary

Introduction

Government through Presidential Regulation no. 02 of 2015 concerning the National Medium-Term Development Plan (RJPMN) 2015-2019 has set an average target of capital expenditure for local governments of 30% of total regional spending. 02 of 2015 concerning the National Medium-Term Development Plan (RJPMN) 2015-2019 has set an average target of capital expenditure for local governments of 30% of total regional spending. There are still many local governments that have realized capital expenditures below the ratio set in the RPJMN. This condition shows that the function of local government in providing public services to the community as confirmed by regional autonomy has not been fully achieved. Local governments can only maintain services to the community if they are able to avoid financial distress (Trussel, 2012; Ziolo, 2015). If the financial distress condition is maintained, there will be stagnation in the level of community welfare which will have an impact on regional economic growth because it is not supported by adequate public services (Sari & Azra, 2019)

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