Municipal Disclosure Timeliness and the Cost of Debt

Published date01 February 2018
Date01 February 2018
The Financial Review 53 (2018) 51–86
Municipal Disclosure Timeliness
and the Cost of Debt
D. Eli Sherrill
Illinois State University
Rustin T. Yerkes
Samford University
A longstanding concern for municipal bond investors is the lack of timely financial
statement disclosures. Municipalities are held to lower disclosure standards than corporations.
Using continuing disclosure dates for audited financial statements, we find bond issuers with
slower disclosure have higher secondary market yields and spreads, less frequent secondary
market trading, and are less likely to issue new bonds. We observe that future disclosure is
largely predictable based on past disclosure and that disclosure often improves prior to new
bond issuances. When municipalities do not capitalize on the benefits of timely disclosure,
economic consequences are imposed on bondholders and taxpayers.
Keywords: municipal bonds, financial statement disclosure, cost of capital, SEC regulation
JEL Classifications: G12, G18
Corresponding author: Samford University Brock School of Business, 800 LakeshoreDr., Birmingham,
AL 35229; Phone: (205) 726-2051; Fax: (205) 726-2464; E-mail:
We acknowledge veryhelpful comments from the editor, Srinivasan Krishnamurthy, anonymous review-
ers, Colin MacNaught (BondLink), Chris Doucet and Will Aycock (Doucet Asset Management), Doug
Cook, Robert Brooks, Jim Ligon, Shawn Mobbs, Junsoo Lee, and seminar participants at the 2012
Financial Management Association, 2012 Southern Finance Association, University of Alabama, Samford
University,Illinois State University, and the University of Alabama at Birmingham.
C2018 The Eastern Finance Association 51
52 D. E. Sherrill and R. T. Yerkes/The Financial Review 53 (2018) 51–86
1. Introduction
Municipal bond issuers have long had a reputation for late and missing financial
statements, particularly with continuing disclosures. As a 2007 Securities and Ex-
change Commission (SEC) white paper notes, “Despite the size and importance of
[the municipal bond] market, it lacks many of the systemic protections customary in
many other sectors of the U.S. capital markets. Investorsin municipal securities are, in
certain respects, afforded second-class treatment under current law” (SEC, 2007). A
2017 Municipal Securities Rulemaking Board (MSRB) report on the timeliness of fi-
nancial reporting by municipalities from 2010 to 2016 finds issuers took an average of
188 days, nearly six months, after the fiscal year end to publish their annual financial
statements and saw disclosure timing remain consistent over the sample (Municipal
Securities Rulemaking Board, 2017). Only 8.8% of survey respondents in a 2011
Governmental Accounting Standards Board (GASB) study called municipal finan-
cial reports “very useful” after receiving them six months following the fiscal year
end (1.5% who waited 12 months said the same, while 87.6% found disclosures
“very useful” within 45 days of the fiscal year end). Survey participants indicate
municipal filings more than six months after fiscal year end have limited valuedue to
the staleness of the information (Governmental Accounting Standards Board, 2011).
In contrast, the SEC requires corporate issuers to file similar reports within
40 or 45 days from quarter end (10-Q) and no more than 60, 75, or 90 days from
fiscal year end (10-K), depending on company size (SEC, 2017). Corporations may
receive an extension of five days for 10-Q filings and a 15-day extension for 10-K
filings. However, penalties for exceeding these periods are severe and may include
loss of SEC registration, exchange delisting, and other legal consequences, yet there
are virtually no such consequences for municipal issuers. Unlike with corporate
bonds, the SEC lacks the authority to mandate disclosure timing for municipal bond
issuers, which is one possible explanation for the persistence of late disclosure. The
Wall Street Journal notes a survey finding 56% of municipal issuers had at least one
missing annual financial statement between 2005 and 2009 with more than a third
of issuers failing to file in three of the sample years (Dugan, 2011). The year 2009
saw over 40% of issuers missing a financial statement in addition to 30% of filings
occurring “extraordinarily late” (Dugan, 2011). Schmitt (2011, cited in Dugan,
2011), the municipal disclosure specialist who conducted the study, suggests, “This
works out to insufficient ongoing disclosure information for more than $2 trillion
of the $3 trillion in outstanding bonds.” Schmitt (2008) also finds the incidence
of delinquency increasing with bond age, significant among all issue sizes and
disproportionately impacts larger issues. In a related study, Schmitt (2009) finds no
financial statement filings in 2007–2008 for half of all sales of distressed bonds.
In this paper, we seek to explore the question of whether late disclosure matters
in the secondary municipal bond market. We contribute to the literature on financial
disclosure, cost of capital, and municipal bonds by examining the impact of munic-
ipal financial disclosure timing on bond yields, liquidity, trading, and issuance. Our
findings indicate late disclosure has a significant economic impact on the municipal
D. E. Sherrill and R. T. Yerkes/The Financial Review 53 (2018) 51–86 53
market in several ways. First, we find bonds from issuers with longer disclosure
times (as measured from the time between the fiscal year end and disclosure filing
date) have higher yields. This suggests poor disclosure negatively impacts existing
bondholders and results in higher cost of debt capital for municipal issuers, ultimately
borne by local taxpayers. Second, we find bonds with longer disclosure times are less
liquid. These bonds have larger yield spreads, fewer trades, and lower probability
of trading than bonds with a better disclosure history. This may be explained by
prospective bondholders’ reluctance to purchase bonds with outdated financial infor-
mation or existing bondholders’ reluctance to sell bonds at depressed prices caused
by untimely disclosure. Additionally, we find issuers with longer-than-expected dis-
closure times are less likely to issue new bonds. Finally, we analyze the factors that
predict disclosure timing. We find past disclosure trends strongly predict future dis-
closure timing and that issuers tend to improve disclosure timing in anticipation of
new bond issuances. When municipalities do not take advantage of the benefits of
timely disclosure, this cost is ultimately borne by bondholders and taxpayers.
The rest of the paper proceeds as follows. In Section 2, we provide an overview
of the municipal bond market, including a background of historical default risk,
bond insurance, and municipal bond regulation. Section 3 provides a summary of the
related literature and Section 4 describes our data, methods, and variables. Finally,
in Section 5, we present the results on yields, liquidity, probability of trading, and
probability of new issuance, as well as several robustness checks. Section 6 presents
our conclusions.
2. Overview of the municipal bond market
In this section, we detail two factors—increased default activity and the decline
of municipal bond insurance—that result in an increased reliance by investors on the
financial information contained in municipal disclosures. We also discuss the role of
regulation in the municipal bond market.
2.1. Rising incidence of municipal bankruptcy and defaults
Municipalities historically use low default rates as an argument against requiring
more stringent financial disclosure. For example, in a 2014 study, Fitch Ratings
(2014) finds the 10-year cumulative default rate for municipal bonds from 1999 to
2013 to be 0.35%. However, there has been a recent increase in the number of larger
issuers in financial distress. For example, four of the fivelargest municipal bankrupt-
cies in U.S. history have occurred since 2010, including an $18 billion bankruptcy by
Detroit, Michigan, in 2013 (Forbes, 2013). Municipal bankruptcies in 2011 include
Central Falls, Rhode Island; Harrisburg, Pennsylvania; and Jefferson County,
Alabama. Municipal bankruptcies in 2012 include Stockton, California; Mammoth
Lakes, California; and San Bernardino, California. Some of these bankrupt issuers
were slow to disclose financials. For example, in the three years leading up to their
bankruptcy, JeffersonCounty had numerous late disclosures, with filings taking over

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