Revista de Contabilidad Spanish Accounting Review 22 (2) (2019) 129-144 REVISTA DE CONTABILIDAD SPANISH ACCOUNTING REVIEW revistas.um.es/rcsar Cost efficiency and financial situation of local governments in the Canary Isles during the recession Diego Priora , Ignacio Martín-Pinillos-Castellanosb , Gemma Pérez-Lópezc , José L. Zafra- Gómezd a) Universitat Autònoma de Barcelona, Spain b) Universidad de la Laguna, Spain c) Facultad de Ciencias Económicas y Empresariales, University of Granada, Spain d) Universidad de Granada, Spain d Corresponding author. E-mail address: jlzafra@ugr.es ARTICLE INFO ABSTRACT Article history: This paper examines cost efficiency in the Spanish municipal public sector, in a specific geographic area (the Received 21 March 2018 Canary Isles, Spain), with respect to financial condition and different types of municipal debt. The study Accepted 4 December 2018 Available online 1 July 2019 focuses on municipalities dependent on tourism and on the consequences to them of the Great Recession, doing so via a two-stage analysis. In the first, the order-m method is used to evaluate the cost efficiency of 77 Canary Isles municipalities, for the period 2008-12. In the second stage, we examine the effect produced on JEL classification: cost efficiency by different types of borrowing (long term, short term, financial and commercial) together with other financial, economic, political and quality variables, using the model developed by Simar and Wilson (2007), based on a truncated bootstrap regression with panel data. Empirical analysis shows that in times of crisis there is a significant relationship between the components of financial condition and Keywords: Efficiency cost efficiency. Inconclusion, municipal cost efficiency increases with commercial debt, but decreases with Financial condition financial debt. Furthermore, certain socioeconomic variables affect the levels of cost efficiency. Borrowing Local public sector ©2019 ASEPUC. Published by EDITUM - Universidad de Murcia. This is an open access article under the Order-m CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). Condición financiera y eficiencia en los gobiernos locales de las Islas Canarias en tiempos de crisis financiera. RESUMEN Códigos JEL: Este trabajo examina la eficiencia de costes para el caso particular del sector público municipal español, concretamente, para el caso de los municipios canarios, poniendo especial énfasis en áreas relacionadas con la condición financiera y diferentes tipologías de deuda, teniendo en cuenta las características propias que estos municipios poseen, como un índice turístico elevado. En primer lugar, se utiliza el método de Palabras clave: orden m para evaluar la eficiencia de costes de 77 municipios de las Islas Canarias, para el período 2008-12. Eficiencia En la segunda etapa, examinamos el efecto producido en la eficiencia de costes por diferentes tipologías Condición financiera de endeudamiento (largo plazo, corto plazo, financiero y comercial) junto con otras variables financieras, Endeudamiento Sector público local económicas, políticas y de calidad, utilizando el modelo desarrollado por Simar y Wilson (2007), basado M-Order en una regresión truncada con datos de panel. Nuestro análisis empírico muestra que en tiempos de crisis existe una relación significativa entre los componentes de la condición financiera y la eficiencia de costes. En particular, concluye que mientras la eficiencia de los costes municipales aumenta con la deuda comercial, disminuye con la deuda financiera. Además, mostramos que ciertas variables socioeconómicas afectan los niveles de eficiencia de costes. ©2019 ASEPUC. Publicado por EDITUM - Universidad de Murcia. Este es un artículo Open Access bajo la licencia CC BY-NC-ND (http://creativecommons.org/licenses/by-nc-nd/4.0/). https://doi.org/10.6018/rcsar.376091 ©2019 ASEPUC. Published by EDITUM - Universidad de Murcia. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc- nd/4.0/). 130 D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 Introduction by Simar and Wilson (2007), which offers more robust res- ults than other models such as ordinary least squares (OLS) The recent economic and financial crisis forced local gov- or Tobit (Da Cruz & Marques, 2014), applying a truncated ernments to seek a more efficient allocation of their re- bootstrap regression with panel data and fixed effects. Many sources, due to the need to provide the same level of ser- previous studies of the influence of certain factors on cost effi- vices with increasingly limited means (López-Hernández et ciency have used Tobit models or bootstrap truncated regres- al., 2012). Among other causes, this situation of scarce sion with cross section data. In our opinion, the approach resources has arisen from falling public administration rev- adopted in the present study provides greater robustness to enues, the increased competences acquired in recent years the analysis of the relationships considered. In this empirical (Balaguer-Coll, 2004), greater demand for public services study, the sample population consists of 77 municipalities in and the enactment of legislation1 strengthening economic- the Canary Isles, Spain (accounting for 83.5% of the total mu- financial control over local entities (as indicated in the pre- nicipalities in the archipelago), all of which have fewer than amble to Act 27/2013, of 27 December, on the Rationalisa- 50,000 inhabitants. tion and Sustainability of Local Administration). This back- The results obtained show that short-term borrowing, com- ground, and the fact that municipal government is the level of pliance with credit limits, the index of budget sustainability public administration that is closest to the citizen, underlies and fiscal pressure per capita all present a significant inverse academic interest in analysing municipal management per- relationship with cost efficiency. On the other hand, com- formance (Zafra-Gómez & Muñiz, 2010) and thus in evaluat- mercial borrowing and the index of public service quality are ing the factors that determine efficiency (Bosch et al., 2012), positively related to cost efficiency. We also obtained evid- especially those related to sources of funding. ence regarding the cost efficiency of other factors such as the In this context, it is especially important to analyse pub- exercise of municipal government by a progressive political lic sector borrowing, as local managers might raise levels of party, of higher levels of population density and the signific- public debt in order to compensate for lags and gaps between ant presence of a population aged over 65 years. All these municipal income flows and costs. Studies of efficiency and circumstances were associated with higher levels of cost effi- borrowing have hypothesised that there may be an inverse ciency. relation between these two elements due to the substitution This paper is structured as follows. After this introduction, effect of borrowing for own resources, in what has been Section 2 describes the theoretical framework employed, re- termed a fiscal illusion (Cabasés et al., 2007; Pérez-López et garding cost efficiency, financial condition and municipal bor- al., 2014), and to the impossibility of reducing public spend- rowing, and sets out the hypotheses to be tested. Section 3 ing (Worthington, 2000; Geys, 2006; Da Cruz & Marquez, provides a detailed description of the research method, the 2014). study sample and the input and output variables used to cal- In view of these considerations, one of the main object- culate cost efficiency, together with the variables used to ana- ives of our paper is to analyse the different characteristics of lyse the financial-condition cost-efficiency relationship. Sec- borrowing and their relationship with cost efficiency, an area tion 4 presents the results obtained, which are then discussed that we believe has been insufficiently addressed in previous in Section 5, followed by a summary of the main conclusions research, with special emphasis on the detailed analysis of dif- drawn. ferent types of borrowing, distinguishing between short and long-term borrowing, and commercial and non-commercial Theoretical framework for local government efficiency borrowing, seeking to determine whether their particular characteristics influence municipal cost efficiency, especially in municipalities dependent on tourism and taking into ac- Cost efficiency and financial condition in municipal govern- count the impact of the Great Recession (the most recent ment transboundary crisis) on levels of municipal efficiency and Cost efficiency and the factors that affect it have been financial condition (Ansell et al., 2010; López-Hernández et widely considered in previous research (De Borger & Ker- al., 2017; Plata-Diaz et al., 2017). In relation to this study stens, 1996a, 1996b; Prieto & Zofio, 2001; Balaguer-Coll, goal, we propose a series of hypotheses on which to base our 2004; Balaguer-Coll et al., 2007; Balaguer-Coll & Prior, 2009; analysis of the impact made by certain economic, financial Benito et al., 2010; Bisogno & Cuadrado-Ballesteros, 2018; and political factors on cost efficiency. Cuadrado-Ballesteros & Bisogno, 2018; Narbón-Perpiñá & De A twofold approach is taken to achieve these goals: first, Witte, 2018a;2018b) ), seeking to identify inefficient activit- order-m frontiers are used to calculate cost efficiency. This ies and to establish models based on local authorities found concept was introduced by Cazals et al. (2002) and later to be relatively efficient. However, a more detailed under- used by Simar (2003), who used a non-parametric model standing is needed of the relationship between cost efficiency to address the main problems encountered in data envelop- and relevant financial factors, measured according to the ment analysis (DEA), a method that has been widely used concept of financial condition (Zafra-Gómez & Muñiz, 2010). in recent years, although rarely for the purpose of evaluat- Accordingly, the first step is to consider which concepts of ef- ing municipal efficiency (Balaguer-Coll et al., 2007; Pérez- ficiency and financial conditionshould be used. López et al., 2015; Narbón-Perpignan & De Witte, 2018a). In Public administrators must decide which services should the second phase of this study, the determinants of cost effi- be provided to citizens, and the quantity and quality of these ciency are analysed in accordance with the method proposed services. To enable them do so, the preferences of society 1 must be determined, by reference to the elements charac- The general legislation on Spanish local government, particularly Local Government Act 7/1985 of 2 April (LRBRL); the local government financial terising the demand for municipal services (Balaguer-Coll et regulations in Spain, in particular the Local Government Finance Act, ap- al., 2007; Zafra-Gómez & Muñiz, 2010, Pérez-López et al., proved by Royal Legislative Decree 2/2004, of 5 March 5 (TRLRHL); and 2015). the regulations on budgetary stability applicable to local government, which includes, in general, Organic Act 2/2012, of 27 April, on Budgetary Stabil- Various theoretical approaches have been developed to ity and Financial Sustainability, and its subsequent amendment Organic Act consider the most appropriate response to citizens’ needs 4/2012, of 28 September (LEPSF). regarding the quantity and quality of goods and services D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 131 provided. In particular, within the framework of the Theory often interchangeable, such as financial position or condition of Local Public Expenditures (Tiebout, 1956), it has been ar- and fiscal stress, crisis or disaster. Among these terms, the gued that if there were more competition between local juris- broadest and most appropriate concept for evaluating the fin- dictions, municipal services would be more efficient, i.e. gov- ancial health of local government is that of financial condi- ernments would use their resources in a way that minimised tion (Zafra-Gómez & López-Hernández, 2006; Zafra-Gómez the cost of providing local public services. On the other hand, et al., 2009a; Hendrick, 2011). Diverse theoretical frame- according to the Median Voter theory, citizens decide the works have been proposed for defining financial performance level of expenditure they require by voting accordingly, opt- (Hendrick, 2011; Turley et al., 2015). These are character- ing for the candidate offering the greatest service efficiency ised by combinations of elements that may differ in their de- (i.e. services provided with respect to taxes paid) (Congleton, nominations, but, in general, use common indicators of li- 2002). As difficulties can arise in identifying citizens’ pref- quidity, debt and budget surplus/deficit, among other para- erences, the theoretical approach of structuralism advocates meters (Zafra-Gómez et al., 2009; Hendrick, 2011). Reviews measuring them through proxy variables such as the demo- of the literature in this field show that the concept of fin- graphic, socioeconomic and fiscal factors within a community ancial condition includes a greater variety of such elements that affect the provision of public services (Hammer & Green, with which to analyse the financial health of local administra- 1996). tions (Zafra-Gómez et al., 2009a; Zafra-Gómez et al., 2009b; Of the different types of efficiency – technical or productive Hendrick, 2011; Cabaleiro et al., 2013). efficiency, allocative or cost efficiency, distributive efficiency According to the Governmental Accounting Standards and dynamic efficiency (Andrews & Entwistle, 2013) – in Board2 (1987), financial condition can be defined as the abil- studies of local government, that of allocative or cost effi- ity to provide services whilst complying with present and fu- ciency is commonly used (Vanden Eeckaut et al., 1993; De ture obligations. For Balaguer-Coll (2002, p.31), financial Borger & Kerstens, 1996; Zafra-Gómez & Muñiz, 2010), due condition is the entity’s capacity to meet its financial obliga- to the complexity of measuring economic efficiency, among tions, including the payment of interest and the repayment other reasons because production prices are often not avail- of debt, and its capacity to provide the level and quality of able and because outputs are (totally or partially) determ- the services required for the welfare of its citizens, at an ac- ined externally (Balaguer-Coll & Prior, 2009; Pérez-López et ceptable level of taxes. Hendrick (2011) defined financial al., 2015). condition as the state of equilibrium that exists between the There are various reasons for wishing to determine overall different dimensions or components of the government’s fin- efficiency rather than that of specific public services (Borge ancial sphere in relation to its spending, obligations, fiscal et al., 2008; Bosch, 2012; Pérez-López et al., 2015). On the resources, income and internal resources. Other authors, one hand, as observed by Giménez and Prior (2007), mu- such as Greenberg and Hiller (1995), CICA (1997), Zafra- nicipalities provide multiple and varied public services, with Gómez et al. (2006, 2009a), Groves et al. (2003) and Wang the common objective of satisfying the needs of local citizens, et al. (2007), have all developed particular views of this and therefore it is appropriate to consider the efficiency of concept. In line with previous approaches in this field (Zafra- these public services as a whole. Furthermore, major diffi- Gómez et al., 2006, 2009a; Cabaleiro et al., 2013) our study culties may arise in selecting and quantifying for analysis the sample was composed following the approach recommended products and services offered by each municipality and in ob- by CICA (1997, 2009), according to which proper measure- taining information on each of the services they provide in- ment of financial condition should include a consideration of dependently (De Borger & Kerstens, 1996). Finally, the avail- sustainability, flexibility and vulnerability. ability of other types of information may make it more ad- For this purpose, sustainability is defined as the organisa- visable to analyse overall efficiency, since it makes no sense tion’s capacity to maintain, promote and preserve the social to assess the efficiency of services independently when the welfare of its citizens through the use of the resources at its variables that will be used to analyse the factors refer to the disposition (Carmeli, 2002; PriceWaterhouseCoopers, 2006; municipality at the overall level (Borge et al., 2008). Zafra-Gómez et al., 2009; Atan et al., 2010; Cabaleiro et al. 2013; Government of Western Australia: Department of In performing this analysis, it is necessary to be aware of Local Government, 2013). Flexibility is taken to be the or- the characteristics of local government financing, and its re- ganisation’s ability to respond to changing economic and fin- lation to efficiency, a question that has been addressed in ancial circumstances, within the limits of its fiscal capacity; various studies. Thus, Dijkgraaf et al. (2003) studied the this ability will be reflected in its reactions to such changes relationship between efficiency and financial situation, and via increases in taxation levels, in public debt or in transfers concluded that when the latter is difficult this forces muni- received (Zafra-Gómez et al., 2009a, 2009b; Hendrick, 2011; cipal managers to improve service efficiency as a means of Cabaleiro et al., 2013). Vulnerability is understood as the or- obtaining cost savings. Similarly, Zafra-Gómez and Muñiz ganisation’s level of dependence on external funding in order (2010) analysed the relationship between efficiency and fin- to maintain public spending levels, via transfers, subsidies ancial structure, observing that the most efficient municipal- and grants (Carmeli, 2002; Atan et al., 2010; Cabaleiro et ities are not those which have the best financial structure, but al., 2013; Government of Western Australia: Department of are characterised as presenting a degree of relaxation in the Local Government, 2013); Zafra-Gómez et al., 2009a, 2009b; search for better financial margins, precisely because they are Plata-Díaz et al., 2017). more cost efficient. Benito et al. (2010) studied the relation- ship between efficiency and the economic level of local gov- ernment, and reached the conclusion that there is no signific- ant relationship between the two. However, most of the cor- relations found were positive, which suggests there is some 2 type of relationship between economic level and efficiency. Established in 1984, the Governmental Accounting Standards Board (GASB) is the independent, private-sector organization based in Norwalk, To properly address the relationship between efficiency Connecticut, that establishes accounting and financial reporting standards and financial situation, we must define what is meant by the for U.S. state and local governments that follow Generally Accepted Account- latter. In this respect, the literature refers to several concepts, ing Principles (GAAP) (https://gasb.org. Accessed: 3 July 2018). 132 D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 Previous empirical evidence and its relation to the theoretical budget deficit. Following Balaguer-Coll et al. (2007; p. 437), framework sustainability is expected to be inversely associated with ef- ficiency, because a situation of deficit may be considered to Previous researchers in this field have placed special em- represent a mismanagement of public resources and, there- phasis on the analysis of efficiency in local administrations, fore, reduced cost efficiency. Accordingly, the first research mainly through the use of non-parametric techniques by hypothesis is posed as follows: which inputs and outputs are determined. A unit of effi- ciency measurement is then configured, either using direct Hypothesis 1: An increase in the budget deficit (sustainability) indicators or proxies (De Borger et al., 1994; De Sousa & will reduce cost efficiency. Stosic, 2005; Balaguer-Coll, 2004; Balaguer-Coll & Prior., 2009; Borge et al., 2008; Balaguer-Coll et al., 2007); Zafra- The second element used in this study to measure financial Gómez & Muñiz, 2010). condition is that of vulnerability, i.e. the ratio of transfers re- In analysing financial and fiscal factors, some authors have ceived to total income. A high value for this indicator means studied the relationships between cost efficiency and vari- that a large proportion of local government revenue is not ables that represent indicators of the three aspects that define obtained directly from the municipal population. This situ- financial condition. Thus, Balaguer-Coll et al. (2007) repor- ation can give rise to the fiscal illusion that any expense can ted an inverse relationship between cost efficiency and the be met because there is sufficient income, and so municipal index of budget sustainability. Vulnerability has been ana- managers could perceive less pressure to operate more effi- lysed by studying the level of transfers, and in this respect ciently (Giménez & Prior, 2007; Bosch et al., 2012). Other Geys (2006) reported that higher transfers were related to authors have associated the effect of fiscal illusion with lower higher rates of efficiency. However, other authors have con- levels of public interest in supervising the policies adopted cluded that an increase in resources that are not obtained dir- by local government, an indifference that ultimately results ectly from citizens can provoke a ‘fiscal illusion’ effect, mak- in decreased cost efficiency (De Borger & Kerstens, 1996; ing municipal managers feel less pressured to achieve effi- Balaguer-Coll, 2002; Balaguer-Coll et al., 2007; Borge et al., ciency in the delivery of public services (Giménez & Prior, 2008; Balaguer-Coll & Prior, 2009). 2007; Bosch et al., 2012). Flexibility can be analysed in terms On the other hand, Geys (2006) reported that the larger of many variables, including debt, fiscal pressure and fiscal the volume of government transfers received, the higher the surplus (Zafra-Gómez et al., 2009a, 2009b; Hendrick, 2011; index of cost efficiency, arguing that subsidies are subject to Cabaleiro et al., 2013). greater supervision and control, which limits the wasteful ap- Many studies have reported finding a negative relationship plication of these resources. As there is no specific empir- between debt and cost efficiency, explained by the presence ical evidence of the impact of this variable on cost efficiency, of financial costs that increase public sector spending, thus the second hypothesis merely suggests that an increase in the reducing cost efficiency (Worthington, 2000; Geys, 2006; value of transfers will affect cost efficiency, without specify- Benito et al., 2010; Da Cruz and Marques, 2014; Cordero ing its sign. et al., 2017). According to the literature on short-term bor- rowing (Worthington, 2000; Geys, 2006), this is an explan- Hypothesis 2: An increase in the level of transfers (vulnerabil- atory variable of cost efficiency, with which it is inversely re- ity) will affect cost efficiency. lated, due to the increased borrowing incurred when finan- cial costs rise. However, an increase in long-term debt is asso- The third element defining financial condition is flexibility, ciated with greater cost efficiency (Benito et al., 2010). Other which is analysed by disaggregating the concept into three variables, too, have been considered in this context. Thus, aspects: borrowing, the index of compliance with credit lim- Geys (2006) and Pérez-López et al. (2014) reported finding its and fiscal pressure. Moreover, it is necessary to distin- a direct relationship between net savings and cost efficiency. guish between short and long-term borrowing, commercial Other studies have analysed the influence of fiscal pressure in borrowing and financial borrowing. The variable ‘net savings’ this respect, producing conflicting results. Some papers have is defined as the resources generated with the current budget concluded that greater fiscal pressure may reduce cost effi- that are really available to finance capital expenses, once the ciency, arguing that when local governments lose the power annual amortisation of the debt has been financed. A greater to generate current revenues, they become less motivated to net saving must result either from increased income or from manage their resources efficiently (De Borger et al., 1994; decreased spending (Pérez-López et al., 2014), and the lower Balaguer-Coll, 2002; Giménez & Prior, 2007; Balaguer-Coll the spending, the higher the cost efficiency. In other words, et al., 2007; Balaguer-Coll & Prior, 2009; Bosch et al., 2012; an increase in net savings will result in decreased spending Cuadrado-Ballesteros et al., 2013). Others, however, affirm and, hence, greater cost efficiency. Note that in Spain a pre- that high taxes can lead voters to require more control of pub- requisite for requesting long-term funding, according to local lic spending, and to urge public managers to improve cost government regulations3 , is that the net savings balance for efficiency (De Borger & Kerstens, 1996; Balaguer-Coll et al., the previous year must have been positive. 2007; Benito et al., 2010). Hypothesis 3a: An increase in positive net savings will increase Research hypotheses cost efficiency. An increase in the second of these variables, fiscal pressure According to the above considerations, the research hypo- per capita, defined as the ratio of municipal tax revenue theses should contain the three elements proposed for meas- to the number of inhabitants in the municipality, can harm uring financial condition – sustainability, flexibility and vul- cost efficiency because the local government could become nerability. The first of these is considered via the budget sus- less competent to generate current income, as a result of tainability index, which reflects the relationship between the volume of local government spending and that of budget rev- 3 Article 53 of Legislative Decree 2/2004, of 5 March, approving the Con- enues. The higher the value of this indicator, the greater the solidated Text of the Local Government Finance Act. D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 133 being less motivated to manage its resources efficiently (De However, we must differentiate between these forms of bor- Borger et al., 1994; Balaguer-Coll, 2002; Giménez & Prior, rowing and commercial debt, which may be related with cost 2007; Balaguer-Coll et al., 2007; Balaguer-Coll & Prior, 2009; efficiency in a different way. This contrast would arise from Bosch et al., 2012; Cuadrado-Ballesteros et al., 2013). On the fact that commercial borrowing does not usually incur the other hand, high local taxes might increase voters’ de- financial costs, and so more income would be available for mands for stricter control of public spending and thus spur application to municipal services. As costs would not thereby public managers to greater cost efficiency (De Borger & Ker- be increased, these funds could be used to improve cost ef- stens, 1996; Balaguer-Coll et al., 2007; Benito et al., 2010). ficiency. To our knowledge, no prior research evidence has Although there is no unanimity on this question in the liter- been reported in this respect. Accordingly, the following hy- ature, the following hypothesis proposes that an increase in pothesis is tested. taxes in relation to the number of local inhabitants will have a negative impact on cost efficiency. Thus: Hypothesis 4c: There is a positive relationship between cost efficiency and commercial debt. Hypothesis 3b: An increase in taxes per capita will reduce cost efficiency. In addition to the above types of borrowing, we examine in- dicators related to compliance with borrowing limits (Pérez- As previously explained, in this paper the question of flexib- López et al., 2014). The indicator of the latter factor is taken ility receives special consideration, and is examined in terms as the ratio between outstanding debt and current municipal of different indicators and types of borrowing. The literature income; thus, the lower the ratio, the further the municipal is not unanimous on the influence of borrowing on cost effi- finances will be from compliance with the 110% index, the ciency (Balaguer-Coll et al., 2007; Benito et al., 2010). The legal limit for long-term investment4 . In other words, the theoretical argument most frequently used is to assume an higher the value of this indicator, the fewer resources will be inverse relationship between borrowing and efficiency, due available to the municipality to devote to public services and, to the presence of financial costs that raise the level of pub- consequently, the less efficient it will be. lic spending and thus reduce cost efficiency (Worthington, Although there is no empirical evidence of the relationship 2000; Geys, 2006; Benito et al., 2010; Da Cruz & Marques, between this variable and cost efficiency, from its own defini- 2014; Cordero et al., 2017). However, this conclusion might tion, an increase in the value of the indicator for compliance be distorted by the different types of government borrowing with borrowing limits is expected to reduce cost efficiency, available, which could plausibly affect the above relationship. thus: Therefore, one of the aims of this study is to disaggregate the borrowing variable according to the term of the debt and the Hypothesis 5: There is an inverse relationship between compli- nature of the financing entity. ance with borrowing limits and cost efficiency. Many previous studies have examined the relationship between cost efficiency and financial debt, but in this respect Quality, political and socioeconomic factors explaining we should distinguish between long and short-term finan- cost efficiency cial borrowing, as each type has its own characteristics that can influence levels of government cost efficiency in differ- Other factors that may influence local government cost ef- ent ways. We adopt the initial premise that long-term finan- ficiency are those related to service quality, political aspects cing can only be used for long-term investments and, in turn, such as political orientation and type of municipal govern- short-term financing can only be used to cover cash shortfalls ment, and socioeconomic factors such as absolute population, related to short-term debts. Indeed, these characteristics are population density, size of population aged under 15 years typical of local government funding (Pérez-López et al., 2013, and/or over 65 years, unemployment rate, economic activity 2014). The view that short-term borrowing is an explanat- and the local importance of tourism. ory variable of cost efficiency and has an inverse relation- There is no concrete evidence of the relationship between ship with this parameter may be justified by observing that the quality of municipal services and cost efficiency increased borrowing takes place in response to rising finan- (Balaguer-Coll & Prior, 2009). In principal, an increase in cial expenses, as observed by Worthington (2000) and Geys quality would imply higher spending and, therefore, that the (2006), and in consequence, cost efficiency deteriorates. municipality would be less efficient. On the other hand, ac- In consequence, the following hypothesis is divided into cording to the theory of Total Quality Management, investing two elements: the first, on the relationship between cost ef- in quality ultimately brings about increased cost efficiency ficiency and short-term borrowing, and the second, on its re- (Prior, 2006). lationship with long-term borrowing. The studies carried out to determine how the ideology of the governing party (i.e., the political condition) affects Hypothesis 4a: Increased short-term financial debt is associ- municipal cost efficiency have produced conflicting results ated with reduced municipal cost efficiency. (Vanden Eeckaut et al., 1993; Benito & Bastida, 2004; Bastida et al., 2009; Kalb et al., 2012). In some cases, governments An increase in borrowing that is used to finance investments with a conservative majority have been found to achieve in public facilities, in other words, long-term debt, can raise greater cost efficiency (Borge et al., 2008; Kalb et al., 2012; cost efficiency (Benito et al., 2010). In this case, the im- Da Cruz & Marques, 2014), but in others government by pro- provement in cost efficiency would be directly related to the gressive parties has been associated with higher levels of mu- volume of municipal investment, and so the following hypo- nicipal cost efficiency (De Borger et al., 1994; Benito et al., thesis is proposed. 2010; Geys et al., 2010). 4 Hypothesis 4b: There is a positive relationship between cost Article 53 of Legislative Decree 2/2004, of 5 March, approving the Con- solidated Text of the Local Government Finance Act, and Final Provision No. efficiency and long-term financial debt. 31 of Act 17/2012, of 27 December, on the General Budget of the State for the year 2013. 134 D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 In this context, it is also important to consider whether the this question and concur that in municipalities with higher party that governs the municipality does so with an absolute levels of economic or commercial activity, policymakers will majority or in coalition. In the former case, the government be exposed to greater pressure to manage local services effi- should have less difficulty in achieving more efficient man- ciently. agement than if a coalition with other parties has to be nego- To conclude this review of socioeconomic factors, it is also tiated and maintained (Benito et al., 2018). Such a coalition important to consider the effect of tourism on the municipal- government might incorporate different styles of manage- ity. When this activity is significant, it requires a certain level ment and even experience policy conflicts among the parties of services, and increased demand in this respect may lead to responsible for municipal government. Empirical evidence greater cost efficiency in municipal government (Diez-Ticio shows that strong political leadership (Borge et al., 2008) & Mancebón, 2002). In contrast, Giménez and Prior (2007), and a high number of votes for the strongest party (Bruns & Bosch et al. (2012) and Da Cruz and Marques (2014) all ar- Himmler, 2011) both have a positive influence on municipal gue that an increase in the local index of tourist activity is cost efficiency. In contrast, other studies have reported find- associated with higher costs in terms of congestion and the ing a relationship between political fragmentation and cost seasonality of services, and hence cost inefficiency. efficiency (Vanden Eeckaut et al., 1993; Balaguer-Coll et al., 2007; Borge et al., 2008). According to Kalb et al. (2012), Methodology this relationship would be explained by the political control exerted over government partners giving rise to more effi- cient management. The research aims of this study are addressed by means In relation to the local population, larger municipalities of a two-stage analysis, following Simar and Wilson (2007), might achieve greater cost efficiency in services and facilit- Balaguer-Coll et al. (2007, 2009), Balaguer-Coll and Prior ies, thanks to economies of scale (De Borger et al., 1994; (2009), Bosch et al. (2012), Cuadrado-Ballesteros et al. Giménez & Prior, 2007; Benito et al., 2010; Bruns & Himmler, (2013) and Pérez-López et al. (2015), among others. In the 2011), but would also have to respond to greater numbers first stage, the cost efficiency of various local public services of users and provide more services. This obligation would is measured for each municipality in the sample, by the order- be accentuated if, in addition, there were a high density of m frontier method. In the second, a truncated regression of population, since the higher the population density, the lar- panel data with fixed effects is applied, following Prior et al. ger the population served by the available infrastructure and (2008), Pascual Arzoz et al. (2008), Bastida et al. (2013) services, and this could produce negative effects from dis- and Pérez-López et al. (2015). This process reveals which economies of agglomeration (Borowiecki, 2013). In fact, our variables exert most influence on municipal cost efficiency. review of previous empirical evidence shows that there is no generally accepted view on the relationship between popu- 3.1. Sample selection lation size and cost efficiency; some studies have reported a positive relationship in this respect (De Borger et al., 1994; The study hypotheses were tested using a sample of muni- De Borger & Kerstens, 1996; Giménez & Prior, 2007; Benito cipalities in the Canary Isles (Spain). These islands are com- et al., 2010; Bruns & Himmler, 2011) while others have ob- monly excluded from efficiency studies due to their special, served the opposite (Dubin & Navarro, 1988; Giménez & insular characteristics (Balaguer-Coll & Prior, 2009; Zafra- Prior, 2007). Gómez et al., 2009a). Nevertheless, it is essential to analyse such a region in order to determine how dependence on tour- What is well established, though, is that the distribution ism may affect the provision of local public services, a ques- and characteristics of the local population can affect muni- tion that has received little previous research attention. The cipal cost efficiency. When there is a large population of municipalities analysed are located within the autonomous inhabitants aged over 65 years, this can have a positive ef- community (region) of the Canary Isles, which is the second fect on local government cost efficiency, as these residents most important in Spain for domestic tourism (accounting are able to exercise greater control over local policies, due to for 17% of the national total). In turn, Spain was fourth- their lower opportunity cost in obtaining information (Bosch ranked in the world by number of foreign tourists in 2010. et al., 2012). On the other hand, Da Cruz and Marques The present research contributes new knowledge on the im- (2014) created an aging index, incorporating both older and pact made by the 2008 Great Recession on cost efficiency, a younger population groups (those aged over 65 and under 15 consequence referred to in a previous study of transboundary years), and reported that both groups require greater spend- crises (Ansell et al., 2010). The 77 municipalities in the study ing on public services. They concluded that the higher this sample represent 87.5% of the total number of municipalities index, the lower the level of municipal cost efficiency. (88) in the islands. These 77 in particular were included be- With respect to local unemployment, contradictory evid- cause a more complete data set was available for them than ence has been reported. According to Sung (2007) and Pérez- for the others, with respect to the study period, thus enabling López et al. (2015), a higher rate of unemployment is associ- us to address one of the main study goals, that of breaking ated with lower cost efficiency, since as the number of jobless down municipal borrowing into commercial and financial persons increases, fewer resources will be available to main- debt.Specifically, the study sample contains data from mu- tain public services, and if the same quantity and level of ser- nicipalities with fewer than 50,000 inhabitants5 . This char- vices are to be provided, this could lead to cost inefficiency. acteristic arises from the fact that the data for the outputs On the other hand, Kalb et al. (2012) affirm that a higher of local public services were obtained from the Spanish Sur- unemployment rate will improve efficiency by reducing pres- vey of Local Equipment and Infrastructure (EIEL), participa- sure on the quality of public services, thus resulting in lower tion in which is not mandatory for municipalities with over costs for the municipality. 5 Regarding economic activity, Balaguer-Coll (2002) con- Towns and cities with over 50,000 inhabitants were excluded because EIEL does not collect this information for large municipalities. This limit- cluded that a higher level of economic activity improves cost ation is also found in studies by Balaguer-Coll et al. (2007); Zafra-Gómez efficiency; however, other studies, such as Giménez and Prior and Muñiz (2010), Pérez-López et al. (2015), Pérez-López et al. (2016) and (2007) and Balaguer-Coll and Prior (2009), have analysed Pérez-López et al. (2018) , among others. D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 135 50,000 inhabitants (which in the Canary Isles is the case of 3. Repeat steps 1 and 2, B times7 . In each round, a coef- eight municipalities). In addition, three municipalities that ficient of efficiency is estimated, such that by the end of the were required to provide this information (all in the island of process we have B coefficients of efficiency ãSb (b=1;2; ...; B). El Hierro) did not in fact do so until 2013 and so these, too, 4. Finally, the arithmetic mean of the estimated efficiency were excluded from the sample. coefficients is calculated as: 1∑ b B 3.2. The order-m method of measuring cost efficiency (Stage αSm = ã 1). B b=1 S Various analyses based on frontier methods have been con- ducted to evaluate the efficiency of the local public sector. In the present study, the selection of study variables is based Most of these studies focus on inputs, in the assumption that on those used in previous empirical research (De Borger & outputs are determined by the institutional context that uni- Kerstens 1996; Balaguer-Coll et al., 2007; Giménez & Prior, fies the goods and public services to be provided, although 2007; Balaguer-Coll & Prior, 2009; Benito et al., 2010; Geys measures of output quality are often included (Cabasés et al., et al., 2010; Da Cruz & Marques, 2014; Ibarzola et al., 2017), 2007). Balaguer-Coll et al. (2007), among others, pointed taking into account the availability of information. out that since in most cases outputs are totally or partially The inputs selected were the amounts of the respective determined by forces beyond the control of the local corpor- chapters of the expenditure budget, following previous em- ation, it seems more logical to evaluate efficiency in terms of pirical studies of municipal cost efficiency such as those by minimising inputs. Zafra-Gómez and Muñiz (2010), Cuadrado et al. (2013) and Among the various types of frontier analysis that may be Pérez-López et al. (2015), considering current and capital considered, many recent studies of local government effi- expenses and excluding financial expenses (Chapters 1, 2, ciency have applied non-parametric models. However, these 4, 6 and 7). Budget settlement data were included in order models can present estimation problems since the efficiency to avoid the inclusion of provisional data, and consolidated estimates obtained by data envelopment analysis (DEA) and data were used, in order to avoid the possible masking of Free Disposal Hull (FDH) methods are very directly correl- data through the use of instrumental agencies (Fresneda & ated (Simar & Wilson, 2007). Moreover, both methods are Hernández, 2018). The information on inputs was obtained very sensitive to outliers and extreme values, since they incor- from the website of the Ministry of Finance and Public Admin- porate all the data points (Daraio & Simar, 2007; Balaguer- istration, via the General Secretariat for Regional and Local Coll et al., 2013); in addition, they are susceptible to meas- Coordination8 . urement errors, because they assume the absence of stat- To define the outputs, we analysed the competences as- istical noise (De Witte & Marques, 2010). Kneip et al. signed to these municipalities under applicable legislation9 , (1998) and Simar and Wilson (2007) were among the first using proxies in order to avoid difficulties in directly eval- studies that attempted to overcome the non-robustness of uating the product or service provided. Most of these mu- non-parametric methods (Cordero et al., 2013). In this re- nicipal services are described by the indicators included in spect, Cazals et al. (2002) and Simar (2003) introduced the EIEL, as presented on the website of the Ministry of Fin- the concept of order-m frontiers, suggesting that efficiency ance and Public Administration (State Secretariat for Public should be evaluated with respect to a partial frontier rather Administration) and in the Unifica internet application made than a complete one. By repeating the evaluation of the sub- available by the Government of the Canary Isles. Therefore, sets of observations taken at random from the sample, a ro- the variables selected for each entity were the total budget bust approach can be configured. Moreover, this approach in euros, as the input measure, and the number of inhabit- makes it possible to perform the statistical inference of the ants, the length of the road network (m), the volume of waste efficiency indicators calculated, something which traditional production (tons), the area of public facilities (sq. m.), the non-parametric models do not allow. The order-m frontier number of street lamps, the length of the water distribution method, accepting the non-convexity of the FDH, resolves network (m) and the surface area of cemeteries (sq. m.), as the presence of extreme values, allowing the location of ob- the output measures. servations beyond the estimated efficiency frontier, and there- fore the borders do not include all the data (Simar & Wilson, 3.3. Truncated bootstrap regression with panel data (Stage 2007). 2). The algorithm for calculating order-m efficiency coeffi- cients considers a positive fixed integer “m”, such that from The research hypotheses were tested by applying the pro- a certain level of input (xo ) and output (yo ), the estimate posal of Simar and Wilson (2007) to the results obtained in defines the expected maximum value of m random variables the first stage, using a truncated bootstrap regression with (Y1 ,..,Ym ), extracted from the distribution of the output mat- panel data, with fixed effects. This method was chosen be- rix Y, which satisfies the condition Ym ≤ yo (Balaguer-Coll et cause alternative procedures, such as OLS and Tobit mod- al., 2013). Therefore, the following steps should be taken to els, have been criticised in the sense that correlation prob- calculate the order-m estimator (Daraio & Simar, 2007): lems could arise between the first and second-stage variables, possibly invalidating the results of the statistical inference 1. For a given level of yo , extract a random sample of size (Fernández-Santos et al., 2015). Furthermore, as observed m6 as a substitute for ysm , such that ysm ≤ yo . 7 2. Using the random sub-sample, estimate the efficiency Although in most applications it is reasonable to use B = 200 (Balaguer- coefficient ãs . Coll et al., 2013), in the present study B = 2,000 is assumed, as suggested by De Witte and Geys (2013). 8 http://serviciosweb.meh.es/apps/EntidadesLocales/ consulted in 6 June 2015. Except data from the municipality of Betancuria (Fuerteven- In the present case, by employing the order-m frontier approach, we work with a cluster value of 50 observations, that is, m = 50, since the tura) for the year 2010, since this information was not on the Ministry’s sensitivity analysis performed, with different values of m, revealed a degree website. Instead, it was obtained directly from the municipality. 9 of convergence in the results for this value. Article 26 LRBRL specifies the powers of the municipalities. 136 D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 Table 1 Table 1. Description of the variables included in Stage 210 Description of the variables included in Stage 2 10 VARIABLE DEFINITION Municipal cost efficiency (dependent Ratio of municipal spending to municipal services. Normally takes values between 0 and 1, variable) but as the order-m method allows superefficiency values, values greater than one may be obtained. Index of budget sustainability Ratio of expenditure (in chapters 1-7) and income (chapters 1-7). Level of government transfers received Current and capital transfers from other public entities as a percentage of total income. Short-term borrowing Short-term consolidated municipal debt. Long-term borrowing Long-term consolidated municipal debt. Financial debt (short and long term) Consolidated municipal debt owed to financial entities. Commercial debt Consolidated municipal debt owed to budget and non-budget creditors and to other public entities. Compliance with borrowing limits Compliance with the borrowing limits imposed by national regulations, i.e. <110% of outstanding debt, in relation to current income. Net saving Current income less current expenses, less debt amortisation. Fiscal pressure per capita Tax revenue in relation to the number of inhabitants. Population density Surface area (km2) of the municipality in relation to the number of inhabitants. Population tranche Categorical variable that classifies municipalities by population size: 0-5000, ppn=0; 5001- 20000, ppn=1; 20001-50000, ppn=2. Population aged under 15 years Number of inhabitants aged under 15 years in relation to the total number of inhabitants. Population aged over 65 years Number of inhabitants aged over 65 years in relation to the total number of inhabitants. Index of unemployment Number of persons unemployed in relation to the total number of inhabitants. Index of economic activity Tax income from total business activities (industrial, commercial and services) and professional activities in relation to the national total and in relation to the total number of inhabitants of the municipality. Index of tourist activity Tax income from economic activities in the tourism sector in relation to the national total and in relation to the total number of inhabitants of the municipality. 11 Index of average quality Variable measuring the average quality of local public services, each of which is assigned the value 1, 2 or 3, corresponding to an evaluation of Poor, Fair or Good quality, respec- tively. For refuse collection, the quality values used are Sufficient= 2 or Insufficient= 1. Political orientation of municipal Variable assigned the following values, according to the orientation of the Mayor’s political government party: Progressive=0; Conservative=1 Type of municipal government Variable assigned the following values, according to the type of governing majority of the Mayor’s political party: Absolute=0; Coalition=1. Source: The authors. Source: The authors. 10 Our analysis of financial condition does not include liquidity because when the study was performed the data for this variable were not available in the Local Information System of the Canary Isles Autonomous Community (Unifica, the official website of the Canary Isles regional government) for the municipalities analysed in this period, and its inclusion 10 part of the sample. would mean losing Our analysis of financial condition does not include liquidity because when the study was performed the data 11 The Quality for thisis variable Indicator composed ofwere not available the following in obtained quality indices the Local Information from the System EIEL: condition of highwayof infrastructure, the Canarycondition Isles ofAutonomous the refuse collection network, condition of public equipment, condition of street lamps, condition of the water distribution network. In addition, equipment with the status "in the process of implementation" is Community (Unifica, the official website of the Canary Isles regional government) for the municipalities excluded from the results since it is not currently being used and therefore is not providing any service to the local inhabitants. In the case of road infrastructure, in some cases the analysed level of quality is in this period, stated as "unpaved" which weand its inclusion categorise would mean losing part of the sample. as poor quality. 11 The Quality Indicator is composed of the following quality indices obtained from the EIEL: condition of highway infrastructure, condition of the refuse collection network, condition of public equipment, condition of street lamps, condition of the water distribution network. In addition, equipment with the status “in the process of implementation” is excluded from the results since it is not currently being used and therefore is not providing any service to the local inhabitants. In the case of road infrastructure, in some cases the level of quality is stated as “unpaved” which we categorise as poor quality. 19 0.9997. The pattern of cost efficiency varies according to the size of the population the research hypotheses. 1). Thus, in the larger municipalities, the cost efficiency increased slightly during t Table 2 shows the descriptive statistics of the variables included in the fir period, whilst D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revistaitdedecreased Contabilidad in the Accounting Spanish others, with Reviewthe exception 22 (2)(2019) of municipalities 129-144 137 with fe analysis. by Balaguer-Coll et al. (2007), many two-stage5,000studies inhabitants, are where Table 2 the level of cost efficiency remained unchanged overall, Tableinput Descriptive statistics: 2. Descriptive and output statistics: variablesinput and output variables (2008-2 (2008-2012) inconsistent because they assess efficiency (in the first stage) with marked variations in the intermediate periods. InStandard general, a worsening of the using non-parametric analysis, but consider the explanatory Variable Mean Median deviation Maximum Minimum cost efficiency was factors in the (second stage) by a parametric method. perceived Total cost (euros) for all population tranches 13,388,847 8,643,118 between 12,451,851 2008 1,279,124 77,448,391 and 2012. The general specification of the truncated regression No. of inhabitants (n) 12,865 8,605 11,085 44,007 772 Length of street network (m) 113,097 92,895 73,042 309,058 11,390 model used in our approach is described by the following Waste production (Tn) 18,178 5,105 60,627 465,361 141 equation: Public equipment (m2) 212,355 139,881 229,194 1,362,507 13,715 Street lamps (n) 2,323 1,821 1,850 8,166 249 Length of the water distribution 81,747 58,740 65,679 286,530 9,227 network (m) Surface area of cemeteries (m2) 6,293 4,105 7,770 57,012 760 αSi m = a + β1 Z1,i t + β2 Z2,i t + β3 Z3,i t + β4 Z4,i t + ϵi Source: The authors, from data published by the Ministry of Finance and Public Administration. Source: The authors, from data published by the Ministry of Finance and Public where: Administration. Figure 1 FigureMunicipal 1. Municipal The cost coststatistics descriptive efficiency efficiency bytranche for each by population population year of tranchevariables the first-stage (2008-2012) (2008-2012) are show i = 1, 2, . . . ,77 (municipalities) Notably, the average total budget costs fell during the study period, as di t = 2008, . . . , 2012 (years) deviation, i.e. the data had a lower level of dispersion. The total volume of w αSi m is the dependent variable represented by the ef- ficiency obtained for each municipality (obtained but all other output variables increased during the same period. In genera in the first stage). deviation of the data increased, except that for the total area of cemeteries. a is a constant term. The results for municipal efficiency are shown in Table 3. Z1,it is the vector of the financial explanatory vari- ables. Z2,it is the vector of the political explanatory vari- Table 3. Cost efficiency of Canary Isles municipalities by population tra ables. 2012) Z3,it is the explanatory variable of service quality. budget costs fell during the2008 study period, 2009as did the 2010 stand- 20 Z4,it is the vector of the socioeconomic explanatory ardPopulation deviation,(thousands) i.e. the data MeanhadS.D. a lower Mean levelS.D.of dispersion. Mean S.D. Mean variables. The total50-20 volume of waste 0.9905 0.0403 decreased,0.9988but all0.0050 1.0000 other output 0.0000 0.9970 β1,...,4 are the vectors of the parameters to be estim- variables increased during the same period. In general, 0.0732 20-10 1.0035 0.0068 0.9753 0.0779 0.9788 the 1.0025 ated in the second stage, which determine The the re- statistics 10-5 descriptive standard for the second-stage deviation 1.0105 0.0663 of the data increased, 1.0052 0.0495 0.9947 variables and except thethat matrix 0.0695 1.0043 for theof correla <5 1.0306 0.1834 1.0445 0.0883 0.9948 0.0779 1.0302 lationship between the independent variables and total area of cemeteries. the dependent variable. presented in Annexes 2 TOTAL and 3, respectively. 1.0097 There 0.1016 is no collinearity, 1.0072 0.0661 0.9930 and 0.0628 so1.0084 the inflation factor (VIF) ϵi is the independent error term (or statistical Thewas determined. results According for municipal to theare efficiency empirical shown in rule Tableproposed 3. by K noise), normally-distributed N (0, δϵ2 , and left trun- The Theabove above values valuesshowshowthat,that, on average, these municipalities on average, achieve a very hi these municip- al. (2004), problems of collinearity alities achieveThose arisehigh a very when VIF of >10. In efficiency. the present case, the avera cated at (1- βb Zi). efficiency. with fewer level than 5,000cost inhabitants obtain the Those highest values obtained was 3.24.withNone fewer than theof5,000 inhabitants obtain the highest values(the hig duringofmost dependent variables the period, while obtained those with highinhabitants 10-20,000 values Table 1 details the second stage variables used in the study. in this respect during most of the period, while those with usually o These were chosen taking into account the methods 6.98), from which adopted it can beinhabitants 10-20,000 concludedusually that there obtainis no thecorrelation worst results. between Over- the exp all, average cost efficiency decreased during 20 the study period, in previous empirical studies in this field, suchvariables as De Bor- of the model. In addition, the standard deviations ger et al. (1994), Balaguer-Coll et al. (2007), Balaguer-Coll from 1.0097 to 0.9997. The pattern of costobtained efficiency show that, in gen varies and Prior (2009), Benito et al. (2010), Bosch etdata according to the size of the population (see do not present a large degree of dispersion, except for per capita fiscal al. (2012) Fig. 1). Thus, in pressure and Pérez-López et al. (2015), and according to the avail- the larger municipalities, the cost efficiency increased slightly populationtodensity. ability of information and the legal framework applicable during the study period, whilst it decreased in the others, these local entities. The information related to these vari- with the exception of municipalities with fewer than 5,000 ables was obtained from the following sources: the Table 4 shows the Ministry results of where inhabitants, the truncated the levelregression with panel of cost efficiency data, performed remained un- to of Finance and Public Administrations (Secretariat changed overall, although with marked variations in the in- studyfor Re- hypotheses, obtained using termediate periods.eachInofgeneral, the above individual of a worsening estimates the aver- as an ind gional and Local Administration and the Virtual Office for the variable. Financial Coordination of Local Entities); the National Insti- age cost efficiency was perceived for all population tranches tute of Statistics (INE); the Survey of Local Equipment and between 2008 and 2012. Infrastructure (EIEL); the Unifica website of the Autonomous The descriptive statistics for the second-stage variables and Government of the Canary Isles; the Economic Yearbook pub- the matrix of correlations are presented in Annexes 2 and 3, lished by La Caixa; the website of the Ministry of the Interior; respectively. There is no collinearity, 21 and so the variance in- and the websites of relevant political parties. flation factor (VIF) was determined. According to the empir- ical rule proposed by Kutner et al. (2004), problems of collin- earity arise when VIF >10. In the present case, the average Analysis of results: relationship between cost efficiency, value obtained was 3.24. None of the dependent variables financial condition and debt obtained high values (the highest was 6.98), from which it can be concluded that there is no correlation between the ex- This section presents the results obtained in the first and planatory variables of the model. In addition, the standard second stages, which are used to test the research hypo- deviations obtained show that, in general, the data do not theses. present a large degree of dispersion, except for per capita Table 2 shows the descriptive statistics of the variables in- fiscal pressure and for population density. cluded in the first stage of the analysis. Table 4 shows the results of the truncated regression with panel data, performed to test the study hypotheses, obtained The descriptive statistics for each year of the first-stage using each of the above individual estimates as an independ- variables are shown in Annex 1. Notably, the average total ent variable. 138 Table D. Prior, 3. Cost efficiency I. Martín-Pinillos, of J.L. G. Pérez-López, Canary Isles Zafra-Gómez municipalities / Revista by Accounting de Contabilidad Spanish population tranche Review 22 (2008- (2)(2019) 129-144 Table 3 2012) Cost efficiency of Canary Isles municipalities by population tranche 2008-2012 2008 2009 2010 2011 2012 Population (thousands) Mean S.D. Mean S.D. Mean S.D. Mean S.D. Mean S.D. 50-20 0.9905 0.0403 0.9988 0.0050 1.0000 0.0000 0.9970 0.0136 0.9994 0.0270 20-10 1.0035 0.0068 0.9753 0.0779 0.9788 0.0732 1.0025 0.0150 0.9724 0.0658 10-5 1.0105 0.0663 1.0052 0.0495 0.9947 0.0695 1.0043 0.0438 0.9842 0.0702 <5 1.0306 0.1834 1.0445 0.0883 0.9948 0.0779 1.0302 0.0994 1.0322 0.0759 TOTAL 1.0097 0.1016 1.0072 0.0661 0.9930 0.0628 1.0084 0.0563 0.9997 0.0644 Table 4 Empirical results of the estimation of the determinants of municipal cost Of the variables measuring flexibility, those analysed were efficiency related to net savings, per capita fiscal pressure, debt and The above values show Variable that, on average, Expected sign Value these municipalities compliance with achieve a very the credit limit.high level oftocost In contrast the findings of Geys (2006) and Pérez-López et al. (2014), net savings efficiency. Index of budget Those with fewer sustainability - than 5,000 inhabitants -0.1135*** did notobtain present thea significant highest values in this relationship respect with cost efficiency, Level of government transfers +/- -0.0842 and so Hypothesis 3a cannot be accepted. On the other hand, received during most of the period, while those with 10-20,000 inhabitants fiscal pressure usually per capita obtain presented the worst a significant negative re- Net savings + 0.0007 lationship (p<0.05) with cost efficiency, which supports Hy- Fiscal pressure per capita - -0.0001* pothesis 3b, and therefore we conclude that if the municipal Short-term borrowing - -0.0232** 20 government lost the power to generate current income it Long-term borrowing + -0.0013 would be less motivated to manage its resources efficiently. These results coincide with those obtained by De Borger et Financial debt (short and long - -0.0013 al. (1994), Balaguer-Coll (2002), Giménez and Prior (2007), term) Balaguer-Coll et al. (2007), Balaguer-Coll and Prior (2009), Commercial debt + 0.0076* Bosch et al. (2012) and Cuadrado-Ballesteros et al. (2013). Compliance with borrowing - -0.0718** In relation to debt, in its various forms, which is the limits main object of this study, the variable short-term debt Index of average quality +/- 0.0906* presents a significant negative relationship with cost effi- Political orientation of municipal + -0.0450*** ciency (p<0.01), meaning that higher financial costs, due government to higher levels of short-term debt, would reduce cost effi- Type of municipal government +/- 0.0162 ciency (Hypothesis 4a). These results coincide with those Population tranche +/- -0.0039 reported by Worthington (2000) and Geys (2006). In con- Population density +/- 0.0008* trast, long-term debt does not present any significant rela- Population aged under 15 years +/- -0.8607 tionship with cost efficiency (Hypothesis 4b), which suggests that long-term debt does not affect short-term management Population aged over 65 years +/- 2.0917*** activities, since most of the budget values used to calculate Index of unemployment +/- 0.5207 cost efficiency correspond to current expenditure (Mugera Index of economic activity +/- -0.0515* & Nyambane, 2015). This finding contrasts with Benito Index of tourist activity - 0.0015 et al. (2010), who observed a significant positive relation- ship between long-term debt and cost efficiency. The results Dummy: 2009 -0.0331** for commercial debt reveal a significant positive relationship Dummy: 2010 -0.0474*** with cost efficiency (p<0.05). Thus, for the first time there is shown to be a clear difference between commercial and Dummy: 2011 -0.0511** financial debt in relation to municipal cost efficiency (and Dummy: 2012 -0.0930*** therefore Hypothesis 4c is accepted). This outcome could be Constant 1.2797*** interpreted as meaning that financial debt affects cost effi- * p<0.05; ** p<0.01; *** p<0.001 ciency due to the impact produced on the municipal budget, unlike commercial debt, which does not impose greater costs Index of robustness: 73.05% on the municipality. The indicator of compliance with the credit limit presents The first analysis performed of these results concerned the a significant negative relationship with cost efficiency analysis performed influence ofofthe these results financial concerned variables the efficiency. on cost influence Theof the (p<0.01). in- financial Thus, the higher the credit limit, the fewer re- variables dex of budget sustainability presents a negative sign and is sources will be available to the municipality for public ser- efficiency.statistically The index of budget significant sustainability (p<0.001). Consequently,presents a negativevices Hypothesis signandand is less cost efficient it will be (therefore, Hypo- so the 1 is verified, corroborating the results obtained by Balaguer- thesis 5 is accepted). lly significant (p<0.001). Coll (2007), meaningConsequently, Hypothesis that the higher 1 is verified, the municipality’s costs corroborating the block of variables, we first considered the av- In the second in relation to its income, the lower the cost efficiency. On erage quality of public services and facilities, obtaining evid- btained bytheBalaguer-Coll (2007), meaning that the higher the municipality’s other hand, no significant evidence was obtained for a ence of costs in a significant positive relationship with municipal cost relation o its income, between the lower the the costvariable reflecting efficiency. On thevulnerability other hand,–no efficiency thesignificant evidence(p<0.05), thus corroborating Zafra-Gómez and level of transfers – and cost efficiency, unlike Geys (2006), De Muñiz (2010). In a previous study, Prior (2006) explained ained for Borger a relation between(1996), and Kerstens the variable reflecting Balaguer-Coll (2002), vulnerability Balaguer- –this therelationship level of as the outcome of Total Quality Manage- Coll et al. (2007), Giménez and Prior (2007), Balaguer-Coll ment, i.e. that investment in quality produces a correspond- – and costandefficiency, Prior (2009)unlikeandGeys Bosch(2006), De Borger et al. (2012), and Kerstens who reported find- (1996), Balaguer- ing increase in cost efficiency. ing a significant relation between this variable and cost effi- In line with De Borge et al. (1994), Benito et al. (2010), 02), Balaguer-Coll et al. (2007), ciency. Accordingly, Giménez Hypothesis and Prior 2 cannot (2007), Balaguer-Coll be accepted. Geys et and al.Prior (2010) and Borge et al. (2008), we find that polit- nd Bosch et al. (2012), who reported finding a significant relation between this and cost efficiency. Accordingly, Hypothesis 2 cannot be accepted. D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 139 ical orientation is inversely associated with cost efficiency, efficiency and that certain socioeconomic variables impact on and that the relation is statistically significant (p<0.001). the cost efficiency achieved. However, no evidence was obtained that the type of mu- The implications drawn from the present study are clear nicipal government affects municipal cost efficiency. These and important from the standpoint of local government man- findings coincide with Benito et al. (2010) and Pérez-López agement and financing. In a context of reduced spending, et al. (2015), according to whom municipalities that are gov- characterised by the presence of a transboundary crisis, an in- erned by progressive political parties obtain higher levels of crease in commercial debt can bring about efficiency improve- cost efficiency. ments in municipalities where the tourism industry plays an In relation to the socioeconomic variables, our results con- important role, while resorting to short-term financial debt firm, with different levels of significance, that greater popu- worsens cost efficiency. Municipal managers in such areas lation density is associated with higher levels of local gov- should take these circumstances into account when consider- ernment cost efficiency. There is also significant evidence ing their financing options during periods of financial reces- that when the municipal population contains a higher pro- sion. portion of older inhabitants, government cost efficiency is A limitation of the present study, but also an indication of greater, which corroborates the results obtained by Bosch et an area of interest for future research, is the need to expand al. (2012). the study to address other regions, in order to examine our Finally, the index of economic activity has a significant in- hypotheses of cost efficiency vs. commercial and financial verse relationship with cost efficiency. However, no signific- debt in other municipal contexts. Furthermore, other meth- ant relationships were found with respect to unemployment, ods of analysis should be considered, such as the DEA-data the index of activity in the tourism sector, the size of the local panel approach used by Surroca et al. (2016), which takes population aged under 15 years or the total population of the into account the unobservable heterogeneity in the units eval- municipality. uated, or the DEA-data panel models developed by Pérez- López et al. (2018) for determining scale efficiency. Conclusions and discussion Acknowledgements The recent economic crisis has heightened the need to im- We are grateful for the financial support received from Min- prove the allocation of resources and to limit public sector isterio de Educación y Ciencia (Spain; ECO2013-48413-R, borrowing (in accordance with new regulations in this re- ECO2016-76578-R and ECO2017-88241-R). spect). This situation has spurred research interest in eval- uating how well municipalities manage their affairs and in determining which factors have most influence on cost effi- Conflict of interests ciency in this sector, especially those related to sources of finance and types of municipal debt. The authors declare no conflict of interests. The theoretical arguments considered in previous research indicate that, in general, public sector borrowing is inversely associated with cost efficiency, due (at least in part) to the References higher spending and lower cost efficiency resulting from increased financial costs (Worthington, 2000; Geys, 2006; Ansell, C., Boin, A., & Keller, A. (2010). Managing trans- Benito el al., 2010; Da Cruz & Marques, 2014; Cordero et boundary crises: identifying the building blocks of an effect- al., 2017). In this context, we apply an order-m methodo- ive response system. Journal of Contingencies and Crisis logy (thus overcoming the limitations of DEA), followed by Management, 18(4), 195–207. bootstrap truncated regression with panel data (as proposed Andrews, R., & Entwistle, T. (2013). Four faces of public by Simar and Wilson, 2007). The novel aspect of the present service efficiency: What, how, when and for whom to pro- study is its emphasis on the need to distinguish between com- duce. 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Overcom- ing cost-inefficiencies within small municipalities: Improve financial condition or reduce the quality of public services? Environment and Planning.C, Government & Policy, 28(4), 609-629. D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144 143 Annex Table Annex 1 1. Descriptive statistics of input and output variables, by year Descriptive statistics of input and output variables, by year 2008 2009 2010 2011 2012 Mean S.D. Mean S.D. Mean S.D. Mean S.D. Mean S.D. Total cost (thousands of euros) 13,730 11,762 14,640 12,970 13,569 12,710 13,558 13,191 11,448 11,626 No. of inhabitants (n) 12,559 10,704 12,787 10,959 12,894 11,100 13,015 11,245 13,069 11,416 Length of street network (m) 99,367 62,930 115,435 75,246 118,288 76,857 115,935 75,020 116,459 75,160 Waste production (Tn) 12,032 15,099 8,948 10,922 8,884 10,647 10,486 18,161 10,541 18,305 Public equipment (m2) 201,642 207,599 211,201 241,476 215,825 233,415 213,476 230,256 219,632 233,222 Street lamps (n) 2,209 1,730 2,329 1,907 2,356 1,867 2,401 1,902 2,318 1,843 Length of the water distribution 77,732 60,586 78,497 61,278 84,947 69,281 84,164 68,013 83,396 69,234 network (m) Surface area of cemeteries (m2) 6,191 7,887 6,244 7,857 6,313 7,702 6,316 7,702 6,399 7,702 Annex 2. Descriptive statistics of the second-stage variables and variance inflation factor Table Annex (VIF) 2 Descriptive statistics of the second-stage variables and variance inflation factor (VIF) STANDARD VARIABLE MEAN MEDIAN MINIMUM MAXIMUM VIF DEVIATION MUNICIPAL EFFICIENCY 1.003599 1 0.071952 0.537322 1.557485 INDEX OF BUDGET SUSTAINABILITY 0.969930 0.958446 0.139215 0.523109 1.619950 1.4 LEVEL OF GOVERNMENT TRANSFERS 0.588158 0.600236 0.174148 0.160724 0.959501 5.35 RECEIVED SHORT-TERM BORROWING 14.880690 14.908130 1.186554 11.479450 17.366010 3.72 LONG-TERM BORROWING 14.563010 14.717250 1.653298 7.453046 17.515700 3.16 FINANCIAL DEBT 14.745870 15.004000 1.692731 7.071955 17.639760 2.24 COMMERCIAL DEBT 14.630770 14.656460 1.226376 6.057557 17.060300 2.36 COMPLIANCE WITH BORROWING LIMITS 0.385593 0.336378 0.304140 0 1.798995 1.89 NET SAVINGS 13.699520 13.696310 1.388470 5.895036 16.641880 2.45 FISCAL PRESSURE PER CAPITA 431.932200 346.530000 246.656500 102.07000 1491.210000 6.98 INDEX OF SERVICE QUALITY 2.435642 2.448859 0.160990 1.781336 2.759871 1.27 POITICAL ORIENTATION 0.163636 0 0.370427 0 1 1.22 TYPE OF MUNICIPAL GOVERNMENT 0.420779 0 0.494327 0 1 1.36 POPULATION TRANCHE 0.989610 1 0.710704 0 2 4.56 INDEX OF UNEMPLOYMENT 0.107202 0.107918 0.026992 0.043742 0.174494 1.84 INDEX OF ECONOMIC ACTIVITY 0.983667 0.671893 1.101559 0 10.057220 1.47 INDEX OF TOURISM ACTIVITY 7.175759 0.785855 14.375890 0 66.829270 4.39 POPULATION AGED UNDER 15 YEARS 0.135765 0.139684 0.026380 0.060270 0.188756 7.02 POPULATION AGED OVER 65 YEARS 0.165357 0.161954 0.058262 0.056045 0.315292 7.3 POPULATION DENSITY 291.988100 179.199500 454.809300 6.561173 3759.106000 1.49 MEAN VIF 3.24 33 Compliance Level of 144 Fiscal Index of Index of Type of Index of Index of Population Population Financial Commercial Long-term Short-term with government Political Population Index of Population Net savings pressure per budget service municipal economic tourism aged under aged over 65 debt debt borrowing borrowing borrowing transfers orientation tranche unemployment density capita sustainability quality government activity activity 15 years years limits received Net savings 1.0000 Table Annex 3 Financial debt 0.0457 1.0000 Commercial 0.1064* 0.6883*** 1.0000 debt Long-term 0.4493*** -0.0141 0.0366 1.0000 borrowing Short-term 0.5179*** -0.0341 0.0542 0.6983*** 1.0000 borrowing Compliance Correlation matrix of study variables with borrowing 0.0352 -0.0105 0.0567 0.5218*** 0.3995*** 1.0000 limits Level of government -0.5956*** 0.0234 -0.0165 -0.6113*** -0.5615*** -0.2635*** 1.0000 transfers received Fiscal pressure 0.5558*** 0.0057 0.0456 0.4374*** 0.4257*** 0.1500*** -0.7908*** 1.0000 per capita Index of budget -0.3370*** -0.0737 -0.0267 -0.0921* 0.0204 0.0276 0.1196** -0.2670*** 1.0000 sustainability Index of 0.1540*** -0.0403 -0.0394 0.1794*** 0.2049*** 0.0207 -0.1080** 0.0649 0.0106 1.0000 service quality Political -0.0405 -0.0144 -0.0586 0.0139 0.0077 -0.1007** -0.0365 -0.0046 -0.0068 0.1662*** 1.0000 orientation Type of municipal 0.1266** -0.1495*** -0.0758 0.2526*** 0.2750*** 0.2514*** -0.2614*** 0.1577*** -0.0296 0.0108 0.0639 1.0000 government Population 0.5816*** -0.0425 -0.0132 0.6298*** 0.7267*** 0.1198** -0.5811*** 0.3672*** -0.0249 0.3330*** 0.0460 0.1459*** 1.0000 tranche Index of 0.0141 -0.1319** -0.2023*** -0.0159 0.0941* -0.1103** -0.0194 -0.2561*** 0.0979* 0.0983* 0.0502 0.0723 0.3031*** 1.0000 unemployment Index of economic 0.2222*** 0.0082 0.0007 0.1741*** 0.1889*** -0.0349 -0.2657*** 0.3108*** 0.0248 0.2116*** 0.2437*** 0.0188 0.2657*** 0.0296 1.0000 activity Index of 0.3804*** 0.0032 0.0531 0.3466*** 0.4038*** 0.179*** -0.5450*** 0.7822*** -0.1554*** 0.1161** -0.0491 0.2344*** 0.2542*** -0.3560*** 0.3536*** 1.0000 tourism activity Population aged under 15 0.4542*** 0.0157 0.0007 0.4455*** 0.5613*** 0.1472*** -0.5107*** 0.2682*** 0.0120 0.1486*** -0.0491 0.1612*** 0.6416*** 0.2558*** 0.157*** 0.0937* 1.0000 years Population aged over 65 -0.5483*** -0.0070 -0.0133 -0.4515*** -0.5975*** -0.1336*** 0.5240*** -0.3944*** 0.0661 -0.2574*** 0.0519 -0.1931*** -0.6521*** -0.1239** -0.2128*** -0.2971*** -0.8679*** 1.0000 years Population 0.1664*** -0.1101** 0.0136 0.2174*** 0.3332*** 0.0146 -0.2095*** 0.0491 0.1062** 0.2498*** 0.0320 0.1461*** 0.3880*** 0.2112*** 0.1419*** 0.1837*** 0.0811 -0.0698 1.0000 density 1 D. Prior, I. Martín-Pinillos, G. Pérez-López, J.L. Zafra-Gómez / Revista de Contabilidad Spanish Accounting Review 22 (2)(2019) 129-144