Agency problems in public financial management: Evidence from debt refinancing practices

In recent years several state governments have reformed their financial management practices by placing greater restrictions on the sale and management of government debt including practices related to debt refinancing. The escalating use of these debt restrictions is predicated on the belief that there may be a pervasive principal-agent problem between taxpayers and public financial managers. Statutory debt restrictions are needed to ensure that a public financial manager's actions reflect the desires and policy goals of the public, which, in this case, are assumed to be the long-term cost efficient and effective management of state debt. However, there is concern that these debt restrictions may not be costless. That is, they may lead to more prudent management of government debt in certain circumstances but, at other times, debt restrictions, including limits on bond refinancing, may unduly restrict public financial managers and lead to a less efficacious debt management program thus undermining the principal's goals.;Utilizing descriptive research, this study begins by generally examining the debt refinancing practices and trends of state governments over the last few decades as a means of providing general context to the main research area at hand. Next, the study applies event analysis from the State of Illinois to investigate the efficacy of statutory restrictions related to bond refinancing practices. Given the potential costs of these debt refinancing restrictions, this study then proceeds to empirically investigate two common decisions in this area of debt management, the refinancing savings structure decision and the decision on bond interest rate mode, to determine whether there is evidence of a pervasive principal-agent problem that would warrant the use of restrictive public managerial control mechanisms. Through the event analysis, this study demonstrates that debt restrictions can lead to unintended consequences whereby the state actually engages in less effective and efficient debt management practices. However, the descriptive research analyzing the two refinancing decisions provides evidence that an agency problem is not widespread in the management of state debt and through linear regression and logit analysis identifies the factors that exacerbate or mitigate these potential agency problems to the extent they are present.