Brusca 2015 Drivers For The Financial Condition of Local Government-A Comparative Study Between Italy and Spain

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT
Vol. 13, No. 2, pp. 161 - 184, April 2015
Drivers for the Financial Condition of Local

Government: A Comparative Study Between
Italy and Spain
ISABEL BRUSCA, FRANCESCA MANES ROSSI & NATALIA AVERSANO 2
ABSTRACT This paper aims to analyse the influence of socioeconomic, political and financial factors on the financial condition
of Italian and Spanish local governments in a comparative approach.
The research is also aimed at understanding to what extent a model
for the analysis of the financial condition can be generalized to
different contexts. We assume that the financial condition is a
multidimensional concept, with the results highlighting that while in
Spain there is a high correlation between the long term financial and
short term economic situations and an indicator can combine both
dimensions, in Italy both dimensions are differentiated. There are
also differences in the drivers of financial sustainability in both
countries.
KEYWORDS: financial condition financial sustainability
financial health financial indicators local government Spain
Italy
CORRESPONDENCE ADDRESS: Isabel Brusca, University of Zaragoza, Department of

Accounting and Finance, Gran V, 50005 Zaragoza, Spain, email: ibrusca@unizar.es.
Francesca Manes Rossi, University of Salerno, Department of Management and
Information Technology, Via Giovanni Paolo II, 84084 Fisciano SA, Italy,
fmanerossi@unisa.it. Natalia Aversano, University of Salerno, Department of
Management and Information Technology, Via Giovanni Paolo II, 84084 Fisciano SA,
Italy, naversano@unisa.it.
DOI 10.4335/13.2.161-184(2015)
ISSN 1581-5374 Print/1855-363X Online 2015 Lex localis (Maribor, Graz, Trieste, Split)
Available online at http://journal.lex-localis.info.
162

I. Brusca, F. Manes Rossi & N. Aversano: Drivers for the Financial Condition of
Local Government: A Comparative Study Between Italy and Spain
Introduction
One of the effects of the recent financial crisis has been to force local governments
(LG) to deal with financial difficulties. In fact, while the resources available have
decreased, citizens continue to ask for an increasing amount and better quality of
public services.
Scholars have discussed at length, the factors that can determine or contribute to
creating financial distress or financial crisis (Groves and Valente, 2003, Klein et
al., 2003, Carmeli, 2007, Jones and Walkers, 2007) and especially in recent
years under the incumbent financial crisis many models have been proposed
both by practitioners and standard setters (CICA, 1997, ICMA, 2003; UK Audit
Commission, 2007) as well as scholars (Zafra-Gmez et al., 2009; Cohen et al.,
2012, Manes Rossi, 2011; Garca-Snchez et al., 2012) to prevent financial
distress. In addition, the IPSASB recently released a Recommended Practice
Guideline (RGS, 2013) Reporting on the Long-Term Sustainability of an Entitys
Finances, highlighting the need to monitor the ability of public entities to sustain
their projects in the long-term.
This study aims to discuss the interesting research theme in a comparative
approach, by analysing the situation of all the Italian and Spanish local
governments with more than 60.000 inhabitants and relating their financial
conditions to some economic and social factors. Italy and Spain have been chosen
because they are two Southern European countries characterised by a Napoleonic
administrative tradition (Peter, 2008). In addition, their financial situation is
controlled by the European Union.
The research is also aimed at understanding to what extent the use of financial
indicators to monitor the financial health of a local government can be generalized
to different contexts and whether a model can have or not an international
application to support both managers and politicians in assuming timely decisions
to avoid financial distress.
A set of indicators has been identified in accordance with previous literature and
its relevance has been evaluated with principal component analysis. The results
highlight that in Spain there is a high correlation between the long term and short
term economic situations, with an indicator combining both dimensions. However,
in Italy two different indicators are necessary to measure both dimensions.
Furthermore, the number of inhabitants and density of the population are two
drivers for fiscal stress in Italy, while in Spain only the number of inhabitants is
significant.
The paper is organized in five sections, excluding the present introduction. First,
the literature review discusses the definitions of financial condition elaborated by

163
scholars as well as the environmental, organizational and financial determinants

that can affect it. The third section describes the Italian and Spanish context, along
with the tools that have already been adopted to prevent financial distress. The
fourth section defines the objectives of the empirical research as well as the
research design, while the fifth presents the results collected and discusses them in
accordance with the objectives. In the conclusion, the results achieved are
summarized, along with the limitations of the study and any possible future
developments.
2
The analysis of financial condition in local goverments: A literature

review
Since the first financial crisis experienced by large cities in the USA in the 197080s, like New York and Cleveland, scholars have discussed the conditions and
effects of the so-called financial distress or financial crisis or fiscal strain
(Honadle et al., 2004). As reported by Dollery and Crase (2006), there are
numerous definitions but no consensus about the concept of financial health and
financial condition. Rivenbark et al. (2010) revise the different concepts used and
define financial condition as a local governments ability to meet its ongoing
financial, service and capital obligations based on the status of resource flow and
stock as interpreted from annual financial statements.
In some countries, the term financial sustainability has become fashionable and
even several standard setters seem to prefer this expression. The
PriceWaterhouseCoopers (2006, 96) report states that the financial sustainability
of a council is determined by its ability to manage expected financial requirements
and financial risks and shocks over the long term without the use of disruptive
revenue or expenditure measures. Along the same lines, the RGS of the IPSASB
(2013) highlights the need to monitor the ability of public entities to sustain their
projects in the long-term. The RGS depicts three intertwined dimensions of longterm financial sustainability: service dimension, revenue dimension and debit
dimension.
Assuming that there is a large variety of nuance inside the concept of financial
sustainability, we consider that this can be analysed with reference to the financial
condition or financial health, which represents the ability to comply with current
and future obligations through a proper inflows by tax, transfers and services as
well as to sustain a certain service level, coherent with the citizens needs
(Honadle et al., 2004). According to Groves and Valente (2003), from an internal
perspective, the financial condition can be synthesised in cash, budgetary, long run
and service solvency of the entity.
Several models have been developed with the aim of assessing the financial
condition, while preventing financial distress. The first group focuses on
164

analysing the financial equilibrium of a LG every year in order to assess if a

condition of distress occurred or not (i.e. Jones and Walkers, 2007). The second
group, which is larger, aims at forecasting the future ability of the LG in
maintaining a financial equilibrium (Kleine et al., 2003; Zafra-Gmez et al., 2009;
Cohen et al., 2012; Garca-Snchez et al., 2012; Manes Rossi et al., 2012). These
models adopt a large variety of techniques, ranging from basic approaches such as
accounting information and financial reporting analysis (e.g. Kleine et al., 2003;
Manes Rossi, 2011), to more sophisticated statistical modelling approaches, even
with the aim of discriminating a financial healthy LG from a distressed one (e.g.
Zafra-Gmez et al., 2009; Cohen et al., 2012; Garca-Snchez et al., 2012; Manes
Rossi et al., 2012).
In addition, standard setters and regulators all over the word have developed
several models to assess financial condition. It is well-known that central
governments need to monitor the financial health of a LG. In several countries, the
control agencies have defined some predictive models. For example, in France, the
Direction Gnrale des Collectivits Locales (1997) has provided an alert system
composed of 7 indicators, while in Australia and the UK, models have been
prepared by control agencies to discriminate a healthy LG from non-healthy ones.
Similarly, in USA, the 10-point scale proposed by Brown (1993) or the model
proposed by the ICMA as developed by Groves and Valente (2003) have been
largely adopted (Zafra-Gmez et al., 2009).
In the European context, some studies focused on a LG credit ratings and
solvability assessment (Manes Rossi, 2011) for the analysis of the financial
condition. In fact, financial equilibrium is an essential prerequisite in order to gain
access to the capital market, by obtaining a good rating (Caperchione and
Salvatori, 2012).
Simultaneously, there is an increasing amount of literature on identifying the
determinants that can provoke or accelerate some detrimental financial conditions.
Some scholars consider environment factors, such as socioeconomic forces
(Peterson 1976; Capalbo and Grossi, 2014), as the principal external determinants
that can affect the financial situation of a LG, assuming that they affect both the
citizens need and demand of public services as well as productive costs (Andrews
et al., 2005; Boyne et al., 2001). Empirical research has tried to analyse the effects
of population, density of the population or gross domestic product (Bahl and
Duncombe, 1993; Zafra-Gmez et al., 2009; Guillamn et al., 2011; GarcaSnchez et al., 2012; Vicente et. al., 2013).
Political factors have also been another issue considered in current literature as
influencing the financial condition of local governments, considering that
conservative parties have a lower level of debt (Kiewiet and Szalky, 1996),
although many studies have not found a relationship between political ideologies

165
and the level of debt (Vicente et. al., 2013). Furthermore, the incidence of political
budget cycles on debt has also been studied (Benito et al. , 2012).
In addition, organizational factors such as human resources and capabilities that
the organization has acquired or developed, have been considered as pivotal for
the LG to have the ability to cope with the need of changes, which in turn support
the possibility of maintaining a financial equilibrium (Carmeli and Cohen, 2001;
Carmeli, 2007). Considering current literature, the study aims to contribute to this
field by creating a model for the analysis of the financial condition of Italian and
Spanish LG, that combines all the above dimensions and tests to what extent
environment factors can influence the financial condition.
3
The Italian and Spanish scenario
3.1
The control of financial health in Italy
Italy belongs to those European countries characterized by a bureaucratic

approach in Public administration, where any reforms are mainly implemented
through the law and with a highly legalistic governance culture (Ongaro and
Vallotti, 2008). Italian Local Governments (ILG) manage most of the public
services and in the last decades, there has been an increasing use of partnerships
with other public or private operators to run services like transportation, waste,
water as well as many others. ILG obtain resources only partially by transfers and
grants from Central and Regional governments, while they have the power to both
increase local taxes as well as manage their own assets.
The law, which also provides a complete set of rules for accounting, describes the
conditions of financial health and sets out ten parameters as indicators of distress
(Manes Rossi, 2011). According to D. Lgs. 267 (art.244) financial distress occurs
when the entity, municipality or province is no longer able to perform its essential
functions and deliver due services, or when it is no longer able to meet debt with
third parties through the ordinary means of restoring the fiscal balance or debt
instrument with an off balance-sheet. The accounting systems requires both the
preparation of a budget and reporting as well as a budgetary modified cash- and
commitment-based accounting systems for both, even if the reporting is integrated
by financial and income statements prepared in accordance with accrual principles
(Nasi and Steccolini, 2008). Three different institutions play the role of watchdogs
regarding the financial condition of ILG: the Ministry of Interior, the National
Audit Court and the State General Accounting Department (which is a part of the
Ministry of Economy). In the case financial distress is declared by the mayor, an
Extraordinary Board is appointed by the central government, upon the suggestion
of the Ministry of the Interior, with the duty to prepare and manage a plan to
extinguish all the expired debts. Meanwhile, the city council has to reorganize the
whole activity, with the aim of removing what has provoked the financial
166

disequilibrium. The declaration of distress has a significant impact on the citizens:

local-tax increases, services are reduced to the mere essential and no personnel
can be hired until the financial equilibrium is restored.
In order to avoid this condition, since 2012 a new regime has been introduced
the so-called financial re-equilibrium procedure where the city council, with the
aim of facing an incumbent distress, prepares a plan (no longer than 10 years) to
cope with the financial equilibrium condition.
3.2
The control of financial sustainability in Spain
Spanish local governments have increased the services delivered since the
decentralisation process in force since the 1990s. The increase in services and the
important expenditures in infrastructures and equipment have led to a continuous
increase in the level of debt of governments. With the financial crisis, the situation
has been aggravated, with the control of public expenditure and debt having
become one of the main objectives for public policies.
In this framework, Spanish Central Governments have always tried to control the
increase of debt of local governments and different laws limit the use of debt for
financing local government expenditures.
These controls have been highlighted by the Spanish financial crisis and different
initiatives have been carried out under the Stability and Growth Pact of the
Member States of the European Union.
With the aim of fulfilling the Treaty, the Spanish Law of Budgetary Stability and
Financial sustainability prohibits public entities from obtaining deficit, increasing
the expenditure over the increase in the Gross Domestic Product (GDP) and limits
public sector administrations debt to 60% of the GDP (44% for Central
Government, 13% Autonomous Communities or States and 3% for local
government). Those entities that do not fulfill the objectives of budgetary stability
must prepare an economic-financial plan that within a year will allow the entity to
fulfill these objectives. The entities that do not achieve the limit of debt must also
elaborate a plan to balance the situation.
In this framework, financial sustainability studies are particularly timely and
relevant both in Spain and Italy, where the control of financial health is currently a
priority of the Government.

Research design
4.1
Objectives and Methodology
167
In order to carry out the analysis, all the Italian and Spanish Local Governments
with more than 60,000 inhabitants were selected.
The analysis has two main objectives:
a) The construction of a model for the analysis of the financial condition that
identifies what dimensions must be considered. Several studies (i.e. Groves and
Valente, 2003; Klein et al., 2003; Jones and Walkers, 2007; Zafra-Gmez et al.,
2009; Cohen et al., 2012; Garca-Snchez et al., 2012; Manes Rossi et al., 2012)
have proposed a methodology for analysing the financial condition of a local
government but it does not coincide with what indicators must be used and how it
must be propounded in order to obtain a score determining the financial condition of
a local government. Furthermore, current literature argues that different indicators
can be suitable for different legal and economic environments (Carmeli, 2007) but
there is no empirical research that proves it.
In this framework, we have tried to obtain a model for the financial analysis of local
governments using both financial and economic indicators. Considering that the
analysis of the financial health of a government requires taking into account
different perspectives, we have used a principal component analysis to identify what
the most relevant indicators are. The variables included in the analysis are based on
the level of debt of the government, along with variables representing the economic
capacity of the entity.
The analysis was carried out in both Spain and Italy, with the aim of not only
comparing the two countries but also to study to what extent the same determinants
can affect the financial condition of Italian and Spanish LG. As previously
suggested by some scholars, the heterogeneity of legal structures and socioeconomic
framework must be controlled (Blejer and Cheasty, 1991). Thus, we intend to verify
to what extent this can influence the analysis of financial condition and whether it is
possible to apply the model on an international level.
The methodology used for this part is principal component analysis (PCA). This
method allows to reduce a data set based on observations of variables into a set of
values of new variables called principal components (PC), characterized by the fact
that they are interrelated. The components are built as a linear combination of the
original variables and collect most of the information contained in the original
variables (Lattin et al. 2003). The first PC explains the maximum percentage of the
total variance of the data, the second the maximum percentage of the remaining
variance, and so on.
168

b) The identification of factors and drivers that can determine or at least affect the
financial condition. Most of the previous studies (Carmeli, 2007; Zafra-Gmez et
al., 2009; Manes Rossi et al. 2012; Vicente et. al., 2013) focus on the analysis of
debt per capita to analyse what factors determine debt level. Our study focuses on
the financial indicators identified in the first part of the analysis.
The objective is to understand what variables affect or can be used to predict a
detrimental change of the financial condition in local governments in Italy and
Spain. We use a linear regression approach to model the relationship between the
financial condition and the explanatory variables.
First, we carried out a simple linear regression analysis with the aim of analysing
whether there is or not the influence of each variable on the financial condition. The
dependent variable is the financial indicator obtained and the independent variables
are the different dimensions. We then considered the dimensions that affect the local
fiscal health according to Hendrick (2004) and grouped the variables into four
classes: size, socio-economic, political and financial structure.
FS= f (size, socioeconomic, political and financial factors).
Simple linear regression analysis allows to select the variables that are significant in
order to construct a model to determine the financial condition that includes the
independent variables through multiple linear regressions. We have used the
stepwise model in which the choice of predictive variables is carried out by an
automatic procedure.
4.2
Sample and Variables
The sample used for the analysis includes all the Italian and Spanish local
governments with more than 60,000 inhabitants: 102 Italian and 123 Spanish local
governments. In order to analyse the financial condition, the budgetary data for
2012 and 2011 were collected, along with other information about the
socioeconomic and political variables used in the analysis, which refer to 2012.
We focus only on the largest cities since they have a high percentage of the total
debt of the local government of both countries, while the debt of the smaller cities
has relatively less importance and is also lower. Bigger cities also have a higher
percentage of the population in both countries, thus representing a higher percentage
of local government expenditure (Hulten and Peterson, 1984; Rivers and Yates,
1997; Vicente et. al., 2013). Furthermore, the data are more reliable for the bigger
entities and sometimes are not available for smaller entities.
Table 1 shows the variables used for the principal component analysis and how they
are defined as well as the descriptive statistics for Italy and Spain.

Table 1:
Variables for the analysis of Principal Components

VARIABLE
LONG TERM FINANCIAL

SITUATION
Debt per capita

Debt over GDP
Debt
over
Operative
revenues
Variation of debt
in the year per
capita
Debt service
Operative Surplus
per capita
SHORT TERM STABILITY
169
Operative Surplus
over
operative
revenues
Operative
expenditure
coverage
Debt
Payments
coverage
Definition
Total debt/Number of
inhabitants
Total debt/GDP
Total debt/operative
revenues
Debt
2012-debt
2011/Number
of
inhabitants
Payments
for
debt+Payments
for
interest
of
debts/operating
revenues
(Operative revenuesOperative
expenditures)/number
of inhabitants.
(Operative revenuesOperative
expenditures)/operativ
e revenues.
Operative
expenditure/operative
revenues
(Operative revenuesoperative
expenditure)/payment
s for
debt
Country
Italy
Spain
Italy
Spain
Italy
Spain
Mean
719.24
765.23
4.65
3.71
74.59
85.30
Std.
Deviation
471.60
516.27
3.70
2.82
45.77
56.42
Italy
Spain
-58.18
210.03
102.41
357.41
Italy
Spain
10.65
10.92
7.89
6.60
Italy
Spain
115.00
171.262
87.98
423.81
Italy
Spain
9.74
10.55
5.08
12.29
Italy
Spain
90.26
89.45
5.08
12.29
Italy
Spain
2.25
22.08
2.56
222.34
The variables expressing the long term situation, in accordance with some previous
studies (Carmeli, 2007; Garca-Snchez et al., 2012; Vicente et. al., 2013) focus on
the level of debt and the capacity of the entity to repay that debt.
Whereas, the variables expressing the short term stability focus on the operating
revenues surplus (Brown, 1993; Cohen et al., 2012; Manes Rossi et al. 2012;
Vicente et. al., 2013).
170

The mean of the debt per capita of local governments is greater for Spanish LG than
for Italian LG, where the standard deviation is also higher. The percentage of debt
over operative revenues is also higher for Spain, with it reaching 85.30. However,
the debt represents a higher percentage of GDP in Italy than in Spain. During 2012,
the data show that while in Italy the mean of the debt per capita decreased to 58.18
per capita, in Spain it increased to 210.03.
Using the indicators constructed with the principal component analysis as dependent
variables, in line with some previous studies, we tried to analyse the effect of size
(Garca-Snchez et al., 2012; Vicente et. al., 2013), socio-economic (Zafra-Gmez
et al., 2009; Vicente et. al., 2013), financial (Skidmore and Scorsone, 2011; ZafraGmez et al., 2009) and political characteristics (Vicente et. al., 2013). Furthermore,
we carried out the same analysis using the variable debt per capita, studied in
numerous papers as a determinant of financial health in local government (Carmeli,
2007; Zafra-Gmez et al., 2009; Guillamn et al., 2011; Manes Rossi et al. 2012;
Vicente et. al., 2013).
Table 2 shows the independent variables used for the analysis of the factors that
influence the financial condition as well as the descriptive statistics for Italy and
Spain.
Table 2:
Independent Variables
POLTICAL
SOCIOECONOMIC
SIZE
VARIABLE
Definition
Population (INH.)
Number
inhabitants
Density of population
(DP)
Country
of
Mean
Std.
Deviation
Italy
Spain
176.023
190.464
306.928
332.177
Number
of
inhabitants/Km2
Italy
Spain
1,486.5
4
2,696.7
26
1,642.73
3,323.74
Unemployment (U)
% of unemployment
people.
Italy
Spain
11.83
15.29
5.40
3.79
Gross Domestic Product

(GDP)
Total
Gross
Domestic Product/n.
inhabitants.
Italy
Spain
16,605.
19
22,166.
60
3,870.51
5,561.65
Political
party
government (PP)
Conservative
party=0
Progressive party=1
Italy
Spain
0.81
0.33
0.39
0.470
Man=0
Woman=1
Italy
Spain
0.06
0.23
0.24
0.421
Gender
Mayor(G)
of
in
the

FINANCIAL STRUCTURE
Capital
expenditure(KE)
Personal
expenditure(PE)
Fiscal pressure(FP)
Fiscal revenues
GDP (FR)
over
Financial
independence(FI)
Operative grants (OG)
Total
capital
expenditure/n.
inhabitants
Personal
expenditure/n.
operative revenues
Fiscal revenues/n.
inhabitants
Fiscal
revenues/GDP
Fiscal
revenues/operative
revenues
Grants for current
expenditure/operati
ve revenues
171
Italy
Spain
187.25
84.76
230.58
61.60
Italy
Spain
27.58
36.44
8.42
6.80
Italy
Spain
Italy
Spain
691.00
613.26
0.043
0.029
232.52
183.90
0. 0174
0.012
Italy
Spain
62.71
66.45
14.72
9.92
Italy
Spain
17.02
31.21
15.39
9.84
We have constructed three multiple linear regressions, one for each dependent
variable, as follows:
Y= + 1 INH + 2 DP + 3 U+ 4 GDP+ 5 PP+ + 6 G + 7 KE + 8PE+
9FP+ 10FR+11FI+ 12 OG+
Regarding the data, it is worth noting that the personal expenditure index is a little
higher in Spain. The fiscal pressure per capita is however higher in Italy, where it
reaches 691 in Italy and 613 in Spain, representing 4.3% of the GDP in Italy and
2.09% in Spain. Nevertheless, the financial independence ratio of Italian local
governments reaches 62.71% compared to 66.45% in Spain. Whereas, relating to
the size, the mean of the number of inhabitants - as well as the density of
population - is slightly higher for Spain. There are also differences in the GDP per
capita, higher in Spain than in Italy but also with more variability. Nevertheless, the
unemployment index is also higher in Spain, with a mean of 15.29%, while in Italy,
it is 11.83%. Regarding the political variables, in most of the Italian LG, there is a
mayor from a progressive party (only in 19% of the cities does a conservative party
govern) and in 94% of the cases, the mayor is a man. In Spain, 67.5% of the mayors
are from a conservative party and the percentage of women increases to 22.8%.
5
Analysis of the results
5.1
Principal Component Analysis
In order to carry out the PCA, first all the variables included in table 1 were
considered. However, considering both the problems of communality and
redundancy, some of them were removed, as highlighted in table 4. Tables 3 and 4
show the results and Graph 1 compares the components for Italy and Spain.
172

Table 3: Matrix of the Principal Component

Country Component
Italy
Spain
1
2
1
2
Total
2.752
2.156
3.860
1.045
Initial Eigen values

% of Variance
% Cumulative
45.871
45.871
35.939
81.811
64.342
64.342
17.409
81.750
Table 4: Extraction Method: Principal Component Analysis with two component

extracts
Debt per capita

Debt/ GDP
Debt/Op. revenues
Op. Surplus/ Percapita
Op. Surplus /op. revenues
Debt-payment
Italy
Components
1
2
.943
.173
.913
.200
.863
.089
-.062
.911
-.050
.939
-.527
.604
Spain
Components
1
2
.900
.250
.884
.226
.948
.122
-.801
.409
-.837
.404
-.164
-.766
Graph 1: Principal components
The PCA shows that there are some differences in the dimensions for the analysis
of the financial condition in Italian and Spanish local governments.
In Italy, the results show that a first component includes the variables representing
the level of debt which is called long term financial situation. The first component
explains a 45.87% of the variance.

173
Long term financial situation = 0.943*Debt Per capita+0.913*Debt/GDP+

0.863*Debt/operative
revenues-0.062*Operative
surplus
percapita0.050*Operative surplus/operative revenues-0.527Debt payment.
The second component explains 35.94% of the variance and includes all the
variables representing a short term economic perspective (Table 3). It reveals that
in Italy there is no correlation between the variables representing the long term
financial situation (level of debt) and short term economic situation (operative
surplus). In fact, the correlation coefficients between both types of variable is very
low.
In Spain, the first component explains 64.34% of the variance but includes both
the long term debt as well as the short term economic dimension in the same
component, but with a negative sign. Those entities with a higher level of debt and
lower surplus will have more financial problems. There is a high correlation
between both dimensions. Those entities with a higher level of debt also have less
operative surplus.
The equation of the first component (explains 64.34% of the variance) is the
following:
Financial situation = 0.900 * Debt Percapita + 0.884 * Debt/GDP + 0.948 *
Debt/operative revenues-0,801*Operative surplus percapita-0,837*Operative
surplus/operative revenues-0,164*Debt payment.
The second component, in Spain, explains only 17.409% of the variance and the
variable with a higher weight is debt payment, since all the others have a high
weight in the first component.
To summarize, while in Spain there is high correlation between long term debt and
the short term economic-financial situation and an indicator that combines both
can explain a high percentage of the variance, in Italy both dimensions have a
different behaviour. The indicators of the economic situation such as operative
deficit and the debt level are in two different components.
5.2
Drivers for financial condition
In the second part, we tried to analyse the factors that influence or can explain the
differences in the financial condition, carrying out a regression analysis with all the
variables so as to analyse whether the variables are significant or not over the
dependent variables. For the variables dummy, the T-test of the difference of means
was used.
Three alternative dependent variables were considered: component 1, component 2
and debt per capita.
174

The results in Tables 5, 6 and 7 show that for Italy the variables that have a
significant influence are: population, density of population and most of the variables
representing the financial structure of expenditures and revenues of local
government. However, the political and socioeconomic variables, such as the
political party in power, the gender of the mayor, unemployment and GDP are not
significant in any of the models. In Spain, the situation is very different: size is
important when measuring the number of inhabitants, with there being less
relevance when considering the density of the population. The political and socioeconomic factors are significant in component 1, that in the case of Spain has a high
explicatory power, with only the gender of the mayor not being significant in any of
the models. The financial structure of the revenues and expenses is also a driver for
financial stress.
Table 5: Factors that explain component 1 in Italian and Spanish LGs
Dependent: Component 1
Population (INH.)
Density of population (DP)
Unemployment (U)
Gross Domestic Product (GDP)
Political party in government (PP)
Gender of the Mayor (G)
Capital expenditure (KE)
Personal expenditure (PE)
Fiscal pressure (FP)
Fiscal revenues over GDP
Financial independence (FI)
Operative grants
Italy
Spain
F/T
Coef.
Sig.
F/T
Coef.
Sig
2.882
-0.169
0.093
0.114
0.031
0.736
3.329
-.181
.071
2.500
-.142
.116
1.518
-.124
.221
7.613
.243
.007
.465
-.069
.497
7.002
-,234
.009
.010
1.536
.132
4.388
2.753
.007
.010
.289
.764
.032
.216
.829
.080
.028
.779
4.341
.186
.039
.305
.056
.582
8.170
.251
.005
1.393
.118
.241
.230
-.044
.633
4.097
.200
.046
1.801
.121
.182
5.213
.225
.025
.580
.069
.448
5.950
-.239
.017
.001
-.003
.973

175
Table 6: Factors that explain component 2 in Italian and Spanish LGs

Population (INH.)
Unemployment (U)
Italy
F/T
Coef.
Sig.
F/T
Coef.
Sig
1.244
0.112
0.093
2.820
0.151
0.096
7.196
.262
.009
.335
-.053
.564
2.255
.150
.136
.129
-.033
.720
.341
.561
.420
-.059
.518
.514
-.059
1.004
.252
.642
1.302
.195
.882
.851
.248
5.171
-.158
.875
.012
.011
.913
1.055
-.093
.306
11.664
-.326
.001
1.383
-.106
.242
5.325
.227
.023
12.669
.308
.001
6.023
.241
.016
11.490
.294
.001
8.962
-.289
.003
8.238
.252
.005
1.524
.124
.220
10.079
-.277
.002

Operative grants
Spain
Table 7: Factors that explain debt per capita in Italian and Spanish LGs
Dependent: Debt Per capita
Italy
Sig.
Spain
Population (INH.)
F/T
4.669
Coef.
-.212
4.953
-.218
Unemployment (U)
1.923
-.138
.028
.169
.433
-.066
.512
.370
1.118
.292
.113
.393
.710
2.403
-.714
.033
F/T
4.669
Coef.
-.212
Sig
.033
.801
-.081
.373
1.784
.121
.184
.871
-.085
.352
4.702
2.760
.007
.477
.570
.076
.452
7.023
.234
.177
-.042
.675
1.565
.113
.009
.213
1.611
.127
.207
4.366
.187
.039
5.381
.227
.226
1.037
.102
.022
.311
6.524
1.724
.119
.012
.192
Operative grants
2.362
-.153
.128
.660
-.074
.418
176

In Italy, the entities with more inhabitants have less financial stress when
considering component 1, which represents the long term financial situation. In fact,
the level of debt per capita is lower for bigger entities, since the coefficient of the
variable in table 7 is negative and significant. Similarly, these entities have a better
short term economic situation, with the variable in table 6 having a positive
coefficient and being significant. The density of the population has a similar
influence: entities with a higher density of the population have fewer problems in
the long term financial situation, debt per capita and a better situation when
considering the second component, which represents the short term economic and
financial situation.
In Spain, the results (contrasting Guillamn et al. (2011) and Vicente et al.
(2013),which found a positive relation as well as Benito and Bastida (2004) which
found no significant relation in a sample including entities up to 50.000 inhabitants)
show that entities with more inhabitants have also a lower level of debt, since the
population variable has a negative coefficient and is significant in the regression
with the debt per capita. They show also a better situation in the short term
economic and financial situations. However, the variable is not significant in
explaining the whole financial condition (component 1) of Spanish local
governments. In spite of the negative impact of the density of the population on the
per capita total expenditures found in Bastida et al. (2013), the results show that the
density of the population is not significant in explaining the differences in financial
health.
The political party is a significant variable in the case of Spain, showing that
progressive governments have more debt per capita and that the financial condition
(component 1) is also higher, in line with the results of Guillamn et al. (2011) and
Vicente et al. (2013). The unemployment rate also has a positive impact on the
financial condition in the case of Spain, and those entities with higher
unemployment have more financial problems, which is in line with Zafra-Gomez et
al. (2009). Nevertheless, in this study, unemployment is not significant for the debt
per capita, contrasting the results of Vicente et al. (2013) where it has a positive
relevance on the level of debt. On the other hand, the GDP is a good driver for
financial health and entities with a higher GDP have lower financial stress. This
confirms the results in Guillamn et al. (2011) but differs from those obtained in
Bastida et al. (2013).
With respect to the financial structure of the revenues and expenses, in Spain those
entities that have a higher capital expenditure per capita have more debt, since the
law requires that debt goes to financial long term investments. Thus, entities with a
higher capital expenditure per capita are more likely to have financial stress.
However, capital expenditure per capita is not relevant for Italian entities. The
percentage of personal expenditure over operative revenues is also significant in
component 1 of Spanish local governments, which shows that the higher the

177
expenses are, the higher the probability to have financial problems is. In Italy, the
last variable is significant only in the short term economic and financial situation
(component 2), but does not influence the long term situation nor the level of debt.
Regarding the revenues, the fiscal revenues over GDP is the variable that has
significant power in explaining both the long term financial stress, short term
economic and financial situation as well as debt per capita in the case of Italy.
Although focusing on operative surplus entities with a higher percentage of
revenues over GDP, they have a better short term financial situation as well as more
debt per capita and more probability of having higher long term financial stress
indicators. Fiscal pressure is also positively correlated with the short term economic
and financial situation (component 2) as well as the financial independence. This
confirms that fiscal policies can influence the level of debt of governments
(Guillamn et al., 2011).
The operative transfer and grants (for financing current expenditures) have a
positive impact on the long term financial situation for Italy, since those entities
with a higher percentage of operative transfer and grants have lower values in
component 1.
In Spain, the percentage of fiscal revenues over GDP also has a positive impact on
the debt per capita and component 2, while it is not significant for component 1.
Fiscal pressure is significant in the debt per capita as well as component 2,
highlighting how those entities with a higher level of taxes per capita also have a
higher debt per capita. Operative transfer and grants are only relevant for
component 2.
With the aim of selecting a group of indicators suitable for predicting financial
distress, all the variables that are significant in the simple regression analysis were
considered in a multiple regression, using the stepwise method of the regression.
The results are shown in Tables 8, 9 and 10.
Table 8: Multiple Regression Analysis for Component 1
Italy
Spain
Coef.
Sig.
-0.230
0.020
Coef.
Sig
0.254
0.003
-0.240
0.004
Population (INH.)
Unemployment (U)
178


0.277
0.001
0.234
0.005

Operative grants
R2
F
-0.286
0.096
6.191
0.004
0.204
8.83
Table 9: Multiple Regression Analysis for Component 2

Italy
Coef.
Spain
Sig.
Population (INH.)
Coef.
0.191
0.207
0.017
-0.212
0.20
0.323
0.001
-0.411
0.000
Sig
0.029
Unemployment (U)
0.318
0.000
Operative grants
R2
F
0.291
11.178
0.108
8.38
Table 10: Multiple Regression Analysis for Debt Percapita

Dependent: Debt Per capita
Population (INH.)
Unemployment (U)
Italy
Spain
Coef.
Sig.
-0.257
0.000
-0.330
0.000
Coef.
Sig

179

0.167
0.006
0.726
0.567
80.846
0.000

Operative grants
Debt per capita t-1
R2
F
0.739
0.545
40.129
0.000
For the first principal component, in the case of Italy, there are only two variables
that enter in the model (due to autocorrelation problems): the density of the
population and the operative grants index. However, the explanatory power of the
model is very low. For component 2, in addition to the density of the population,
personal expenditure index, fiscal revenues over GDP and financial independence
are also significant. In this case, the explanatory power of the model increases to
29.1%.
In the case of the debt per capita, the level of debt of the previous year (lagged
variable) was also considered, taking into account that it is a variable that
maintains a certain stability. For Italy, in addition to the debt of 2011, the
population and the density of the population are significant in the model in
explaining 73.9% of the variance of the debt per capita.
In Spain, there are four variables that enter into the multiple regression for the
financial health indicator (component 1): unemployment, political party, capital
expenditure and personal expenditure. The R2 of the model is 20.4%. For
component 2, the variables are population and fiscal revenues over GDP. In the
debt per capita regression, the significant variable is also the percentage of fiscal
revenues over GDP, in addition to the debt of the previous year. The model
explains 72.6% of the variance of the debt per capita.
6
Conclusions
The global financial crisis has had significant effects on the viability and financial
conditions of the public sector, including local governments. They are facing
financial difficulties, in part related to the need to increase public services
180

provided with a reduction of available resources and in part connected to the

financial crisis.
In this new era, it has become extremely relevant for the on-looking agencies,
politicians and citizens to detect the financial performance of local governments
(Cohen et al., 2012) as well as a more general concept of financial condition. In
current literature, several studies (i.e. Kleine et al., 2003; Jones and Walkers,
2007; Zafra-Gmez et al., 2009; Cohen et al., 2012; Garca-Snchez et al., 2012;
Manes Rossi et al., 2012) along with standard setters and regulators all over the
world (CICA, 1997, ICMA, 2003; UK Audit Commission, 2007) have developed
several model to assess and prevent financial distress.
The novelty of this study is threefold: it presents a comparison between two
European countries affected by the financial crisis, attempting to discover the
dimensions of the financial condition of Italian and Spanish local governments
using principal component analysis, while studying how the economic and social
conditions of the local government affect their financial health.
The analysis of the financial condition shows relevant differences between Italy
and Spain. In Italy, the results highlight how the long term financial situation and
the short term economic perspective are not correlated to each other and have a
different behaviour. Thus, the analysis of the financial health should be carried out
considering both dimensions separately. On the contrary, in Spain these two
dimensions are strongly negatively correlated. In other words, entities with a
higher level of debt and lower operative surplus will have more financial
problems.
Moreover, the results also highlight how the factors that can explain the results
highlight how differences in the financial health are strongly different in Italy and
Spain. The number of inhabitants is an important element in both countries,
therefore the Italian and Spanish larger local governments have a lower level of
debt and better situation in the short term economic and financial situation.
However, the density of the population is not a significant variable for Spanish
LG, while it has a negative effect on the level of debt of Italian LG.
The socioeconomic and political variables have no impact on the financial health
of the Italian municipalities but, for the Spanish LG, the results highlight how the
progressive political party and unemployment rate have a positive impact on the
financial stress.
Differences also emerge in relation to the influence of the financial variables on
the financial health of LG.

181
For example, capital expenditure per capita and the percentage of personal
expenditure over operative revenues influence the financial stress of the Spanish
municipalities, while they do not have a strong influence on the Italian ones.
On the other hand, the fiscal revenues over GDP, fiscal pressure and the operative
transfer and grants have a stronger influence on the financial health of Italian LG.
These results could support managers and politicians in understanding which
factors should be constantly monitored, with the aim of assuming timely decisions
so as to avoid financial distress.
In this framework, the law also plays an important role in the control of financial
health of the local governments. In fact, in both countries, it is expected that the
municipalities in financial difficulty have to prepare a financial rebalancing plan
in order to avoid financial distress.
This study highlights how, even if Italy and Spain have a similar economic, social
and administrative environments, the factors that have an impact on the financial
distress are different. For these reasons, it is difficult to create a single model to
prevent the financial crisis of LGs for all countries, while it is more correct to
develop a specific model that reflects the peculiarities of each country.
Nevertheless, the analysis presents several limitations. First, the data for only for
one year was analysed because we want to related the financial condition to
political variables, that can change in a three-five year period. Moreover, the
sample focuses on entities with more than 60,000 inhabitants, with it being
necessary to extend the analysis to smaller entities. Further possible developments
of the research could include the analysis and comparison with other countries
with a different socioeconomic framework, with the aim of highlighting the main
differences in the factors affecting the financial distress.
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LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Vol. 13, No. 2, pp. 161 - 184, April 2015

Drivers for the Financial Condition of Local

CORRESPONDENCE ADDRESS: Isabel Brusca, University of Zaragoza, Department of

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

scholars as well as the environmental, organizational and financial determinants

The analysis of financial condition in local goverments: A literature

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

analysing the financial equilibrium of a LG every year in order to assess if a

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

The Italian and Spanish scenario

The control of financial health in Italy

Italy belongs to those European countries characterized by a bureaucratic

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

disequilibrium. The declaration of distress has a significant impact on the citizens:

The control of financial sustainability in Spain

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Objectives and Methodology

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Sample and Variables

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Variables for the analysis of Principal Components

LONG TERM FINANCIAL

Debt per capita

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Gross Domestic Product

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Analysis of the results

Principal Component Analysis

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Table 3: Matrix of the Principal Component

Initial Eigen values

Table 4: Extraction Method: Principal Component Analysis with two component

Debt per capita

Graph 1: Principal components

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Long term financial situation = 0.943*Debt Per capita+0.913*Debt/GDP+

Drivers for financial condition

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Table 6: Factors that explain component 2 in Italian and Spanish LGs

Gross Domestic Product (GDP)

Density of population (DP)

Gross Domestic Product (GDP)

Political party in government (PP)

Gender of the Mayor (G)

Capital expenditure (KE)

Personal expenditure (PE)

Fiscal pressure (FP)

Fiscal revenues over GDP

Financial independence (FI)

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Capital expenditure (KE)

Fiscal pressure (FP)

Table 9: Multiple Regression Analysis for Component 2

Table 10: Multiple Regression Analysis for Debt Percapita

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Gross Domestic Product (GDP)

Financial independence (FI)

LEX LOCALIS - JOURNAL OF LOCAL SELF-GOVERNMENT

Long term financial situation = 0.943Debt Per capita+0.913Debt/GDP+