Università degli Studi di Cagliari PhD in Economic and Business Sciences Cycle XXX Cutting down public sector debt or funding investment? The fit-for-purpose perspective Scientific Disciplinary Sector SECS-P/07 PhD Student: Davide Eltrudis Coordinator of the PhD Programme Prof. Andrea Melis Supervisor Ass. Prof. Patrizio Monfardini Final exam. Academic Year 2016 - 2017 Thesis defence: March 2018 Session to Stefania CONTENTS Summary of the PhD thesis I References VIII Funding Local Governments through bonds: a feasible 1 alternative to banks? References 13 The impact of a widespread use of municipal bonds on 15 financial autonomy References 28 Strategies to Reduce Public Sector Debt: sub-sovereign 31 bond buyback References 53 Appendix A 57 Appendix B 61 Appendix C 64 Summary of the PhD thesis CONTEXT OF THE ANALYSIS The reduction of public debt assumed primary significance in the European political and economic debate in the last decades, and only recently European Union member states agreed to sign the Fiscal Compact (part of the Stability and Growth Pact) to pursue progressive reduction of their public-sector debt as the over-riding strategy for “fiscal consolidation”. However, the attempts to reduce the debt have been accompanied by harsh austerity policies whose negative consequences seemed not compatible with European’s ideals of social justice, equity and solidarity (Bracci et al., 2015). Italy and other member countries with huge debts have been and still are forced into a trade- off between observing European strict financial rules and carrying out investments, which often results to relinquish the latter. These severe EU fiscal consolidation rules also compromised the devolution of political, fiscal and administrative powers to subnational levels of government. Several countries experienced the counter-movement towards the reassertion the role of the centre of the post-NPM era, but within the EU the reclaim of the control took place at the upper level of governance. This process flattened the decision making process to the centre, failing to take into account the local differences (Cepiku and Mussari, 2010). Because the criteria for monitoring the local indebtness have been established by international agreements, they do not reflect the specific contexts in which Local Governments (LGs) operate. This thesis deals with the Italian case because, given its considerable high public sector debt, the autonomy of local level (strong but fragmented) has been reduced by the governance at national state level as a result of its and membership at European Union (OECD, 2017). Indeed, since the ‘90s, the Italian public-sector finance has been involved in a process of reform which has gradually transformed a model based on government transfers to a system in which LGs raise local taxes and benefit from a range of possible options to fund and finance their investments. Per contra, the constraints imposed by the Stability and Growth Pact requested member countries to reduce the deficit spending, as well as the relationship between the amount of debt and the Gross Domestic Product, so the LGs have to realize a reduction of the debt by carrying a strict policy of controlling the debt. I The constraints on expenditures, the reduction in transfers and the acknowledging of financial and fiscal autonomy meant that LGs have to finance themselves almost exclusively through their own resources or by access to debt. Loans and innovative financial instruments (such as bonds, leasing, PPPs/PFIs, swaps) are currently used for financing investments: this PhD thesis focuses on bond issuing and buyback of municipal bonds, and aims to investigate their influence within the Italian context to finance investments and to cut down the sovereign debt. Bonds have been internationally issued over decades to finance investments, but due to the impact of the conventional funding methods on competitiveness and effectiveness levels they became obsolete (Bailey, 2009). Historically the Italian LGs debt market has never grown up, and the bank lending channel was prevalent, but since 2000s many alternative sources of funding represented the alternative to traditional banking funding methods. THEORETICAL FRAMEWORK Assuming that none of the policies is absolutely appropriate (or inappropriate), this work adopts the “fit for purpose” perspective, based on the contingency theory (Freeman, 1973; Hofer, 1975; Feldman, 1976; Khandwalla, 1977; Dewar and Hage, 1978; Otley, 1980; Van de Ven and Ferry, 1980; Marsh and Mannari, 1981; Schoonhoven, 1981; Drazin and Van de Ven, 1984, 1985; Donaldson, 2001; Chenhall, 2003, 2007; Otley, 2016). This theory assumes that there is no a best way to come to a decisions, but rather the “performance is a function of the fit or match between two or more factors” (Van de Ven and Drazin, 1985, p. 537), and therefore the optimal choice is contingent upon the existence of several feasible options. Contingency-based research in the accounting literature has been thoroughly reviewed firstly by Otley (1980) and then by Chenhall (2003, 2007) who identified its pros and cons: arguments in favour lead to think of this as a theory that exhibits an appropriate matching of specific aspects with certain defined circumstances; arguments against are based on the assumption that these specific aspects are so subjective to not have general applicative value. Actually, as Chenhall (2007) observed, “the term contingency means that something is true only under specified conditions. As such there is no ‘contingency theory’, rather a variety of theories may be used to explain and predict the conditions under which particular MCS [management control system] will be found or whether they will be associated with enhanced performance.” (p. 191). However, “a contingency-based approach attempts to map variables and demonstrate potential relationships between variables, which may include power and politics, and indicate potential links with outcomes” (p. 194). Contingency theory derives from the study of organizational behaviour, and implies that the design and function of organizations are influenced by contingent factors such as technology, II culture and the external environment (Drazin and Van de Ven, 1984, 1985): its underlying assumption is that there is not a role model of organizational structure, but different solutions are equally acceptable. Van de Ven and Drazin (1984) have developed the key concept of fit in contingency theory on the basis of the selection, interaction, and systems approaches. Studies that adopt the selection approach aim to investigate the connection between the context features and the structure of an organization; studies that rely on the interaction approach analyse the effect of context and structure on performance. While the previous focused separately on contingencies, structural options and performance, studies that embrace systems approach address them simultaneous: this approach, rather than assuming that there is unique solution, agrees that “multiple, equally effective alternatives may exist” (Van de Ven and Drazin, 1984, p. 14). However, as Otley (2016) pointed out, “whereas initially it developed from the idea that no universal solution to the problems of control was feasible [...] research over the past four decades has come up with an extended list of possibly significant contingencies that are faced by organizations, many of which suggest conflicting recommendations” (p. 46). Contingency theory has been widely used by management accounting researchers in order to address questions about the fit between organizational control and structure, the impact of such fits on performance, and to investigate of multiple contingencies and their impact on organizational design (Islam and Hu, 2012). Even if there is “a considerable body of literature, which while not without imperfections in method, has provided a basis for generalized propositions between elements of MCS and context” (Chenhall, 2007, p. 194), it has been highlighted a general lack of recognition of which form of fit are relevant to studies (Gerdin and Greve, 2004; Cadez and Guilding, 2008). However, Chenhall himself pointed out that although contingency-based research should adopt more interpretive and critical views rather than rely exclusively on traditional, functionalist theories, management accounting research might certainly pursue to use this theory by virtue of its potential strength that makes it possible to uncover generalizable findings. On the other hand, despite contingency theory has not so much been applied in public management literature, Otley (2016) highlighted that the public sector is suffering from the failure of alignment of contrasting systems with each other suggesting that even in this sector the theory could be usefully applied, and therefore the fit for purpose perspective has been recently introduced in the academic debate (Gauld and Mays, 2006; Osborne, 2010; Radnor and Osborne, 2013; Osborne et al., 2013; Radnor et al., 2014; Osborne et al., 2015; Hiedemann et al., 2017). This thesis serves these two streams of literature, and in particular suggests to apply the fit-for-purpose theory to public finance. III According to Gerdin and Greve (2004) and Cadez and Guilding (2008) about the need to make clear which form of fit is relevant for the study, being aware that on this issue “research does not often lead to establishing what does or does not work in a specific organizational context.” (Saulpic and Zarlowski, 2014, p. 215), this