Beyond 5 Percent: Optimal Municipal Slack Resources and Credit Ratings

Abstract

Local governments tend to keep large amounts of slack financial resources to hedge against risk and uncertainty. To date, there has been little empirical research on whether those slack holdings are inadequate, adequate, or perhaps excessive relative to those risks and uncertainties. I address this gap in current research by using credit quality as a criterion to consider “optimal” slack resource levels. I find that for a national sample of local governments, slack resources’ effect on credit quality is statistically but not substantively significant. Having some rather than no slack increases, the likelihood of receiving a more desirable rating by 5–9 percent, but large slack holdings have little if any additional effect. These findings have implications for future work on slack resources, and for debt management broadly.