Internal Control Deficiencies and Municipal Borrowing Costs

Abstract

“Internal controls” refer to organizational rules and procedures used to safeguard assets and to detect fraud, waste, and abuse. This study examines the relationship between internal control deficiencies and municipal bond borrowing costs. The most severe form of internal control deficiencies (i.e., material weaknesses) is associated with higher borrowing costs for municipal bonds, between 10 and 18 basis points. Credit ratings mediate some of the effect of material weaknesses in internal controls but the indirect effect is relatively small. The effect of internal control deficiencies on borrowing costs was consistent in the time period before and after the financial crisis.