The International Differences in the Relationship between Public Financial Reports and Bond Markets: A Comparison between Japanese Local Governments and U.S. States

Japanese local governments just began to prepare full-accrual based financial reports. In 2015, the Japanese central government agency released the uniform accounting standards for local governments which required public financial reports (PFRs) be prepared on an accrual basis no later than 2017 fiscal year. The introduction of these new public accounting standards not only facilitated comparability of PFRs among Japanese local governments but also effectively established international comparability. Several previous studies about U.S. local governments shed light on the relationship between PFRs and bond ratings (PFR-BR relationship) and showed that financial indicators calculated using information in PFRs of U.S. local governments have a significant effect on bond ratings. However, no previous studies have investigated the PFR-BR relationship for Japanese local governments. Therefore, we examine the PFR-BR relationship of Japanese local governments, and compare it with that of U.S. states using the same financial indicators calculated from PFRs. Our main findings are as follows. First, while our results on U.S. states strongly support the findings of previous studies, the PFR-BR relationship doesn't appear in Japan. Second, no clear PFRBR relationship in Japan is caused by the lower variance of financial indicators of Japanese local governments compared to that in U.S. states. Further, we suggest two possible reasons for the difference between the two countries. One is the different proportion of adoption of strict "balanced budget requirement" among local governments between the two countries. Another is the so-called "implicit central government guarantees" in Japan. The evidence we provide will contribute to clarifying the decision-usefulness of PFR information in bond markets in diverse countries