Information asymmetry and municipal revenue bonds

This paper provides theoretical arguments for the existence of, and measurement of, information asymmetry in the market for municipal revenue bonds. Using a sample of revenue bonds issued during the period 1987 to 1990, we examine the relationship between bond ratings, sinking funds, quality-differentiated audits and measures of bond interest cost. The results of this study are consistent with the notion that investors associate the sinking fund provision in municipal revenue bonds with riskier projects or riskier issuers, either of which results in increased borrowing costs to issuers. With respect to quality-differentiated audits, we find that Big 6 auditors are significantly associated with higher interest costs, but are not associated with the use of sinking funds. Although this result is contrary to prior municipal revenue bond research the result is consistent with Wallace's discussion of audit quality as a signal of credit-worthiness for risky debt offerings.