The Organizational Structure of City Finance Offices.

This article describes a recent GFOA study of the organization of city finance offices across the U.S. and investigates whether integrated finance organizations are more efficient and effective.

Nearly a century ago, the model city charter of the National Municipal League recommended that local governments combine their finance functions into a single, integrated finance office. This article examines the prevalence today of a single finance office in large U.S. cities and investigates whether any obvious relationship exists between the centralization of finance activities and the efficiency and effectiveness of the finance organization.

In the spring of 2000, the GFOA Research Center conducted a study of the finance offices in the 75 largest U.S. cities. Using official government documents, the Research Center gathered data on the structure and expenditures of nearly 200 finance offices. The study made the following findings.

* Most large U.S. cities have a simple organizational structure in which one or two departments carry out the government's major finance responsibilities.

* Finance responsibilities are less centralized in the largest cities.

* The finance organizations of large U.S. cities have become more centralized in the past 15 years.

* A majority of chief financial officers report directly to the chief executive.

* Finance responsibilities are usually not performed in an office headed by an elected official.

* A single, integrated finance office is not necessarily more effective, but appears to be more efficient than multiple finance offices.

Past Research. Very few studies are available on the organization of local government finance offices. In the mid-1960s, Marshall W. Meyer conducted a GFOA study of 254 local government finance organizations. Meyer studied the centralization and decentralization of authority in finance offices. In the mid-1980s, Petersen, Watt, and Zorn conducted a GFOA study of 551 local governments. Petersen, et. al., focused on the functional responsibilities, qualifications, and compensation of chief finance officials. In the October 1987 issue of the Government Finance Review, Daniel E. O'Toole and James Marshall discussed the findings of their study of the budget offices in 358 local government jurisdictions.

Organization in Large U.S. Cities

There is much diversity in the structures of the finance organizations of large U.S. cities. However, several basic structures exist for organizing finance responsibilities. The simplest structure is the classic, integrated finance organization in which all finance activities are housed in a single department. Another structure is to divide finance responsibilities into two separate offices--typically a budget office and a finance office. A more complex structure is to divide responsibilities further into three or four separate offices responsible for broad categories of activities such as accounting, treasury, revenue collection, and budgeting. Typically, at least one of these offices is elected. Another structure is to combine finance responsibilities with general city management responsibilities to create a department of finance and administration. Some cities also give their finance offices miscellaneous non-finance responsibilities such as managing the city cafeteria and neutering dogs and cats.

Finance Organization Structural Types. To facilitate analysis, the numerous types of organizational structures were categorized into the following six structural types:

1) one finance office;

2) two non-elected finance offices;

3) one elected and one non-elected finance office;

4) three non-elected finance offices;

5) one elected and two non-elected finance offices;

6) more than two elected or three non-elected finance offices.

This typology categorizes organizational structures based on their centralization and complexity.

The first structural type, one finance office, is the simplest and most centralized structure, while the sixth structural type is the most complex and decentralized structure. It can be argued that a finance organization becomes more decentralized and complex as the number of finance offices increases and as finance offices are headed by an elected official. A finance organization with multiple offices will tend to have less coordination because decision-making authority is dispersed among two or more individuals who can report independently to the mayor or city manager. If one of these offices is elected, there will tend to be even less coordination because there is no organizational link between the two offices. Thus, two finance offices in which one of the offices is elected (#3) is considered to be less centralized than two non-elected finance offices (#2).

Centralization and Decentralization of Finance Offices. The study found that more than 80 percent of large American cities have a simple organizational structure in which all major finance activities [1] are carried out by one or two departments. Nearly 40 percent of the cities have a single finance office, and 42 percent of the cities have two main finance offices. Of those cities with two finance offices, 88 percent are headed by appointed officials. In most cases, these two offices are a finance office and budget office.

In an apparent new development, finance organizations have become more centralized in the past 15 years. Nearly a decade ago, Edward Lehan noted that, "the integrated approach has not replaced the fragmented approach particularly in larger jurisdictions." [2] Lehan's observation was based on a 1985 GFOA study which found that the percentage of cities with a single finance leader for 10 core finance functions was 20 percent for cities with a population greater than 500,000. The recent GFOA study found that today, 33 percent of cities of the same size have a single finance office. A similar increase has occurred for cities with a population of 100,000 to 500,000. In 1985, 31 percent of cities of this size had a single finance office. Today, 41 percent of these cities have a single finance office.

The structure of finance organizations tend to become more complex and more decentralized as cities increase in size. Exhibit I divides the largest 75 cities into fifths with the first fifth made up of cities with the smallest population in the sample. The exhibit reveals that the cities in the first three-fifths of the sample (i.e., less than 460,000 population) primarily have finance organizations with the first two structural types. In fact, nearly 90 percent of these cities have a simple organizational structure with one finance office or two non-elected finance offices. A majority of the cities in the last two-fifths (i.e., greater than 460,000 population) also have finance organizations with the first two structural types. However, about 40 percent of these cities have more complicated organizational structures, represented by types three to six.

The above analysis focuses solely on major finance activities and excludes activities that are sometimes separated from a main finance office, such as internal auditing and capital budgeting. Including all finance activities [3] in the analysis produces a similar result. The number of separate finance offices varies from an average of two offices for the smallest cities in the sample, to three offices for the largest cities. The result is similar regardless of whether population or total general fund expenditures is used as a measure of size.

Reporting Relationships. In the model city charter suggested by the National Municipal League, the head of the integrated finance office, or chief financial officer, reports directly to the chief executive. In many cases, however, the CFO reports to an assistant city manager or another appointee instead of the chief executive. Lehan describes this distancing of the CFO from the chief executive as "a sharp and serious departure from the classical concept of the finance directorate." [4] Currently, a majority of the 27 cities with an integrated finance office report directly to the chief executive. About 44 percent are separated from the chief executive by one layer of bureaucracy.

Elected and Appointed Finance Offices. In large U.S. cities, it is uncommon for a finance office to be led by an elected official. Of the 195 finance offices in the sample, only 13 percent are led by an elected official. Only one quarter of the 75 largest U.S. cities have one or more finance offices led by an elected official. Five of these cities have two or three offices led by an elected official. Exhibit 2 lists these cities and their respective elected offices.

When a finance office is elected, it is typically given responsibility for internal auditing, central accounting, revenue collection, and cash management. In general, these responsibilities are carried out by an elected official with the title "Comptroller," "Treasurer," or "Auditor." Exhibit 3 lists the most common responsibilities of elected finance offices and the number of elected offices with each responsibility. Exhibit 3 shows that, of the 26 finance offices that are led by an elected official, 50 percent have internal auditing responsibilities, and 35 percent have central accounting or revenue collection responsibilities.

Another way of looking at the responsibilities of elected finance offices is to calculate the percentage of instances in which a finance responsibility is carried out by an elected rather than an appointed finance office. Exhibit 4 lists 16 finance responsibilities and the percentage of the time that each responsibility is performed by an elected finance office. Exhibit 4 shows that finance responsibilities are usually not performed by an elected official. However, nearly 20 percent of finance offices responsible for internal auditing are led by an elected official. This is consistent with the notion of giving a degree of independence to the internal auditor.

Division of Responsibilities among Finance Offices. The study found that cities tend to group together the same types of finance responsibilities. There are three major groupings of finance responsibilities. One grouping, which is typically called the "Finance Department," includes: central accounting, cash/investment management, debt management/administration, central payroll, and revenue collection. The analysis shows that nearly all of these functions have correlations of 0.50 or greater. A correlation of 1.00 indicates that the responsibilities are always performed by the same office. A correlation of -1.00 indicates that the responsibilities are never performed by the same office. A second grouping, which is typically called the "Budget Office," includes: annual budgeting, multi-year financial plans, revenue forecasting, management and policy analysis, and capital investment planning. Nearly all of these functions also have correlations of 0.50 or greater. A third grouping, which is usually called the " Auditor's Office," includes: internal auditing, fraud/abuse investigations, and performance audits. Internal (financial) auditing and performance auditing have a very high correlation of 0.71.

The responsibilities of Auditor's Offices (i.e., internal auditing, fraud/abuse investigations, and performance audits) are usually separated from other finance responsibilities such as budgeting and central accounting. This finding is based on the analysis which showed that these auditing responsibilities are negatively correlated with all other finance responsibilities.

Efficiency and Effectiveness

Many argue that a city's finance organization will be more efficient and effective with an integrated, rather than a fragmented, organizational structure. In his chapter in Local Government Finance: Concepts and Practices, Lehan states that for the past 100 years, "the key organizational issue of local government finance has been integration." [5] Lehan continues by stating that "the incomplete realization of the integration ideal represents an important item of unfinished business for those interested in the efficient and effective management of local government and its finance." [6] In this statement, Lehan makes a clear connection between an integrated structure and a finance organization's efficiency and effectiveness. Lehan also points Out that because a single, integrated finance office is larger than several independent finance offices, an integrated office can hire better talent because it can offer a higher salary with more responsibility. In GFOA's Elected Official's Guide to Government Finance, Gi rard Miller also recommends an integrated organizational structure: "Whenever possible, the legislative body and the chief executive should promote coordinated organizational structures for all financial operations. Accountability and professionalism seldom are achieved through fragmented financial offices." [7] Here, Miller argues that coordinated organizational structures promote accountability and professionalism. [8]

Since an integrated organizational structure is commonly considered to be more efficient and effective than a fragmented structure, it was considered appropriate to test this commonly held assumption empirically. The study investigates whether any obvious relationship exists between the centralization of finance activities and the efficiency and effectiveness of the finance organization.

Are Integrated Organizations Clearly More Efficient? Efficiency is to produce the greatest output with the fewest resources. Efficiency was measured by calculating the operational cost of the finance organization as a percentage of the total government's budget. Finance organizations that require a larger chunk of the total budget to manage the city's finances are assumed to be less efficient than organizations that cover the same responsibilities with fewer resources.

Because of the difficulty of measuring efficiency, two different measures of efficiency were used. Each measure draws from a separate data set. One measure uses U.S. Census data on local government expenditures. This measure divides the expenditure for financial administration by the total general government expenditures. A second measure uses the GFOA Finance Organization Database. This measure divides the expenditures for 18 finance activities by the total general fund expenditures. [9]

The analysis found that finance organizations that are more integrated tend to be more efficient than finance organizations that are more decentralized. Both measures of efficiency showed that cities with a single finance office tend to be more efficient than cities with two separate finance offices. Exhibit 5 shows that, on average, the cities with two separate finance offices had higher expenditures for financial administration than those cities with a single finance office. The difference is small, but still amounts to about 0.6 percent to 0.8 percent of total citywide general expenditures. Although types three to six have low percentages, this is due to the fact that cities with these structural types tend to be larger, and thus experience economies of scale. When the size of the government is controlled for, these structural types become less efficient.

A regression analysis showed that after controlling for the size of the government, finance organizations with a simpler structural type tend to be more efficient than those with a more complex structural type. On average, cities with a simpler structural type spend about $1.1 million less than cities with a more complicated structural type. For example, a city with a total general expenditure of $400 million and expenditures of $8.4 million for financial administration spread between two offices (structural type 2), spends, on average, $1.1 million more for financial administration than another government of the same size with one finance office (structural type 1).

Are Integrated Organizations Clearly More Effective? Effectiveness is the ability to accomplish a desired result. Effectiveness was measured with two criteria: 1) the ability of the government to produce high quality financial documents--as reflected by the GFOA awards for comprehensive annual financial reports (CAFRs) and budget documents; and 2) the ability of the government to maintain a good financial condition--as reflected by a set of financial ratios. Although there are many ways to evaluate the effectiveness of a city's finance organization, [10] the focus was on the quality of each city's financial documents because this represents the finance organization's ability to communicate financial information clearly to stakeholders inside and outside the government. Financial health was the focus for the second criteria because this is the ultimate responsibility of the finance organization. In fact, many finance offices state these two goals in their department's mission statement.

A city's budget document and CAFR are two of the most important financial documents that a city produces. The best data on the quality of these two documents is the results of the GFOA Distinguished Budget Presentation Awards program and the GFOA Certificate of Achievement for Excellence in Financial Reporting program. Every year, these programs review thousands of budgets and CAFRs based on a set of criteria that reflect the current standard in the profession.

Financial ratios are a convenient and widely used measure of financial health. [11] Of the dozens of financial indicators, eight ratios [12] were selected for which the finance organization has a large measure of control. In other words, indicators that primarily reflect the quality of the financial management rather than the local economy or political environment were used.

The analysis found that there is no obvious difference between the effectiveness of integrated (structural type one) and non-integrated finance offices (structural types two to six). Cities with various structural types have very similar results for their financial indicators and their receipt of the GFOA budget and CAFR awards. The first structural type had a slightly higher percentage of receiving the GFOA awards, but had a slightly lower rating for financial indicators. The second structural type had the highest average ratings for the financial indicators, however, this result is not statistically significant.

Conclusion

This article examined the organization of the finance function in large U.S. cities, and investigated whether any obvious relationship exists between the centralization of finance activities and the efficiency and effectiveness of the finance organization. A study of the finance offices in the 75 largest U.S. cities found that most large U.S. cities have a simple organizational structure in which one or two departments carry out the government's major finance responsibilities. Previous surveys of city finance organizations found that large cities tend to have fragmented organizational structures, however, in the last 15 years, the finance organizations of large U.S. cities have become more centralized. The study also found that finance responsibilities are usually not performed in an office led by an elected official.

Since an integrated organizational structure is commonly considered to be more efficient and effective than a fragmented structure, this assumption was tested by investigating whether any obvious relationship exists between the centralization of finance activities and the efficiency and effectiveness of the finance organization. The study found that a single, integrated finance office is not necessarily more effective, but appears to be more efficient than multiple finance offices. This finding is preliminary, and does not provide a conclusive answer to the question of whether an integrated structure promotes efficiency and effectiveness. The reader should note that the scope of the study was limited to large U.S. cities. It is difficult to answer this question conclusively for several reasons:

1) it is difficult to define and measure efficiency and effectiveness, 2) it is very difficult to control for other factors that may affect efficiency and effectiveness, such as the quality of the organization's staff and leadership, and 3) it is difficult to compare financial data across governments. In the coming months, the GFOA will publish additional research on the organzational structure of city finance offices.

R. GREGORY MICHEL is a Senior Policy Analyst in GFOA's Research Center in Chicago. He holds a master's degree in public policy from the University of Chicago.

NOTES

(1.) "Major finance activities" are defined as budgeting, central accounting, cash management, debt administration, debt issuance, disbursements, investments management, policy analysis and research, payroll, and revenue collection.

(2.) Local Government Finance: Concepts and Practices, GFOA, 1991, p. 29.

(3.) The finance activities that are included here are: pre-audit, post-audit, budgetary control, budget preparation, capital planning and budgeting, cash and investment management, central accounting, debt issuance and administration, disbursements, financial planning, financial reporting, fixed asset management, grants management, internal audit, payroll, pension administration, policy analysis and research, program evaluation, revenue collection, revenue forecasting, and utility billing. This list excludes the following activities which are sometimes included in finance offices: assessment, management information systems, property management, purchasing, and risk management.

(4.) Concepts and Practices, p. 31.

(5.) Ibid, p. 29.

(6.) Ibid, p. 29.

(7.) Miller, Girard, An Elected Official's Guide to Government Finance, p. 37.

(8.) Miller does not insist that all financial functions be placed in one office, but recommends that governments emphasize coordination and communication.

(9.) These activities include: central accounting, budgeting, capital budgeting, cash/investment management, debt issuance/ management, delinquent revenue collection/receivables, fixed asset management/ inventory, fraud/ abuse investigations, multiyear financial plans, pension administration, performance audits/ program evaluation, central payroll, internal auditing, revenue collection, revenue forecasting, management/policy analysis, utility billing/management, and grant management. Some of the financial data in this measure are not exact comparisons because of accounting differences.

(10.) For three additional methods of evaluating a local government's finance organization, see: Chan and Miranda, "Principles for Designing the Finance Organization: A Guide for Reform Efforts and Leadership Transitions," Government Finance Review, June 1998, p. 15-19; The Government Performance Project, Governing magazine and the Maxwell School of Citizenship and Public Affairs, www.cityandstate.com/gpp; and, Ammons, David N., Municipal Benchmarks: Assessing Local Performance and Establishing Community Standards, 1996, p. 76-95.

(11.) For a good discussion of financial indicators, see: Groves and Valente, Evaluating Financial Condition: A Handbook for Local Government, ICMA, 1994.

(12.) The eight indicators that we selected were: operating position, fund balance, liquidity, current liabilities, compensated absences liability, size of transfers, history of transfers, and debt service expenditures.

CITIES WITH MORE THAN ONE ELECTED FINANCE OFFICE

Offices Led by an Elected Official:

Milwaukee

* Comptroller

* City Treasurer

Nashville

* Property Assessor

* Division of Property Tax Collections (Trustee)

* County Clerk 

San Francisco 

* Assessor/Recorder

* Treasurer/Tax Collector

St. Louis

* Collector of Revenue

* Department of Finance (includes Comptroller)

* Treasurer

Virginia Beach 

* City Treasurer

* Commissioner of the Revenue