The Financial Performance Comparison between Local Government
with Flypaper Effect and Non-Flypaper Effect: Empirical Study on
East Java Province in 2015
Maola Fiernabella Restantri and Murdiyati Dewi
Department of Accounting, Faculty of Economics and Business, Airlangga University, Surabaya, Indonesia
Keywords: Cost Ratio, Effectiveness Ratio, Expenditure Ratio, Financing Ability Ratio, Financial Performance,
Flypaper Effect, Revenue Composition.
Abstract: This study aims to examine whether there are differences in the financial performance of local governments
that are experiencing a flypaper effect and local governments that are not. Based on the census method of
sampling, 35 data samples were obtained, consisting of 27 regencies and eight municipalities. The selection
of sample types from flypaper effect regions and non-flypaper effect regions was analyzed using multiple
regression of local government revenue and general allocation fund to local expenditure. Accounting
performance data were analyzed with the Mann-Whitney U-test and independent sample t-test. The results
show that seven regions experience the flypaper effect and 28 regions do not experience the flypaper effect.
The average revenue composition of non-flypaper effect regions is higher than is the case in flypaper effect
regions and significantly different. The average cost, expenditure and effectiveness ratio of flypaper effect
regions are higher than non-flypaper effect regions but not significant. The average financing ability ratio of
non-flypaper effect regions is higher than flypaper effect regions but not significant.
1 INTRODUCTION
Public sector accounting in Indonesia has been
progressing over time. One of the main triggers was
the reformation in 1998. This reformation included
the demands of the public for good governance and
the enforcement of public accountability, honesty,
and development programs that support the welfare
of society; consequently, the 1998 reformation
generated the concept of public sector accounting
reformation in Indonesia as a whole. One of the
elements of total reformation is the demand for
granting wide autonomy or authority for
municipalities and districts, so MPR Decree No. XV
/ MPR / 1998 was issued on the Implementation of
Regional Autonomy; Setting, Distribution, and
Utilization of National Resources with Justice and
the Central and Regional Financial Balance in the
Framework of the Unitary State of the Republic of
Indonesia (Mardiasmo, 2002), which later became
the basis for the issuance of Law no. 22 of 1999, on
Regional Government, and Law no. 25 of 1999, on
Financial Balance between Central and Regional
Government.
Municipal and district governments can be more
effective in running their wheels effectively and
efficiently without strong intervention from the
central government in line with the issuance of the
policy. Each region or district has different potential
revenue that leads to the difference in Region or
District’s Own Source Revenue (PAD). In order to
reduce the PAD gap among local governments and
also to improve the tax system and fiscal efficiency,
the central government intervenes with the transfer
of funds balance for the region. Law no. 33 of 2004
explains the transfer of central government balance
funds to local governments in the form of General
Allocation Fund (DAU), Special Allocation Fund
(DAK), and Revenue Sharing Fund (DBH). The
balancing fund is an income component for the local
government along with the PAD derived from local
taxes and regional charges, financing, and other
income.
Local governments are theoretically expected to
be able to finance their regional expenditures with
revenues sourced from local taxes and retributions.
However, the data indicate that the proportion of
PAD is only able to finance local government
spending at the maximum of 20 per cent (Kuncoro,
2004). This shows that the sensitivity of local
government spending in obtaining transfer revenues
is still high, which means that local governments are
254
Restantri, M. and Dewi, M.
The Financial Performance Comparison between Local Government with Flypaper Effect and Non-Flypaper Effect - Empirical Study on East Java Province in 2015.
In Proceedings of the Journal of Contemporary Accounting and Economics Symposium 2018 on Special Session for Indonesian Study (JCAE 2018) - Contemporary Accounting Studies in
Indonesia, pages 254-260
ISBN: 978-989-758-339-1
Copyright © 2018 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved

still too dependent on balancing funds transfers from
central government. The flypaper effect indicates
that there is inefficiency of regional expenditure
since the local government’s sensitivity to the
transfer of funds from the central government is still
high, so, that local expenditures are mostly funded
by transfers from the central government, which
means that regional expenditure exceeds the actual
capability of local government, which is reflected in
the PAD. Potential misappropriation by the
government is likely to occur so that the
government’s performance as a driver of governance
needs to be properly guarded. One of the most
important aspects of performance that must be
considered is financial performance, because it
represents the performance of government or
regional capability. In this study, the financial
performance of the region is measured by the
financial ratio approach. The financial performance
measurement approach used in this research is 10
financial ratios used by Galariotis et al. (2016),
which is a development of the Brown (1993) ratio
that was successfully applied in the United States.
This ratio is divided into four categories, namely
revenues composition, costs and expenditures,
financing ability and debt burden, and tax rates.
One aspect of good government performance is
reflected in the maximum collection of local
revenues so that if the PAD is high, the income can
be used to pay loans from external parties. For
regions experiencing the flypaper effect, local
governments prefer central government transfers to
settle their debts, which means that PAD allocation
will be more absorbed for expenditure and cash
reserves so that the funds to pay debts are lower.
Prakosa (2004) shows that there is a flypaper effect
on the implementation of regional autonomy in some
areas so it can be concluded that the dependence of
local government on allocation of funds from central
government is still relatively high. The dependence
of local governments on transfers from the center
may indicate that the financial performance of the
regions is declining. Therefore, this research is done
by categorizing areas experiencing flypaper effect
and areas not experiencing flypaper effect. This
study aims to see the differences in regional
financial performance; in this case it is reflected in
the ratios of those regions that experienced the
flypaper effect and those that did not. This research
was conducted in all regencies and cities in East
Java, considering that East Java has a considerable
area coverage compared to other provinces in
Indonesia. In addition, the PAD of cities and
districts in East Java is relatively high compared to
others in Indonesia.
Based on the background of the problems
described above, the purpose of this study is as
follows: to find out information and empirical
evidence of differences in revenue composition in
areas experiencing the flypaper effect and areas that
are not experiencing the flypaper effect; to know
information and empirical evidence of differences in
cost and expenditure ratio in areas experiencing the
flypaper effect and areas not experiencing the
flypaper effect; to know information and empirical
evidence of differences in financing ability ratio in
areas experiencing the flypaper effect and areas not
experiencing the flypaper effect; and to know the
empirical information and evidence of the difference
of effectiveness ratio in areas experiencing the
flypaper effect and areas not experiencing the
flypaper effect.
Test results show that first, the average revenue
composition differs significantly between areas
experiencing the flypaper effect with those that were
not. Second, the areas not experiencing the flypaper
effect have a greater ability to absorb local revenue
to finance development compared to those
experiencing the flypaper effect. Lastly, the
optimization of development in the areas not
experiencing the flypaper effect is more emphasized
on the ability of the region to collect the potential of
regional income.
2 THEORETICAL
BACKGROUND
The main theory used in this research is agency
theory, with reference to flypaper effect, and the
financial performance of local government. Agency
theory by Jensen and Meckling (1976) illustrates the
existence of a working relationship between
principal (owner) and agent (management). The
existence of separation between ownership by
principal and controlling by agent in an organization
tends to cause an agency problem, where the agent is
responsible to optimize profit or profit of the
principal while, on the one hand, the agent also has
an interest to maximize its own prosperity. In the
public sector, agency theory is used to analyze
principal-agent relationships in relation to public
sector budgeting (Latifah, 2010). The budgeting is
the preparation of a Regional Revenue and
Expenditure Budget (APBD), which is a document
of local government activity plans in the form of
monetary units in a one-year period, generally one
year. APBD consists of budgeted revenue, budget,
and financing budgets. The agency theory in this
budgeting will impact one of them on the central
government’s transfer policy to the local
government.
The Financial Performance Comparison between Local Government with Flypaper Effect and Non-Flypaper Effect - Empirical Study on
East Java Province in 2015
255

The flypaper effect is a condition when the
stimulus to regional expenditures or expenditures
caused by changes in transfer amounts from the
central government is greater than that caused by
changes in local revenue (Oates, 1999). Flypaper
effects in relation to agency theory will further
impact on the performance of local governments.
Local government performance can be both financial
and non-financial performance.
Halim (2007) stated that one of the tools to
analyze the performance of local government in
managing its regional finances is by doing a
financial ratio analysis to APBD that has been
established and implemented. The financial
performance measurement approach used in this
research is the ten financial ratios used by Galariotis
et al. (2016), which is a development of the Brown
(1993) ratio successfully applied in the United
States. This ratio is divided into four categories
covering different dimensions, namely revenues
composition, costs and expenditures, financing
ability and debt burden, and tax rates. Galariotis et
al. (2016) describe the ratios used, namely, the first
revenues composition indicates financial
independence, i.e. how much the ability of the
region’s financial resources is able to build the
region, in addition to being able to compete healthily
with other regions in achieving regional autonomy
without assistance or subsidies from the central
government. Cost and expenditure indicates the level
of sustainability, i.e. the ability to meet budget
obligations without relying on debt. Financing
ability and debt liabilities represents the flexibility of
local governments in meeting debt obligations. The
last dimension used by Galariotis et al. (2016) in
assessing the local government’s financial
performance is to assess the tax rate level. Some
other ratios can be used to measure the financial
performance of local government in addition to the
ratio used Galariotis et al. (2016), and one of them,
according to Halim (2007), is the ratio of
effectiveness. The effectiveness ratio measures the
level of effectiveness to find out whether or not the
achievement of budget goals is achievable.
2.1 Differences of Revenue Composition
in the Region Experiencing
Flypaper Effect and Region Not
Experiencing Flypaper Effect
Communities participate in regional development
through the payment of local taxes and levies.
However, if local governments prioritize
development from general allocation funding
sources, then it will potentially lead to inefficient
PAD excavations with a smaller revenue-
composition ratio. This is in accordance with
research conducted by Tahar and Zakhiya (2011)
stating that PAD has a significant effect on regional
independence. Based on the empirical study above,
the researcher formulated the research hypothesis as
follows:
H1: There is a difference in revenue composition
in areas experiencing the flypaper effect and areas
not experiencing the flypaper effect.
2.2 Differences Cost and Expenditure
Ratio in the Region Experiencing
Flypaper Effect and Region Not
Experiencing Flypaper Effect
Kuncoro (2004) explained that the increase in
transfer allocation was also followed by higher
spending growth. There is an indication that the high
increase in expenditure is due to inefficiency in local
government expenditures, especially routine
expenditures. This long-term trend will result in an
increase in horizontal fiscal inequality. Based on the
empirical study above, the researcher formulated the
research hypothesis as follows:
H2a: There are differences in cost ratio in areas
experiencing the flypaper effect and areas that do
not experience the flypaper effect.
H2b: There is a difference in the expenditure
ratio of the area experiencing the flypaper effect and
the non-flypaper effect area.
2.3 Differences of Cost and Expenditure
Ratio in the Region Experiencing
Flypaper Effect and Region Not
Experiencing Flypaper Effect
Kuncoro (2004) explains that if transfers from the
center are less predictable in the number and time of
their search, local governments will use regional
loans as an alternative to financing their fiscal
operations. These cues need to be wary of lending so
as not to become a burden on the budget in the form
of repayments and interest payments that will reduce
the financial capacity of the region but can be a
driving factor for regional development. Based on
the empirical study above, the researcher formulated
the research hypothesis as follows:
H3: There is a difference in financing ability
ratio in areas experiencing flypaper effect and areas
that is not experiencing flypaper effect.
JCAE Symposium 2018 – Journal of Contemporary Accounting and Economics Symposium 2018 on Special Session for Indonesian Study
256

2.4 Differences of Effectiveness Ratio in
the Region Experiencing Flypaper
Effect and Region Not
Experiencing Flypaper Effect
Areas that are not experiencing flypaper effects will
seek to maximize local revenues to spend their
money so that DAU is used to meet the
shortcomings of PAD. In contrast, areas
experiencing flypaper effects tend to maximize the
acquisition of DAU to finance their regional
expenditures so that PAD is used to meet the
shortcomings of DAU. Based on the empirical study
above, the researcher formulated the research
hypothesis as follows:
H4: There is a difference in the effectiveness
ratio of the area experiencing the flypaper effect and
the area with no flypaper effect.
3 RESEARCH METHODOLOGY
This research is a quantitative research with a
comparative causal approach that aims to analyze
the comparison of one group to another group.
Measurements used in this study are local
government financial performance shown by
revenues composition, cost and expenditures ratio,
financing ability ratio, and effectiveness ratio. The
formulas to calculate the ratios of financial
performance are provided in Table 1. The
measurement variables were used to compare two
independent sample groups that were formed,
namely: the group of regions experiencing the
flypaper effect and group of regions that did not
experience the flypaper effect.
Table 1: The Formula of District Financial Performance
Measurements
Variable Name Formula
Revenue
Composition
= Own Source Revenue/ Total
Revenue
Cost Ratio
= (Administration Expenses –
Employee Expenses)/ Total
Expenses
Expenditure Ratio
= Investment Expense / Total
Revenue
Financing Ability
Ratio
= (Total Revenue-Total
Expenses)/ Total Revenue
Effectiveness
Ratio
= Own Source Revenue
Realization/ Own Source
Revenue Budget
Determination of the area with the flypaper
effect is performed based on the value of coefficient
PAD and DAU on BD in the multiple linear
regression calculations. The area is experiencing a
flypaper effect when the coefficient of DAU is
larger than PAD and is significantly correlated with
BD. The data used in this study is data sourced from
the Financial Statements of Regional Government of
Regency and City in East Java Province, which has
been audited by BPK, from 2011-2015. The
population in this study is all cities and districts in
East Java Province in 2015, comprising 27 districts
and eight cities. The sampling technique used is a
saturated or census sample. The statistical methods
used are descriptive statistics that have a direct
relationship with data collection and data centering
measures as well as the presentation of the results of
the data centering measures.
The normality test in this study is the
Kolmogrov-Smirnov non-parametric statistical test
(K-S). The K-S test is used by creating an
unstandardized residual variable:
is normally
distributed and
is abnormally distributed data. If
the probability α > 0.05
is accepted and if the
probability α < 0.05
is rejected, then accepted
indicates that data is normally distributed (Ghozali,
2006). If after the normality test data is normally
distributed, then the data analysis technique that will
be used to test the hypothesis is an independent
sample t-test. If the data does not show normal
distribution, then the Mann-Whitney U test is used.
4 RESEARCH RESULTS
Table 2 below is the result of Mann-Whitney U test
to test hypothesis 1:
Table 2: Mann-Whitney U Test
Variable N
Mean
Rank
Mann-
Whitney
U Test
Score
Asymp.
Sig
Revenue
Composi-
tion
Non
Flypa-
per
28 19.61
53.000 0.063
Flypa-
per
7 11.57
The Financial Performance Comparison between Local Government with Flypaper Effect and Non-Flypaper Effect - Empirical Study on
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257

Hypothesis 1 (one) states that there are
differences in revenue composition in areas
experiencing flypaper effect and areas not
experiencing flypaper effect. The results showed that
the average revenue composition of areas
experiencing the flypaper effect differed
significantly from regional revenue composition that
did not experience the flypaper effect. The results
showed that areas not experiencing the flypaper
effect have a greater ability to absorb local revenue
to finance development compared to areas
experiencing the flypaper effect. It also shows that
areas not experiencing the flypaper effect optimize
efforts to absorb their own local income, so that the
optimization of development is more emphasized on
the ability of the region to collect the potential of
regional income. This condition is different from the
area experiencing the flypaper effect, which
emphasizes regional development on government
aid fund, one of which is the general allocation fund,
so that efforts to collect local revenue potential are
lessened. Areas experiencing flypaper effects are
more dependent on government grants to finance
development.
Table 3 below is the result for independent
sample t-test to test hypotheses 2a and 2b.
Table 3: Independent T-Test
Variable N
Mea
n
Ra-
nk
T
Score
Asym
p. Sig
Cost
Non
Flypa-
per
2
8
0.26
-0.836 0.428
Flypa-
per
7 0.29
Expendi-
ture
Non
Flypa-
per
2
8
0.20
-0.041 0.969
Flypa-
per
7 0.20
Hypothesis 2a states that there is a difference in
the cost ratio of the area experiencing the flypaper
effect and the area that does not experience the
flypaper effect. The results showed that the average
cost ratio of areas experiencing the flypaper effect
did not differ significantly from the cost ratio of
areas that did not experience the flypaper effect.
This is because the existing areas, whether with or
without a flypaper effect, prioritize administrative
spending as one of the important spending
components in regional development. The results
showed that the area experiencing the flypaper effect
provides a larger portion of administrative
expenditure in addition to personnel expenditures,
i.e. goods and services expenditure, maintenance
expenditure, and official travel expenditure in
regional development, compared to areas not
experiencing the flypaper effect. This is because
operational expenditure is intended for daily
government operations, which in practice are more
funded by central government fund transfers,
resulting in the potential for the flypaper effect.
However, the existing administrative expenses
allocation difference is not large enough to occur
between areas experiencing the flypaper effect and
areas with no flypaper effect.
Hypothesis 2b states that there are differences in
expenditure ratios in areas experiencing the flypaper
effect and areas not experiencing the flypaper effect.
The results showed that the average expenditure
ratio of areas experiencing the flypaper effect did
not differ significantly from the expenditure ratio of
areas that did not experience the flypaper effect.
This is because both the areas experiencing the
flypaper effect and areas not experiencing the
flypaper effect are carrying out investment spending,
which is very important in the process of regional
development. The results show that areas
experiencing the flypaper effect provide a larger
portion of investment spending compared to areas
not experiencing the flypaper effect. This is because
the expenditure of the area experiencing the flypaper
effect spends more of its revenues on capital
expenditure. This statement is supported by Kuncoro
(2004), who states that the increase in transfer
allocation is also followed by higher spending
growth. However, the difference in investment
spending is not large enough between areas
experiencing the flypaper effect with areas not
experiencing the flypaper effect.
Table 4 provides the result of the independent t-
test for the financial ability ratio to test hypothesis 3:
Table 4: Independent T-Test
Variable N
Mean
Rank
T Score
Asymp.
Sig
Financing
Ability
Ratio
Non
Flypa-
per
28 0.10
0.281 0.787
Flypa-
per
7 0.08
JCAE Symposium 2018 – Journal of Contemporary Accounting and Economics Symposium 2018 on Special Session for Indonesian Study
258

Hypothesis 3 (three) states that there are
differences in the financing ability ratio in areas
experiencing the flypaper effect and areas not
experiencing the flypaper effect. The results showed
that the average financing ability ratio of the area
experiencing the flypaper effect did not differ
significantly with the financing ability ratio of the
area that did not experience the flypaper effect. This
is because both the areas experiencing and not
experiencing the flypaper effect equally prioritize
the fulfillment of obligations/debts on external
parties. The results show that areas not experiencing
the flypaper effect have greater ability in fulfilling
their obligations in paying debts. This is because the
potential revenue of native regions in areas not
experiencing the flypaper effect should be higher
than the areas experiencing the flypaper effect. The
potential of existing local revenue will be allocated
to development expenditures and fulfill the debt
obligations held by the regions. The amount of
potential revenue for a region not experiencing the
flypaper effect will encourage the local government
to immediately pay all its debt obligations. However,
the difference in the ability to pay the debt
obligations is very small, so there is no significant
difference in the ability to pay the debt. Areas
experiencing the flypaper effect will fulfill their debt
obligations through grant allocations, granted by the
government. The areas experiencing the flypaper
effect will attempt to increase the payment of their
debt obligations through the grant funds provided,
resulting in the expectation of obtaining additional
grant funds in the future.
Table 5 shows the independent t-test for testing
hypothesis 4:
Table 5: Independent t Test
Variable N
Mean
Rank
T Score
Asymp.
Sig
Effectiveness
Non
Flypa-
per
28 0.89
-0.647 0.526
Flypa-
per
7 0.91
Hypothesis 4 (four) states that there is a
difference of effectiveness ratio in areas
experiencing the flypaper effect and areas not
experiencing the flypaper effect. The results showed
that the average ratio of effectiveness of areas
experiencing the flypaper effect did not differ
significantly from the effectiveness ratio of areas
that did not experience the flypaper effect. This is
because both areas are trying to achieve the target
revenue of the original region because, in addition to
being very important for development, high PAD
can also be a surplus for local government. The
results show that areas experiencing the flypaper
effect have a greater ability to absorb local revenue
to finance development compared to areas not
experiencing the flypaper effect. In addition, the
areas experiencing the flypaper effect have greater
capability and effort to achieve the original revenue
target area that has been determined. This is because
the area experiencing the flypaper effect targets the
relatively small revenue of the region to the total
income compared to the non-flypaper effect area
because the local government that does not
experience the flypaper effect puts more emphasis
on the optimization of development by using the
regional capability in collecting the potential of
regional income. As a result, the area tends to set
PAD revenue targets that are too high to have a
heavier load in realizing it compared to areas
experiencing the flypaper effect.
5 CONCLUSION
Based on the results of the research discussions that
have been described previously, the following
conclusions can be made:
1. Test results and analysis show that the average
revenue composition of areas not experiencing the
flypaper effect is greater than that of areas not
experiencing the flypaper effect and significantly
different.
2. Test results and analysis show that the average
cost ratio and expenditures ratio of areas
experiencing the flypaper effect are greater than
areas not experiencing the flypaper effect and do not
differ significantly.
3. Test results and analysis show that the average
financing ability ratio of areas not experiencing the
flypaper effect is greater than in areas experiencing
the flypaper effect and does not differ significantly.
4. Test results and analysis show that the average
ratio of effectiveness of areas experiencing the
flypaper effect is greater than is the case for areas
not experiencing the flypaper effect and does not
differ significantly.
Not all local government financial reports in East
Java that have been audited by the Supreme Audit
Agency are available in accordance with the sample
period used in this study. It is expected that further
research will be able to further explore the variables
and other measurements and use financial statements
The Financial Performance Comparison between Local Government with Flypaper Effect and Non-Flypaper Effect - Empirical Study on
East Java Province in 2015
259

spanning a longer period in order to obtain more
significant difference results between one group and
another group.
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