From lapdogs to watchdogs : random auditor assignment and municipal fiscal performance

Author / Creator

Vannutelli, Silvia

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Online

Summary

A classic problem in public finance is the over-expenditure of local governments in expectation of a bailout from higher-level administrations. While monitoring could mitigate agency problems, it c...

A classic problem in public finance is the over-expenditure of local governments in expectation of a bailout from higher-level administrations. While monitoring could mitigate agency problems, it can itself be rendered ineffective if auditors are corruptible. I evaluate whether limiting auditors' conflicts of interest improves effectiveness and affects the financial health of local governments. I exploit the staggered introduction of a reform that removed the control of auditors' appointment from local politicians and introduced a random assignment mechanism. I obtain four main findings. First, random matching severes auditors-mayors connections. Second, treated municipalities significantly improve their net surpluses and debt repayments, per national government objectives. Third, the fiscal improvement results from a sizeable increase in tax capacity. Fourth, treatment effects are a combination of selection, matching and incentive effects. These findings highlight the value of auditor independence and illustrate how changes in the organizational design of the state can improve government performance.

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