From Lapdogs to Watchdogs: Random Auditor Assignment and Municipal Fiscal Performance (WP-22-48)
Silvia Vannutelli
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. Vannutelli evaluates whether limiting auditors' conflicts of interest improves effectiveness and affects the financial health of local governments. She exploits the staggered introduction of a reform that removed the control of auditors' appointment from local politicians and introduced a random assignment mechanism. She obtains four main findings. First, random matching severs 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.