Description:

Silvia Vanutelli (Boston University) - "Monitoring and Local Governance: Evidence from Italy"

Abstract: Monitoring by external auditors is a ubiquitous practice in complex organizations. Frequently, the audited entity appoints the external auditor. While locally-appointed auditors might have better local knowledge, leaving discretion in the hands of the audited party might impair monitoring quality. In this paper, I exploit a unique setting which allows me to evaluate this trade-off in the context of auditing of municipal budgets of local governments. In 2011, Italy introduced a reform that removed the discretion of the appointment of municipal auditors from mayors and introduced a random-assignment system. The objective of the reform was to strengthen monitoring and ensure fiscal sustainability of municipal budgets. I study the consequences of increased monitoring on public finance outcomes of local governments. My identification exploits the staggered introduction of the reform across municipalities in an event-study setting. I obtain three main findings. First, the reform greatly increased compliance with fiscal rules: treated municipalities increase their surpluses by 20% and their debt repayments by 2%. Second, improvements largely come from municipalities in which the mayor had control of the appointment of the previous auditor and from those local governments that were running deficits before the reform. Third, the improvement in compliance with fiscal rules comes at a cost: treated municipalities significantly cut investment expenditures by over 7% and increase local taxes by 8%.