From Lapdogs to Watchdogs: Random Auditor Assignment and Municipal Fiscal Performance in Italy

Abstract: Monitoring is a common tool used to mitigate agency problems. Monitors themselves, however, may be biased or corrupt, in particular if they feel obliged to please the party that appoints them. In this paper, I evaluate whether shifting control over auditor assignments improves monitoring effectiveness and impacts outcomes of the audited party. In 2011, Italy switched from allowing mayors to appoint municipal auditors to a system of random assignment, to strengthen oversight and ensure the financial soundness of municipal budgets. My identification exploits the reform's staggered introduction across municipalities in a generalized difference-in-differences setting. I obtain three main findings. First, treated municipalities increase their net surpluses by 9\% and debt repayments by 8\%, in accordance with national government objectives. Second, the improvement is achieved through revenue-based consolidation, rather than by cutting expenditures. Third, treatment effects are significantly larger for municipalities that were more at risk of collusion before the reform, and for those that are matched to a more distant or less connected auditor. Taken together, these findings provide novel quantitative evidence on the importance of independence in auditing, and highlight the improvement in outcomes that may result from changes in the design of monitoring institutions.