Does Fiscal Monitoring Make Better Governments? Evidence from US Municipalities

Abstract

I study the effect of state fiscal monitoring on municipal governance. I focus on governance outcomes related to financial reporting quality, local corruption, political entrenchment, and the financial soundness of municipalities. I exploit the staggered adoption of fiscal monitoring policies, which entail a regular review of municipal financial reporting for signs of fiscal distress. I find that the introduction of monitoring policies is associated with an increase in proxies for reporting quality, a decrease in corruption convictions, and a reduced likelihood of reelection of incumbent politicians. Consistent with the intended purpose of state monitoring, I find evidence consistent with the financial health of municipalities improving following the initiation of state monitoring, as measured with financial statement-based ratios. Collectively, my results are consistent with state fiscal monitoring improving several important aspects of municipal governance.