From lapdogs to watchdogs: Selecting monitors in multi-layered organizations

A fundamental challenge in any hierarchy is aligning incentives across layers. While monitoring can mitigate agency problems, it may itself be rendered ineffective if monitors are corruptible. In this paper, I evaluate the consequences of changes in the design of monitoring institutions for organizational performance. I exploit the staggered introduction of a reform that removed the control of municipal auditors' appointments from local politicians and introduced a random assignment mechanism. I obtain four main findings. First, random matching severs auditorsmayors connections. Second, treated municipalities significantly and persistently improve their net surpluses and debt repayments, in line with national government objectives. Third, the fiscal improvement results from a sizeable increase in tax capacity. Fourth, 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. These findings highlight the value of monitors' independence and illustrate how changes in organizational design can substantially improve governance.