Local government audit and municipal debt risk: Evidence from audit reform in China

The high level of local government debt surged during the past years and became a serious policy concern in China. This paper provides evidence supporting the positive effect of local government audits on municipal debt risk. Using the 2015 audit reform in China as a shock to the indepen-dence of local government auditors, we find that audits significantly decrease local government over-debts. The effect is more pronounced when local officials face stronger promotion motiva-tion and severer soft budget constraints. Further, the role of local government audits in mitigating municipal debt risk depends on the legal environment and provincial government bureaucracies.