Government Subsidies and Corporate Fraud
59 Pages Posted: 13 Sep 2017 Last revised: 19 Dec 2018
Date Written: December 19, 2018
I study the relation between firms' receipt of significant subsidies in their home states and their subsequent propensities to engage in financial fraud. Firms that receive subsidies are likely to have greater influence over the lawmakers who award these subsidies, relative to nonrecipient firms, but may also be subject to higher external scrutiny. I find that firms receiving tax breaks -- but not cash grants -- tend to engage in fraud more frequently relative to nonrecipient firms. Additionally, there is no relation between fraud and subsidies received in other states, even though those subsidies are similar in other respects; only firms' home-state subsidies are associated with higher levels of corporate fraud, consistent with lower enforcement intensity as a result of capture. I also show that the relation between targeted subsidies and fraud is mitigated in the presence of high third-party interest, measured using Google search volume intensity; counterfactual analysis suggests that a 1% increase in subsidy scrutiny would be associated with a roughly 1.3% decrease in fraud by subsidized firms. My findings provide insight into the relation between subsidies and financial fraud, suggesting that recent recommendations by standard-setters for additional subsidy disclosures by both governments and firms provide useful information to policymakers and investors.
Keywords: subsidies, fraud, regulatory capture
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