Do Government Subsidies Affect Income Smoothing?

64 Pages Posted: 31 Oct 2017 Last revised: 28 Jul 2020

See all articles by Kostas Pappas

Kostas Pappas

University of Liverpool - Accounting and Finance Division

Martin Walker

University of Manchester - Manchester Business School

Liang (Alice) Xu

University of Manchester - Manchester Business School

Cheng Zeng

University of Manchester; Hong Kong Polytechnic University

Date Written: July 27, 2020

Abstract

This study examines the relationship between government subsidies and income smoothing using a sample of US listed firms. We find that subsidized firms smooth their earnings more aggressively than their unsubsidized peers, consistent with firms that receive subsidies bearing higher political costs and having more incentives to smooth earnings to avoid public attention. Smoothing by subsidized firms is more pronounced when the subsidies are granted through non-tax-related channels than tax-based channels, and for firms with more opaque information environments. In addition, smoothing by subsidized firms reduces the ability of current earnings to predict future cash flows. Using textual content analysis, we find that the MD&As of subsidized firms provide less explanatory content to explain accruals, consistent with smoothing being used to obfuscate earnings. Overall, our results shed light on how government subsidies shape the accounting and disclosure choices of firms.

Keywords: Income smoothing; Subsidies; Political cost; Textual analysis

JEL Classification: H70, M41, M48, G38

Suggested Citation

Pappas, Kostas and Walker, Martin and Xu, Liang (Alice) and Zeng, Cheng, Do Government Subsidies Affect Income Smoothing? (July 27, 2020). Available at SSRN: https://ssrn.com/abstract=3061933 or http://dx.doi.org/10.2139/ssrn.3061933

Kostas Pappas

University of Liverpool - Accounting and Finance Division ( email )

Liverpool
United Kingdom

Martin Walker

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Liang (Alice) Xu

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Cheng Zeng (Contact Author)

University of Manchester ( email )

Oxford Road
Manchester, M13 9SS
United Kingdom

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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