Government Subsidies and Income Smoothing

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. This finding is consistent with the reasoning that
subsidized firms bear higher political costs and have more incentives to smooth earnings to
avoid public attention. In addition, smoothing by subsidized firms is more pronounced when
the subsidies are granted through non-tax-related channels than through tax-based channels,
and the positive association between government subsidies and income smoothing is stronger
for firms under higher public scrutiny and with less transparent information environments.
Further analysis shows that smoothing by subsidized firms serves mainly to obfuscate earnings
and subsidized firms that smooth earnings tend to continue receiving subsidies in the future.
Overall, our results help explain the role of government subsidies in shaping firms’ accounting
and disclosure choices.

Keywords: Income smoothing; Subsidies; Political cost; Obfuscation

JEL Classification: H70, M41, M48, G38