Unveiling the Hidden Risks of Government Subsidy Reliance: Evidence from Stock Price Crashes

Abstract

We develop a novel index to quantify the extent to which firms' key operations—such as investment, operating efficiency, innovation, and liquidity—depend on government subsidies received in a fiscal year. Analyzing data from Chinese listed firms from 2007 to 2021, we find that a one percent increase in this index is associated with a 2.6% increase in ex-post stock price crash risk. This effect is significant across government subsidies, except for tax rebates. To address endogeneity concerns, we employ a DID approach, leveraging China's anti-corruption campaign, which mitigates the observed relationship, and an IV approach, using proximity to subsidy-allocating offices and city-level fiscal capacity as instruments that drive the relationship. Additionally, the effect is most pronounced in financially constrained firms and those with lower institutional holdings. We confirm the robustness of these findings through alternative variable definitions, estimation methods, and sample criteria. Channel analysis further identifies information disclosure quality and operational risk intensity as key mechanisms underlying the observed relationship. These findings reveal the hidden risks of government subsidies in relation to stock price crashes, offering practical and policy insights for managers of subsidy-dependent firms.

Keywords: government subsidy, information disclosure, operational 28 risk, crash risk