Do Government Subsidies Affect 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, 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.