Is the squeaky wheel getting the grease? Earnings management and government subsidies

We study the impact of earnings management on government subsidies using a sample of China's utility firms. Our findings suggest that negative earnings management is associated with increased government subsidies, especially for policy subsidies with the goal of helping weak firms and high government discretion in target selection. The findings are robust to a battery of alternative variable definitions and estimation methods. We further observe that perk consumption, empire building, and promotion may be the three motivations for managers engaging in earnings management. Incentive compensation increases the cost of understating income while rent seeking and political connections can substitute for earnings management in obtaining subsidies; thus, the above results hold only for firms with no incentive compensation, low rent seeking, or no political connection. Effective external monitoring can reduce managers' misbehavior, so the positive effect is not significant for strong monitoring firms. Moreover, negative earnings management will reduce firm profitability and destroy firm value in the future, while improving social performance in hiring more employees and paying more taxes, which could impair firm profitability.