Does Local Government Financing Vehicle Shareholding Affect Corporate Earnings Management?

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Abstract
Emerging economies grapple with a structural tension between subnational infrastructure investment demands and long-term fiscal sustainability. China’s unique institutional innovation resides in the paradigmatic transformation of Local Government Financing Vehicles (LGFVs), subnational fiscal entities that have evolved from traditional off-budget financing instruments into sophisticated equity market participants with strategic ownership stakes in listed firms, thereby reshaping the state-market boundary. Using a comprehensive panel dataset of A-share listed firms on the Shanghai and Shenzhen Stock Exchanges (2009–2021), we document that LGFVs shareholding exerts a significant disciplinary effect, constraining both corporate accrual-based and real earnings management. Mechanism tests propose a novel dual-channel framework, showing that LGFVs shareholding concurrently improves resource provision by mitigating financial distress incentives and enhances corporate governance through strengthened monitoring capabilities. Heterogeneity analyses further reveal that the governance effect of LGFVs shareholding on corporate earnings management is particularly salient for LGFVs with higher administrative ranks or concentrated minority ownership, while the impact is attenuated among state-owned firms and high-performing firms. Our empirical findings highlight that market-embedded LGFVs represent a distinct institutional archetype, innovatively integrating developmental state objectives with capital market discipline while upholding rigorous financial disclosure standards.

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