"If you make the conquered city a puppet state, you gain the benefit of the city's research and its output of gold, while taking a much smaller hit to your citizen's happiness."
Few things in Civ V caught me as much off guard as that one line in the manual. I went through the entire industrial era, and part of the modern era, with my economy crippled due to my lack of understanding of puppet states.
I had conquered my Chinese neighbors as my civ entered the industrial age. I had nine cities of my own, and four puppet states (formerly the Chinese nation.) When I reached the industrial age, I was very disappointed to see that I had no coal available in my borders. However, there was a nice deposit right across the border in the United States. Only one answer: invade!
So invade I did. And I took over five of his cities (made into puppet states) in a protracted war that decimated my treasury... but at least I got that coal! Build me a mine, and figure out where to use it. Hey, 7 coal from one mine? Great! It's factory time.
Now here's where things went from bad to worse. You see, puppet states will build whatever they want. Except units. And you still have to pay maintenance on what they build. I didn't understand this, so I just ignored them. I figured, like the manual said, I would enjoy their gold and science and let them do what they wanted.
One of the things it turns out they wanted... to build factories. Five of the puppet states built factories, not only using 5/7 of my coal, but also allowing them to build more worthless treasury draining buildings over the years.
Thank goodness I posted here on Ploy and got some great answers to help resolve this. Only after systematically switching my puppet states to regular cities did I discover how much they had screwed me over.
Once I fixed that issue, my economy took off... however, my building maintenance was over 500 gold per turn (unit and tile combined was only 350) so the damage was done. I still managed a space race victory in 2037, but I can only wonder how I'd have done without those vampire states. A valuable lesson learned...
The manual should be more specific. An occupied city without a courthouse has a -5 happiness penalty (Prince difficulty). Building a courthouse will elimiate this penalty entirely; the city will function otherwise as if you had built it. Making it a puppet state will provide no benefits other than avoiding the process described above.