Accounting Conservatism and Key Firm Stakeholders
Suppliers and Customers’ Influence on Accounting Practices
A firm’s important long-term corporate suppliers and corporate customers look to the firm’s accounting performance to assess its long-term financial viability and the risk of making investments into their relationship with the firm. For instance, a supplier involved in a long-term transaction with a firm might make investments so that it can produce specific products for the firm, while a customer involved in a long-term transaction may tailor its production technology to process products purchased from the firm. If the firm were to go out of business, the supplier and customer could face large costs as a result of the investments made into their relationships with the firm.
Suppliers and customers that have important business relationships with a firm that involve multi-year maintenance contracts and contracts involving the sale of spare parts will also look to the firm’s accounting performance to evaluate the risk that the firm might go bankrupt. For example, a supplier could be concerned with whether the firm can continue providing it with revenue from multi-year maintenance contracts on the products it sells to the firm, while a customer might be worried about whether the firm can provide it with continued high quality spare parts and service for the products it buys from the firm.
The authors predict that the importance of a firm’s accounting performance for its suppliers and customers leads to a demand from these stakeholders for the firm to have more accounting conservatism when it reports its accounting performance, where accounting conservatism is measured by the extent to which a firm makes quicker adjustments to its accounting numbers in response to bad news versus good news. For instance, a firm’s customers and suppliers would prefer that it quickly adjusts downward its earnings numbers if its sales numbers were to suddenly drop, but they would be less concerned with the firm quickly adjusting its earnings numbers upward if the firm’s sales were to suddenly increase. The reason that it is important for a firm’s suppliers and customers that it quickly adjusts its accounting performance numbers downward in response to negative news is that this makes it easier for suppliers and customers to use the firm’s accounting numbers to assess the risk the firm might go out of business and that it would consequently be risky to conduct business with the firm.The authors expect that a firm only meets the underlying demand for accounting conservatism from its suppliers or customers when these stakeholders have bargaining advantages over it that allow them to dictate terms of trade or whether trade occurs at all. Using a number of different measures that proxy for the bargaining power of a firm’s suppliers and customers they find that when suppliers and customers have more bargaining power over a firm it has more accounting conservatism when it reports its accounting performance. Overall, their results suggest that a firm’s accounting practices are impacted by the extent to which the firm has suppliers and customers that have bargaining power over it.
Kai Wai Hui is with the Hong Kong University of Science and Technology. Sandy Klasa is an associate professor of finance and the Brun Family Foundation Fellow with the Eller College of Management, University of Arizona. Eric Yeung is with the University of Georgia.
Forthcoming in the Journal of Accounting and Economics.