Supply Chain Power and Real Earnings Management: Stock Market Perceptions, Financial Performance Effects, and Implications for Suppliers

Abstract

This study examines supply chain power in the context of real earnings management (REM), instances in which executives execute (or forego) operations transactions for the sole purpose of meeting or beating earnings targets. We examine whether powerful major customers in supply chains exploit their positions to engage in REM to a greater degree than less powerful firms. We also examine (1) whether the stock market reacts differently to major customers’ and nonmajor customers’ REM, (2) whether any difference exists between major customers’ and nonmajor customers’ post‐REM financial performance, and (3) how suppliers are impacted by their major customers’ REM behavior. Results suggest that major customers exploit their supply chain power to engage in more REM. In contrast to the skeptical stock market reaction when other firms engage in REM, we find no evidence that major customers’ earnings are discounted when there is evidence of REM. Instead, the market appears to interpret major customers’ behavior as “legitimate” uses of power in supply chain management, rather than REM typically considered to be value‐destroying. Further, we find that in post‐REM periods, major customers that engage in REM exhibit better operating cash flow performance than nonmajor customers who do so. These findings suggest that the consequential costs of REM are lower for major customers than for nonmajor customers. Finally, we report evidence that the particular form of major customers’ REM appears to determine the impact on their suppliers. Suppliers’ financial performance deteriorates when major customers’ REM entails discretionary expense cuts. These findings offer new insights into the benefits and uses of power in supply chain relationships, in a previously unexplored context. We discuss the implications of the findings for future research.

Impact of financial risk on supply chains: a manufacturer-supplier relational perspective

“…Financial performance between different supply chain stakeholders is well explored (e.g. Shi and Yu 2013;Kim and Henderson 2015;Wandfluh, Hofmann, and Schoensleben 2016); however, the influence of financial risk on supply chain stakeholders is critical for understanding their negative influence on the overall performance of the supply chain (Lanier, Wempe, and Swink 2019). Individual stakeholders' financial circumstances influence supply chain relationships, performance and decisions.…”

Major customer network structure and supplier trade credit

“…Using the partial differential equation, Atalay et al (2011) show that the suppliers' cost of goods sold ratio of the customers in the major customer relationships has no distribution bias, indicating that suppliers are sampled evenly from the customers' perspective. Prior studies have also constructed a major customer network using a similar approach (Ak and Patatoukas, 2016; Su et al , 2020; Lanier et al , 2019).…”

“…We construct a longitudinal database with 1,211 firms from 1998 to 2013 using financial data of US public firms from Compustat. To measure structural embeddedness in the major customer network, we use the customer segment data from Compustat to construct supply networks consisting of major customers following recent studies (Kim, 2017; Lanier et al , 2019; Kao et al , 2019; Su et al , 2020). Using fixed effect panel regression, we show that structural embeddedness in major customer networks has differing impacts on supplier trade credit.…”

Competitive sustainability and stakeholder engagement: Exploring awareness, motivation, and capability

“…These 3,087 cases correspond to 4,386 major customer firm‐year observations, of which 2,682 are unique major customer firm‐years. Following the work of Lanier Wempe, and Swink (2019), this study employs a control sample of major customer firms' nonmajor customer industry year counterparts. We also considered the length of the relationship within our sample.…”