Product Market Competition and Shareholder Rights: International Evidence

This paper examines the interaction between product market competition and international differences in shareholder rights in relation to firm performance and corporate policies. In contrast to existing literature, we provide evidence of complementarities between product market competition and country shareholder rights protections. The benefits of shareholder rights protections for firm performance are conditional on the presence of a competitive industry environment. We find that stronger shareholder rights protections are associated with better firm performance in competitive industries. However, this relation is not significant in concentrated industries. Consistent results are obtained from the analysis of key corporate policies.     

Cultural tightness and accounting conservatism

This study investigates the effect of intrastate cultural tightness-looseness (CTL) on accounting conservatism, using firms located in 50 states of the United States, from 1988 to 2016. It finds that firms located in culturally tight states prefer to take a cautious approach to reduce uncertainty of future economic events by increasing accounting conservatism compared to those located in culturally loose states. Moreover, we find that the positive effect of cultural tightness on accounting conservatism is more pronounced as product market competition increases. Taken together, our findings provide evidence that intrastate CTL has differential impacts on accounting conservatism in the same national culture, and product competition strategically reinforces the positive effect of CTL on accounting conservatism.     

Managerial myopia and the unintended real consequences of conditional conservatism

We examine whether the demand for conditional conservatism produces unintended real consequences that are exacerbated by managerial incentives to report higher earnings. We document a robust positive association between conditional conservatism and real earnings management (REM), particularly for firms whose CEOs face greater compensation incentives and capital market incentives to report higher earnings. Using mediation analyses, we find that conservatism has a negative indirect relation with future returns via REM over the next 1–3 years. In additional tests, we find that the relation between conservatism and REM is attenuated for firms with higher debt-to-equity, which suggests that debtholders moderate the negative relation between conditional conservative reporting and REM. Our findings suggest that, in contrast to its monitoring benefit, conditional conservatism can exacerbate managerial myopia, resulting in negative consequences for future firm value.     

Conditional accounting conservatism and future negative surprises: An empirical investigation

We investigate whether conditional accounting conservatism has informational benefits to shareholders. We find some evidence that higher current conditional conservatism is associated with lower probability of future bad news, proxied by missing analyst forecasts, earnings decreases, and dividend decreases. Second, we find weak evidence that the stock market reacts stronger (weaker) to good (bad) earnings news of more conditionally conservative firms. Thus, we provide additional evidence that conditional conservatism affects stock prices.     

Financial Distress and the Earnings‐Sensitivity‐Difference Measure of Conservatism

Following Basu (1997 ), the difference between the sensitivity of accounting earnings to negative equity return (proxy for bad news) and its sensitivity to positive equity return (proxy for good news) is interpreted as an indicator of conditional accounting conservatism. However, there is concern that the earnings‐sensitivity difference (ESD) may be affected by factors other than conditional conservatism, and that this may impair its reliability as an indicator of conditional conservatism. Motivated by such concerns and by recognition that financial distress could contribute to an ESD through a conditional‐conservatism route and/or through a non‐conditional‐conservatism route, we examine the association between financial distress and the ESD for U.S. non‐financial firms. By decomposing the association into an element arising from accruals, which can reflect conditional conservatism, and an element arising from cash flow from operating activities (CFO), which cannot directly reflect conditional conservatism, we seek evidence as to whether such association arises through a conditional‐conservatism route or through a non‐conditional‐conservatism route. We find that positive association between financial distress and the ESD arises predominantly through the accruals component of earnings rather than the CFO component, consistent with it arising primarily because of a higher degree of conditional conservatism in relatively financially distressed firms. The inference that there is a positive association between financial distress and conditional conservatism is supported by other non‐equity‐return‐based measures of conditional conservatism. The evidence in this paper suggests that the effect of financial distress does not significantly impair the reliability of the ESD as an indicator of conditional conservatism.     

Accounting conservatism and voluntary corporate governance mechanisms by Australian firms

This study examines the relationship between voluntary adoption of selected corporate governance mechanisms and accounting conservatism for a sample of firms listed on the Australian Securities Exchange (ASX) over the 11‐year period prior to the promulgation of the ASX Corporate Governance Council Good Governance Principles and Best Practice Recommendations in 2003. Using four accounting and market‐based accounting conservatism measures, our results provide evidence of both conditional and unconditional conservatism in accounting reporting for Australian firms. We find that voluntary audit committee formation, increasing board independence and decreasing board size are positively associated with unconditional accounting conservatism and negatively related to the degree of conditional conservatism. Our results support the contention that firms voluntarily adopting perceived best practice corporate governance mechanisms employ unconditional accounting conservatism as a complimentary agency control device and are consistent with the observed negative association between the unconditional and conditional forms of accounting conservatism practice.     

Product market competition,competitive strategy,and analyst coverage

This paper examines how product market competition and strategic interactions among peer firms influence analyst coverage. First, we hypothesize that product market competition increases both the demand and supply of analyst coverage. Using three variations of industry concentration ratios and a firm specific measure of competition, we test and find a positive and significant effect of market competition on analyst coverage. Second, we explore an information transfer channel through which product market affects analyst coverage. We hypothesize that information flows more freely among firms selling similar products. Such information flows lowers analyst information collection and processing costs, which in turn increases analyst coverage. Using product similarity index developed by Hoberg and Phillips (J Polit Econ 124(5):1423–1465, 2016) to capture the effect of information transfer, we find that analyst coverage increases with product similarity. Third we examine the role of competitive strategy in analyst coverage. We split our sample into markets of strategic complements and strategic substitutes. We find that the effect of market competition and analyst coverage is more pronounced in markets where firms compete as strategic complements.     

The effect of supplier industry competition on pay-for-performance incentive intensity

We examine how supplier industry competition affects CEO incentive intensity in procuring firms. Using Bureau of Economic Analysis data to compute a weighted supplier industry competition measure, we predict and find that higher supplier competition is associated with stronger CEO pay-for-performance incentive intensity. This effect is incremental to that of the firm's own industry competition previously documented and is robust to alternative measures of supplier competition and to exogenous shocks to competition. Importantly, we show that performance risk and product margin act as mediating variables in the relation between supplier competition and CEO incentive intensity providing support for the theory underpinning our finding. We document that CEO compensation contracts are used as a mechanism to exploit the market dynamics of upstream industries to a firm's benefit. Our findings are economically important as suppliers provide, on average, 45 percent of the value delivered by procuring firms to the market (BEA, 2016).     

Asset specificity and conditional accounting conservatism

Asset specificity, the redeployability of an asset to alternative uses, is a key determinant of an asset's resale value. Asset specificity has a direct impact on a firm's ongoing fair value determination, bankruptcy risk, liquidation value, and abandonment option. We document a significant negative association between asset specificity and conditional conservatism. Further tests reveal that this inverse relation manifests as bad news being less quickly incorporated in earnings as asset specificity increases. We find no difference in the extent to which good news is delayed in earnings for firms conditional on asset specificity. In addition, the documented association is stronger when asset specificity arises from lower within‐industry acquisition activity. The association is also more pronounced for firms that are in less competitive industries, have institutional investors, have limited access to the public debt market, and/or have more unsecured debt. Our findings are noteworthy for regulators and researchers given the recent interest in the determinants of conservatism.     

Conditional conservatism and labor investment efficiency

Prior literature documents that asymmetric timely recognition of losses versus gains (also known as conditional conservatism) can induce management to make more efficient investment decisions by mitigating information asymmetry between management and investors and providing early signals about the profitability of projects that are undertaken. In this paper, we investigate the impact of conservatism on an important investment decision that has been overlooked, namely, investment in labor. We find that conservatism is negatively associated with labor investment inefficiency; more specifically, conservatism reduces inefficient investment practices on the labor market, including over-hiring, under-firing, under-hiring, and over-firing. Our results hold after controlling for managerial ability, corporate governance, and other investments.     

Employee‐friendly practices,product market competition and firm value

In this paper, we examine whether employee‐friendly practices are associated with product market competition, and whether firm value is related to employee‐friendly practices and product market competition. Using a large sample of US firms, we find positive and significant associations between employee friendliness and product market competition, and between firm value and employee friendliness when product market competition is high, consistent with the value creation theory. Both positive relations hold when we account for corporate governance. In addition, using the list of Fortune's ‘100 Best Companies to Work For’ as an alternative measure of employee‐friendly policies, we find firms in more competitive industries are more likely to treat their workers favourably. Furthermore, we find that the market reaction is more positive when firms in more competitive industries are selected for the Fortune list.     

Does banking deregulation affect accounting conservatism?

This study examines the effect of banking competition on borrowing firms’ conditional accounting conservatism (i.e., asymmetric timely loss recognition). The context of the study is the staggered passage of the Interstate Banking and Branching Efficiency Act (IBBEA), the deregulation that permits banks to establish branches across state lines and increases bank competition. I find that firms report less conservatively after the passage of the IBBEA in their headquarter states. The effect on conditional conservatism is stronger for firms in states with a greater increase in competition among banks, firms that are more likely to borrow from in-state banks, firms with greater financial constraint, and firms subject to less external monitoring. Additional tests confirm that the decline in conditional conservatism is observed only after the adoption of IBBEA and lasts for two years. The findings indicate that banks tend to “lowball” borrowers when competition arises by relaxing their demand for conservative reporting. Overall, this study highlights the unintended impacts of banking competition on borrowing firms’ financial reporting.     

Agency problems,product market competition and dividend policies in Japan

This study investigates whether product market competition reduces agency problems between controlling shareholders and minority shareholders in Japan. In particular, we examine firms’ dividend policies in competitive versus concentrated industries. In a large sample of Japanese firms, we find that firms in more competitive industries pay more dividends, are more likely to increase dividends and are less likely to omit dividends. Furthermore, the impact of firm‐level agency problems on dividend payouts is weaker in highly competitive industries. The results suggest that product market competition can be an effective industry‐level governance mechanism that can force managers to disgorge cash to outside investors.     

Product market competition,ultimate controlling structure and related party transactions

Previous studies have shown that product market competition has an important effect on corporate strategies and internal governance mechanisms. Using a sample of China’s listed firms from 2004 to 2009, we explore the relationship between product market competition and normal related party transactions and find a significant positive relationship. In addition, we investigate the substitutive effect of product market competition and the cash flow rights owned by ultimate controlling shareholders on the extent of normal related party transactions. In particular, our results suggest a positive relationship between the ultimate controlling shareholders’ cash flow rights and normal related party transactions that is strongest in noncompetitive industries and weakens as product market competition increases.     

Is there a dark side of competition? Product market competition and auditor-client contracting

This study establishes the informational value of a company's product market competition, derived from qualitative nonfinancial disclosures, in the audit contracting process. Greater product market competition could either serve as means of mitigating agency costs between managers and shareholders or heightening managerial rent-seeking activities and the incentive to distort disclosures. Consequently, greater competition could either increase or decrease audit engagement risk. We find that greater product market competition is associated with greater engagement risk. Auditors respond to the higher risk by assessing greater audit fees. Although auditors respond by charging higher fees and dedicating greater effort to these engagements, we nonetheless find that audit quality is negatively affected by greater competition. Our findings are consistent with the dark side hypothesis of product market competition. Overall, our study provides evidence that company-level competition effects convey valuable information to auditors.     

Multidimensional Competition and Corporate Disclosure

In this paper, we argue that the influence product market competition exerts on disclosure is defined by the combined effect of the incentives and disincentives to disclose raised by the multiple competition dimensions. We distinguish between firm‐ and industry‐level competition measures, and we hypothesize that the former raises agency and proprietary costs, whereas the latter creates incentives to disclose either to fulfil the owners’ need for information to monitor managers or to deter the entrance of new competitors in the industry. Our research design allows for non‐monotonic relationships between competition and disclosure as well as for interactions between competition dimensions. Using a sample of US manufacturing companies, we gather evidence that is consistent with our hypotheses. First, we find an inverted U‐shape relationship between corporate disclosure and a firm's abnormal profitability, which is suggestive of firms being reluctant to disclose when they are underperforming (outperforming) their rivals because of the fear of unveiling agency conflicts (raising proprietary costs). Second, we observe a U‐shape relationship between corporate disclosure and industry profitability, although this U design evolves to approximate a rising function as the protection provided by entry barriers increases.     

Conditional conservatism and cost of capital

We empirically test the association between conditional conservatism and cost of equity capital. Conditional conservatism imposes stronger verification requirements for the recognition of economic gains than economic losses, resulting in earnings that reflect losses faster than gains. This asymmetric reporting of gains and losses is predicted to lower firm cost of equity capital by increasing bad news reporting precision, thereby reducing information uncertainty (Guay and Verrecchia 2007) and the volatility of future stock prices (Suijs 2008). Using standard asset-pricing tests, we find a significant negative relation between conditional conservatism and excess average stock returns over the period 1975–2003. This evidence is corroborated by further tests on the association between conditional conservatism and measures of implied cost of capital derived from analysts’ forecasts.     

Product market competition and earnings management: A firm‐level analysis

In this paper, we employ a firm‐level measure of product market competition constructed from the textual analysis of firms’ 10‐K filings to examine the relationship between managers’ perceived competition pressure and earnings management. We find that accounting irregularities and accrual‐based earnings management are positively related to product market competition. This finding is consistent with the notion that competition pressure increases managerial incentives to manage earnings, due to their career concerns. We also find that real earnings management is negatively related to product market competition. This finding suggests that real earnings management involves actions that decrease firms’ competitiveness and thus is costly for firms confronted with high competition pressure.     

Product market competition and analyst forecasting activity: International evidence

In this study, we investigate how product market competition affects the extent of analyst following and the properties of analyst forecasts. Using a broad sample of firms from 37 countries over the 1990–2008 period, we find that firms that operate in more concentrated industries and with stronger pricing power are associated with greater analyst following, higher forecast accuracy, and lower forecast dispersion. Moreover, the effect of product market power on analyst following and forecast properties is more pronounced in countries with less effective competition laws and higher entry costs. These findings suggest that high industry concentration and a dominant market position enhance the earnings predictability of firms and lower their information uncertainty, and that country-level institutions that promote competition effectively constrain the power in product markets.     

Conditional conservatism and the limits to earnings management

We examine the impact of conditional conservatism on earnings management. Our findings support the view that conditional conservatism reduces accruals-based earnings management but also triggers a trade-off between accruals and real earnings management. In our main tests we use the passage of SFAS 121 as a plausibly exogenous regulatory change that increased the level of conditional conservatism but did not materially affect earnings management. We find that, after the regulation, treated firms reduce accruals-based earnings management and increase real earnings management, and are less likely to be marginal or habitual beaters of earnings benchmarks. Given the crucial role of earnings for firm valuation and analysis, and that conditionally conservative accounting choices are observable, our results should be of wide interest for investment professionals.