Trade liberalization and conditional accounting conservatism: evidence from import competition

Review of Quantitative Finance and Accounting - This study examines the impact of import competition, an underexplored but integral component of trade liberalization, on conditional accounting...     

Product market competition and cost stickiness

Extant literature on cost stickiness has focused on how firm-specific characteristics affect the asymmetric cost behavior. In this paper, we explore how a firm’s operating environment affects the firm’s cost stickiness. Specifically, we examine the effect of product market competition on cost stickiness since a firm’s investment and cost retention decisions partly depend on how the firm interacts with its rival firms in the product markets. Using two firm-level text-based product market competition measures extracted from management disclosures in firms’ 10-K filings (Li et al. in J Account Res 51(2):399–436, 2013; Hoberg and Phillips in Rev Financ Stud 23(10):3773–3811, 2010; J Polit Econ, 2015), we find strong evidence consistent with cost asymmetry increasing in competition after controlling for known economic determinants of cost stickiness. In additional analyses, we also find that the effect of product market competition on the degree of cost stickiness increases in firms’ financial strength, likely because management in financially stronger firms has more resources for investment expenditures in spite of a sales fall. We also find that cost stickiness is increasing in competition if management is optimistic about future demand, whereas competition is not associated with cost asymmetry if management is pessimistic about future demand. Finally, we find that the relationship between competition and cost stickiness, although statistically insignificant at conventional levels, is more pronounced for single-segment firms relative to multi-segment firms.     

Product market competition and credit risk

This study theoretically and empirically investigates effects of product market competition on credit risk. We first develop a real-options-based structural model in a homogeneous oligopoly and show that credit spreads are positively related to the number of firms in an industry. The disparity of firm size in an industry is relevant to both product market competition and credit risk, and we therefore extend the model to an asymmetric duopoly case. In particular, we demonstrate that credit spreads of relatively small (large) firms within an industry are positively (negatively) related to Herfindahl-Hirschman index, and the relative firm size in an industry is an important determinant of credit risk. The models’ implications are empirically scrutinized by a reduced-form hazard model and generally supported. By performing out-of-sample analyses, the results demonstrate that firm size together with the interaction terms between intra-industry firm size dummies and competition intensity can effectively predict default.     

Product market competition and intermediate-term momentum

Financial Markets and Portfolio Management - This paper examines the relationship between product market competition and intermediate-term relative strength strategies in the U.S. over the past two...     

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.     

Product market competition and the disclosure of supply chain information

We investigate how product market competition affects corporate voluntary disclosure decisions, specifically regarding supply-chain information. Our results, based on a sample of manufacturing companies listed in China from 2010 to 2016, show that companies in more competitive industries disclose less customer/supplier information. The main results stand through several robustness tests. Further analyses show that the negative relationship between product market competitiveness and supply-chain information disclosure is stronger when the disclosure contains more incremental information and when competitors are more capable of gaining competitive advantage using the disclosed information. Our study contributes to the understanding of both the relationship between product market competition and voluntary disclosure decisions and the regulation of information disclosure to build a transparent capital market.     

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.     

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.     

Agency costs of free cash flow and conditional conservatism

This study investigates whether agency costs of free cash flow (FCF) are associated with conditional conservatism. Prior research documents that conditional conservatism improves ex ante efficient investment decisions and facilitates ex post monitoring of managers’ investment decisions. As conditional conservatism can provide protection from possible managerial expropriation, the demand for conditional conservatism should increase with the agency costs of FCF. Using excess cash as a proxy for the agency costs of FCF, I provide evidence that firms with higher agency costs of FCF incorporate losses in a timelier manner relative to gains compared to their counterparts. Additionally, the association between excess cash and conditional conservatism predictably varies with the presence of alternative monitoring mechanisms that mitigate FCF problems, such as debt or dividend payouts or repurchases. Further investigation suggests that greater conservatism is associated with a lower likelihood of overinvestment among firms bearing high agency costs of FCF, demonstrating the ability of conservatism to reduce agency costs of FCF.     

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.     

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.     

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 corporate advertising expenditure: Evidence from a natural experiment

Using the implementation of “Catalogue for the Guidance of Industries for Foreign Investment” in China in 2015 as an exogenous shock, we adopt the difference-in-differences (DIDs) method to explore the relationship between product market competition and corporate advertising expenditure. The result shows that product market competition significantly promotes corporate advertising expenditure, and the result is robust after conducting a series of robustness tests. In addition, we further examine the effects of product market competition on corporate advertising expenditure in firms with different characteristics. The results show that the effect is more pronounced for non-state-owned enterprises, small-scale firms, and high-tech firms. Overall, this paper supports that product market competition plays a vital role in promoting corporate advertising expenditure.     

Product market competition and the value of corporate cash: Evidence from trade liberalization

This paper uses the 1989 Canada–U.S. Free Trade Agreement as a source of exogenous variation in product markets to establish the impact of increased competition on the market valuation of corporate cash reserves. I find that the trade liberalization leads to a significant increase in the value of cash for firms experiencing a larger shock to their competitive environment. The impact of the trade liberalization is stronger among firms that face greater risk of losing investment opportunities to rivals. I also show that these inferences about the valuation effect of competition apply more broadly to a large sample of firms.     

Product market competition and the value of corporate cash: An agency theory explanation

In this paper, we document the effect of product market competition on cash value and provide evidence supporting the agency discount mechanism. Using the regulation-induced IPO suspensions in China as shocks to product market competition, we find that reduced competition threat, induced by competitors' IPO delay, decreases incumbent firms' value of cash reserve. The effect of IPO suspension on cash holding is more pronounced for companies with severe agency problems and loose governance mechanisms but not statistically different across high and low predation threats. Furthermore, we show that the marginal value of cash increases when IPO restarts, and our baseline results hold in both a large sample and a matched sample of firms. Our paper contributes to the literature by providing the plausibly causal effect of product market competition on cash value and an explanation from the perspective of competition's disciplinary role in mitigating managers' slack.     

Securities class actions and conditional conservatism: Evidence from two legal events

We use two US court rulings as exogenous shocks to firms' litigation environment and examine the changes in conservative financial reporting following these court decisions. The Silicon Graphics ruling in 1999 imposed a heightened pleading standard and discouraged the filing of shareholder lawsuits against firms with headquarters in the Ninth Circuit. The Tellabs ruling in 2007, however, effectively reversed the Silicon Graphics ruling and made it easier to file securities litigation against Ninth Circuit firms. We predict and find that the reduced litigation risk following the Silicon Graphics ruling discourages conservative reporting for Ninth Circuit firms. By contrast, the elevated threat of shareholder lawsuits following the Tellabs ruling encourages conservative reporting for Ninth Circuit firms relative to non-Ninth Circuit firms. The disciplining effect of the threat of shareholder lawsuits on conservatism is stronger for firms facing higher ex ante litigation risk. The litigation-risk-induced increase (decrease) in reporting conservatism leads to higher (lower) firm valuations.     

Product market competition and earnings management: Evidence from discretionary accruals and real activity manipulation

We examine the association between product market competition and earnings management activities. We use the Herfindahl-Hirschman Index (HHI), a widely used measure for market concentration, as a proxy for product market competition. We examine two forms of earnings management: accrual-based and real activity-based. Our results are mixed, but generally suggest that both income-increasing accrual manipulation and real activity-based manipulation are more prevalent among firms in low competition industries than those in high competition industries. Our findings are robust to various measures of earnings management, alternative measures of product market competitions, and different subsamples. We further explore the reasons why firms in low competition industries are more inclined to manage earnings and find that the market consequences of missing important earnings targets are more severe among firms in low competition industries than those in high competition industries.     

Product market competition and the cost of bank loans: Evidence from state antitakeover laws

The extant literature documents a positive relationship between a firm’s takeover vulnerability and its agency cost of debt. Using state antitakeover laws as an exogenous measure of variation in takeover vulnerability, I investigate whether product market competition has a disciplinary effect that can lower a firm’s cost of bank loans. After taking into account the industry composition of borrowers, I find that banks charge higher spreads to borrowers that are vulnerable to takeovers, but only in concentrated industries. In the absence of disciplinary competitive pressure, the effect of takeover vulnerability on the cost of bank loans is mitigated for larger firms, firms followed by analysts, firms with existing credit ratings, non-family firms, and for borrowers with shorter maturity loans or loans with covenants and collateral in place. Taken together, the results suggest that the effect of governance on the cost of financing is not homogenous across all industries, and that concentrated industry firms may need to use supplementary governance mechanisms to mitigate debt holder agency problems.     

Strategic IPOs and product market competition

We examine firms' incentives to go public in the presence of product market competition. As a result of their greater ability to diversify idiosyncratic risk in the capital market, public firms' owners tolerate higher profit variability than owners of private firms. Consequently, public firms adopt riskier and more aggressive output market strategies than private firms, which improves the competitive position of the former vis-à-vis the latter. This strategic benefit of being public, and thus, the proportion of public firms in an industry, is shown to be positively related to the degree of competitive interaction among firms in the output market, to demand uncertainty, and to the idiosyncratic portion of this uncertainty. Additional empirical predictions concern the effect of a firm's initial public offering on its market share and on its rivals' valuations. We test the model's predictions and find empirical support for most of them.     

Product market competition in accounting,finance, and corporate governance: A review of the literature

Product market competition has been identified as one of the most powerful corporate governance tools for motivating managers to maximize firm value. Consistent with this view, a large body of theoretical and empirical research over the years has investigated the implications of product market competition. This paper synthesizes and critically evaluates the empirical literature on the consequences of product market competition in the accounting, finance, and corporate governance domains. Our review focuses on issues like financial reporting quality, analyst forecasting activities, asset pricing, investment, and financing decisions, and the substitutive versus complementary relationships between product market competition and other corporate governance tools. Our review suggests that, although market competition has profound implications for these issues, the empirical findings often provide conflicting results. We highlight such contradictory findings and offer suggestions for future research. Our review will help researchers intending to further investigate the implications of product market competition, both in the US and internationally.