Customer Concentration and Income Smoothing Activities

Abstract

We examine how customer concentration affects managers’ income smoothing incentives to signal their private information about risk and future earnings. We find a negative relation between customer concentration and income smoothing, suggesting that improved information sharing from suppliers to customers through private channels reduces managers’ incentives to smooth earnings. To mitigate endogeneity issues, we perform (1) a change in variables analysis, (2) a propensity score matching approach, and (3) a two-stage least squares regression analysis. Lastly, we document that managers’ income smoothing activities decrease as the length of the relationship between a supplier and its major customers increases, corroborating our main findings. Prior studies have paid relatively little attention to the effects of various stakeholders, especially customers, on managers’ income smoothing activities. Our study fills this void in the literature by illustrating that customer concentration is an important determinant of income smoothing incentives.

Keywords: Customer concentration, Supplier-customer relationship, Income smoothing, Information sharing, Future earnings response coefficient

JEL Classification: M41