The Influence of a Firms’ Business Strategy on the Downside Risk of Earnings, Accruals and Cash Flow

54 Pages Posted: 13 Jun 2017

See all articles by Panagiotis Loukopoulos

Panagiotis Loukopoulos

University of Strathclyde

Georgios Loukopoulos

The Open University

Anastasios Evgenidis

Central Bank of Ireland

Costas Siriopoulos

Zayed University - College of Business; University of Patras

Date Written: June 11, 2017

Abstract

This study examines whether a firm’s business strategy is an underlying determinant of downside risk in accounting earnings and its components. Based on organizational theory we predict that firms following an innovative “prospector” strategy exhibit lower profitability tendencies than firms following a cost-oriented “defender” strategy. Further, we anticipate that these strategies are asymmetrically positioned towards environmental uncertainty, with defenders focusing their efforts to efficiency, cost control, and minimizing exposure to downside risk, whereas prospectors direct their resources to flexibility, innovation, and maximizing the growth potential through aggressive expansion to new product markets. We find that prospectors are indeed less profitable than defenders. We also demonstrate that prospectors have greater total and downside earnings risk. Finally, we decompose earnings into accruals and cash flow and show that the higher exposure of prospectors to earnings downside risk is driven by the cash flow component rather than the accrual component. Collectively, our results suggest that considering how strategy interacts with financial reporting attributes is a useful way for evaluating a firms’ risk profile.

Keywords: Earnings downside risk, Business strategy, Accruals risk, Cash flow risk

JEL Classification: M41, M21

Suggested Citation

Loukopoulos, Panagiotis and Loukopoulos, Georgios and Evgenidis, Anastasios and Siriopoulos, Costas, The Influence of a Firms’ Business Strategy on the Downside Risk of Earnings, Accruals and Cash Flow (June 11, 2017). Available at SSRN: https://ssrn.com/abstract=2984625 or http://dx.doi.org/10.2139/ssrn.2984625

Panagiotis Loukopoulos (Contact Author)

University of Strathclyde ( email )

Curran Building
100 Cathedral Street
Glasgow G4 0LN
United Kingdom

Georgios Loukopoulos

The Open University ( email )

Walton Hall
Milton Keynes, MK6 7AA
United Kingdom

Anastasios Evgenidis

Central Bank of Ireland ( email )

Dame street
2
Dublin
Ireland

Costas Siriopoulos

Zayed University - College of Business ( email )

Zayed University
P.O. Box 144534
Abu Dhabi
United Arab Emirates
0525219780 (Phone)

University of Patras ( email )

Patras
Greece
00306944780680 (Phone)

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