Customer Bargaining Power and Strategic Financial Reporting
52 Pages Posted: 4 Nov 2020 Last revised: 30 Nov 2023
Date Written: November 28, 2023
Abstract
We investigate whether bargaining incentives between suppliers and customers affect financial reporting decisions. We posit that firms with major customers strategically classify certain costs as cost of goods sold (COGS) rather than as selling, general, and administrative expenses (SG&A) in order to deflate their gross margin and reduce the bargaining power of their major customers. Holding profitability constant, we find customer concentration (our proxy for major customers with bargaining power) is positively associated with a higher ratio of COGS to SG&A. To distinguish between strategic cost classification and differences in real economic cost structure associated with customer concentration, we use external monitoring as a moderating variable and show that greater monitoring by auditors and analysts attenuates the association. In cross-sectional tests, our results are strongest where theory suggests customer-supplier bargaining is most likely. Taken together, our results provide evidence that customer negotiations are an important consideration in suppliers’ financial reporting decisions.
Keywords: expense classification, customer concentration, bargaining power
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