Customer Bargaining Power and Strategic Financial Reporting

Abstract

Abstract: We investigate whether economic bargaining incentives between suppliers and
customers affect financial reporting decisions. We posit that firms with major customers will
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. Taken together, our results suggest that customer negotiations are an important
consideration in suppliers’ financial reporting decisions.

Keywords: expense classification, customer concentration, bargaining power