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 activities, indicating that improved information sharing from suppliers to customers through private channels reduces managers’ incentives to smooth earnings to provide private information about viability. To mitigate endogeneity issues, we perform three robustness tests: (1) a change in variables analysis, (2) a propensity score matching approach, and (3) a two-stage least squares regression analysis. We also show that the negative relation is more pronounced for supplier firms with larger relationship-specific investments for their major customers. Lastly, further analysis shows that managers’ income smoothing activities decrease as the length of the relationship between a supplier and its major customers increases, corroborating our main findings.

Keywords: Customer concentration, Supplier-customer relationship, Income smoothing, Information sharing, Private communication

JEL Classification: M41