Customer-connected peer firms and real earnings management

This study examines the association between competitive threats to firms’ major customer relationships and real earnings management (REM). Using the presence of customer-connected peer firms (CCPs) to measure competitive threats, we document a positive association between CCP presence and REM. The CCP/REM association strengthens with poorer external monitoring and financial reporting readability, weakens when firms have major government customers, and is robust to the inclusion of multiple measures of product market competition. Difference-in-differences analysis shows that firms with CCPs decrease their use of REM following CCP bankruptcy filings, which supports our claim that CCP presence motivates REM practices. Additional tests show that REM becomes less responsive to CCP threats when there are higher numbers of CCPs, and REM decreases terminations of major customer relationships involving CCP-shared customers. Our findings are consistent with firms using REM to favorably influence major customer perceptions of their relationship with the firm when customers engage with multiple suppliers.