Top

Journal of Business Ethics

Published in:

16-01-2020 | Original Paper

Do Corporate Frauds Distort Suppliers’ Investment Decisions?

Authors: Cheng Yin, Xin Cheng, Yinan Yang, Dan Palmon

Published in: Journal of Business Ethics | Issue 1/2021

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

This study examines whether customer firms’ unethical behavior distorts suppliers’ investment decisions. Using litigation and restatement to measure unethical behavior, we find that suppliers with customers engaged in frauds tend to invest more during the cheating period, compared to unaffected suppliers. In cross-sectional analyses, we examine the moderating effect of suppliers’ reliance on customer information and peer information. Results show that more industry peers’ voluntary disclosures and analyst coverage, lower sales volatility, and lower relationship-specific investments mitigate the distortion effect on suppliers. Suppliers’ overinvestments caused by customers’ misreporting also lead to the suppliers’ inferior future performance and subsequent negative market reaction, and the severity of customers’ misreporting influences the magnitude of suppliers’ investment distortions. These results are robust in a dynamic difference-in-difference specification, an SEC enforcement sample, and a sample that excludes observations for suppliers and customers in the same industry. This paper contributes to the ethics literature by emphasizing the importance of creditable supply-chain information transfer to investment decisions and clarifying the nontrivial influence of principal customers in the supply-chain network.

previous article The Association Between Vertical Equity and Presidential Voting Behavior and Taxpayers’ Compliance

next article Doing Good While Behaving Badly: Checkout Charity Process Mechanisms

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Available only for authorised users

For brevity, “affected” suppliers are suppliers who do business with misreporting customers, whereas “unaffected” suppliers are suppliers who have no misreporting customers.

In our setting, “overstatement” means a relative increase in suppliers’ capital expenditures during their customers’ misconduct period compared to their capital expenditures in the period with no customers’ misreporting. The firm-years with no misreporting by customers are the natural control group, as opposed to those in the misreporting period. This approach is simple and has been widely used in prior studies to investigate the association between investment and financial misconduct (Beatty et al. 2013; Li 2016; Kedia and Philippon 2007).

We follow prior literature (e.g., Wang, Winton, and Yu 2010) and focus on frauds that are detected ex post.

Following McNichols and Stubben (2008), a principal customer is any disclosed customer that contributes to at least 10% of its supplier’s total sales.

The three earnings management measures include abnormal operating cash flows, abnormal production costs, and abnormal discretionary expenses.

We also perform the regression by adding the three real earnings management measures separately in the model, and the result is statistically unchanged.

If a supplier has multiple customers in the current year, we compute the weighted average value for each control variable using the sales ratio of each customer.

Since R&D intensive industries are more likely to create relationship-specific assets (Allen and Phillips 2000), in an untabulated test, we use a R&D dummy to proxy the existence of RSIs, where it equals 1 if suppliers have non-zero R&D expenditures, and 0 otherwise. The cross-sectional empirical results for both samples are unchanged.

The management forecast data was collected from I/B/E/S.

The misreporting period is the period when a customer is engaged in misconduct from the beginning date to the end date of the fraud.

0.92 = 0.006 (the coefficient of the dummy)/0.065 (the mean of CAPX).

We also test whether suppliers’ sales dependence on their misreporting customers would affect the severity of distortions in their investment decisions. Following prior studies, we measure a supplier’s dependence on a customer as the annual sales contributed by that customer out of its total sales, and we do not find significant results. Therefore, our sample only covers suppliers with principle customers (i.e.,: at least 10% sales ratio), and the variation of the dependency ratio is small (only 0.486), both of which may lead to the insignificant results. .

Unlike Kedia and Philippon (2007), we create the control group in the 2 years before the fraud period, not at the beginning of our sample. Since fraudulent firms are likely to prepare for misconduct in advance, it is reasonable to consider a longer window to observe the dynamics of performance. However, because our paper focuses on spillover effects due to customers’ frauds over the supply-chain, a shorter window is more appropriate. .

Aivazian, V. A., Ge, Y., & Qiu, J. (2005). The impact of leverage on firm investment: Canadian evidence. Journal of Corporate Finance, 11(1–2), 277–291.CrossRef

Ajzen, I. (1991). The theory of planned behavior. Organizational Behavior and Human Decision Processes, 50(2), 179–211.CrossRef

Ajzen, I., & Madden, T. J. (1986). Prediction of goal-directed behavior: Attitudes, intentions, and perceived behavioral control. Journal of Experimental Social Psychology, 22(5), 453–474.CrossRef

Allen, J. W., & Phillips, G. M. (2000). Corporate equity ownership, strategic alliances, and product market relationships. The Journal of Finance, 55(6), 2791–2815.CrossRef

Almeida, H., & Campello, M. (2007). Financial constraints, asset tangibility, and corporate investment. The Review of Financial Studies, 20(5), 1429–1460.CrossRef

Anand, V., Dacin, M. T., & Murphy, P. R. (2015). The continued need for diversity in fraud research. Journal of Business Ethics, 131(4), 751–755.CrossRef

Arthaud-Day, M. L., Certo, S. T., Dalton, C. M., & Dalton, D. R. (2006). A changing of the guard: Executive and director turnover following corporate financial restatements. Academy of Management Journal, 49(6), 1119–1136.CrossRef

Beatty, A., Liao, S., & Yu, J. J. (2013). The spillover effect of fraudulent financial reporting on peer firms’ investments. Journal of Accounting and Economics, 55(2–3), 183–205.CrossRef

Bendixen, M., & Abratt, R. (2007). Corporate identity, ethics and reputation in supplier–buyer relationships. Journal of Business Ethics, 76(1), 69–82.CrossRef

Benlemlih, M., & Bitar, M. (2018). Corporate social responsibility and investment efficiency. Journal of Business Ethics, 148(3), 647–671.CrossRef

Cen, L., Chen, F., Hou, Y., & Richardson, G. (2014). Customer-supplier relationships and strategic disclosures of litigation loss contingencies. Available at SSRN.

Chen, R., El Ghoul, S., Guedhami, O., & Wang, H. (2017). Do state and foreign ownership affect investment efficiency? Evidence from privatizations. Journal of Corporate Finance, 42, 408–421.CrossRef

Chen, L., & Lee, H. L. (2009). Information sharing and order variability control under a generalized demand model. Management Science, 55(5), 781–797.CrossRef

Core, J. E. (2001). A review of the empirical disclosure literature: discussion. Journal of Accounting and Economics, 31(1–3), 441–456.CrossRef

Durnev, A., & Mangen, C. (2009). Corporate investments: Learning from restatements. Journal of Accounting Research, 47(3), 679–720.CrossRef

Fee, C. E., Hadlock, C. J., & Thomas, S. (2006). Corporate equity ownership and the governance of product market relationships. Journal of Finance, 3, 1217–1251.CrossRef

Fee, C. E., & Thomas, S. (2004). Sources of gains in horizontal mergers: evidence from customer, supplier, and rival firms. Journal of Financial Economics, 74(3), 423–460.CrossRef

Files, R., & Gurun, U. G. (2018). Lenders’ response to peer and customer restatements. Contemporary Accounting Research, 35(1), 464–493.CrossRef

Freeman, R. E., Wicks, A. C., & Parmar, B. (2004). Stakeholder theory and “the corporate objective revisited”. Organization Science, 15(3), 364–369.CrossRef

Geyskens, I., Steenkamp, J. B. E., & Kumar, N. (2006). Make, buy, or ally: A transaction cost theory meta-analysis. Academy of Management Journal, 49(3), 519–543.CrossRef

Giannetti, M., & Wang, T. Y. (2016). Corporate scandals and household stock market participation. The Journal of Finance, 71(6), 2591–2636.CrossRef

Guan, Y., Wong, M. F., & Zhang, Y. (2015). Analyst following along the supply chain. Review of Accounting Studies, 20(1), 210–241.CrossRef

Ha, A. Y., & Tong, S. (2008). Contracting and information sharing under supply chain competition. Management Science, 54(4), 701–715.CrossRef

Healy, P. M., & Palepu, K. G. (2001). Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of Accounting and Economics, 31(1–3), 405–440.CrossRef

Hui, K. W., Klasa, S., & Yeung, P. E. (2012). Corporate suppliers and customers and accounting conservatism. Journal of Accounting and Economics, 53(1–2), 115–135.CrossRef

Johnson, W. C., Xie, W., & Yi, S. (2014). Corporate fraud and the value of reputations in the product market. Journal of Corporate Finance, 25, 16–39.CrossRef

Kale, J. R., & Shahrur, H. (2007). Corporate capital structure and the characteristics of suppliers and customers. Journal of Financial Economics, 83(2), 321–365.CrossRef

Kang, J. K., Tham, M., & Zhu, M. (2012). Spillover effects of earnings restatements along the supply chain. Unpublished working paper. Singapore: Nanyang Technological University.

Karpoff, J. M., Lee, D. S., & Martin, G. S. (2008a). The consequences to managers for financial misrepresentation. Journal of Financial Economics, 88(2), 193–215.CrossRef

Karpoff, J. M., Lee, D. S., & Martin, G. S. (2008b). The cost to firms of cooking the books. Journal of Financial and Quantitative Analysis, 43(3), 581–611.CrossRef

Kedia, S., & Philippon, T. (2007). The economics of fraudulent accounting. The Review of Financial Studies, 22(6), 2169–2199.CrossRef

Kumar, P., & Langberg, N. (2009). Corporate fraud and investment distortions in efficient capital markets. The Rand Journal of Economics, 40(1), 144–172.CrossRef

Lee, H. L., Padmanabhan, V., & Whang, S. (1997). Information distortion in a supply chain: The bullwhip effect. Management Science, 43(4), 546–558.CrossRef

Li, V. (2016). Do false financial statements distort peer firms’ decisions? The Accounting Review, 91(1), 251–278.CrossRef

Macaulay, S. (1963). Non-contractual relations in business: A preliminary study. American Sociological Review, 28, 55–67.CrossRef

McLean, R. D., Zhang, T., & Zhao, M. (2012). Why does the law matter? Investor protection and its effects on investment, finance, and growth. The Journal of Finance, 67(1), 313–350.CrossRef

McNichols, M. F., & Stubben, S. R. (2008). Does earnings management affect firms’ investment decisions? The Accounting Review, 83(6), 1571–1603.CrossRef

Ozdagli, A. K. (2012). Financial leverage, corporate investment, and stock returns. The Review of Financial Studies, 25(4), 1033–1069.CrossRef

Özer, Ö., & Wei, W. (2006). Strategic commitments for an optimal capacity decision under asymmetric forecast information. Management Science, 52(8), 1238–1257.CrossRef

Pandit, S., Wasley, C. E., & Zach, T. (2011). The effect of research and development (R&D) inputs and outputs on the relation between the uncertainty of future operating performance and R&D expenditures. Journal of Accounting, Auditing & Finance, 26(1), 121–144.CrossRef

Plambeck, E. L., & Taylor, T. A. (2006). Partnership in a dynamic production system with unobservable actions and noncontractible output. Management Science, 52(10), 1509–1527.CrossRef

Poterba, J. M. (1988). Are consumers forward looking? Evidence from fiscal experiments. The American Economic Review, 78(2), 413–418.

Raman, K., & Shahrur, H. (2008). Relationship-specific investments and earnings management: Evidence on corporate suppliers and customers. The Accounting Review, 83(4), 1041–1081.CrossRef

Rauh, J. D. (2006). Investment and financing constraints: Evidence from the funding of corporate pension plans. The Journal of Finance, 61(1), 33–71.CrossRef

Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Accounting and Economics, 42(3), 335–370.CrossRef

Shroff, N., Verdi, R. S., & Yost, B. P. (2017). When does the peer information environment matter? Journal of Accounting and Economics, 64(2–3), 183–214.CrossRef

Subramani, M. (2004). How do suppliers benefit from information technology use in supply chain relationships? MIS Quarterly, 28, 45–73.CrossRef

Taylor, T. A., & Plambeck, E. L. (2007). Supply chain relationships and contracts: The impact of repeated interaction on capacity investment and procurement. Management Science, 53(10), 1577–1593.CrossRef

Taylor, T. A., & Xiao, W. (2010). Does a manufacturer benefit from selling to a better-forecasting retailer? Management Science, 56(9), 1584–1598.CrossRef

Tong, Z. (2008). Deviations from optimal CEO ownership and firm value. Journal of Banking & Finance, 32(11), 2462–2470.CrossRef

Yu, Z., Yan, H., & Cheng, T. C. E. (2001). Benefits of information sharing with supply chain partnerships. Industrial Management & Data Systems, 101(3), 114–121.CrossRef

Title: Do Corporate Frauds Distort Suppliers’ Investment Decisions?
Authors: Cheng Yin
Xin Cheng
Yinan Yang
Dan Palmon
Publication date: 16-01-2020
Publisher: Springer Netherlands
Published in: Journal of Business Ethics / Issue 1/2021
Print ISSN: 0167-4544
Electronic ISSN: 1573-0697
DOI: https://doi.org/10.1007/s10551-019-04369-4

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 1/2021

Behavioral Integrity: Examining the Effects of Trust Velocity and Psychological Contract Breach

The Association Between Vertical Equity and Presidential Voting Behavior and Taxpayers’ Compliance

Between Morals and Markets? An Interdisciplinary Conceptual Framework for Studying Working Conditions at Catholic Social Service Providers in Belgium and Germany

When Blame-Giving Crisis Communications are Persuasive: A Dual-Influence Model and Its Boundary Conditions

Sustainability Beyond Instrumentality: Towards an Immanent Ethics of Organizational Environmentalism

A Pyramid of Hate Perspective on Religious Bias, Discrimination and Violence