Competitive pressure and managerial decisions

Abstract

Purpose This study aims to examine the impact of product market competition (PMC) from existing rivals and potential market entrants on earnings quality (EQ) in China. Design/methodology/approach This study examines the impact of PMC on EQ by using the EQ measure of Kothari et al. (2005), and it uses measures for competition from existing and potential rivals. This study analyzed Chinese firms for the period of 2000-2014 and also examined the impact of International Financial Reporting Standards (IFRS) adoption and state ownership on the relationship between PMC and EQ. Findings This study found a positive relationship between PMC and EQ. It also documents that competition from existing rivals does not improve EQ by reducing real activity manipulation, but competition from potential entrants does. The findings propose that market competition from existing rivals is a relevant factor for determining EQ before and after IFRS adoption, but competition from potential entrants improves EQ only after IFRS adoption. Moreover, the results suggest that market competition plays no role in improving the EQ of state-owned enterprises (SOEs). Originality/value The results support the argument that PMC acts as a governance mechanism and influences managerial decisions regarding financial reporting. Our study also helps to understand the impact of change in the regulatory regime, i.e. IFRS adoption, on the relationship between PMC and EQ. This study also helps demonstrate the impact of competition on management decisions with respect to the EQ of SOEs.