Do Suppliers Benefit from Customer Concentration: Evidence from Real Earnings Management

Abstract

This study investigates whether and how customer concentration in supply chains affects suppliers’ incentive to engage in real earnings management. Building on the recent debate over the collaboration hypothesis and the rent extraction hypothesis, we show that with concentrated major customers, suppliers are more likely to engage in real earnings management, resulting in higher current and future profitability. Further analysis reveals that capital markets may unravel the positive effect of real earnings management on supplier profitability: stock return is significantly negative for suppliers who take more real earnings management as a result of customer concentration. Our results are robust to alternative measures of customer concentration and real earnings management and to the instrumental variable approach. Collectively, our empirical evidence supports the rent extraction hypothesis, suggesting that the positive association between customer concentration and supplier profitability may partially be driven by real earnings management.