The spillover effect of customers' financial risk on suppliers' conservative reporting: Evidence from China

Abstract

This study examines how customer firms' financial risk affects supplier firms' conservative reporting. Customers' high financial risk increases suppliers' uncertainty in future performance. We find that suppliers, in response to investors' demand, become more conservative in financial reporting when their customers' financial risk is higher. In support of the contracting explanation, we show that this spillover effect is salient for supplier firms in need of bank loans and for those with better corporate governance. In addition, this effect disappears for suppliers in regions with weak protection of investor rights and when customers are state-owned enterprises. Furthermore, we find the effect intensified by the extent of suppliers' dependence on their customers. Our study provides insights into the externality of customers' risk on the suppliers' financial reporting policy in the emerging markets.