Real earnings management, business strategy and product market competition

Abstract

Purpose – This research aims to investigate the relationships among firm-level business strategy (BS), industry-level market competition (MC), and real earnings management (REM), focusing on how BS and MC firsts jointly affect firms’ engagement in the management of real activities. Design/methodology/approach – Archival data from U.S. nonfinancial public firms in the period 2000-2019 were analyzed. The measurement of real earnings management was based on models that capture the abnormal level of activities related to REM practices. Business strategy was calculated using a composite score built on Miles and Snow’s (1978; 2003) framework, while market competition is measured at industry level through multiple measures. The hypotheses were tested using OLS regressions controlled for year and industry fixed effects. Findings – The empirical results suggest that firms following an innovative-oriented prospector strategy are associated with lower levels of engagement in real earnings management, while firms following an efficiency-oriented defender strategy are associated with higher levels of REM. Also, firms in less competitive industries are less associated with REM practices compared to those in more competitive environments. However, the combined effect of business strategy and market competition reveals that prospectors in less competitive markets engage more in real earnings management than defenders in similar environment. Originality/Value – This research contributes to earnings management literature by documenting how a firm’s business strategy and the level of industry competition are related with the level of firms’ engagement on real earnings management. Thus, this study joins to the scarce literature that documents the singular and the combined effects of both business strategy and market competition on real earnings management, showing that this practice can be affected not only by exogenous determinants of competition within an industry, but also by the internal choices of allocating resources accordingly with a business strategy