Competition’s Impact on Research & Development Real Activities Earnings Management

• In Event: Management

Abstract

The purpose of this study is to examine how a research and development (R&D) real activities earnings management strategy for earnings loss avoidance is influenced by competition and the influence this strategy has on future firm performance. First, we examine industry competitiveness and find product market fluidity (P_Threat) is incrementally informative to Herfindahl Competition (H_Comp) in predicting abnormally low R&D activities. We then examine the within-industry competitive position of firms by testing how transparency and firm life cycle stage within the P_Threat environment influence a managers’ R&D activities earnings management strategies. We find that as transparency increases in high P_Threat environments, firms are less likely to engage in an R&D activities earnings management strategy to avoid a loss. We also find that firms in the growth stage are less likely to engage in R&D activities earnings management to avoid losses when P_THREAT is high. This is consistent with the market not significantly penalizing firms in the growth stage for reporting losses and therefore, there may be less pressure for these firms to engage in R&D activities earnings management to avoid earnings losses. Last, we find that, on average, firms in a high P_Threat environment that use an R&D activities earnings management strategy experience higher adjusted future cash flows. This finding is consistent with the notion that meeting an earnings benchmark can enhance a firm’s credibility and reputation with stakeholders. Improved relationships with customers, suppliers, and creditors as a result of achieving an earnings benchmark can lead to better future firm performance when P_THREAT is high.

Authors

• Dana Hollie, University of Toledo

• Russell Barber, University of Colorado - Denver