Customer Bargaining Power and Strategic Financial Reporting

We investigate whether economic bargaining incentives between suppliers and customers affect financial reporting decisions. We posit that firms with major customers will strategically classify certain costs as cost of goods sold rather than as selling, general, and administrative expenses in order to deflate their gross margin and reduce the bargaining power of their major customers. Holding profitability constant, we find customer concentration (our proxy for major customers with bargaining power) is positively associated with a higher ratio of cost of goods sold to selling, general and administrative expenses. To distinguish between strategic cost classification and differences in real economic cost structure associated with customer concentration, we use external monitoring as a moderating variable and show that greater monitoring by auditors and analysts attenuates the association. Taken together, our results suggest that customer considerations can play an important role in suppliers’ financial reporting decisions.