PurposeThe purpose of this study is twofold: (1) to examine the incremental contribution of product market fluidity (P_THREAT), another measure of competition from that of the Herfindahl index (H_COMP) and (2) to examine how a research and development (R&D) real activities earnings management strategy to meet an earnings target is influenced by competition.Design/methodology/approachUsing a linear probability model, we test whether P_THREAT is incremental to the H_COMP competition measure and whether it influences the likelihood of firms using abnormally low R&D real activities earnings management to meet an earnings target.FindingsWe find that P_THREAT is incrementally informative to the commonly used Herfindahl measure of competition in predicting abnormally low R&D real activities earnings management activities. This finding is consistent with the notion of examining P_THREAT because the Herfindahl index alone may be incomplete, depending on the product makeup of a company. The negative coefficient suggests that reducing discretionary spending on R&D in the short run could have a detrimental effect on long-term profits because bypassed R&D opportunities would put firms at a disadvantage with their competitors' R&D efforts. In contrast, we find that firms are more likely to use R&D activities earnings management as a mechanism to meet an earnings target when P_THREAT is high. This suggests that when high competitive pressure exists, firms are more likely to use abnormally low R&D as a mechanism to meet an earnings target.Originality/valueWe specifically focus on R&D activities earnings management because our primary competition measure, P_THREAT, captures changes in rival firms' products relative to the firm. Because R&D is primarily what drives product change, R&D is the type of real activities earnings management that is most relevant to our competition measure. Hence, this study contributes to the literature by examining how competition influences the likelihood of firms possibly engaging in R&D activities earnings management and meeting earnings targets in the presence of P_THREAT competition.
On April 11, 2017, the SEC announced charges against KPMG – arising from their participation in a scheme to use confidential information relating to the PCAOB’s planned inspections of KPMG. The incident was colloquially labeled the KPMG ‘steal the exam scandal.’ We use this setting to investigate whether the market finds information concerning individual partner identity useful. Since KPMG withheld the names of the audit partners involved in the scandal, the market was unable to distinguish between rotation-induced audit partner turnover and regulatory-related, audit partner terminations. Following information economics models of non-disclosure, we predict the market would use information about KPMG audit partner turnover as evidence of regulatory-related, audit partner terminations and impose costs on KPMG audit clients who experienced audit partner turnover. The results are consistent with our prediction as KPMG’s overall reputation was not damaged, whereas audit engagements involving audit partners potentially involved in the scandal were.
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