Journal of Supply Chain Management

2019, 55(1), 48–70

© 2018 Wiley Periodicals, Inc.

SUPPLY CHAIN POWER AND REAL EARNINGS

MANAGEMENT: STOCK MARKET PERCEPTIONS,
FINANCIAL PERFORMANCE EFFECTS, AND
IMPLICATIONS FOR SUPPLIERS
DANNY LANIER JR.
Elon University

WILLIAM F. WEMPE AND MORGAN SWINK

Texas Christian University

This study examines supply chain power in the context of real earnings
management (REM), instances in which executives execute (or forego)
operations transactions for the sole purpose of meeting or beating earn-
ings targets. We examine whether powerful major customers in supply
chains exploit their positions to engage in REM to a greater degree than
less powerful firms. We also examine (1) whether the stock market
reacts differently to major customers’ and nonmajor customers’ REM,
(2) whether any difference exists between major customers’ and nonmajor
customers’ post-REM financial performance, and (3) how suppliers are
impacted by their major customers’ REM behavior. Results suggest that
major customers exploit their supply chain power to engage in more REM.
In contrast to the skeptical stock market reaction when other firms engage
in REM, we find no evidence that major customers’ earnings are discounted
when there is evidence of REM. Instead, the market appears to interpret
major customers’ behavior as “legitimate” uses of power in supply chain
management, rather than REM typically considered to be value-destroying.
Further, we find that in post-REM periods, major customers that engage in
REM exhibit better operating cash flow performance than nonmajor cus-
tomers who do so. These findings suggest that the consequential costs of
REM are lower for major customers than for nonmajor customers. Finally,
we report evidence that the particular form of major customers’ REM
appears to determine the impact on their suppliers. Suppliers’ financial
performance deteriorates when major customers’ REM entails discretionary
expense cuts. These findings offer new insights into the benefits and uses
of power in supply chain relationships, in a previously unexplored context.
We discuss the implications of the findings for future research.

Keywords: interorganizational relationships; power; archival research; regression

analysis

INTRODUCTION 1959). Research studies show that occupying a power-

Interorganizational relationships create both oppor-
tunities and risks in supply chain management
(SCM). Prior research on relationships examines the
performance effects of firm power, supply chain (SC)
membership, and SCM competence, where power
refers to the ability of one SC partner to influence the
actions of another (Emerson, 1962; French & Raven,
ful position in a trading relationship generally
enhances performance. However, such studies mainly
focus on power in the contexts of innovation, collabo-
ration, procurement, and “normal exchange situa-
tions” (Cox, Ireland, Lonsdale, Sanderson & Watson,
2001; Reimann & Ketchen, 2017, p. 6; Terpend &
Krause, 2015). Little attention has been given to

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Volume 55, Number 1
 Supply Chain Power and Real Earnings Management
complexities surrounding power, and instances in
which power is exercised (Reimann & Ketchen, 2017).
In this study, we consider the possibility that SC
power influences buying firms’ operational decisions
regarding their short-term financial reporting needs. We
first examine whether powerful firms are more inclined
to manipulate real, operational transactions with their
SC partners in order to meet or beat earnings targets at
the ends of financial reporting periods—a behavior
known as real earnings management (REM). We then
examine three performance implications of powerful
SC firms’ REM, including stock market reactions, future
financial performance for buying firms, and financial
performance consequences for their captive suppliers.
Prior research persuasively shows that executives use
REM to meet or beat earnings targets. For example,
Gunny (2010), Chen, Rees and Sivaramakrishnan
(2010), and Roychowdhury (2006) provide evidence
that managers manipulate sales, production levels, and
discretionary expenses to meet or beat earnings targets.
In fact, Graham, Harvey and Rajgopal (2005) report
that 78 percent of executives have used REM to this
end,1 executing (or foregoing) transactions that would
not be executed (or forgone) in the absence of earnings
targets. Some firms engage in income-increasing REM
by simply increasing production, which charges more
fixed production costs to the balance sheet as year-end
inventory, rather than to the income statement as cost
of goods sold.2 Ramping up production may require
unplanned, increased, and expedited shipments of
materials from suppliers, thus raising costs. Alterna-
tively, buying firms may decrease, postpone, or cancel
planned purchases, or demand price concessions from
suppliers in order to manage earnings upward. Finally,
in another form of REM a firm might offer price dis-
counts or lenient credit terms to its customers in efforts
to increase earnings via increased sales. Such a move
has considerable impacts on suppliers if the firm also
negotiates related purchase price discounts or demands
increased and/or expedited shipments of inputs.
Prior research has explored some of these types of
REM actions. But some forms of REM are subtler. For
example, Crosby (2017) describes how Hormel beat
an earnings forecast by cutting advertising $25 mil-
lion, an action that undoubtedly affected one or more
1
Many studies (e.g., Ayers, Jiang & Yeung, 2006; Jones, 1991)
show that firms manipulate accruals to manage earnings. Accru-
als manipulation requires no transaction, only an accounting
entry. The behavior we examine, REM, requires transactions with
SC partners.
2
If fixed production costs are $5 million and a firm produces
10,000 units and sells 8,000 units, then $4 million of cost is
charged to cost of goods sold, with $1 million charged to the
balance sheet. Overproduction decreases the unit cost of goods
sold, thereby increasing earnings by $1 million, relative to what
earnings would have been had 8,000 units been produced.
January 2019
of its trading partners. Our study examines whether
actions of this type are unusually prevalent in the con-
text of powerful buying firms attempting to beat earn-
ings targets, and how such actions affect stock market
returns, subsequent financial performance, and suppli-
ers’ performance.
Powerful SC firms use various bases of power (e.g.,
mediated and nonmediated) to influence suppliers’
actions and commitment (Chae, Choi & Hur, 2017;
French & Raven, 1959; Maloni & Benton, 2000),
thereby extracting favorable terms from their trading
partners (Galbraith & Stiles, 1983; Kim, 2017).
Recently, researchers have pointed out that our under-
standing of how and when firms use or restrain use of
power is unclear (Reimann & Ketchen, 2017). Our
study responds to Reimann and Ketchen’s (2017, p. 6)
call for research that examines conditions under which
weaker SC members might be exploited. We demon-
strate that financial benefits of SC power extend beyond
those realized in steady state operating conditions. Fol-
lowing methods validated in previous SC and account-
ing research, we measure the SC power and REM
actions of firms in multiple ways (Chen et al., 2010;
Gunny, 2010; Roychowdhury, 2006) and then analyze
associations between these variables and outcomes for
the firms and their captive suppliers.
Our findings suggest that powerful major customers
exert power episodically to manage earnings for the
benefit of financial reporting. In other words, major
customers are better able to execute REM transactions
by virtue of their power over SC partners. The findings
also point to a previously unexplored benefit of SC
power—stock market investors’ and analysts’ favorable
perceptions of powerful SC firms’ REM-aided earnings.
Because they occupy powerful positions in the SC,
major customers appear to be able to execute REM
with lower consequential costs both in the stock mar-
ket and for financial returns. Finally, results suggest
that while some forms of REM may be harmful to
major customers’ suppliers, other forms may benefit
them. Overall, our study’s findings have implications
for managers of firms that occupy either powerful or
weak SC positions, and may suggest additional con-
siderations for sourcing and procurement strategies.
Finally, our findings have implications for future
research of the broader benefits and contexts of power
in SC relationships.
PRIOR LITERATURE AND RESEARCH
HYPOTHESES
We rely on literature from both SCM and account-
ing to develop four hypotheses. SCM researchers often
employ resource dependence theory (RDT; Pfeffer &
Salancik, 1978) to explain a firm’s performance based
on its ability to obtain resources, in part through its
49
 Journal of Supply Chain Management
relationships with other firms (see Elking, Paraskevas,
Grimm, Corsi & Adams, 2017 for a recent brief review
of related studies). Prior accounting research describes
how and why executives deploy REM.
Exchange Relationships and RDT
Power dependence in SC exchange relationships has
many sources, including the presence or absence of
alternatives, idiosyncratic investments, embeddedness,
social capital, and other factors (Hawkins, Wittmann
& Beyerlein, 2008). RDT argues that a firm’s depen-
dence on external organizations to provide key
resources grants power to those organizations. Thus,
RDT views power as control over valued resources
(Huo, Flynn & Zhao, 2017). In their articulation of
RDT, Pfeffer and Salancik (1978) identify the relative
magnitudes of the exchange relationship as a primary
determinant of SC dependence and power. Accord-
ingly, researchers have used a buying firm’s major cus-
tomer status—that is, the extent of a supplier’s sales
that is consumed by the buyer—as a proxy for the
buyer’s power (i.e., supplier dependence) (Elking
et al., 2017; Kim, 2017). Because a major customer
accounts for a large proportion of a given supplier’s
sales, the supplier is likely to be quite financially
dependent on the major customer, giving the major
customer greater ability to control or influence behav-
ior (Elking et al., 2017; Handley & Benton, 2012;
Huo et al., 2017). In this context, the major customer
may dictate exchange terms that are favorable to itself,
even when they are potentially detrimental to its sup-
plier (Crook & Combs, 2007; Emerson, 1962; Gal-
braith & Stiles, 1983; Gosman & Kohlbeck, 2009;
Kim, 2017). For example, Pulles, Veldman, Schiele
and Sierksma (2014) find that the coercive power of
buyers is more strongly associated with suppliers’
resource allocations when buyers control larger shares
of the suppliers’ sales. Their finding suggests that sup-
pliers are more likely to allocate materials and capac-
ity to major customers, and to give priority to their
requests. This is consistent with other studies (e.g.,
Buchanan, 1992; Crook & Combs, 2007; Gosman &
Kohlbeck, 2009) that demonstrate the propensity for
powerful buyers to use their power for advantage and
financial gain.
Prior studies also examine the performance effects of
major customer relationships. Gosman, Kelly, Olsson
and Warfield (2004) find that major customers
achieve unusually high profitability, profitability per-
sistence, and market valuations. Lanier, Wempe and
Zacharia (2010) find that supplying firms’ financial
performance is inversely associated with the level of
their dependence on major customers, whereas Pata-
toukas (2012) reports a positive correlation between
customer concentration and profitability. Kalwani and
Narayandas (1995) document that major customers’
50 Volume 55, Number 1
suppliers reduce costs through better inventory man-
agement, but that major customers extract extraordi-
nary savings from suppliers via lower prices. Kim
(2017) shows that suppliers’ performance is negatively
impacted by higher levels of customer concentration
(proportion of supplier’s sales concentrated to fewer
customers). Finally, Elking et al. (2017) demonstrate
that buying firms that enjoy favorable financial depen-
dence asymmetries with suppliers outperform other
buying firms.
Earnings Targets, Earnings Management, and
REM
Executives emphasize meeting or beating earnings tar-
gets for several reasons—for example, to maximize their
bonus compensation (e.g., Healy, 1985), to avoid
lower equity valuations (e.g., Bartov, Givoly & Hayn,
2002; Lopez & Rees, 2002; Skinner & Sloan, 2002), or
to comply with the terms of agreements with lenders
(Beneish & Press, 1993). Executives are particularly
mindful of three targets: zero earnings, prior-period
earnings, and analysts’ forecasts of earnings (Degeorge,
Patel & Zeckhauser, 1999). Some researchers (e.g.,
Burgstahler & Dichev, 1997; Degeorge et al., 1999)
infer earnings management from the disproportionate
number of firms that meet or just beat earnings targets.
Other studies find evidence of earnings management
via accruals (Ayers et al., 2006; Matsumoto, 2002),
accounting standard adoption (Gujarathi & Hoskin,
1992; Henry, 2009), or inventory valuation method
choices (Cushing & LeClere, 1992).
In REM studies, Bartov (1993) shows that fixed asset
sales and early debt retirements are used to meet or
beat targets, and Frankel and Trezevant (1994) suggest
that executives manage earnings by manipulating
inventory transactions. Roychowdhury (2006) finds
that firms with suspect earnings offer price discounts to
increase sales, reduce discretionary expenses to improve
margins, and overproduce inventory to reduce unit
costs and report lower cost of goods sold. Gunny
(2010), Chen et al. (2010), and Cohen, Mashruwala
and Zach (2010) report similar evidence with respect
to the association between suspect earnings and REM.
Hypotheses
A firm seeking an earnings boost may execute REM
in ways that result in abnormally high total produc-
tion costs or abnormally low discretionary expenses.3
The firm may demand price reductions from suppli-
ers, a behavior described in both the academic litera-
ture (e.g., Bloom & Perry, 2001; Gosman et al., 2004;
3
When firms negotiate input price reductions, they often pass
the savings on to customers, causing them to report high sales
to assets and cost of sales to assets ratios. The latter is a key ele-
ment of REM studies’ production cost metrics.
 Supply Chain Power and Real Earnings Management
Ryals, 2006) and the business press (e.g., Banham,
2001; Fishman, 2003; Looft, 2006; Moore, 2008). For
example, Knight (2013) notes that Caterpillar “looked
to its supply base” to weather a 2013 financial storm.
Ziobro and Ng (2015) describe how concern over
near-term financial results led Wal-Mart to direct sup-
pliers to cut joint marketing costs and plow the sav-
ings into lower prices. The ability to squeeze suppliers
on prices allows powerful major customers to pass
savings on to their customers, thereby increasing the
major customer’s sales and earnings. Such actions
improve major customers’ margins and increase their
total production costs relative to their assets.
Firms may also execute REM by reducing discre-
tionary expenses. They may reduce purchase volumes
or shift more responsibility to suppliers for activities
such as inventory handling, shared advertising, and
technical support (e.g., Bloom & Perry, 2001; Crook
& Combs, 2007; Gosman & Kelly, 2002; Gosman
et al., 2004; Ryals, 2006). For example, if a major cus-
tomer and a weaker trading partner engage in joint
R&D (e.g., Belderbos, Carree & Lokshin, 2006), more
R&D-related tasks may be shifted from the major cus-
tomer to the partner. Shon and Yan (2015) find that
R&D cuts—which impact trading partners—are more
prevalent in the fourth quarter, when annual audits
prompt managers to shift from accruals-based earn-
ings management to REM, which is less constrained
by auditors. Firms may also delay payments to suppli-
ers, which shifts working capital costs back in the SC
(Gosman et al., 2004; Moore, 2008). Finally, buying
firms may engage in REM by ramping up production,
which may benefit their captive suppliers if any incre-
mental unit sales volume the suppliers capture is not
offset by price cuts or other demands.
Under RDT, a major customer and its captive sup-
plier rely on each other for resources (Ulrich & Bar-
ney, 1984). Because a major customer is less
dependent on the supplier than the supplier is on the
major customer, we expect that a major customer is
more likely to engage in behaviors that extract value
from suppliers when doing so is necessary to meet or
beat earnings targets. The supplier’s dependence on
the major customer often leaves it little choice but to
accept the major customer’s demands. Such a choice
is economically rational if the supplier expects higher
profits from continuing its relationship with the major
customer than from ending the relationship and seek-
ing out other exchange relationships (Hawkins et al.,
2008).
It might be argued that major customer firms con-
tinuously exploit their captive suppliers, without
regard to earnings targets. But exploitation of SC part-
ners is not costless, and powerful SC firms assert their
power judiciously (Cox et al., 2001; Crook, Craighead
& Autry, 2017; Hawkins et al., 2008). Such
January 2019
judiciousness is consistent with both social exchange
theory and the theory of embeddedness, which posit
that collaborative, rather than adversarial, relation-
ships produce better results (e.g., Balakrishnan &
Geunes, 2004; Chen, Paulraj & Lado, 2004; Hawkins
et al., 2008; Kim, 2017). A buying firm’s inclination
to execute REM is therefore likely moderated by its
interest in avoiding the costs of doing so. Buyers who
ask suppliers to support rapid and short-term changes
needed for REM likely face increased coordination
and transaction costs, as suppliers push back or ask
for transition cost sharing. In the longer term, such a
buyer may experience supplier retaliation and costly
churning of its supply base—concerns that encourage
more collaborative supplier relationships (e.g., Trebil-
cock, 2015, 2017). We expect that these consequential
costs of REM are lower for major customers, because
of their positions of power. Dependent suppliers are
less able to extract compensation for supporting oper-
ational changes necessary for REM. Consequently,
powerful major customers face lower costs of REM,
while enjoying at least the same potential REM bene-
fits as other firms. Given that REM potentially allows
any firm to garner the benefits of meeting or beating
an earnings target (e.g., Bartov et al., 2002; Lopez &
Rees, 2002; Skinner & Sloan, 2002), a major customer
is more likely to engage in REM, because of its lower
consequential costs.
Accordingly, our first hypothesis is:
H1: Major customers’ REM is more extensive than
nonmajor customers’ REM.
Our second hypothesis explores the influence of SC
power on market perceptions of firms’ REM behaviors.
Firms engage in REM in part to avoid negative market
responses to falling short of earnings targets. At the
same time, accounting research posits that REM
destroys value, and market perceptions of REM can
generate negative responses. Cohen et al. (2010)
describe REM as a detriment to lifetime earnings and
firm value, a view that is consistent with Graham
et al. (2005) and Roychowdhury (2006). Although
their empirical evidence is mixed, Chen et al. (2010)
posit that REM produces adverse future cash flow con-
sequences. Finally, Gunny (2010) indicates that REM’s
longer-term adverse effects may exceed the short-term
benefits of meeting or beating an earnings target.
We posit that a firm’s major customer status influ-
ences the market’s perceptions of its REM. Assuming
it is known that major customers enjoy the ability to
dictate transaction terms to their captive suppliers, the
market may not perceive major customers’ REM as
differing substantially from their other exertions of SC
power in the normal course of business (e.g., Bucha-
nan, 1992; Crook & Combs, 2007). In other words, if
market analysts perceive that major customers’
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 Journal of Supply Chain Management
favorable positions enable them to dictate transaction
terms at little cost, then they may interpret major cus-
tomers’ REM as routine exertions of SC power, rather
than as value-destroying, abnormal behavior. Hence,
investors may view major customers’ REM less skepti-
cally, anticipating that major customers’ REM-related
net benefits will exceed the analogous net benefits of
nonmajor customers’ REM as a result of major cus-
tomers’ lower execution or consequential costs. A tes-
table implication of this differential interpretation of
major customers’ and nonmajor customers’ REM is
that, unlike nonmajor customers, major customers’
earnings success will not be discounted by the stock
market when investors perceive that major customers
used REM to meet or beat earnings targets. Our sec-
ond hypothesis is:
H2: The market reaction to major customers’ REM
is more favorable than the market reaction to non-
major customers’ REM.
As noted, prior studies suggest that REM is value-
reducing, producing negative future operational conse-
quences (Chen et al., 2010; Cohen et al., 2010;
Gunny, 2010). Executives who pursue REM divert
their operations from previously developed, presum-
ably optimal plans which may have already been set
in motion (Chen et al., 2010), thus necessitating
costly future actions. Chapman and Steenburgh
(2011) show that deviating from marketing plans
boosts (reduces) current (subsequent) quarter earn-
ings by five (seven) percent, and Shon and Yan
(2015) document that fourth quarter R&D cuts are
reversed in subsequent quarters. Further, Mizik (2010)
and Bhojraj, Hribar, Picconi and McInnis (2009) also
find that cutting discretionary costs improves current
profitability at the expense of future performance.
Overproduction also raises costs of capital and pro-
duct obsolescence, in addition to costs associated with
ramp-up and with exceeding efficient levels of utiliza-
tion. Finally, there are the aforementioned transition
and transactional costs required to implement REM.
On the other hand, REM can create future benefits.
Beating earnings targets sends positive signals to stake-
holders (Gunny, 2010), which might preserve or grow
the credibility of the firm’s managers, thereby securing
preferential access to capital and other resources (Bar-
tov et al., 2002). Bartov (1993) also suggests that tar-
get-beating REM may help firms to avoid violating
debt covenants and/or to decrease the cost of debt.
Chen et al. (2010) add that target-beating success may
enable firms to secure more favorable contracts with
new suppliers.
We expect that major customers’ and nonmajor
customers’ deployments of REM have differing
implications for future performance. Whereas a non-
major customer’s REM may be negatively associated
52 Volume 55, Number 1
with future performance (e.g., due to SC turbulence,
transition costs, etc.), a major customer’s REM is
less likely to be a detriment to future performance,
because of the power-based advantages the major
customer possesses. A nonmajor customer is less
likely to be able to push REM-related costs of tran-
sitions, recoveries, and inefficiencies on to suppliers,
whereas a powerful major customer is in a better
position to ask its suppliers to absorb these costs, at
least partially. Accordingly, our third hypothesis is:
H3: The association between REM and future finan-
cial performance is greater (more positive) for
major customers than for nonmajor customers.
We now turn to the question of how major cus-
tomers’ REM affects their captive suppliers’ contem-
poraneous financial performance. Recall that REM is
potentially comprised of two main types of opera-
tional actions: (1) reductions in discretionary costs
either through purchase volume reductions or price
cuts, and (2) deferrals of fixed production costs into
inventory via ramped-up production. Because they
are motivated by REM that occurs in the latter part
of a reporting period, such actions likely involve
very short-term notice to suppliers. Viewing these
actions as activations of power, we expect that they
will produce detrimental effects on weaker partners
(Elking et al., 2017; Huo et al., 2017). If major cus-
tomers effect REM through discretionary cost reduc-
tions, suppliers’ contemporaneous financial
performance is almost surely adversely affected,
whether the reductions are accomplished via
reduced purchase volumes or reduced prices. If
major customers execute REM by ramping up pro-
duction, the effects on suppliers are less clear. On
the one hand, suppliers may benefit from increased
orders needed to support the major customer’s pro-
duction ramp-up. However, these positive effects
may be offset by costs of expediting, expanding
(e.g., hiring temporary workers or working over-
time), and other unplanned transitions. Given the
likely disruptive nature of REM on suppliers’ opera-
tions, we posit that REM’s effects on suppliers’
financial performance are mostly negative in the
short term.
The popular press describes how strong buyers
exploit their power over suppliers to improve their
own performance, perhaps at suppliers’ expense. In
an example of Wal-Mart’s willingness to demand
suppliers’ help in meeting its short-term earnings
goals, Layne (2015) reports that an earnings warn-
ing led Wal-Mart to turn up the heat on suppliers
in the form of both price cuts and new fees. One
consultant observed that “suppliers are going to
have to help Wal-Mart get back on track.” Falling
iPhone sales prompted Apple to reduce purchase
 Supply Chain Power and Real Earnings Management
volumes for parts while simultaneously demanding
price cuts from suppliers. The company’s actions
were described as likely to “shore up Apple’s earn-
ings in the second half, but dampen profit out-
looks for suppliers. . .” (Dou, 2016). Johnsson and
Robison (2018) describe Boeing’s emergence as a
Wall Street darling, while noting that at least one
supplier missed its own earnings forecasts as a
result of Boeing’s pricing pressure, which the sup-
plier likened to “walking down the street and
being mugged” (p. 47).
Heavy-handedness on the part of the more powerful
partner in a power-imbalanced trading relationship
likely affects the weaker partner, whether the powerful
partner’s actions are undertaken in the ordinary
course of business or to beat an earnings target. In
our final hypothesis, we consider the possibility that a
major customer’s REM is detrimental to suppliers
naming it as a major customer:
H4: Major customers’ REM is negatively associated
with their captive suppliers’ contemporaneous
financial performance.
METHODOLOGY AND DATA
Data and Sampling
We use Compustat data to identify major customers
as reported by their suppliers. For 1980–2015, we
identify 16,393 cases in which a supplying firm dis-
closes at least one major customer that is a public
firm with data available on Compustat. These 16,393
supplier firm-years correspond to 21,290 major cus-
tomer firm-year observations, of which 9,062 are
unique major customer firm-years. Our analyses
require a control sample of major customer firms’
nonmajor customer industry-year counterparts. Fol-
lowing Roychowdhury (2006), we require at least 15
nonmajor customer observations for each two-digit
(SIC) industry-year group. After imposing Compustat
and Center for Research in Security Prices (CRSP) data
availability requirements, our major customer sample
consists of 5,442 firm-years encompassing 42 nonreg-
ulated and nonfinancial industries (Compustat and
CRSP are the sources of all data used in the study).
The distributions of major customer and control firm-
years across industries indicate that 66 percent are
concentrated in manufacturing industries (SIC codes
20–39), with another 20 percent in the wholesale and
retail industries (codes 50–59). Given that over-
production as a REM strategy is only available to
manufacturing firms, the heavy concentration in man-
ufacturing suggests that overproduction is a viable
option for a substantial portion of our sample (tests
of manufacturers only yield inferences identical to
those reported).
January 2019
Measuring REM
As in Roychowdhury (2006), Cohen et al. (2010),
and Gunny (2010), we use abnormal production costs
and abnormal discretionary expenses as indicators of
REM. Using price discounts to boost sales and over-
producing to reduce cost of goods sold both result in
abnormally high production costs relative to sales.
Further, reducing Advertising, SG&A, and R&D expen-
ditures can lead to abnormally low discretionary
expenses relative to sales.
We follow Roychowdhury (2006), Cohen et al.
(2010), and Gunny (2010) in estimating normal
levels of production costs and discretionary expenses.
We define production costs (PROD) as the sum of
cost of goods sold and change in inventory and, using
the control sample, specify the normal level of pro-
duction costs by estimating the following industry-
year equation, where A is total assets, S is sales, and
ΔS is change in sales:
PRODt =At
1 ¼ a0 þa1 ð1=At
1 Þþb1 ðSt =At
1 Þ
ð1Þ
þb2 ðDSt =At
1 Þþb3 ðDSt
1 =At
1 Þþet :
We define discretionary expenses (DISX) as the sum
of Advertising, SG&A, and R&D and model the nor-
mal level of DISX as a linear function of lagged sales:
DISXt =At
1 ¼ a0 þa1 ð1=At
1 ÞþbðSt
1 =At
1 Þþet : ð2Þ
We estimate equations (1) and (2) cross-sectionally
for each industry-year group. Abnormal production
costs (ABN_PROD) and abnormal discretionary
expenses (ABN_DISX) are the differences between
actual values and the levels predicted by equations (1)
and (2). We follow Kothari, Leone and Wasley (2005)
in using performance-matched values of these REM
indicators. Like Kothari et al. (2005), we match each
firm-year in our major customer sample to the non-
major customer firm-year in its industry (i.e., two-digit
SIC) with the closest return on assets (ROA) in year
t
1. We measure performance-matched production
costs (PM_PROD) as the difference between abnormal
production costs for a major customer firm-year and
its matching control firm-year. Performance-matched
discretionary expenses (PM_DISX) are measured
similarly.
If major customers engage in more REM, then the
association between suspect earnings and abnormally
high production costs and abnormally low discre-
tionary expenses will be increasing in major customers’
SC power (i.e., more positive in the case of production
costs; more negative in the case of discretionary
expenses). Since firms are likely to use a combination
of tactics to beat earnings targets, we also report results
53
 Journal of Supply Chain Management
using a comprehensive measure of REM (COMP_-
PROXY)—the sum of PM_PROD and PM_DISX, after
first multiplying values of PM_DISX by negative one so
that positive values of COMP_PROXY are indicative of
income-increasing REM.
Measuring SC Power
One requirement of our study is that SC power be
measured from the perspective of those firms whose
REM behavior is posited to be affected by such power
—that is, buying firms. Thus, the supplier-centric sales
concentration measures used in prior research (e.g.,
Ak & Patatoukas, 2016; Dhaliwal, Judd, Serfling &
Shaikh, 2016; Irvine, Park & Yildizhan, 2016; Kim,
2017; Patatoukas, 2012; Saboo, Kumar & Anana,
2017) are ill-suited for our study. Further, other mea-
sures of a buying firm’s cost of goods sold or operat-
ing input provided by captive suppliers (e.g., Elking
et al., 2017; Lanier et al., 2010) fail to capture major
customers’ power to effect REM via their transactions
with suppliers.4
We posit that a major customer’s SC power is
increasing in the number of suppliers naming it as a
major customer. Thus, our proxy for SC power
(POWER) is the natural logarithm of the number of
suppliers disclosing the firm as a major customer,
after first adding a value of one. This approach
ensures that values of POWER are strictly positive for
major customer firms and are coded zero for the con-
trol sample. Most important, POWER is (1) measured
from the perspective of buyers, (2) calculated in refer-
ence to suppliers having at least 10% sales concentra-
tion, and (3) increasing in the number of suppliers
naming a major customer as such.
Measuring Incentives to Engage in REM
Consistent with prior studies (e.g., Cohen et al.,
2010; Gunny, 2010; Roychowdhury, 2006), we focus
on managers’ incentives to meet or beat both zero
earnings and prior year’s earnings. We identify firm-
years that meet or just beat zero earnings (MEET_-
ZERO) as those in which net income before extraordi-
nary items, scaled by lagged total assets, is between 0
and 0.005. We identify firms that meet or just beat
prior year’s earnings (MEET_PY) as those in which the
change in net income before extraordinary items,
scaled by lagged total assets, is between 0 and 0.005.
4
The latter measure does not distinguish between buying 10% of
operating input from one captive supplier and buying a total of
10% of operating input from five captive suppliers. This distinc-
tion is likely important in examining major customers’ REM
behavior. The measure is also subject to multiple interpretations.
Lanier et al. (2010) construe it as a measure of potentially
value-enhancing supply consolidation, whereas Elking et al.
(2017) construe dependence (i.e., weakness) as being increasing
in the measure.
54 Volume 55, Number 1
Following Gunny (2010), we identify suspect firm-
years as those falling into either category. In our
empirical models, such firms—suspected of engaging
in REM to beat earnings benchmarks—are coded
BENCH = 1, with other firms coded BENCH = 0.
Descriptive Statistics
The Appendix defines all variables in the study. In
the Appendix and both panels of Table 1, we display
three categories of variables: (1) descriptive variables,
(2) REM-related variables, and (3) other variables
used in tests. Table 1 presents descriptive statistics,
with continuous variables winsorized at the 1st and
99th percentiles. Panel A shows that major customers
are larger and more profitable than nonmajor cus-
tomers, consistent with prior research (e.g., Gosman
et al., 2004; Lanier et al., 2010). Compared to non-
major customers, major customers have (on average)
higher market capitalization ($13.2 billion versus $1.3
billion), total assets ($11.4 billion versus $1.2 bil-
lion), total sales ($11.4 billion versus $1.2 billion),
net income before extraordinary items ($652 million
versus $59 million), and cash flows from operations
($1.5 billion versus $142 million).5
Mean ROA is higher for major customers than for
nonmajor customers (6% versus 1%), and major cus-
tomers also exhibit a higher mean market-to-book
ratio (MTB) than their nonmajor customer counter-
parts (3.3 versus 2.8). Major customers’ ability to
incur lower discretionary expenses (DISX/A) than
nonmajor customer firms (35% versus 44%) is consis-
tent with both scale advantages and the efficiency of
SCM. Mean production cost (PROD/A) is greater for
major customers (101%) than for nonmajor cus-
tomers (94%). Since cost of goods sold is a major
component of total production costs, this finding is
consistent with evidence that major customers exhibit
higher mean asset turnover (1.35 versus 1.30), com-
pared to nonmajor customers. Overall, these results
suggest that major customers enjoy an operating
advantage associated with their SC power.
Panel B of Table 1 compares the 471 suspect major
customer firm-years to all other major customer firm-
years. On average, suspect major customers report
lower MVE ($11.9 billion versus $13.3 billion), lower
MTB (2.56 versus 3.37), and higher sales ($12.7 bil-
lion versus $11.3 billion). There is no significant dif-
ference between suspect major customers and
nonsuspect major customers with respect to mean
total assets. However, compared to nonsuspect major
customers, suspect major customers exhibit lower
mean DISX/A (30% versus 35%) and higher mean
5
Among the sensitivity tests described at the end of the Results
section are two that reduce the significant firm size difference in
the major customer and control samples.
 TABLE 1
Descriptive Statistics

Major Customer Firms Nonmajor Customer Firms Difference in

Variable Mean SD Min Median Max Mean SD Min Median Max Means Medians
Panel (A) Comparison of major customer firm-years (n = 5,442) to the control sample of nonmajor customer firm-years (n = 70,277)
Descriptive variables
MVE ($) 13,223.91 17,397.94 1.34 4,688.42 52,797.86 1,345.44 4,853.82 1.34 122.43 52,797.86 11,878.47*** 4,565.99***
MTB 3.30 3.30 0.27 2.31 22.81 2.81 3.34 0.27 1.81 22.81 0.49*** 0.50***
Total assets ($) 11,363.42 13,768.75 2.29 4,905.55 42,847.25 1,213.31 4,166.67 2.29 132.22 42,847.25 10,150.11*** 4,773.33***
Sales ($) 11,401.90 13,446.70 1.03 5,405.38 42,201.00 1,186.2 3,964 1.03 149.26 42,201.00 10,215.7*** 5,256.12***
IBEI ($) 652.00 954.01
294.04 209.70 2,852.90 58.53 267.16
294.04 3.07 2,852.90 593.47*** 206.63***
ROA 0.06 0.10
0.81 0.06 0.35 0.01 0.17
0.81 0.04 0.35 0.05*** 0.02***
CFOa 1,451.38 1,873.54
60.62 575.91 5,747.74 141.85 531.78
60.62 9.45 5,747.74 1,309.53*** 566.46***
Asset turnover 1.35 0.91 0.10 1.10 4.53 1.30 0.79 0.10 1.17 4.53 0.05***
0.07**

REM-related variables
DS/A 0.13 0.31
0.88 0.08 1.92 0.14 0.37
0.88 0.09 1.92
0.01
0.01
COGS/A 1.00 0.92 0.02 0.72 4.61 0.92 0.77 0.02 0.74 4.61 0.08***
0.02
INV/A 0.17 0.15 0.00 0.13 0.81 0.21 0.17 0.00 0.17 0.81
0.04***
0.04***
PROD/A 1.01 0.93 0.03 0.73 4.51 0.94 0.78 0.03 0.75 4.51 0.07***
0.02
DISX/A 0.35 0.28 0.02 0.30 1.82 0.44 0.34 0.02 0.36 1.82
0.09***
0.06***

January 2019
ABN_PROD
0.01 0.20
0.65
0.01 0.55
0.01 0.20
0.65 0.00 0.55 0.00
0.01***
ABN_DISX
0.04 0.22
0.50
0.05 1.08 0.00 0.27
0.5
0.04 1.08
0.04***
0.01***
PM_PROD
0.02 0.25
0.86
0.02 0.82
0.01 0.29
0.86
0.01 0.82
0.01**
0.01***
PM_DISX 0.04 0.27
1.08 0.02 1.15 0.01 0.36
1.08 0.01 1.15 0.03*** 0.01***
COMP_PROXY
0.05 0.48
1.74
0.05 1.64
0.02 0.58
1.74
0.01 1.64
0.03***
0.04***

Other variables used in empirical tests

Supply Chain Power and Real Earnings Management

BENCH 0.09 0.28 0.00 0.00 1.00 0.07 0.25 0.00 0.00 1.00 0.02*** 0.00***
POWER 1.08 0.62 0.69 0.69 4.69 0.00 0.00 0.00 0.00 0.00 1.08*** 0.69***
AdjSIZE 3.06 1.67
3.66 3.30 5.27 0.25 1.88
3.66 0.18 5.27 2.81*** 3.12***
AdjMTB 0.56 3.03
4.05
0.20 17.23
0.03 3.01
4.05
0.71 17.23 0.59*** 0.51***
AdjROA 0.07 0.11
0.76 0.06 0.36 0.02 0.17
0.76 0.04 0.36 0.05*** 0.02***
BEAT 0.80 0.40 0.00 1.00 1.00 0.72 0.45 0.00 1.00 1.00 0.08*** 0.00***
BENCH_NREM 0.04 0.21 0.00 0.00 1.00 0.03 0.18 0.00 0.00 1.00 0.01*** 0.00***
BENCH_REM 0.04 0.20 0.00 0.00 1.00 0.04 0.18 0.00 0.00 1.00 0.00*** 0.00***
DNI/A 0.008 0.090
0.463 0.008 0.588 0.008 0.135
0.463 0.007 0.588 0.000 0.001
RET 0.005 0.443
0.989
0.030 2.493
0.002 0.591
0.989
0.090 2.493 0.007 0.060***
ZSCORE 2.26 1.61
9.72 2.17 6.64 1.74 2.40
9.72 2.11 6.64 0.52*** 0.06***
(continued)

55
56
TABLE 1 (continued)

Major Customer Firms Nonmajor Customer Firms Difference in

Variable Mean SD Min Median Max Mean SD Min Median Max Means Medians
DROA
0.004 0.102
0.583
0.001 0.803
0.003 0.167
0.583
0.003 0.803
0.001 0.002*
DCFOa
0.002 0.091
0.492
0.003 0.730 0.007 0.154
0.492
0.001 0.730
0.009***
0.002***

Suspect Major Customer Firms Other Major Customer Firms Difference in

Variable Mean SD Min Median Max Mean SD Min Median Max Means Medians
Panel (B) Comparison of suspect major customer firm-years (n = 471) to all other major customer firm-years (n = 4,971)
Descriptive variables
MVE ($) 11,908.78 16,195.53 7.03 4,500.95 52,797.86 13,348.51 17,503.99 1.34 4,702.67 52,797.86
1,439.73*
201.72
MTB 2.56 2.11 0.27 1.99 22.34 3.37 3.38 0.27 2.34 22.81
0.81***
0.35***
Total assets ($) 11,900.02 13,751.85 19.45 5,564.77 42,847.25 11,312.57 13,770.65 2.29 4,844.84 42,847.25 587.45 719.93*
Sales ($) 12,700.94 14,034.06 10.46 6,337.36 42,201.00 11,278.82 13,384.64 1.03 5,351.19 42,201 1,422.12** 986.17***
IBEI ($) 636.40 890.81
294.04 205.16 2,852.90 653.48 959.86
294.04 209.76 2,852.9
17.08
4.60
ROA 0.05 0.05
0.28 0.05 0.27 0.06 0.11
0.81 0.06 0.35
0.01
0.01***
CFOa 1,386.84 1,789.20
60.62 567.00 5,747.74 1,457.22 1,881.07
60.62 576.40 5,747.74
70.38
9.40
Asset turnover 1.44 0.97 0.23 1.19 4.53 1.34 0.90 0.10 1.09 4.53 0.10** 0.10**

REM-related variables
DS/A 0.09 0.24
0.88 0.07 1.92 0.14 0.32
0.88 0.08 1.92
0.05***
0.01***
COGS/A 1.11 0.99 0.03 0.82 4.61 0.99 0.92 0.02 0.71 4.61 0.12*** 0.11***

Volume 55, Number 1

INV/A 0.19 0.15 0.00 0.15 0.81 0.17 0.15 0.00 0.13 0.81 0.02*** 0.02***
PROD/A 1.12 0.99 0.03 0.84 4.51 1.00 0.93 0.03 0.72 4.51 0.12*** 0.12***
DISX/A 0.30 0.22 0.02 0.27 1.44 0.35 0.28 0.02 0.30 1.82
0.05***
0.03***
Journal of Supply Chain Management

ABN_PROD 0.03 0.18
0.56 0.02 0.55
0.01 0.20
0.65
0.02 0.55 0.04*** 0.04***
ABN_DISX
0.08 0.19
0.50
0.07 0.72
0.03 0.22
0.5
0.04 1.08
0.05***
0.03***
PM_PROD 0.03 0.24
0.67 0.01 0.82
0.02 0.25
0.86
0.02 0.82 0.05*** 0.03***
PM_DISX
0.02 0.25
1.08 0.00 1.05 0.05 0.27
1.08 0.02 1.15
0.07***
0.02***
COMP_PROXY 0.05 0.45
1.49
0.01 1.64
0.06 0.48
1.74
0.05 1.64 0.11*** 0.04***

Other variables used in empirical tests

BENCH 1.00 0.00 1.00 1.00 1.00 0.00 0.00 0.00 0.00 0.00 1.00 1.00***
POWER 1.11 0.66 0.69 0.69 4.62 1.08 0.62 0.69 0.69 4.69 0.03 0.00
AdjSIZE 3.09 1.52
3.66 3.27 5.27 3.06 1.69
3.66 3.30 5.27 0.03
0.03
AdjMTB
0.02 2.26
4.05
0.44 17.23 0.62 3.09
4.05
0.16 17.23
0.64***
0.28***
AdjROA 0.06 0.07
0.23 0.05 0.33 0.07 0.11
0.76 0.06 0.36
0.01**
0.01***
BEAT 0.00 0.00 0.00 0.00 0.00 0.87 0.33 0.00 1.00 1.00
0.87***
1.00***
BENCH_NREM 0.51 0.50 0.00 1.00 1.00 0.00 0.00 0.00 0.00 0.00 0.51*** 1.00***
(continued)
 Supply Chain Power and Real Earnings Management

PROD/A (112% versus 100%). This suggests a greater

nary items or the change in net income before extraordinary items is between 0 and 0.5% of lagged assets. Dollar ($) amounts are in millions. *, **, and *** denote significance
at the 10%, 5%, and 1% levels based on two-tailed t-tests (for differences in means) or two-tailed Wilcoxon tests (for differences in medians). See the Appendix for variable defi-

We require that cash flows from operations (CFO) be available on Compustat, which restricts the sample for these variables to the post-1986 period. For CFO, n for the major
customer (nonmajor customer) sample is 4,664 (55,668) in Panel A. For ΔCFO, n for the major customer (nonmajor customer) sample is 4,449 (50,877) in Panel A. For CFO, the
The full sample is n = 75,719 firm-years, of which 5,442 are major customer firm-years. Suspect firm-years are defined as firm-years in which either net income before extraordi-

number of suspect major customers (other major customers) is 387 (4,277) in Panel B. For ΔCFO, the number of suspect major customers (other major customers) is 367 (4,082)

0.008***

0.003***
Medians extent of REM among suspect major customers than

0.018

0.003
0.00

0.03
other major customers. Lastly, we note that POWER
Difference in

does not differ significantly between suspect and non-

suspect major customers, with mean POWER for both
samples suggesting that the typical major customer is
***

0.008*

0.004

0.005

0.008
named as such by two suppliers.
Means
0.49

0.09

RESULTS
Correlations among Regression Variables
0.589
2.493

0.803
0.730
0.00

6.64

Given the large sample size, nearly all correlations

Max

displayed in Table 2 are significant. By construction,

COMP_PROXY is highly correlated with PM_PROD
and PM_DISX. It is also apparent from the first line of
0.010

0.032

0.001

0.002
Median
Other Major Customer Firms

0.00

2.18

Table 2 that smaller firms and firms with weaker

returns, market-to-book ratios, and ROA are more
likely to engage in REM.

0.463

0.989

0.583

0.492
0.00

9.72
Min

Effect of SC Power on REM Utilization

We test H1 by estimating the three equations indi-
cated in Table 3. In these equations, the dependent
0.093
0.449

0.105
0.094
0.00

1.63

variable is COMP_PROXY or one of its two compo-

SD

nents. As previously indicated, BENCH equals one

TABLE 1 (continued)

(zero otherwise) for firm-years with suspect earnings.

Following Roychowdhury (2006) and Gunny (2010),
0.009
0.005

0.003

0.001
0.00

2.25

we control for (1) variation in abnormal production

Mean

costs and discretionary expenses associated with firm

size (AdjSIZE) and growth opportunities (AdjMTB),
and (2) measurement error in our estimation of
0.539
2.336

0.305
0.321

abnormal values that is correlated with performance

1.00

6.64
Max

(AdjROA). Like REM’s components, AdjSIZE,

AdjMTB, and AdjROA are expressed as deviations
from the respective industry-year means for nonma-
0.002

0.014

0.004

0.005
Suspect Major Customer Firms

jor customer firms.

Median
0.00

2.15

With COMP_PROXY as the dependent variable, we

expect the coefficient on POWER (b4, as indicated in
Table 3) to be positive, consistent with SC power

0.463

0.989

0.328

0.369
0.00

9.72

being associated with abnormally high production

Min

costs and/or abnormally low discretionary expenses in

steady state. We expect the coefficient on BENCH (b5)
to be positive, consistent with REM occurring around
0.048
0.372

0.049
0.059
0.50

1.42

earnings benchmarks, irrespective of SC power. H1

SD

predicts that the coefficient on BENCH*POWER (b6)

is positive, consistent with REM increasing in SC
power.
0.001
0.001

0.008

0.009
0.49

2.34
Mean

In Table 3 and following tables, equations are esti-

mated using pooled cross-sectional regressions. A key
concern is how to correct standard errors (and t-statis-
tics) for the cross-sectional and time-series depen-
BENCH_REM

dence that is likely present in our panel data.

Following Gow, Ormazabal and Taylor (2010), and
ZSCORE

in Panel B.

consistent with Bray and Mendelson (2012), Petersen

DCFOa
Variable

DROA
DNI/A

nitions.

(2009), Thompson (2009), and Cameron, Gelbach

RET

and Miller (2008), we address both forms of depen-

a

dence by using standard errors that are corrected for

January 2019 57
58
TABLE 2
Correlations

COMP_ PM_ PM_

Variable PROXY PROD DISX RET POWER BENCH AdjSIZE AdjMTB AdjROA DROAt+1a DCFOt+1a ZSCORE
COMP_PROXY 0.863
0.909
0.043
0.018 0.021
0.087
0.186
0.075
0.011 0.011
0.032
PM_PROD 0.866
0.618
0.072
0.011 0.014
0.074
0.148
0.189 0.007 0.044
0.081
PM_DISX
0.917
0.606 0.015 0.023
0.023 0.081 0.179
0.019 0.017 0.012 0.001
RET
0.046
0.064 0.025 0.033
0.006 0.036
0.074 0.263 0.183 0.038 0.196
POWER
0.004 0.003 0.009
0.001 0.018 0.328 0.089 0.080 0.007
0.012 0.038
BENCH 0.023 0.015
0.024
0.022 0.017 0.042
0.039
0.009
0.025 0.004 0.026
AdjSIZE
0.086
0.071 0.082
0.051 0.356 0.042 0.321 0.324
0.057
0.048 0.124
AdjMTB
0.174
0.111 0.190
0.067 0.049
0.045 0.195 0.144
0.068
0.023 0.112

Volume 55, Number 1

AdjROA
0.001
0.173
0.128 0.187 0.075 0.033 0.286
0.069
0.192
0.121 0.540
DROAt+1a
0.028 0.024 0.060 0.127
0.002
0.021
0.051 0.033
0.294 0.414
0.181
DCFOt+1a
0.009 0.057 0.055 0.033
0.017
0.007
0.054 0.043
0.204 0.520
0.108
Journal of Supply Chain Management

ZSCORE 0.035
0.070
0.104 0.121 0.058 0.049 0.174
0.121 0.705
0.250
0.171
The full sample is n = 75,719 firm-years, of which 5,442 are major customer firm-years. Pearson (Spearman) correlation coefficients appear in the lower (upper) diagonal. All val-
ues are measured in year t, unless otherwise noted. Given the large samples, most correlations displayed are significant. For example, for the smallest sample tested (n = 49,418,
as indicated below), correlations of only 0.01 (0.02) are significant at p = 0.026 (p < 0.0001) in two-tailed tests. See the Appendix for variable definitions.
a
The sample reduces to 64,438 observations with available data to measure the year-ahead changes in ROA (DROA). Additionally, we require that cash flows from operations
(CFO) be available on Compustat (post-1986 period), which further reduces the sample to 49,418 observations with data available to measure DCFO.
 Supply Chain Power and Real Earnings Management

TABLE 3
Effect of SC Power on the Association Between Suspect Earnings and REM (Test of H1)

Dependent Variable
Coef. COMP_PROXY PM_PROD PM_DISX
*** *
Intercept b0
0.020 (
3.91)
0.005 (
1.95) 0.015*** (4.91)
AdjSIZE b1
0.019*** (
7.07)
0.001 (
0.45) 0.018*** (10.57)
AdjMTB b2
0.031*** (
19.35)
0.012*** (
14.98) 0.019*** (20.95)
AdjROA b3 0.014 (0.36)
0.319*** (
20.88)
0.311*** (
12.31)
POWER b4 0.045*** (3.59) 0.020*** (2.83)
0.024*** (
3.77)
BENCH b5 0.036*** (4.22) 0.016*** (3.67)
0.020*** (
4.14)
BENCH*POWER (+, +, –) b6 0.035** (2.29) 0.015** (1.99)
0.021** (
2.26)
F-value 310.23 433.34 447.04
RMSE 0.57 0.28 0.35
Adjusted R2 0.03 0.05 0.06
The sample of n = 75,219 consists of 5,442 major customer firm-years and 70,277 nonmajor customer firm-years. The t-statistics
reported in parentheses are calculated using standard errors clustered by firm and year as in Bray and Mendelson (2012), Gow
et al. (2010), and other prior studies. See the Appendix for variable definitions. *, **, and *** denote significance at the 10%, 5%,
and 1% levels based on one-tailed tests for hypothesized relations, and two-tailed tests otherwise.

clustering among both firms and years.6 With
COMP_PROXY as the dependent variable, b4 is posi-
tive (0.045) and significant at p < 0.01 (t = 3.59),
consistent with major customers exploiting their SC
power without regard to earnings management incen-
tives. b5 is also positive (0.036) and is significant at
the 1 percent level, consistent with firms engaging in
REM regardless of their SC power. Consistent with
H1, the coefficient on BENCH*POWER (b6) is posi-
tive (0.035) and significant at p < 0.05 (t = 2.29), sug-
gesting that major customers, compared to nonmajor
customers, engage in more REM.
The second (third) column of Table 3 provides results
using PM_PROD (PM_DISX) as the dependent variable.
b6 is positive (negative) and significant at p < 0.05 when
PM_PROD (PM_DISX) is the dependent variable. Taken
together, the findings reported in Table 3 support the
H1 prediction that major customers, compared to non-
major customers, engage in more REM.
Effect of SC Power on the Association between
REM and Market Returns
To test H2, we estimate the equation indicated in
Table 4, where RET, the dependent variable, is the
6
Petersen (2009)suggests that even in cases where correcting for
both forms of dependence is unnecessary, doing so is a useful
robustness test. Also, our inferences are unchanged when we
estimate equations using OLS or, when in two separate tests, we
correct for only one form of dependence. Inferences are also
unchanged when we use Fama–MacBeth cross-sectional regres-
sions (Fama & MacBeth, 1973), with t-statistics corrected for
autocorrelation using the Newey–West procedure (Newey &
West, 1987).
market return from three months after year-end for
t
1 through three months after year-end for year t,
expressed as a deviation from the industry-year mean
return of nonmajor customers. In this model, BEAT
equals 1 (0 otherwise) if BENCH is equal to zero, and
either (1) net income scaled by lagged assets is equal
to or greater than 0.005, or (2) the change in net
income scaled by lagged assets is equal to or greater
than 0.005. Thus, b1 reflects the return premium for
nonsuspect firms that exceed either earnings bench-
mark (or both) by at least 0.005. We partition suspect
firm-years into two categories based on whether they
exhibit income-increasing REM. BENCH_NREM equals
1 (0 otherwise) for suspect firm-years in which
COMP_PROXY is equal to or less than zero; BENCH_-
REM equals 1 (0 otherwise) for suspect firm-years in
which COMP_PROXY is positive. To control for earn-
ings’ effects, we include ΔNI, which is the change in
net income before extraordinary items during year t
scaled by lagged assets, expressed as a deviation from
the industry-year mean for nonmajor customers.
AdjSIZE and AdjMTB control for the influences of firm
size (Fama & French, 1992) and growth (Collins &
Kothari, 1989; Skinner & Sloan, 2002) on market
returns. All other variables are as previously defined.
Controlling for the effects captured by b6 through
b8, b0 reflects the mean return for firms that miss the
earnings benchmark, and b3 captures the shift in
returns for firms using REM to meet or just beat the
benchmark. b5 captures the effect of SC power on the
association between returns and REM-aided suspect
earnings. H2 predicts that b5 will be positive, consis-
tent with the market surmising that suspect major

January 2019 59
 Journal of Supply Chain Management

TABLE 4
Effect of SC Power on the Association Between REM-Aided Suspect Earnings and Market Returns
(Test of H2)

BENCH_REM and BENCH_NREM Based on Sign of

Coef. COMP_PROXY PM_PROD PM_DISX
Intercept b0
0.128 ***
(
11.27)
0.128 ***
(
11.26)
0.128*** (
11.26)
BEAT b1 0.173*** (12.51) 0.173*** (12.50) 0.173*** (12.51)
BENCH_NREM b2 0.110*** (7.03) 0.105*** (6.52) 0.103*** (6.60)
BENCH_REM b3 0.058*** (3.30) 0.063*** (3.53) 0.066*** (3.67)
POWER b4 0.027*** (3.63) 0.027*** (3.61) 0.027*** (3.65)
BENCH_REM*POWER (+,+,+) b5 0.057*** (3.01) 0.052*** (2.91) 0.052*** (2.66)
DNI b6 0.639*** (12.27) 0.639*** (12.27) 0.639*** (12.28)
AdjSIZE b7
0.017*** (
3.30)
0.017*** (
3.30)
0.017*** (
3.30)
AdjMTB b8
0.013*** (
7.18)
0.013*** (
7.17)
0.013*** (
7.17)
F-value 431.86 431.21 430.99
RMSE 0.56 0.56 0.56
Adjusted R2 0.06 0.06 0.06
The sample includes 5,442 major customer firm-years and 70,277 nonmajor customer firm-years. BENCH_REM (BENCH_NREM) is
an indicator variable equal to 1 for suspect firm-years in which the signs of COMP_PROXY, PM_PROD, and PM_DISX are (are not)
positive, positive, and negative, respectively. The t-statistics reported in parentheses are calculated using standard errors clustered
by firm and year as in Bray and Mendelson (2012), Gow et al. (2010), and other prior studies. See the Appendix for variable defini-
tions. *** denotes significance at the 0.01 level based on one-tailed tests for hypothesized relations, and two-tailed tests otherwise.

customers are better positioned than suspect nonma-
jor customers to avoid any adverse consequences of
REM.
The left column of Table 4 presents results with
income-increasing REM defined as positive values of
COMP_PROXY. The estimate of b0 reflects a penalty of

12.8 percentage points for missing the earnings
benchmark. b3 (the marginal effect of a suspect firm
beating the benchmark via REM) is positive (0.058)
and significant at p < 0.01 (t = 3.30). However, b3 is
significantly smaller (p < 0.01 in F-tests) than both b1
(the effect of nonsuspect firms beating the benchmark)
and b2 (the effect of suspect firms beating the bench-
mark without resorting to REM). Consistent with Gra-
ham et al. (2005), the result for b3 suggests that
managers engage in potentially value-reducing REM to
avoid at least some of the short-term costs of missing
earnings benchmarks. The smaller magnitude of b3 in
comparison with b1 and b2 is consistent with prior evi-
dence of market rewards for meeting or beating earn-
ings benchmarks, but discounting of those rewards for
firms suspected of earnings management (e.g., Bartov
et al., 2002; Lopez & Rees, 2002). b5 is positive (0.057)
and significant at p < 0.01, which supports H2.
The middle and right columns of Table 4 report the
results from re-estimating the equation defining
BENCH_NREM and BENCH_REM based on the
respective signs of PM_PROD and PM_DISX. The
results are consistent with those in the left column.
We conclude that investors do not discount powerful
SC firms’ REM-aided earnings, as they do for other
firms. Instead, REM is perceived as a managerial
choice that allows powerful SC firms to avoid the neg-
ative market reaction to missing earnings targets.
Effect of SC Power on the Association between
REM and Future Performance
If investors react more favorably to powerful SC
firms’ REM than other firms’ REM, then we expect cor-
responding differences in the firms’ future financial
performance. Following Gunny (2010), we test this
prediction (H3) by estimating the equation indicated
in Table 5, where the dependent variable is the
change in return on assets (ΔROA) or the change in
cash flows from operations scaled by assets (ΔCFO),
both measured in year t + 1, relative to their respec-
tive averages in the two prior years. We expect the
coefficient on BENCH_REM*POWER (b5) to be posi-
tive. We include AdjROA during year t to control for
the time-series properties of performance, and expect
its coefficient (b6) to be negative. We include AdjSIZE
and AdjMTB to control for variations in future perfor-
mance associated with firm size and growth opportu-
nities. We include RET to control for the association
between market returns and future earnings (Kothari
& Sloan, 1992), and ZSCORE to control for firms’
financial health (Mackie-Mason, 1990); other vari-
ables are previously defined.

60 Volume 55, Number 1

 TABLE 5
Effect of SC Power on the Association Between REM-Aided Suspect Earnings and Future Financial Performance (Test of H3)

BENCH_REM and BENCH_NREM Based on Sign of

COMP_PROXY PM_PROD PM_DISX
Coef. DROAt+1 DCFOt+1 DROAt+1 DCFOt+1 DROAt+1 DCFOt+1
*** *** ***
Intercept b0
0.026 (
4.50)
0.002 (
0.26)
0.026 (
4.51)
0.002 (
0.25)
0.026 (
4.50)
0.002 (
0.26)
BEAT b1 0.049*** (14.34) 0.021*** (8.75) 0.049*** (14.34) 0.021*** (8.73) 0.049*** (14.34) 0.021*** (8.74)
***
BENCH_NREM b2 0.036*** (9.29) 0.018*** (7.58) 0.037*** (9.49) 0.017*** (6.59) 0.034 (8.75) 0.018*** (6.70)
***
BENCH_REM b3 0.034*** (8.26) 0.020*** (6.20) 0.033*** (8.23) 0.021*** (6.90) 0.036 (8.80) 0.020*** (6.93)
POWER b4 0.002 (1.16)
0.001 (
1.30) 0.002 (1.13)
0.001 (
1.21) 0.002 (1.17)
0.001 (
1.27)
BENCH_REM*POWER b5 0.001 (0.25) 0.007** (1.79) 0.002 (0.57) 0.005 (1.21) 0.001 (0.34) 0.006** (1.69)
(+,+,+,+,+,+)
AdjROA b6
0.342*** (
13.23)
0.189*** (
8.98)
0.342*** (
13.23)
0.189*** (
8.98)
0.342*** (
13.23)
0.189*** (
8.98)

January 2019
AdjSIZE b7 0.003*** (7.44)
0.0001 (
0.25) 0.003*** (7.45)
0.0001 (
0.25) 0.003*** (7.45)
0.0001 (
0.25)
AdjMTB b8 0.0004 (0.81) 0.002*** (4.11) 0.0004 (0.81) 0.002*** (4.11) 0.0004 (0.82) 0.002*** (4.10)
RET b9 0.044*** (14.09) 0.014*** (5.67) 0.044*** (14.09) 0.014*** (5.67) 0.044*** (14.10) 0.014*** (5.67)
ZSCORE b10
0.004*** (
3.35)
0.001 (
1.33)
0.004*** (
3.35)
0.001 (
1.33)
0.004*** (
3.35)
0.001 (
1.33)
Industry dummies Yes Yes Yes Yes Yes Yes
F-value 123.01 33.56 123.06 33.68 123.09 33.50
RMSE 0.14 0.13 0.14 0.13 0.14 0.13
Supply Chain Power and Real Earnings Management

Adjusted R2 0.14 0.05 0.14 0.05 0.14 0.05

The sample includes 64,438 firm-years when the dependent variable is DROA, and 49,418 firm-years (all post-1986), when the dependent variable is DCFO. BENCH_REM
(BENCH_NREM) is an indicator variable equal to 1 for suspect firm-years in which the signs of COMP_PROXY, PM_PROD, and PM_DISX are (are not) positive, positive, and nega-
tive, respectively. The t-statistics reported in parentheses are calculated using standard errors clustered by firm and year as in Bray and Mendelson (2012), Gow et al. (2010), and
other prior studies. See the Appendix for variable definitions. ** and *** denote significance at the 0.05 and 0.01 levels, respectively based on one-tailed tests for hypothesized
relations, and two-tailed tests otherwise.

61
 Journal of Supply Chain Management
The left two columns of Table 5 present results using
the two alternative dependent variables, and with
income-increasing REM defined as positive values of
COMP_PROXY. Without regard to H3, the results pro-
vide little indication that future performance is contin-
gent on whether a firm deployed REM. The
coefficients on BENCH_NREM and BENCH_REM,
while less than the coefficients on BEAT, are not signif-
icantly different from each other in untabulated tests.
For our variable of interest, BENCH_REM*POWER,
the coefficient b5 is positive with either dependent
variable, and in the equation with ΔCFO as the depen-
dent variable, the 0.007 coefficient is significant at
p < 0.05. Overall, these results do not support the
claims in prior research that REM may be detrimental
to future performance. However, consistent with H3,
the results provide evidence that powerful SC firms
that deploy REM to beat earnings targets produce bet-
ter future financial performance than other firms who
engage in such behavior to beat targets. This inference
is also supported by the results reported in the right
two columns of Table 5, which define BENCH_NREM
and BENCH_REM based on the signs of PM_DISX.
Effect of Major Customers’ REM on Suppliers’
Financial Performance
In previous tests, positive values of COMP_PROXY
indicate REM, and positive (negative) values of
PM_PROD (PM_DISX) suggest that a firm ramped up
production (cut expenses) to effect REM. If, as H4
posits, such actions are harmful to suppliers, then
major customers’ COMP_PROXY, PM_PROD, and
PM_DISX should be associated with their suppliers’
contemporaneous financial performance. To test this
prediction, we construct a sample of supplier–buyer
dyads from our original data set of 16,393 supplier
firm-years and their named major customers. If a sup-
plier names more than one major customer in a given
year, we retain only the dyad linking the supplier to
its most significant major customer based on the level
of sales concentration, thereby ensuring that each sup-
plier firm-year appears only once in our sample.7 After
imposing data availability requirements, our final
sample consists of 4,162 unique dyads. We describe
7
A given supplier-year is included only once, but suppliers and
years are included multiple times. Thus, we again double cluster
standard errors. This approach allows the same major customer
to be served by multiple suppliers in a given year, which is true
to some degree in most samples of firms—that is, some portion
of firms’ sales is to common customers. However, in two sensi-
tivity tests we screened the sample to allow a firm to be a sup-
plier’s major customer only one time in a given year. In the first
test, we retained the supplier providing the greatest portion of a
major customer’s operating input; in the second test, we retained
the supplier with the highest sales concentration. Under these
screens, the sample is reduced by nearly half, but the results are
qualitatively similar to those reported in Table 7.
62 Volume 55, Number 1
the sample in Table 6 and observe substantial varia-
tion in terms of size and ROA. Suppliers in the sam-
ple have significant sales concentrations—mean sales
concentration to the most significant major customer
is 25%, and mean sales concentration to all named
major customers is 41%. In our main empirical test,
we estimate equations analogous to those estimated
for major customers. Here, the dependent variable is
the change in the supplier’s ROA or CFO, relative to its
average ROA or CFO in t
1 and t
2; AdjSIZE,
AdjMTB, AdjROA, RET, and ZSCORE are previously
defined firm attributes, calculated here for suppliers;
and CusBENCH is the previously defined measure of
suspect earnings (coded 1 here if the supplier’s major
customer reported suspect earnings, 0 otherwise).
In Panel A, Cus_REM equals COMP_PROXY if
COMP_PROXY is positive for the supplier’s major cus-
tomer, 0 otherwise. Thus, b6 captures the mean effect
on supplier performance when major customers
report abnormally high production costs and/or
abnormally low discretionary expenses, without regard
to the major customers’ earnings performance. b7 cap-
tures any (main) effect on supplier performance when
major customers report suspect earnings. If suppliers’
performance is damaged when major customers with
suspect earnings execute REM (the H4 prediction),
then b8 will be negative. Lastly, b1 through b5 are
coefficients on variables that may also affect suppliers’
year t performance.
In Panel B, Cus_PROD and Cus_DISX replace Cus_-
REM. For each supplier, Cus_PROD equals its major
customer’s PM_PROD when the major customer’s
PM_PROD is positive, 0 otherwise. Similarly, Cus_-
DISX equals the major customer’s PM_DISX when the
major customer’s PM_DISX is negative, 0 otherwise.
Although we generally expect major customers’ REM
to be detrimental to suppliers, the equation in Panel B
examines the possibility that the effect of a major cus-
tomer’s REM on its supplier is contingent on whether
the major customer’s REM is ramped-up production
(which potentially benefits the supplier) versus discre-
tionary cost cuts (which are almost surely detrimental
to the supplier). If suppliers suffer (benefit) from
major customers ramping up production, then the
coefficient on Cus_PROD*CusBENCH (b9) will be
(negative) positive. If suppliers are harmed when
major customers cut discretionary costs, then the coef-
ficient on Cus_DISX*CusBENCH (b10) will be positive
(recall that negative CusDISX indicates cost cutting).
With major customers’ income-increasing REM
defined based on the sign of COMP_PROXY
(Panel A), b8 is negative but not statistically signifi-
cant when either ΔROA or ΔCFO is the dependent
variable. This suggests either that a major customer’s
REM has no effect on a supplier’s performance or that
the directional impact depends on the type of REM
 Supply Chain Power and Real Earnings Management

TABLE 6
Descriptive Statistics for Sample of Supplier Firm-Years Used to Test H4

Variable Mean SD Min Median Max

MVE 1,679.92 4,627.71 1.46 191.30 30,992.81
MTB 2.77 3.26 0.27 1.77 22.10
Sales 1,225.73 3,670.53 2.93 182.93 29,723.00
IBEI 55.18 225.92
294.04 2.86 1,526.00
ROA 0.00 0.17
0.72 0.03 0.34
CFOa 173.22 504.39
60.62 14.60 3,445.00
DROA
0.008 0.170
0.566
0.007 0.803
DCFOa
0.001 0.127
0.397
0.004 0.475
Number of disclosed major customers 2.24 1.08 1.00 2.00 5.00
Sales concentration to all major customers 0.41 0.24 0.10 0.37 1.00
Sales concentration to most significant major 0.25 0.15 0.10 0.20 0.82
customer
The sample includes 4,162 unique dyad-years. By construction, each dyad links a supplier firm-year to its most significant major
customer (in terms of sales concentration percentage) during year t. See the Appendix for variable definitions.
a
We require that cash flows from operations (CFO) be available on Compustat, which restricts the sample for these variables to
the post-1986 period. For these variables, n is 3,470.

deployed by the major customer. In Panel B, the
results provide support for the latter explanation.
When the dependent variable is ΔROA, the coefficients
on CusPROD*CusBENCH (b9 = 0.144) and CusDISX*-
CusBENCH (b10 = 0.203) are both positive, with b9
being just shy of significant in a two-tailed test
(t = 1.56; p = 0.119) and b10 being significant at
p < 0.05 in a one-tailed test (t = 2.02). These findings
suggest that when major customers ramp up produc-
tion (cut discretionary expenses) to effect REM, their
suppliers benefit (are harmed). Panel B reports similar
findings when the dependent variable is ΔCFO. How-
ever, the significance of b9 declines in a two-tailed test
(t = 1.23), while b10 remains significant at p < 0.05 in
a one-tailed test (t = 1.67). Overall, the results in
Panel B of Table 7 provide considerable evidence that
the financial performance of suppliers is negatively
impacted when major customers cut discretionary
expenses in REM to hit earnings targets.
Additional Analyses
Tests Using “Pseudo” Earnings Benchmarks. If the
association between SC power and REM is significant
in earnings intervals where no earnings management
incentives exist, then our main results may be spuri-
ous. We re-estimated the H1 equation using 20
“pseudo” benchmarks, defined as the 10 intervals to
the left and right of BENCH firm-years. Of the 21
regressions, the coefficient on BENCH*POWER was by
far the greatest for the BENCH interval defined in our
main test, and the coefficient was positive and signifi-
cant for only one “pseudo” benchmark, an occurrence
rate of only 5%.
Tests of the Association between SC Power and Accru-
als Manipulation. Any evidence suggesting that major
customers’ SC power is associated with accruals-based
earnings management might indicate that our results
are due to an unidentified effect correlated with both
REM and accruals manipulation. We re-estimate the
H1 equation using as the dependent variable perfor-
mance-matched discretionary accruals (Kothari et al.,
2005). We find no evidence that major customers’
SC power influences the extent of their accruals
manipulation.
Alternative Measures of SC Power. Our main SC
power measure—the natural logarithm of the number
of suppliers naming a major customer as such—cap-
tures both the power imbalance in a given major cus-
tomer/captive supplier relationship (i.e., captive
suppliers’ sales concentrations are at least 10%, and
average more than 20% in our sample) and a major
customers’ number of power-imbalanced relation-
ships. We also used alternative measures. In a test
with a coarser measure, using a dummy variable
coded 1 if a firm is named as a major customer (0
otherwise) yields identical inferences. We also used
more granular measures of SC power, including (1) a
variable based on Hoskisson, Hitt, Johnson and Moe-
sel’s (1993) entropy measure; (2) the sum of the
squares of captive suppliers’ percentages of sales to
the major customer; and (3) major customers’ market
shares in their two-digit SICs. The Hoskisson et al.
(1993) and sum of squares variables produce identical
inferences in all cases. The market share variable—
which captures downstream, rather than upstream,
power—produced identical inferences for H2, but

January 2019 63
 Journal of Supply Chain Management

TABLE 7
Impact of Major Customers’ REM on Suppliers’ Contemporaneous Financial Performance (Test of H4)

Coef. DROAt DCFOt

Panel (A) Results using composite measure of REM deployed by a supplier’s major customer
Intercept b0
0.021 (
0.80)
0.003 (
0.17)
AdjSIZE b1 0.006*** (3.15)
0.002 (
1.32)
AdjMTB b2 0.0003 (0.14) 0.001 (1.18)
AdjROA b3
0.332*** (
5.89)
0.141*** (
3.51)
RET b4 0.043*** (6.16) 0.014*** (3.42)
ZSCORE b5
0.003 (
1.04) 0.002 (0.75)
CusREM b6 0.007 (0.64) 0.008 (1.56)
CusBENCH b7
0.007 (
0.93) 0.004 (0.52)
CusREM*CusBENCH b8
0.015 (
0.47)
0.012 (
0.43)
Industry dummies Yes Yes
F-value 12.44 3.84
RMSE 0.16 0.12
Adjusted R2 0.15 0.04
Panel (B) Results using decomposed measures of REM deployed by a supplier’s major customer
Intercept b0
0.021 (
0.90)
0.003 (
0.22)
AdjSIZE b1 0.006*** (3.16)
0.002 (
1.36)
AdjMTB b2 0.0003 (0.14) 0.001 (1.17)
AdjROA b3
0.333*** (
5.94)
0.142*** (
3.51)
RET b4 0.043*** (6.50) 0.014*** (3.50)
ZSCORE b5
0.003 (
0.99) 0.002 (0.78)
CusPROD b6
0.042* (
1.68) 0.012 (0.49)
CusDISX b7
0.066** (
2.39)
0.008 (
0.23)
CusBENCH b8
0.007 (
0.93) 0.020** (2.84)
CusPROD*CusBENCH (?) b9 0.144 (1.56) 0.103 (1.23)
CusDISX*CusBENCH (+) b10 0.203** (2.02) 0.169** (1.67)
Industry Dummies Yes Yes
F-value 11.69 3.55
RMSE 0.16 0.12
Adjusted R2 0.15 0.04
The sample includes 4,162 dyad-years when the dependent variable is DROA and 3,470 dyad-years (all post-1986) when the
dependent variable is DCFO. Each dyad links a supplier firm-year to its most significant major customer (in terms of sales concen-
tration percentage) during year t. In Panel A, the extent of REM deployed by a supplier’s major customer (Cus_REM) is set equal
to the major customer’s COMP_PROXY (0 otherwise) if the major customer’s COMP_PROXY is positive. In Panel B, Cus_PROD
(Cus_DISX) equals the major customer’s PM_PROD (PM_DISX) (0 otherwise) if the major customer’s PM_PROD (PM_DISX) is posi-
tive (negative). The t-statistics reported in parentheses are calculated using standard errors clustered by firm and year as in Bray
and Mendelson (2012), Gow et al. (2010), and other prior studies. See the Appendix for variable definitions. *, **, and *** denote
significance at the 10%, 5%, and 1% levels based on one-tailed tests for hypothesized relations, and two-tailed tests otherwise.

insignificant results in other tests. These insignificant
results for a common but downstream-based measure
suggest that our main measure is capturing buyers’
power to engage in REM via their interactions with suppli-
ers. In another sensitivity test, we included a variable
(the sum of captive suppliers’ sales to the major cus-
tomer, scaled by the major customer’s cost of sales) to
control for the percentage of inputs the major cus-
tomer acquires from captive suppliers. Inferences were
unchanged.
Size of Control Firms. Our models control for the
between-sample difference in firm size. We repeated
our analyses twice using only those nonmajor cus-
tomer firm-years for which the natural logarithm of
total assets is within two or one standard deviation of
the mean value for the major customer sample.
Despite substantial reductions in the nonmajor cus-
tomer sample sizes, our main inferences were
unchanged. Under the latter restriction, b5 is signifi-
cantly positive in the H3 test of ΔROA (consistent
with our prediction), compared to the insignificant
results reported in Table 5.
Dropping AdjSIZE from Models and Adding
BENCH_REM*AdjSIZE to Models. Inferences are

64 Volume 55, Number 1

 Supply Chain Power and Real Earnings Management
unchanged when AdjSIZE is omitted from equations.
We also added BENCH_REM*AdjSIZE to our models.
With one exception, results were similar to our main
results. For H2, the coefficients on BENCH_REM*Adj-
SIZE were significant in all three tests. The coefficients
on BENCH_REM*POWER remained positive in all
three tests but were not significant at conventional
levels. Thus, it is possible that among REM-deploying
firms, SC power’s effects on market returns may be
indistinguishable from the effects of firm size.
Other Tests. In our main analyses, we winsorize vari-
ables at 1% and 99%. Results are unchanged when we
winsorize at 5% and 95%. Also, our data span 1980–
2015, but the results we document are generally preva-
lent throughout the period studied. Lastly, we
expanded the H4 equation to include the same five
variables for major customers that are included for sup-
pliers. None of the added major customer variables
were significant, and our inferences were unchanged.
DISCUSSION AND CONCLUSION
Many prior studies provide evidence that firms exer-
cise SC power in purchasing negotiations, product
innovation, and other contexts. Reimann and Ketchen
(2017, 6) call for research examining the conditions
under which weaker SC members are likely to “absorb
the bulk of damage.” In this study, we show that in
times of financial reporting pressures, powerful major
customers execute REM in ways that enhance their
financial performance, but that may be either harmful
or beneficial to their suppliers’ performance. Further,
we examine a previously unexplored benefit of SC
power, the differential and favorable investor percep-
tions of suspected REM. This section explains the
scholarly and managerial contributions of this
research and discusses paths for future research.
Scholarly Contributions
We demonstrate that powerful SC firms enjoy lower
consequential costs (both to performance and to mar-
ket value) from erratic, potentially disruptive behav-
iors that are usually seen to be value-destroying. In
doing so, our study provides a new application of
RDT in which major customers’ influence on suppli-
ers’ resources appears to provide immediate financial
benefits as well as potential longer-term benefits from
favorable capital market perceptions. These findings
add to our understanding of how powerful firms exer-
cise SC power to their advantage, in a previously
unexplored context—the attainment of short-term
financial reporting objectives.
Results of the study support three predictions:
(1) Major customers, compared to nonmajor cus-
tomers, engage in more REM; (2) the stock market
views major customers’ REM more favorably than
January 2019
nonmajor customers’ REM; and (3) the association
between REM and post-REM financial performance is
more favorable for major customers than nonmajor
customers. Results also suggest that major customers’
captive suppliers’ performance is impacted negatively
when major customers engage in expense-cutting
forms of REM.
Prior REM studies’ designs do not account for the
possibility that powerful SC firms may possess a
greater ability to execute REM, or that they may incur
fewer consequential costs in doing so. Thus, our find-
ing that major customers, compared to nonmajor cus-
tomers, are more likely to engage in REM and largely
avoid any associated weakness in stock market or
post-REM financial performance is an important
extension of prior accounting research.
Our findings also provide important new insights
for the SCM literature—insights that have practical
economic implications. For example, the results in
Table 3 indicate that a typical benchmark-beating firm
named by two suppliers as a major customer executes
twice (+106%) as much REM as a firm not named as
a major customer at all. The results in Table 4 imply
that when a firm not named as a major customer uses
REM, it is penalized by the market; it receives only
about 50% of the benefit that target-beating firms
receive when they do not use REM. However, when a
twice-named major customer engages in REM to meet or
beat an earnings target, it receives approximately the
same benefit as a non-REM firm would receive; the
entire penalty associated with missing a target is elimi-
nated.8 Finally, the results in Table 7 provide marginal
evidence that major customers’ production ramp-ups
are associated with better supplier performance,
whereas major customers’ cuts in discretionary
spending are firmly associated with worse supplier
performance.
Managerial Contributions
Our study also has managerial implications. We
show that investors do not frown upon powerful
firms’ REM, as they do other firms’ REM. Moreover,
engaging in REM does not foretell weakness in power-
ful firms’ future financial performance as some
researchers have suggested (Cohen et al., 2010; Gra-
ham et al., 2005; Roychowdhury, 2006). Rather, it
may serve as a positive signal to stakeholders (Gunny,
8
In Table 3, the coefficient on BENCH is 0.036. For a firm
named twice as a major customer, the shift is 0.035 times the
natural logarithm of 3, or 0.038, for a total of 0.074, which is
106% more than 0.036. In Table 4, the penalty for missing an
earnings target (the intercept) is
0.128. The coefficient on
BENCH_REM, 0.058, is 45% of
0.128. The combined effect of
BENCH_REM (0.058) and BENCH_REM*POWER (0.057*natu-
ral logarithm of 3) is 0.121, or 95% of the penalty for missing
an earnings target (
0.128).
65
 Journal of Supply Chain Management
2010). These results suggest that powerful SC firms
suffer few consequences when they exert power to hit
earnings targets. Moreover, the results suggest that
consolidating purchases among fewer suppliers may
aid firms in extracting concessions from suppliers for
REM purposes. Finally, our study highlights potential
new costs and risks of serving concentrated customer
bases. Suppliers on the weaker side of asymmetric
trading relationships must potentially cope with pow-
erful customers’ heavy-handedness in the normal
course of business. In addition to responding to
demands major customers may place on suppliers in
the course of collaborative innovation efforts, procure-
ment decisions, and normal operations, suppliers may
do well to anticipate potentially disruptive demands
for rapid changes occurring near the ends of cus-
tomers’ financial reporting periods.
Future Research
Our study is subject to the limitations inherent in
analyses of secondary data of large firms. Nevertheless,
when viewed through the lens of buyer–supplier power
relations, our findings pose new questions for future
research, some of which could address limitations of
our study. Future research might investigate whether
short-term benefits of REM that accrue to major cus-
tomers are outweighed in the longer term by negative
effects of degradations in supplier trust, commitment,
and cooperation, and whether major customers’.
REM decreases the duration of supplier relationships.
Further, research should investigate the spillover effects
to suppliers. For example, our findings suggest that
major customers’ REM impacts suppliers either favor-
ably or unfavorably, depending on the mode of REM
pursued. A more fine-grained analysis might examine
the direct impacts of major customers’ REM upon sup-
pliers of different types. Kraljic’s (1983) famous typol-
ogy of commodity types (noncritical, leverage,
bottleneck, strategic) provides a potentially useful way
to examine the costs and benefits of this activity in
buyer–supplier relationships.
The findings also point to broader questions regard-
ing SC power. Future research should further explore
the extent to which occupying a powerful SC position
entitles a major customer to broader market benefits.
Our findings suggest that investor markets understand
and differentially interpret a firm’s actions based on its
position of power. Future research could address the
extent to which other markets recognize these differ-
ences. For example, do major customers have greater
and more preferential access to capital, debt, or other
sources of financing? Do they enjoy advantages in
reaching out to new demand markets because of their
SC power? Are such advantages recognized and fac-
tored in to SC strategic decisions? A stream of research
addressing these types of questions will extend the
66 Volume 55, Number 1
understanding of SC design decisions beyond direct
transaction cost perspectives to address a larger set of
indirect, yet potentially significant, factors.
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 Supply Chain Power and Real Earnings Management

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Danny Lanier Jr. (Ph.D., University of Georgia) is
Assistant Professor, Department of Accounting, Martha
and Spencer Love School of Business at Elon Univer-
sity. His research interests include the financial report-
ing effects of significant seller–buyer (supply chain)
relationships, earnings management, accounting fraud,
and whistleblowing. His research has appeared in
Journal of Operations Management, Journal of Forensic
and Investigative Accounting, and International Journal of
Management and Marketing Research.
William F. Wempe (Ph.D., Texas A&M University)
is a Professor at Texas Christian University. His
research interests include interface of accounting and
supply chain and management/accounting topics in
healthcare; his current projects are in healthcare man-
agement and healthcare insurance.
Morgan Swink (Ph.D., Indiana University) is Profes-
sor, Eunice and James L. West Chair of Supply Chain
Management, and Executive Director, Supply and Value
Chain Center, Information Systems and Supply Chain
Management Department, Neeley School of Business,
Texas Christian University. His research interests include
the following: Innovation in the Supply Chain: Integra-
tion of product/process technology development and
supply chain operations; Outsourced design and co-
development; Management of innovation projects Sup-
ply Chain Integration: Internal cross-functional pro-
cesses; External customer/supplier collaboration
Operations Strategy: Competitive priorities/capabilities;
and Strategy formulation and implementation Supply
Chain Technologies: Advanced technology adoption and
implementation (e.g., analytics, supply chain systems,
process technologies). His current research projects
address digital transformation and cutting-edge compe-
tencies in supply chain management, financial impacts
of supply chain management, collaborative integration,
supply chain organizational structures, innovation initia-
tives, and project success factors.

APPENDIX
VARIABLE DEFINITIONS

All variables (except where indicated) are calculated using data obtained from Compustat. Where applicable, the
Compustat item names appear in parentheses.

Descriptive variables
MVE Market value of equity (PRCC_F * CSHO)
MTB Market-to-book ratio, measured as MVE divided by book value of equity (CEQ)
Assets (A) Total assets (AT)
Sales (S) Sales (SALE)
IBEI Income before extraordinary items (IB)
ROA Return on assets, measured as IBEI, divided by beginning assets
CFO Cash flow from operations (OANCF)
Asset turnover Sales divided by average assets
REM-related variables
ΔS Sales in year t minus Sales in year t
1
COGS Cost of goods sold (COGS)
INV Inventory (INVT)
Production costs COGS + change in INV, scaled by lagged assets
(PROD)
Discretionary R&D (XRD) + Advertising (XAD) + Selling, General and Administrative expenses
expenses (DISX) (XSGA), scaled by lagged assets; missing values of Advertising and R&D are
coded as zero if SG&A is available
(continued)

January 2019 69
 Journal of Supply Chain Management

ABN_PROD Abnormal production costs, measured as the difference between actual PROD
for each observation and normal levels of PROD estimated from the
corresponding industry-year regressions: PRODt/At-1 = a0 + a1(1/At-1) + b1(St/At-1)
+ b2(ΔSt/At-1) + b3(ΔSt-1/At-1) + et
ABN_DISX Abnormal discretionary expenses, measured as the difference between actual
DISX for each observation and normal levels of DISX estimated from the
corresponding industry-year regressions: DISXt/At-1 = a0 + a1(1/At-1) + b(St-1/At-1)
+ et
PM_PROD Performance-matched abnormal production costs, measured as the difference
between ABN_PROD for each firm-year and abnormal production costs for the
nonmajor customer in the same industry-year with the closest ROA from year
t
1.
PM_DISX Performance-matched abnormal discretionary expenses, measured as the
difference between ABN_DISX for each firm-year and abnormal discretionary
expenses for the nonmajor customer in the same industry-year with the closest
ROA from year t
1.
COMP_PROXY PM_PROD + [(
1)*PM_DISX]
Other variables used in empirical tests
BENCH Indicator variable set to equal 1 (0 otherwise) for firm-years in which 1) net
income before extraordinary items, scaled by lagged assets, is between 0 and
0.005; or 2) the change in net income before extraordinary items, scaled by
lagged assets, is between 0 and 0.005
POWER Natural logarithm of the quantity (1+ the number of supplying firms naming the
buyer as a major customer during year t).
AdjSIZE SIZE is the natural logarithm of MVE. AdjSIZE is the difference between SIZE for
each firm-year and industry-year mean SIZE for nonmajor customer firms.
AdjMTB The difference between MTB for each firm-year and industry-year mean MTB for
nonmajor customer firms.
AdjROA The difference between ROA for each firm-year and industry-year mean ROA for
nonmajor customer firms.
BEAT Indicator variable equal to 1 (0 otherwise) for firm-years in which (a) net income
scaled by lagged assets is equal to or greater than 0.005 or (b) the change in
net income scaled by lagged assets is equal to or greater than 0.005 and (c)
BENCH is equal to zero.
BENCH_NREM Indicator variable set equal to 1 (0 otherwise) for firm-years in which (a) BENCH
= 1; and (b) COMP_PROXY ≤ 0.
BENCH_REM Indicator variable set equal to 1 (0 otherwise) for firm-years in which (a) BENCH
= 1; and (b) COMP_PROXY > 0.
ΔNI Change in income before extraordinary items, scaled by lagged assets,
expressed as deviations from the corresponding industry-year mean for
nonmajor customer firms.
RET Share return (from CRSP), measured from the period beginning 9 months before
the end of the fiscal year to 3 months after fiscal year-end, expressed as
deviations from the corresponding industry-year mean for nonmajor customer
firms.
ZSCORE Measure of financial health computed as: 3.3*(ROA) + 1.0*(St/At-1) + 1.4*
(Retained Earnings/At-1) + 1.2*(Working Capital/At-1).
ΔROA ROA in year t, minus the average ROA over the two prior years.
ΔCFO CFO in year t divided by assets, minus the average of the same value in the two
prior years.

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