The Effect of Customer－Subcontractor Relationship on Subcontractors’ Accounting Choices

[Purpose]This study analyzes the effect of the customer－subcontractor relationship on the subcontractor’s accounting choice. Subcontractors want to maintain a continuous relationship with large customers. For subcontractors, relationships with large customer create two conflicting incentives. Since large customers want stable supply partner that can observe delivery due date and quality, subcontractor have an incentive to report stable performance. On the other hand, if profits are excessive, pressure to lower unit prices may increase from large customers, so there is also an incentive to report earning to a low level. In this paper, we analyze whether subcontractors have a high incentive to report stable earning or a high incentive to report low earning. [Methodology]This study used earning smoothing to measure incentives to report stable earning levels of subcontractors, and discretionary accruals were used to measure incentives to report low earnings. Using data from 2004 to 2014, it was analyzed whether there was a significant difference in earning smoothing and earning downward adjustment using discretionary accruals by comparing companies that are large customers’ subcontractors and those that do not. [Findings]As a result of test, it was found that subcontractors chose earning downward adjustment rather than earning smoothing. This can be interpreted as reflecting the subcontractors’ accounting choice tendency to avoid pressure to lower unit prices due to excessive earning rather than incentives to maintain a continuous relationship with large customers by reporting stable earnings. [Implications]This study has several contribution in that it revealed that the transactional relationship is a factor that can affect the subcontractors’ accounting choices. It also showed that the transactional relationship is another governance structure that can affect the decision－making of subcontractors without an equity relationship. Finally, previous studies on the earning downward adjustment studied this behavior in specific circumstances, but this study showed that earning downward adjustment may occur even in continuous transaction relationships.