Large Customers, Earnings Persistence, and Earnings Management

We propose that the presence of large customers makes supplier firms’ earnings more persistent, which leads to earnings shocks having a greater impact on stock prices of these firms. As a result, the managers of firms with large customers have stronger incentives to manage earnings. We formalize this idea in a theoretical framework similar to Stein (1989). We then provide supporting empirical evidence that firms with large customers have more persistent earnings, are more likely to engage in earnings management, and tend to receive more negative stock price reactions when they miss or barely meet forecast earnings.