A study on the relationship between Cost leadership strategy, Market Competition, and earnings management in the Tehran Stock Exchange (TSE)

Introduction
In this study, we use Porter’s (1980) organizational strategy typology to examine the impact of leadership cost, as one of the trading strategies, and market competition on real earnings management. By doing so, we provide evidence on whether cost leadership strategy is one of the underlying determinants of earnings management. Furthermore, we examine the interactions between cost leadership strategy and market competition and its impact on earnings management, providing evidence on whether an external contributing factor such as market competition may have incremental influence over earnings management through its impact on an internal factor such as business strategy. Business strategy, as an important factor affecting internal governance mechanism (Miles and Snow, 1978, 2003; Ittner et al., 1997) has received little attention on its impacts upon earnings management. Our study, for the first time, attempts to explore whether cost leadership strategy maybe an underlying determinant of earnings management.
 
Hypotheses
Based on the theoretical literature and the conducted studies, research hypotheses were developed as follows:
First main hypothesis: Product market competition affects accounting information quality.
The minor hypotheses are:
H1: Cost leadership strategy is positively associated with the level of earningsmanagement.
H2: The interaction of market competition and cost leadership strategy will exhibita positive relationship with earnings management.
 
Methods
The research methodology is a quantitative research that adopts the scientific method and empirical evidence, based on hypotheses and ex-post research designs. This type of research is utilized when criteria data quantitative are used. In this research, data of 128 companies are analyzed for the period of 2010-2015. The related data was collected through observation of Iranian database of the Tehran Stock Exchange (Tadbir Pardaz), annual data files and accompanying notes as found on www.rdis.com. For statistical analysis and to test hypotheses, descriptive statistics (i.e., mean, maximum, minimum and standard deviation) and inferential statistics (i.e., unit root test, enter multiple linear regression and analysis of variance) were used. Collected data was calculated via the Excel software and was analyzed using Eviews-9.
In this study, we use real activities manipulations to measure earnings management. Consistent with prior research (Roychowdhury, 2006; Cohen and Zarowin, 2010; Zang, 2012), we use three measures to capture real activities manipulations:
(1) abnormal production costs caused by manipulations of manufacturing process;
(2) abnormal operating cash flows caused by manipulations of sales activities; and
(3) abnormal discretionary expenditures caused by manipulations of expenditures activities.
Herfindahl-Hirschman index was employed as a proxy for the industry-level market competition and the share index (SHARE) was used to measure firm-level competition. In this study Asset Turnover of Operation (ATO) index was employed as a proxy for cost leadership strategy. Firms use the cost leadership strategy to achieve its uniqueness in an industry through lowering costs. A high AT means that the firm is more capable of obtaining revenues through efficient business operations and utilizing its resources well, which indicates that the firm is positioned more toward a cost leadership strategy.
 
Results
The result shows that leadership cost strategy has significant relation with real earnings management. The positive relation among leadership cost strategy and earnings management indicates that the companies with leadership cost strategy has tend to high earnings management. Moreover, the earnings management can intensify by using leadership cost strategy and increasing the level of competition.
 
Discussion and Conclusion
In this study, we investigate the impacts of business strategies on earnings management. We examine the relationship between business strategies and earnings management, and find that business strategies have significant effects on earnings management. The cost leadership strategy is positively related to earnings management, indicating that those firms that follow cost leadership strategy tend to have a higher level of earnings management. Our findings indicate that the level of earnings management of cost leaders gets worse when market competition increases. These findings suggest that although market competition may decrease the degree of information asymmetry which is one of the factors causing earnings management, it cannot totally nullify the effects of other factors on earnings management. Considering these findings, regulators should improve and perfect the market so that the market plays its due roles. To prevent earnings management, the government could also consider strengthening its regulatory rules over industry competitions. Product market competition is an important determinant of corporate decisions, and in particular on decisions about a firm's disclosure strategy. The goal of this research was to study the effects of product market competition on the accounting information quality of listed companies in the TSE. This study would enhance our understanding of how firms make their financial disclosure decisions when facing various degrees of the product market competition. Furthermore, the results might be able to resolve the seemingly conflicting predictions from prior analytical models and will provide some implications for regulatory agencies' future policy setting. One important suggestion is that, when there is a fierce competition both at the firm and at industry level, more disclosure should be attempted. In general, considering the potential strategic choice of the firms in voluntary disclosure, the level of a mandatory disclosure can be tuned more to the less competitive industry where investors are less likely to receive timely financial reporting of high quality.