Conservative Reporting and Product Market Competition

Abstract

Competing firms are affected by financial reporting mainly through revealing relevant information. As suggested by recent literature (Bagnoli, et al. 2010), the biased disclosure has impact on the firms’ competitive position in a product market setting. So when such information is distorted by regulated bias such as conservative reporting policy, it comes into question whether it affects the outcome of product market competition. The paper investigates the effect of such distortion on the output and profits of firms that competing in a product market. And besides incumbent firms competing in a Cournot fashion, the setting also allows an entry game where the disclosed information might induce a potential entrant. Through this setting the interaction between product market competition and conservative bias is studied. The results show that when potential entry is not considered and competing firms precommit to such accounting reporting system, firms would benefit from reporting conservatively by obtaining higher output, and there is an optimal level of conservatism to maximize the expected profit in the duopoly setting however it depends on the information quality of the signal. When in the presence of a potential entrant, a more conservative reporting system would not necessarily benefit the incumbent firms although the potential entrant would benefit from a less conservative reporting system.