Flexible Business Models and Firms’ Financial Reporting Practices

Abstract

In this study, we examine whether the flexibility in a firm’s business model (i.e., the way in which the firm manages and deploys its resources) is associated with its financial reporting practices. Recent survey evidence suggests that executives view firms’ business models as a key determinant of earnings quality. The premise underlying this study is that firms with relatively more flexible business models are more likely to achieve financial reporting objectives by taking advantage of their operational and financing flexibility rather than through accrual-based earnings management. We draw on prior research to identify attributes that are associated with flexible business models and develop a within industry, within year composite measure of the flexibility of a firm’s business model. After validating the measure, we use it to test our predictions. We find that firms with flexible business models are more likely to meet or beat analysts’ consensus forecasts, but are associated with lower discretionary accruals and a lower likelihood of financial restatements. In addition, we find that flexible business model firms are significantly more likely to use stock repurchases (but not discretionary accruals) to achieve important earning benchmarks. We contribute to the literature by highlighting that firms with flexible business models are able to exploit their operational and financing flexibility (in lieu of accrual manipulation) to meet financial reporting objectives.

Keywords: Business Models, Earnings Benchmarks, Earnings Management, Resource-based view of firm

JEL Classification: G32, M41, L20