Gross profit manipulation in emerging economies: evidence from India

Purpose This study aims to explore peer performance as the motivation behind gross profit manipulation through two different channels, namely, cost of goods sold (COGS) misclassification and revenue misclassification. Design/methodology/approach Gross profit expectation model (Poonawala and Nagar, 2019) and operating revenue expectation model (Malikov et al., 2018) are used to measure COGS and revenue misclassification, respectively. The panel data regression models are used to analyze the data for this study. Findings The study results show that firms engage in gross profit manipulation to meet the industry’s average gross margin, implying that peer performance is an important benchmark that firms strive to achieve through misclassification strategies. Further results exhibit that firms prefer COGS misclassification over revenue misclassification for manipulating gross profit, implying that firms choose the shifting strategy based on the relative advantage of each shifting tool. Practical implications The findings suggest that firms that just meet or slightly beat industry-average profitability levels are highly likely to engage in classification shifting (CS). Thus, investors and analysts should be careful when evaluating such firms by comparing them with other firms in the same industry. Originality/value First, this study is among earlier attempts to investigate CS motivated by peer performance. Second, this study investigates both tools of gross profit manipulation by taking a uniform sample of firms over the same period and provides compelling evidence that firms prefer one shifting tool over another depending on the relative advantage of each shifting tool.

Performance Feedback Persistence: Comparative Effects of Historical Versus Peer Performance Feedback on Innovative Search

Firms use aspirations to regulate innovative search activities, but peer and historical referents may contain different signals regarding performance feedback. Integrating insights from the literature on profit persistence with the behavioral theory of the firm, we propose a persistence-based framework of organizational innovative search that connects the persistence characteristics of feedback from peer and historical referents with innovative search. We first predict that feedback from peer referents is more persistent than feedback from historical referents. Further, we theorize that peer performance feedback produces more pronounced effects: Performance above (below) peer aspiration leads to less (more) innovative search compared with performance above (below) the historical aspiration level. In addition, because industries impose heterogeneous levels of profit persistence, the differential effect between peer and historical performance feedback on innovative search is likely to be more evident in highly persistent industries. Examining the research-and-development intensity of a comprehensive panel of Compustat manufacturing firms over the past 45 years, our results from quasi–maximum likelihood analysis and fixed-effect panel regression largely support our theoretical development. Our study extends a nascent understanding of aspiration heterogeneity by revealing and empirically confirming the critical role of persistence.