For Copycat Accountants, Location Matters

There’s a long and ignoble history of companies copying competitors from down the street. Silicon Valley, for example, is a breeding ground not only for innovation but replication as well. Instagram is a knock-off of Snapchat. Amazon’s Prime Video channeled its inner Netflix.

Mimicking a sales technique, product feature, or site location are all tactics in business trench warfare. But what about mimicking accounting practices? It’s not as far-fetched as you may think.

Current accounting standards allow for considerable managerial discretion in reporting decisions affecting a company’s financial statements. The allowance for doubtful accounts, for example, represents a firm’s best estimate of the amount of accounts receivable that will not be paid by customers. If a firm’s managers want to gain legitimacy for their decisions and reduce regulatory scrutiny, “they may be motivated to mimic the accounting approach of other firms in the industry, especially those of larger and more established peers,” says Yu Hou, associate professor at Smith School of Business, Queen’s University.

Proximity Matters

 Hou decided to test the idea that proximity factors into how companies approach their financial statements. Working with colleagues Gus De Franco (Tulane University) and Mark (Shuai) Ma (University of Pittsburgh), Hou studied the likelihood of firms imitating the accounting of peers headquartered in the same city. The study was based a U.S.-based sample of more than 10 million firm-peer observations spanning 24 years, from 1993 to 2017.

They revealed that firms do, indeed, mimic their neighbours. Specifically, financial statements were more comparable between firms located in the same Metropolitan Statistical Area (MSA) than with peers located in other MSAs. This effect wasn’t simply a product of firms sharing auditors; it existed even when different auditors were at work.

The researchers also found greater comparability between industry leaders and industry followers than between two leaders or two followers, as well as during uncertain or volatile times.

This all seems to support the idea that smaller firms try to bolster the credibility of their financial statements by following an established leader.

Once a Copycat, Always a Copycat

The network effect is certainly at play. In this study, firms with stronger networks within their metropolitan area were more likely to have statements resembling their neighbours. This is driven by a few factors. One, a dense network makes it easier for a firm’s managers to learn from their peers and gain access to their processes. And two, local auditing talent is shared widely within a city’s business community.

But what happens when copy-cat firms relocate? Hou and his colleagues dug deeper and looked at organizations that moved their headquarters. They found that, in these cases, the firms’ financial statements evolved: they became less comparable to their old neighbours and started to imitate firms located in their new geographic area.

If you’re an economic development officer or an investor, you should be pleased with these results. The study offers another piece of evidence in support of geographically-based industry clusters. Firms located within clusters are said to reap the benefits of scale, specialization, a deep labour poor, and knowledge sharing within networks.

As for investors and creditors, being able to compare the financial statements of firms knowing they take similar accounting approaches makes it easier to assess financial performance. It reduces the cost of both acquiring and analyzing a firm’s financials, the researchers point out. “Financial statement comparability with industry peers increases analyst coverage and leads to more accurate analyst forecasts.”

— Kate Irwin