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Volume 17, Number 2 – June 2015
C h i n a A c c o u n t i n g a n d F i n a n c e R e v i e w
2015 6 17 2
Proprietary Costs and the Disclosure of Information about Major Customers: Evidence from Chinese Listed Firms * Song Tang, Kaigang He, and Jie Xu 1
Received 5th of August 2014 Accepted 13th of March 2015
© The Author(s) 2015. This article is published with open access by The Hong Kong Polytechnic University
Abstract This paper empirically investigates the effect of proprietary costs on firms’ choices
regarding the disclosure of major customer information in China. We document widespread
variation in firms’ choices regarding the disclosure of the identities of their top five
customers. Firms with high proprietary costs are more likely to conceal the identities of their
top five customers. Specifically, firms with higher advertising expenditure and higher
research and development (R&D) expenditure and firms operating in industries with intense
product market competition tend to conceal the identities of their major customers.
Considering the unique institutional environment in China, we further find that among
politically connected firms, non-SOEs have a greater tendency to conceal the identities of
their top five customers than SOEs. In addition, after controlling for the financing benefits
gained from disclosing the identities of top five customers, our results do not change. Taken
together, the results of this paper suggest that proprietary costs are an important factor in
firms’ choices regarding the disclosure of information about major customers in China.
Keywords: Proprietary Costs, Disclosure of Major Customer Information, Product Market
Competition, Nature of Ownership, Political Connections
CLC codes: F23, F830.91
* We acknowledge the support given by the National Natural Science Foundation of China (No. 71372042
and No. 71372041) and the MOE Project for Key Research Institutes of Humanities and Social Science in Universities (No. 13JJD790019). We appreciate the helpful comments of Professor Nancy Su (the executive editor) and two anonymous reviewers. Any remaining errors are our own.
1 Corresponding author: Song Tang, PhD, Associate Professor, School of Accountancy/Institute of Accounting and Finance, Shanghai University of Finance and Economics; E-mail: [email protected]. Kaigang He, PhD candidate, School of Accountancy, Shanghai University of Finance and Economics. Jie Xu: MPAcc, Shanghai office, KPMG China.
DOI 10.7603/s40570-015-0006-x
I. Introduction
Information about the market for a firm’s product is vital to investors. From
information on major customers, investors can not only know the concentration of current
sales and future income trends but can also assess the influence of the loss of an important
customer on the firm’s revenue. This helps investors to make wise decisions on their
investments. Thus, there is a strong demand from the capital market for information about a
firm’s major customers. As the regulator of the market in China, the China Securities
Regulatory Commission (CSRC) requires listed companies to disclose the proportion of
sales to top five customers to total sales in their annual reports.2 In addition, the CSRC also
requires market intermediary institutions, such as auditors, to focus on the authenticity of
initial public offering (IPO) firms’ information about major customers.3 Thus, the disclosure
of customer information is important for both investors and regulators.
However, we find that there are significant variations in the disclosure of information
about major customers among listed firms in China. Among the firms who disclose
information about their top five customers, some only report sales to top five customers and
the proportion of sales to top five customers to total sales in line with the minimum
requirement of the CSRC. Other firms further disclose more detailed information, such as
the identity of and sales to each major customer and the proportion of sales to top five
customers to total consolidated sales revenue. Why are the choices regarding the disclosure
of information about major customers different among listed firms? And what are the factors
that affect the above disclosure behaviour? We try to investigate and answer these questions
in this paper.
As mentioned above, there is a strong demand for information about firms’ major
customers from the capital market. Without considering other factors, firms pursuing value
maximisation have incentives to disclose customer information to investors (Grossman,
1981; Milgrom, 1981; Milgrom and Roberts, 1986). However, customer information is a
typical type of proprietary information, the disclosure of which will bring about a
proprietary cost for disclosing firms.4 Once the information is disclosed, the disclosing
2 See Standards for Contents and Formats of Information Disclosure by Companies Publicly Offering
Securities No. 2 - Contents and Formats of Annual Reports (revised edition in 2012). Article 21 in these standards states that listed firms should disclose information about their top five major customers and the ratio of sales to these customers to total annual sales. The disclosure of sales to each of the top five customers is encouraged.
3 On 16 December 2012, the CSRC released Notes on Risk of Accounting Supervision No.4: Audit of IPO Firms, which pointed out that auditors should pay great attention to information about major customers and major suppliers provided by issuers or sponsors in IPO audits. The CSRC further reminded auditors to do a field investigation or telephone review according to the importance of major customers and suppliers. Moreover, auditors should carefully screen whether there are relations between the ultimate controllers or key staff of customers or suppliers and the issuers.
4 We discuss the concept of proprietary information and proprietary costs in more detail in the literature review.
Proprietary Costs and the Disclosure of Information about Major Customers 101
firms’ investors and competitors have easy access to this information. Competitors are likely
to achieve a competitive edge either directly by capturing customer resources revealed by
disclosing firms or indirectly by breaking the relationship between disclosing firms and their
customers. Thus, when deciding how much information to disclose about customers, firms
face the trade-off between the benefits gained from mitigating the information asymmetry
between firms and investors and the costs caused by revealing information about major
customers to rivals which puts them in a disadvantageous position (Wagenhofer, 1990;
Hayes and Lundholm, 1996).
Using a data set of customer information in the annual reports of Chinese A-share listed
firms in 2011, this paper examines how proprietary costs affect firms’ choices regarding the
disclosure of information about their top five customers. We find that firms with high
proprietary costs (e.g. higher advertising expenditure; higher research and development
(R&D) expenditure; in industries with more intense product market competition) tend to
conceal the identities of their top five customers. Furthermore, considering the unique
institutional environment in China, we conjecture that firms’ choices regarding the
disclosure of information about major customers vary with the nature of ownership and
political ties of firms. Our empirical tests confirm that politically connected
non-state-owned enterprises (non-SOEs) are more likely to conceal the identities of their top
five customers than politically connected state-owned enterprises (SOEs). In addition, after
controlling for the financing benefits gained from disclosing the identities of major
customers, our main results do not change. Taken together, the results of this paper suggest
that proprietary costs are an important factor in firms’ choices regarding the disclosure of
information about major customers. In the situation in which the cost of revealing major
customer information varies with political connections, non-SOEs and SOEs show a
significant difference in behaviour with regard to the disclosure of information about major
customers.
This paper contributes to the extant literature in three ways. First, to the best of our
knowledge, it is the first paper to study Chinese firms’ choices regarding the disclosure of
information about major customers and thus fills a gap in the relevant empirical research in
China. In addition to the common measures of proprietary costs introduced in the Western
literature, this paper further investigates how proprietary costs associated with the nature of
ownership and political connections affect firms’ disclosure of information about major
customers in China’s unique institutional environment. Our results suggest that among
politically connected firms, non-SOEs are more likely to conceal the identities of major
customers than SOEs because politically connected non-SOEs face higher proprietary costs.
This finding is complementary to the findings in the Western literature.
Second, a firm’s choice to disclose the identities of its major customers is voluntary.
There is a prevailing and formidable problem within the extant literature on voluntary
102 Tang, He, and Xu
disclosure, namely that researchers often cannot distinguish between deliberate concealment
by managers and genuine lack of information when firms do not disclose any information
(Verrecchia, 1983; Dye, 1985; Hribar, 2004). In drawing on a sample of firms that have
disclosed sales to top five customers, we make sure that our sample firms have information
about the identities of these customers.5 Thus, we avoid the fault in the previous literature.
Lastly, while the Chinese literature about firms’ voluntary disclosure mainly focuses on
the benefits side (see, for example, Wang and Jiang, 2004; Zeng and Lu, 2006; Shen et al.,
2010; Meng et al., 2010), very few papers have examined how the costs of information
disclosure affect disclosure behaviour. In the context of the disclosure of major customer
information, this paper provides empirical evidence in support of the argument that
proprietary costs are an important factor in firms’ information disclosure choices. Thus, our
paper enhances our understanding of firms’ voluntary disclosure choices in China.
II. Literature Review, Theoretical Analysis, and Hypotheses
A great deal of the theoretical and empirical research in China and Western countries
has shown that information disclosure is crucial in mitigating information asymmetry
between firms and external investors in the capital market. Sufficient information disclosure
decreases the cost of external financing by reducing information asymmetry (see, for
example, Frankel et al., 1995; Lang and Lundgholm, 2000; Sengupta, 1998; Wang and Jiang,
2004; Zeng and Lu, 2006; Meng et al., 2010). However, the information disclosed by firms
may be proprietary information. The disclosure of such information will directly reduce
firms’ future cash flow (Scott, 1994)6 because proprietary information is not only obtained
by investors when disclosed but also easily accessed by rivals, which would put firms in a
disadvantageous position in terms of their competitiveness. Such costs caused by the
disclosure of proprietary information are called proprietary costs. Because of proprietary
costs, firms’ information disclosure is constrained to some extent. In other words, after
controlling for the benefits gained from disclosure, proprietary costs will influence firms’
voluntary disclosure choices.
2.1 Proprietary Costs and Voluntary Information Disclosure
Some previous papers have studied the effect of proprietary costs on firms’ voluntary
disclosure behaviour in different contexts. For instance, Scott (1994) investigates Canadian
firms’ voluntary disclosure of information about defined benefit pension plans and finds that
5 Top five customers must exist since firms have disclosed sales to them. If the identities of top five
customers are not disclosed, this must be the choice of the firm’s manager for some reason. 6 Correspondingly, if the information disclosure does not influence future cash flow, then the information
is called non-proprietary information.
Proprietary Costs and the Disclosure of Information about Major Customers 103
firms tend to reduce the disclosure of relevant information when the labour union is likely to
use the information to the disadvantage of the firms. In the context of management’s
earnings forecasts and guidance, Bamber and Cheon (1998) find that firms in industries with
higher proprietary costs are more likely to disclose less informative qualitative forecasts
rather than point or interval forecasts. Li (2010) further shows that the quality of
management earnings forecasts is lower in industries with intense product market
competition because the level of competition will influence the optimism of forecasts on
industry profit levels. In a recent paper, Ali et al. (2014) examine how proprietary costs
influence management forecasts and find that there are fewer announcements of
management forecasts in “higher concentration industries”. In the context of segment
reporting choices, Harris (1998) finds that prior to the release of the Statement of Financial
Accounting Standards (SFAS) No. 131 (FASB, 1997), which required firms to increase
disclosure of segment information, firms in less competitive industries were less likely to
voluntarily report detailed segment information. Botoson and Stanford (2005) further
examine the firms that only disclosed information on one segment prior to SFAS No. 131
but then had to disclose information of multiple segments after the adoption of SFAS No.
131; their results show that firms in less competitive industries tend to conceal information
about their more profitable segments, which is exactly the same as the situation prior to the
regulation. Using a sample of 49 newly listed biotech firms, Guo et al. (2004) find that firms
disclose less product-related information when they are faced with higher proprietary costs.
In addition, Jones (2007) investigates the relation between proprietary costs and the
disclosure of information about R&D expenditure. He shows that firms with higher
proprietary costs are more likely to disclose less information about R&D expenditure. In
summary, the extant literature shows that proprietary costs significantly affect firms’
voluntary information disclosure.
Among the information disclosed by firms, information about customers is highly
relevant to investors and is a typical type of proprietary information. Using a sample of US
listed firms, Ellis et al. (2012) find that proprietary costs are an important factor influencing
the disclosure of customer information. To the best of our knowledge, there have been no
studies examining firms’ behaviour regarding the disclosure of customer information in
China. Thus, following Ellis et al. (2012) and referring to the unique Chinese institutional
environment, we investigate how proprietary costs affect the disclosure of customer
information in China in order to fill the gap in the Chinese literature.
2.2 Proprietary Costs and Disclosure of Major Customer Information
The disclosure of customer information helps investors evaluate current and future
sales and cash flow, which effectively reduces the information asymmetry between
disclosing firms and external investors: for example, investors can gauge the potential
104 Tang, He, and Xu
influence of losing a major customer according to the degree of concentration in a firm’s
customer base (Patatoukas, 2012). In addition, given that high customer concentration may
reflect some specific relationship investment and that this type of investment should
strengthen the stability of the relationship between the parties to the trading, information
about sales concentration can be used to assess the expected variance in future revenues
(Fee et al., 2006). Furthermore, the disclosure of customer information may help to improve
investors’ impression of the disclosing firm, especially when the firm is building a stable
relationship with a steadily growing customer. Looking further ahead, a firm delivers a
signal that it is an excellent supplier by disclosing customer information if the customer is
able to discern qualified suppliers out of a range of choices. Because of the benefits
mentioned above, firms have strong incentives to disclose customers with good performance
and a good public image (Dye, 1986; Lang and Lundholm, 1996). In addition, if customers
are listed firms, investors are able to get more information about them when the identities of
customers are disclosed by firms and to use this information to further evaluate and validate
the revenues of the disclosing firms (Cohen and Frazzini, 2008; Pandit et al., 2011).
Moreover, investors get more timely and complete information about customers because of
differences in disclosure time intervals and levels of detail between disclosing firms and
their customers. In conclusion, all other things being equal, firms pursuing value
maximisation have incentives to disclose information about their customers (Grossman,
1981; Milgrom, 1981; Milgrom and Roberts, 1986).
However, as customer information is a typical type of proprietary information, the
disclosure of which also gives rise to proprietary costs.
On the one hand, rivals may take advantage of the information about customers to
compete with disclosing firms by adopting tactics such as snatching customers. Some
theoretical models of disclosure choices have considered both capital and product market
competition from incumbents and potential entrants. For instance, Darrough and Stoughton
(1990) and Wagenhofer (1990) have developed models of voluntary disclosure choices
which suggest that firms make a trade-off between the benefits gained from higher market
value and the costs caused by new entrants. Similarly, Hayers and Lundholm (1996) model
this trade-off in the disclosure of segment information. These models illustrate that
proprietary costs caused by information disclosure vary with the degree of product market
competition. Besides theoretical research, Graham et al. (2005) have surveyed more than
400 chief financial officers (CFOs) and found that about 60% of them agreed or strongly
agreed that proprietary costs are the biggest obstacle for increasing voluntary disclosure.
Graham et al. (2005) point out that CFOs do not want to explicitly reveal sensitive
proprietary information on a platter to competitors, even if such information could be
partially inferred by competitors from other sources, such as trade journals or trade
conferences. The disclosure of customer information makes it easier for rivals to access and
Proprietary Costs and the Disclosure of Information about Major Customers 105
even capture customers and also helps competitors to evaluate the productivity of disclosing
firms: for example, disclosure of a large retailer such as JD.com7 as a major customer for
the first time would deliver a signal to competitors that the firm has sufficient production
capacity to supply large retailers; furthermore, rivals would be able to accurately estimate
important business information of the disclosing firm, such as profit margin, using the
disclosed sales to JD.com and the retail prices that are easily obtained from the JD.com
website.
On the other hand, a customer may request the supplier to conceal its identity and
purchase quantity if the specific types or quantities of the input materials of the customer’s
products are a production secret, since such information might help the customer’s rivals to
imitate their product (Ellis et al., 2012). Lastly, it is also possible that the disclosure of
supplier-customer relationships may trigger scandals and rumours related to the disclosing
firms and their customers and even greater government regulation.
In conclusion, although firms get a financing benefit from the disclosure of information
about customers, costs are induced from disseminating information to rivals. Thus, firms
facing higher proprietary costs are more reluctant to publicly disclose detailed information
about major customers.
Listed firms are required by the CSRC to report sales revenues from their top five
customers and the proportion of these revenues to annual total sales.8 Therefore, the
disclosure of sales to top five customers is a mandatory minimum requirement and must be
obeyed by all listed firms in China. But firms can voluntarily choose whether or not to
disclose the identity of and sales revenue from each of their top five customers separately.
On the basis of the above theoretical analysis, we conjecture that proprietary costs will
influence the choice regarding the voluntary disclosure of information about top five
customers. Thus, our first hypothesis is as follows:
Hypothesis 1: Ceteris paribus, firms facing higher proprietary costs are more
likely to conceal the identities of their top five customers.
The Western literature suggests that firms with higher advertising expenditure, higher
R&D expenditure, and higher intangible asset intensity and firms operating in a more
competitive industry are associated with higher proprietary costs of information disclosure.
This is because a higher amount of these types of expenditure and greater intangible asset
intensity represent the large amount of capital and effort invested by a firm to obtain
customers and maintain relationships with them. Once the firm loses a major customer, it
will not be able to recover the large amount of previous investment associated with the
7 JD.com is the largest online direct sales company in China in terms of transaction volume in 2014. 8 See Footnote 1 in…
C h i n a A c c o u n t i n g a n d F i n a n c e R e v i e w
2015 6 17 2
Proprietary Costs and the Disclosure of Information about Major Customers: Evidence from Chinese Listed Firms * Song Tang, Kaigang He, and Jie Xu 1
Received 5th of August 2014 Accepted 13th of March 2015
© The Author(s) 2015. This article is published with open access by The Hong Kong Polytechnic University
Abstract This paper empirically investigates the effect of proprietary costs on firms’ choices
regarding the disclosure of major customer information in China. We document widespread
variation in firms’ choices regarding the disclosure of the identities of their top five
customers. Firms with high proprietary costs are more likely to conceal the identities of their
top five customers. Specifically, firms with higher advertising expenditure and higher
research and development (R&D) expenditure and firms operating in industries with intense
product market competition tend to conceal the identities of their major customers.
Considering the unique institutional environment in China, we further find that among
politically connected firms, non-SOEs have a greater tendency to conceal the identities of
their top five customers than SOEs. In addition, after controlling for the financing benefits
gained from disclosing the identities of top five customers, our results do not change. Taken
together, the results of this paper suggest that proprietary costs are an important factor in
firms’ choices regarding the disclosure of information about major customers in China.
Keywords: Proprietary Costs, Disclosure of Major Customer Information, Product Market
Competition, Nature of Ownership, Political Connections
CLC codes: F23, F830.91
* We acknowledge the support given by the National Natural Science Foundation of China (No. 71372042
and No. 71372041) and the MOE Project for Key Research Institutes of Humanities and Social Science in Universities (No. 13JJD790019). We appreciate the helpful comments of Professor Nancy Su (the executive editor) and two anonymous reviewers. Any remaining errors are our own.
1 Corresponding author: Song Tang, PhD, Associate Professor, School of Accountancy/Institute of Accounting and Finance, Shanghai University of Finance and Economics; E-mail: [email protected]. Kaigang He, PhD candidate, School of Accountancy, Shanghai University of Finance and Economics. Jie Xu: MPAcc, Shanghai office, KPMG China.
DOI 10.7603/s40570-015-0006-x
I. Introduction
Information about the market for a firm’s product is vital to investors. From
information on major customers, investors can not only know the concentration of current
sales and future income trends but can also assess the influence of the loss of an important
customer on the firm’s revenue. This helps investors to make wise decisions on their
investments. Thus, there is a strong demand from the capital market for information about a
firm’s major customers. As the regulator of the market in China, the China Securities
Regulatory Commission (CSRC) requires listed companies to disclose the proportion of
sales to top five customers to total sales in their annual reports.2 In addition, the CSRC also
requires market intermediary institutions, such as auditors, to focus on the authenticity of
initial public offering (IPO) firms’ information about major customers.3 Thus, the disclosure
of customer information is important for both investors and regulators.
However, we find that there are significant variations in the disclosure of information
about major customers among listed firms in China. Among the firms who disclose
information about their top five customers, some only report sales to top five customers and
the proportion of sales to top five customers to total sales in line with the minimum
requirement of the CSRC. Other firms further disclose more detailed information, such as
the identity of and sales to each major customer and the proportion of sales to top five
customers to total consolidated sales revenue. Why are the choices regarding the disclosure
of information about major customers different among listed firms? And what are the factors
that affect the above disclosure behaviour? We try to investigate and answer these questions
in this paper.
As mentioned above, there is a strong demand for information about firms’ major
customers from the capital market. Without considering other factors, firms pursuing value
maximisation have incentives to disclose customer information to investors (Grossman,
1981; Milgrom, 1981; Milgrom and Roberts, 1986). However, customer information is a
typical type of proprietary information, the disclosure of which will bring about a
proprietary cost for disclosing firms.4 Once the information is disclosed, the disclosing
2 See Standards for Contents and Formats of Information Disclosure by Companies Publicly Offering
Securities No. 2 - Contents and Formats of Annual Reports (revised edition in 2012). Article 21 in these standards states that listed firms should disclose information about their top five major customers and the ratio of sales to these customers to total annual sales. The disclosure of sales to each of the top five customers is encouraged.
3 On 16 December 2012, the CSRC released Notes on Risk of Accounting Supervision No.4: Audit of IPO Firms, which pointed out that auditors should pay great attention to information about major customers and major suppliers provided by issuers or sponsors in IPO audits. The CSRC further reminded auditors to do a field investigation or telephone review according to the importance of major customers and suppliers. Moreover, auditors should carefully screen whether there are relations between the ultimate controllers or key staff of customers or suppliers and the issuers.
4 We discuss the concept of proprietary information and proprietary costs in more detail in the literature review.
Proprietary Costs and the Disclosure of Information about Major Customers 101
firms’ investors and competitors have easy access to this information. Competitors are likely
to achieve a competitive edge either directly by capturing customer resources revealed by
disclosing firms or indirectly by breaking the relationship between disclosing firms and their
customers. Thus, when deciding how much information to disclose about customers, firms
face the trade-off between the benefits gained from mitigating the information asymmetry
between firms and investors and the costs caused by revealing information about major
customers to rivals which puts them in a disadvantageous position (Wagenhofer, 1990;
Hayes and Lundholm, 1996).
Using a data set of customer information in the annual reports of Chinese A-share listed
firms in 2011, this paper examines how proprietary costs affect firms’ choices regarding the
disclosure of information about their top five customers. We find that firms with high
proprietary costs (e.g. higher advertising expenditure; higher research and development
(R&D) expenditure; in industries with more intense product market competition) tend to
conceal the identities of their top five customers. Furthermore, considering the unique
institutional environment in China, we conjecture that firms’ choices regarding the
disclosure of information about major customers vary with the nature of ownership and
political ties of firms. Our empirical tests confirm that politically connected
non-state-owned enterprises (non-SOEs) are more likely to conceal the identities of their top
five customers than politically connected state-owned enterprises (SOEs). In addition, after
controlling for the financing benefits gained from disclosing the identities of major
customers, our main results do not change. Taken together, the results of this paper suggest
that proprietary costs are an important factor in firms’ choices regarding the disclosure of
information about major customers. In the situation in which the cost of revealing major
customer information varies with political connections, non-SOEs and SOEs show a
significant difference in behaviour with regard to the disclosure of information about major
customers.
This paper contributes to the extant literature in three ways. First, to the best of our
knowledge, it is the first paper to study Chinese firms’ choices regarding the disclosure of
information about major customers and thus fills a gap in the relevant empirical research in
China. In addition to the common measures of proprietary costs introduced in the Western
literature, this paper further investigates how proprietary costs associated with the nature of
ownership and political connections affect firms’ disclosure of information about major
customers in China’s unique institutional environment. Our results suggest that among
politically connected firms, non-SOEs are more likely to conceal the identities of major
customers than SOEs because politically connected non-SOEs face higher proprietary costs.
This finding is complementary to the findings in the Western literature.
Second, a firm’s choice to disclose the identities of its major customers is voluntary.
There is a prevailing and formidable problem within the extant literature on voluntary
102 Tang, He, and Xu
disclosure, namely that researchers often cannot distinguish between deliberate concealment
by managers and genuine lack of information when firms do not disclose any information
(Verrecchia, 1983; Dye, 1985; Hribar, 2004). In drawing on a sample of firms that have
disclosed sales to top five customers, we make sure that our sample firms have information
about the identities of these customers.5 Thus, we avoid the fault in the previous literature.
Lastly, while the Chinese literature about firms’ voluntary disclosure mainly focuses on
the benefits side (see, for example, Wang and Jiang, 2004; Zeng and Lu, 2006; Shen et al.,
2010; Meng et al., 2010), very few papers have examined how the costs of information
disclosure affect disclosure behaviour. In the context of the disclosure of major customer
information, this paper provides empirical evidence in support of the argument that
proprietary costs are an important factor in firms’ information disclosure choices. Thus, our
paper enhances our understanding of firms’ voluntary disclosure choices in China.
II. Literature Review, Theoretical Analysis, and Hypotheses
A great deal of the theoretical and empirical research in China and Western countries
has shown that information disclosure is crucial in mitigating information asymmetry
between firms and external investors in the capital market. Sufficient information disclosure
decreases the cost of external financing by reducing information asymmetry (see, for
example, Frankel et al., 1995; Lang and Lundgholm, 2000; Sengupta, 1998; Wang and Jiang,
2004; Zeng and Lu, 2006; Meng et al., 2010). However, the information disclosed by firms
may be proprietary information. The disclosure of such information will directly reduce
firms’ future cash flow (Scott, 1994)6 because proprietary information is not only obtained
by investors when disclosed but also easily accessed by rivals, which would put firms in a
disadvantageous position in terms of their competitiveness. Such costs caused by the
disclosure of proprietary information are called proprietary costs. Because of proprietary
costs, firms’ information disclosure is constrained to some extent. In other words, after
controlling for the benefits gained from disclosure, proprietary costs will influence firms’
voluntary disclosure choices.
2.1 Proprietary Costs and Voluntary Information Disclosure
Some previous papers have studied the effect of proprietary costs on firms’ voluntary
disclosure behaviour in different contexts. For instance, Scott (1994) investigates Canadian
firms’ voluntary disclosure of information about defined benefit pension plans and finds that
5 Top five customers must exist since firms have disclosed sales to them. If the identities of top five
customers are not disclosed, this must be the choice of the firm’s manager for some reason. 6 Correspondingly, if the information disclosure does not influence future cash flow, then the information
is called non-proprietary information.
Proprietary Costs and the Disclosure of Information about Major Customers 103
firms tend to reduce the disclosure of relevant information when the labour union is likely to
use the information to the disadvantage of the firms. In the context of management’s
earnings forecasts and guidance, Bamber and Cheon (1998) find that firms in industries with
higher proprietary costs are more likely to disclose less informative qualitative forecasts
rather than point or interval forecasts. Li (2010) further shows that the quality of
management earnings forecasts is lower in industries with intense product market
competition because the level of competition will influence the optimism of forecasts on
industry profit levels. In a recent paper, Ali et al. (2014) examine how proprietary costs
influence management forecasts and find that there are fewer announcements of
management forecasts in “higher concentration industries”. In the context of segment
reporting choices, Harris (1998) finds that prior to the release of the Statement of Financial
Accounting Standards (SFAS) No. 131 (FASB, 1997), which required firms to increase
disclosure of segment information, firms in less competitive industries were less likely to
voluntarily report detailed segment information. Botoson and Stanford (2005) further
examine the firms that only disclosed information on one segment prior to SFAS No. 131
but then had to disclose information of multiple segments after the adoption of SFAS No.
131; their results show that firms in less competitive industries tend to conceal information
about their more profitable segments, which is exactly the same as the situation prior to the
regulation. Using a sample of 49 newly listed biotech firms, Guo et al. (2004) find that firms
disclose less product-related information when they are faced with higher proprietary costs.
In addition, Jones (2007) investigates the relation between proprietary costs and the
disclosure of information about R&D expenditure. He shows that firms with higher
proprietary costs are more likely to disclose less information about R&D expenditure. In
summary, the extant literature shows that proprietary costs significantly affect firms’
voluntary information disclosure.
Among the information disclosed by firms, information about customers is highly
relevant to investors and is a typical type of proprietary information. Using a sample of US
listed firms, Ellis et al. (2012) find that proprietary costs are an important factor influencing
the disclosure of customer information. To the best of our knowledge, there have been no
studies examining firms’ behaviour regarding the disclosure of customer information in
China. Thus, following Ellis et al. (2012) and referring to the unique Chinese institutional
environment, we investigate how proprietary costs affect the disclosure of customer
information in China in order to fill the gap in the Chinese literature.
2.2 Proprietary Costs and Disclosure of Major Customer Information
The disclosure of customer information helps investors evaluate current and future
sales and cash flow, which effectively reduces the information asymmetry between
disclosing firms and external investors: for example, investors can gauge the potential
104 Tang, He, and Xu
influence of losing a major customer according to the degree of concentration in a firm’s
customer base (Patatoukas, 2012). In addition, given that high customer concentration may
reflect some specific relationship investment and that this type of investment should
strengthen the stability of the relationship between the parties to the trading, information
about sales concentration can be used to assess the expected variance in future revenues
(Fee et al., 2006). Furthermore, the disclosure of customer information may help to improve
investors’ impression of the disclosing firm, especially when the firm is building a stable
relationship with a steadily growing customer. Looking further ahead, a firm delivers a
signal that it is an excellent supplier by disclosing customer information if the customer is
able to discern qualified suppliers out of a range of choices. Because of the benefits
mentioned above, firms have strong incentives to disclose customers with good performance
and a good public image (Dye, 1986; Lang and Lundholm, 1996). In addition, if customers
are listed firms, investors are able to get more information about them when the identities of
customers are disclosed by firms and to use this information to further evaluate and validate
the revenues of the disclosing firms (Cohen and Frazzini, 2008; Pandit et al., 2011).
Moreover, investors get more timely and complete information about customers because of
differences in disclosure time intervals and levels of detail between disclosing firms and
their customers. In conclusion, all other things being equal, firms pursuing value
maximisation have incentives to disclose information about their customers (Grossman,
1981; Milgrom, 1981; Milgrom and Roberts, 1986).
However, as customer information is a typical type of proprietary information, the
disclosure of which also gives rise to proprietary costs.
On the one hand, rivals may take advantage of the information about customers to
compete with disclosing firms by adopting tactics such as snatching customers. Some
theoretical models of disclosure choices have considered both capital and product market
competition from incumbents and potential entrants. For instance, Darrough and Stoughton
(1990) and Wagenhofer (1990) have developed models of voluntary disclosure choices
which suggest that firms make a trade-off between the benefits gained from higher market
value and the costs caused by new entrants. Similarly, Hayers and Lundholm (1996) model
this trade-off in the disclosure of segment information. These models illustrate that
proprietary costs caused by information disclosure vary with the degree of product market
competition. Besides theoretical research, Graham et al. (2005) have surveyed more than
400 chief financial officers (CFOs) and found that about 60% of them agreed or strongly
agreed that proprietary costs are the biggest obstacle for increasing voluntary disclosure.
Graham et al. (2005) point out that CFOs do not want to explicitly reveal sensitive
proprietary information on a platter to competitors, even if such information could be
partially inferred by competitors from other sources, such as trade journals or trade
conferences. The disclosure of customer information makes it easier for rivals to access and
Proprietary Costs and the Disclosure of Information about Major Customers 105
even capture customers and also helps competitors to evaluate the productivity of disclosing
firms: for example, disclosure of a large retailer such as JD.com7 as a major customer for
the first time would deliver a signal to competitors that the firm has sufficient production
capacity to supply large retailers; furthermore, rivals would be able to accurately estimate
important business information of the disclosing firm, such as profit margin, using the
disclosed sales to JD.com and the retail prices that are easily obtained from the JD.com
website.
On the other hand, a customer may request the supplier to conceal its identity and
purchase quantity if the specific types or quantities of the input materials of the customer’s
products are a production secret, since such information might help the customer’s rivals to
imitate their product (Ellis et al., 2012). Lastly, it is also possible that the disclosure of
supplier-customer relationships may trigger scandals and rumours related to the disclosing
firms and their customers and even greater government regulation.
In conclusion, although firms get a financing benefit from the disclosure of information
about customers, costs are induced from disseminating information to rivals. Thus, firms
facing higher proprietary costs are more reluctant to publicly disclose detailed information
about major customers.
Listed firms are required by the CSRC to report sales revenues from their top five
customers and the proportion of these revenues to annual total sales.8 Therefore, the
disclosure of sales to top five customers is a mandatory minimum requirement and must be
obeyed by all listed firms in China. But firms can voluntarily choose whether or not to
disclose the identity of and sales revenue from each of their top five customers separately.
On the basis of the above theoretical analysis, we conjecture that proprietary costs will
influence the choice regarding the voluntary disclosure of information about top five
customers. Thus, our first hypothesis is as follows:
Hypothesis 1: Ceteris paribus, firms facing higher proprietary costs are more
likely to conceal the identities of their top five customers.
The Western literature suggests that firms with higher advertising expenditure, higher
R&D expenditure, and higher intangible asset intensity and firms operating in a more
competitive industry are associated with higher proprietary costs of information disclosure.
This is because a higher amount of these types of expenditure and greater intangible asset
intensity represent the large amount of capital and effort invested by a firm to obtain
customers and maintain relationships with them. Once the firm loses a major customer, it
will not be able to recover the large amount of previous investment associated with the
7 JD.com is the largest online direct sales company in China in terms of transaction volume in 2014. 8 See Footnote 1 in…