Customer Monitoring Of Internal Information Processes And Firms' External Reporting

Customers monitor their suppliers’ internal information processes to reduce uncertainty about the suppliers’ ability to fulfill their commitments. In this paper, I argue that these monitoring procedures improve the suppliers’ internal information, which in turn leads to higher quality external reporting. Using a dataset of U.S. government contracts, and employing both cross–sectional and within–firm research designs, I find a positive relation between government contracts and the quality of firms’ external reporting environment. Consistent with government monitoring driving this relation, I find that firms improve their external reporting when they first start contracting with the government, and that the magnitude of the improvement varies predictably with contract characteristics and is largest for contracts that entail a greater degree of government scrutiny. Finally, I use the establishment of the Cost Accounting Standards Board (CASB) in 1970 as an exogenous shock to contractor monitoring, and find greater improvements in the external reporting environment among firms affected by the CASB’s monitoring requirements. Overall, these results suggest that customer monitoring can play a role in shaping the firm’s external reporting environment.