This study extends the literature by examining the effect of a firm’s earnings management behavior, as measured by discretionary accruals, on its suppliers’ investment efficiency. By using the association between current investment and future cash flow to measure the efficiency of a supplier’s investment, this study finds that a supplier’s investment efficiency is negatively related to the lag of its customer’s absolute value of discretionary accruals. The finding supports the prediction that a firm’s earnings management behavior affects their suppliers’ investment efficiency. Additionally, the results show different reactions to positive and negative discretionary accruals – a significant negative association between customers’ positive discretionary accruals and suppliers’ investment efficiency, but an insignificant negative association between customers’ negative discretionary accruals and suppliers’ investment efficiency. This indicates that compared to negative discretionary accruals, positive discretionary accruals are more likely to induce suppliers’ subsequent investment inefficiency. Finally, the results show that the negative association between customers’ absolute value of discretionary accruals and suppliers’ investment efficiency is more severe when the economic bond between supplier and customer is higher and the duration of the supplier-customer relationship is shorter.

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