Finance-accounting, and family business seminar

(Speakers: Itay Kama & Roby Lehavy (TAU & U Michigan

Abstract: The documentation of asymmetric cost behavior in response to changes in demand has attracted much scholarly attention over the past decade. Most studies suggest that this cost asymmetry is due to the influence of management expectations on their deliberate resource allocation decisions. Our study contributes to this research by providing direct empirical evidence in support of this explanation. Using the tone in the forward-looking statements (FLS) of a sample of 10-K reports as a measure of management expectations, we find a positive and significant relation between the favorableness of management FLS tone and the degree of cost stickiness. In addition, we examine the interaction between management expectations and the amount of slack resources available. When the amount of slack resources is high, we find that negative expectations result in anti-stickiness, whereas positive expectations result in sticky cost behavior. Accordingly, we find that managers’ expectation-driven decisions can reverse the previously documented anti-sticky cost behavior imposed by high slack resources. Finally, we find that the impact of management expectations on the degree of cost asymmetry is strongest when both the initial amount of slack resources and the magnitude of the adjustment costs are high. Conversely, when both the magnitude of the adjustment costs and the initial amount of slack resource are low, management expectations have no impact on the degree of cost asymmetry. Our combined evidence supports the explanation that management expectations influence their resource allocation decisions, and indicates that other economic determinants may need to be considered when assessing the impact of these decisions on a firm’s cost structure.