Demand Uncertainty and Cost Behavior Banker, Rajiv D.; Byzalov, Dmitri; Plehn-Dujowich, Jose M.
The Accounting review,
05/2014, Letnik:
89, Številka:
3
Journal Article
Recenzirano
We investigate analytically and empirically the relationship between demand uncertainty and cost behavior. We argue that with more uncertain demand, unusually high realizations of demand become more ...likely. Accordingly, firms will choose a higher capacity of fixed inputs when uncertainty increases in order to reduce congestion costs. Higher capacity levels imply a more rigid short-run cost structure with higher fixed and lower variable costs. We formalize this "counterintuitive" argument in a simple analytical model of capacity choice. Following this logic, we hypothesize that firms facing higher demand uncertainty have a more rigid short-run cost structure with higher fixed and lower variable costs. We test this hypothesis for the manufacturing sector using data from Compustat and the NBER-CES Industry Database. Evidence strongly supports our hypothesis for multiple cost categories in both datasets. The results are robust to alternative specifications.
Accountants examine multiple indicators when assessing whether individual assets are impaired. Different indicators predict cash flows over varying time horizons, and their importance varies with how ...far into the future individual assets are expected to generate cash flows. We predict that earnings exhibits asymmetric timeliness with respect to multiple indicators, including stock return, sales change, and operating cash flow change, which differentially explain write-downs of current assets, long-lived tangible assets, and indefinite-lived goodwill. We predict an interaction effect between indicators, such that the total impact of several consistent indicators is greater than the sum of their individual impacts. Empirical estimates for U.S. firms are consistent with our predictions and yield new insights about the effects of multiple indicators for both conservatism and impairment research. Our multi-indicator asymmetric models also change inferences about the relative explanatory power of economic factors versus reporting incentives in asset impairments.
Earnings management research often uses discretionary accruals from Jones-type models. These models assume a linear relation between sales changes and accruals. However, we predict and find that ...sales changes have a non-linear asymmetric effect on accruals through managers’ operating decisions. By forcing a linear specification on this non-linear effect, the modified Jones model overestimates (underestimates) discretionary accruals for moderate (extreme) sales changes. This non-linear bias causes excessive type-I error in tests of positive (negative) discretionary accruals for subsamples with moderate (extreme) sales growth. The literature often controls for non-linearities using performance matching (Kothari et al. in J Account Econ 39(1):163–197,
2005
). However, we show that this approach leads to false inferences due to matching on the dependent variable. We use a flexible non-linear spline specification to control for the non-linear operating effect of sales changes. Our method successfully mitigates the bias, improves type-I errors without sacrificing test power, and changes inferences about major prior findings.
Researchers often use regression-based x-Scores (e.g., conservatism C-Score, misstatement F-Score) from a stage 1 model as a dependent variable in stage 2. We argue that this x-Score analysis can ...cause coefficient biases and interpretation problems because (1) x-Score does not capture new sources of variation, and (2) the estimates often hinge on unacknowledged technical assumptions. Instead, we recommend that researchers include the test variables and the relevant controls in stage 1, obviating the need for an x-Score. In replication analyses, some important published findings change after we remove the coefficient bias caused by the use of x-Score as a dependent variable.
•Popular x-Scores (e.g., C-Score, F-Score, Z-Score) should not be used as Y variables•x-Scores miss new sources of variation, leading to biased, uninformative estimates•x-Score estimates often hinge entirely on unacknowledged technical assumptions•Instead, researchers should use a single-stage model for the focal outcome•Published findings change after undoing the coefficient bias in x-Scores
We develop new distribution discontinuity tests conditional on multiple explanatory variables for analyzing meet-or-just-beat behavior around benchmarks. These tests combine Burgstahler and Dichev's ...(1997) meet-or-just-beat intuition with a flexible statistical model that addresses important limitations of the existing tests. Our method considerably outperforms logit-based tests of distribution discontinuity determinants and changes the interpretation of a major finding in the earnings discontinuity literature. As a secondary benefit, it also has slightly higher statistical power than histogram-based tests of distribution discontinuity existence. Our method is robust, easy to implement using our publicly available Stata command, and could benefit researchers in many fields.
•We develop distribution discontinuity tests with multiple explanatory variables.•Our tests measure the determinants of distribution discontinuity much better than the standard logit approach.•Our tests detect the existence of discontinuity a little better than standard histogram-based tests.•Our tests change a major finding in the earnings discontinuity literature.•Our distribution discontinuity tests are flexible, robust, and easy to implement with our custom Stata estimation command.
Conditional conservatism is an integral but often unmodeled part of the normal accrual process. The standard economic determinants of accruals contain information about unrealized losses. We argue ...that accountants recognize these unrealized losses as disaggregated write-downs for small asset pools. Modeling disaggregated impairments yields new economic insights about accruals and improved accrual models. We predict that accrual conservatism manifests as a sum of asymmetries for a vector of news indicators, rather than as an asymmetry for a scalar aggregate news proxy. We argue that more detailed segment-level and quarterly indicators have an incremental effect on annual firm-level accruals. We also predict a dynamic effect of successive loss indicators because accountants look for consistent patterns in these variables. Empirical results for U.S. firms support our predictions. The asymmetries in accruals are consistent with conservatism in validation tests. We also document improved statistical power and type I error in earnings management tests.
Central to the economic theory of sticky costs is the proposition that managers consider adjustment costs when changing resource levels. We test this proposition using employment protection ...legislation (EPL) provisions in different countries as a proxy for labor adjustment costs. Using a large sample of firms in 19 OECD countries during 1990–2008, we find that the degree of cost stickiness at the firm level varies with the strictness of the country-level EPL provisions. This finding supports the theory that cost stickiness reflects the deliberate resource commitment decisions of managers in the presence of adjustment costs.
► We develop and test the economic theory that can explain the pervasive empirical findings of sticky costs. ► If the theory holds, higher adjustment costs should increase stickiness. ► Employment protection legislation (EPL) strictness is a reliable empirical proxy for labor adjustment costs. ► In cross-country analysis for 19 OECD countries, stricter EPL is associated with higher stickiness, supporting the theory.
Asymmetric Cost Behavior Banker, Rajiv D.; Byzalov, Dmitri
Journal of management accounting research,
12/2014, Letnik:
26, Številka:
2
Journal Article
Recenzirano
ABSTRACT
We synthesize the growing literature on asymmetric cost behavior—a new way of thinking about costs and, by extension, earnings. While the traditional cost behavior model describes a ...mechanistic relation between activity and costs, this alternative view recognizes the primitives of cost behavior—resource adjustment costs and managerial decisions. These primitives give rise to “sticky” and “anti-sticky” costs, along with traditional “fixed” and “variable” costs as extreme cases. We formulate an integrated framework of asymmetric cost behavior and review the empirical evidence in support of this framework and its implications for both cost and financial accounting research. We clarify empirical issues and show that recent contrary claims about the validity of findings in the literature are unwarranted because of econometric errors. We present new comprehensive evidence from Global Compustat, which demonstrates that asymmetric cost behavior is a pervasive global phenomenon. We also discuss research opportunities.
Sales decreases affect earnings more than sales increases because of cost stickiness. We hypothesize that this correlated omitted variable constitutes a confounding effect in standard asymmetric ...timeliness models. Controlling for a piecewise linear effect of sales changes in these models decreases the measured asymmetric timeliness significantly and changes inferences about the average level of conservatism and the extent of cross-sectional variation in conservatism. Validation tests confirm that the asymmetry for sales changes is consistent with sticky costs and is distinct from conditional conservatism. Future empirical research on conditional conservatism should recognize the potential confounding effect of sticky costs.
•Sales change affects earnings and accruals asymmetrically because of sticky costs.•Sales change is a correlated omitted variable that distorts conservatism estimates.•Controlling for cost stickiness changes inferences in conservatism models.•Cost stickiness biases estimates of standard proxies of demand for conservatism.•How the sticky cost modification should be used depends on the research question.
ABSTRACT
Recent research documents the empirical phenomenon of “sticky costs” and attributes it to a theory of deliberate managerial decisions in the presence of adjustment costs. We refine this ...theoretical explanation and show that it gives rise to a more complex pattern of asymmetric cost behavior that combines two opposing processes: cost stickiness conditional on a prior sales increase, and cost anti-stickiness conditional on a prior sales decrease. These predictions reflect the structure of optimal decisions with adjustment costs and the impact of prior sales changes on managers' expectations about future sales changes. Empirical estimates for Compustat data support our hypotheses. We further verify our predictions using additional proxies for managers' expectations, and show that our model offers important new insights.
JEL Classifications: D24; M41.
