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Journal of Management Control
Published in: Journal of Management Control 1/2021

01-03-2021 | Original Paper

Financial constraints and asymmetric cost behavior

Authors: Mabel D. Costa, Ahsan Habib, Md. Borhan Uddin Bhuiyan

Published in: Journal of Management Control | Issue 1/2021

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Abstract

This study investigates the association between financial constraints and cost asymmetry. Using a large U.S. sample of firms from 1976 to 2016, we find that financially constrained firms exhibit less cost asymmetry. However, such low cost asymmetry is more pronounced for SG&A cost category compared to operating cost category. Our results remain generally consistent across various specifications of financial constraints measures and various asymmetric cost behavior measures. We explore three contextual settings that might affect the association differentially, namely, the future value-creating potential of SG&A expense setting, the investment opportunities setting, and the earnings management setting. In addition, we find evidence that financial constraint leads to lower cost asymmetry, even when managers have received optimistic signals about future sales. As resources drive the costs of a business, and financial constraints affect resource availability, studying the cost behavior of constrained firms makes a valuable contribution to the existing cost asymmetry literature.
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Appendix
Available only for authorised users
Footnotes
1
Li and Zheng (2017) find that the positive relation between product market competition and cost stickiness is more pronounced for firms having strong financial positions (an inverse proxy of financial constraints). Their test considers financial constraints as a moderating variable. We, on the other hand, consider financial constraints as the primary driver of cost stickiness. Costa and Habib (2020) document that trade credit lowers cost stickiness, arguing that suppliers are likely to monitor customers’ actions related to downward resource adjustment, because the retention of unutilized resources would affect the current cash flows of customers adversely, with a detrimental effect on suppliers’ finances and overall operation. However, the Costa and Habib (2020) paper differs from ours as their paper is theoretically grounded on the monitoring role of trade credit.
 
2
Fixed-term workers have a flexible fixed-term contract and, therefore, can be laid off without incurring the severance payment that is required to lay off permanent workers (Fernandes and Ferreira 2017).
 
3
The original Anderson et al. (2003) version did not include DECDUM as a standalone variable. Chen et al. (2012) used a variation of the Anderson et al. (2003) model; whereas, Banker et al. (2013) did not incorporate any standalone variable. Holzhacker et al. (2015) and Golden et al. (2020) used a version by incorporating DECDUM as a standalone variable. Kim et al. (2019) used a model with two-way interaction with changes in sales, but did not incorporate DECDUM as a standalone variable.
 
4
We assess the sensitivity of our results related to operating costs by calculating OC as the difference between Compustat data item SALE and IB. Results remain the same.
 
5
Chen et al. (2019) document that firms adjust their COGS by 0.86%, but their SG&A expenses by 0.41% only, in response to a 1% decrease in sales revenue.
 
6
A plausible explanation for our findings might be related to managers’ engagement in cost classification shifting or the “SG&A shell game” (Hartlieb et al. 2020). There is no reason to believe that managers of financially constrained firms do not move cost from SG&A to COGS or vice versa (depending on the stipulations in debt contracts or discussions with lenders). Such potential ‘classification shifting’ could also explain the lack of results of overall operating costs.
 
7
We use INVt+1=α0 + α1 CFOt + α2 Qt + α3 LEVt + α4 DIVt + α5 CASHt + α6 SGt + αj INDj, to estimate a cross-sectional regression in each period and estimate investment opportunities (INVEST) as the predicted value of the regressions. Refer to the appendix for variable definitions.
 
8
We used model C of Banker et al. (2014); thus, excluded RET in this model.
 
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Metadata
Title
Financial constraints and asymmetric cost behavior
Authors
Mabel D. Costa
Ahsan Habib
Md. Borhan Uddin Bhuiyan
Publication date
01-03-2021
Publisher
Springer Berlin Heidelberg
Published in
Journal of Management Control / Issue 1/2021
Print ISSN: 2191-4761
Electronic ISSN: 2191-477X
DOI
https://doi.org/10.1007/s00187-021-00314-7

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