The Cost Stickiness Phenomenon

The analysis and prediction of cost behavior is clearly relevant to accounting researchers, managers, financial analysts, and professional investors, since all these groups rely fundamentally on cost accounting data for their core work activities. According to traditional models of cost behavior, as presented in accounting textbooks, costs are considered to be either fixed or variable with respect to changes in the activity level of a firm. By definition, at least in the short run, fixed costs are independent of the level of activity. Variable costs, by contrast, are commonly considered to change symmetrically or even proportionally with changes in activity. This implies that the extent of a change in variable costs depends only on the extent of the simultaneous change in activity level and not on the direction of the change.

This chapter provides the framework for the subsequent ones and reveals potential for future research through a comprehensive discussion of the cost stickiness phenomenon. Section 2.1 differentiates between sticky cost behavior and the traditional assumption of symmetric or proportional changes in costs in response to changes in activity. For this purpose, Section 2.1 first presents the main findings from several research studies that provide early indications of an asymmetric reaction of costs to changes in activity. Furthermore, Section 2.1 discusses the seminal study of Anderson et al. [2003], which links cost stickiness to deliberate managerial behavior and laid the groundwork for cost stickiness as a distinct field of research. Section 2.2 discusses and structures the existing research literature on the characteristics of cost stickiness. The discussion of these studies is divided into several subsections, each of which has an individual focus and explores either general, firm-specific, industry-specific, or country-specific characteristics of cost stickiness. Section 2.3 elaborates on studies analyzing the impact of managerial incentives on sticky cost behavior.

The following chapter addresses the relationship between cost stickiness and fundamental analysis by using the example of contradictory interpretations of an increase in the ratio of selling, general, and administrative costs to sales (SG&A ratio). Anderson et al. [2007] attribute the existence of positive and negative impacts of an increase in this important ratio on future performance to the sticky behavior of costs. I provide an alternative approach to determine the information content of the SG&A ratio and compare this approach to the method suggested by Anderson et al. [2007]. The analysis in the following chapter is largely based on my research study, which I have presented at the 2009 AAA Northeast Region Meeting in Cambridge, Massachusetts and at the Journal of Management Accounting Research Conference in Seattle, Washington. A former version of this study has also been published as a double-peer-reviewed journal article in the 2010 issue of the Journal of Management Accounting Research.

The analysis of financial analysts’ consideration of cost stickiness presented in the following chapter is based on my research study, which has been presented at the 34^th Annual Congress of the European Accounting Association in Rome, Italy, and at the 2011 Annual Meeting of the American Accounting Association in Denver, Colorado.

Understanding cost behavior is a fundamental element of cost accounting and the management of a firm. Deviating from the traditional assumption of symmetric cost behavior, numerous recent research studies show that costs are sticky, that is, they decrease less when sales fall than they increase when sales rise. Beginning with Anderson et al. [2003], accounting research explains this observation in terms of an alternative model in which costs arise due to deliberate adjustment decisions made by managers. When activity declines, forward-looking managers balance adjustment costs against those of temporarily keeping idle capacity, in order to maximize the long-term value of the firm. Additionally, self-interested managers are affected by different incentives, such as status considerations, which induce them to omit or delay reasonable resource reductions. A wide range of accounting research studies builds on this alternative model and addresses different characteristics and implications of sticky cost behavior. This doctoral thesis contributes to the field of research on cost stickiness in three distinct ways.