Culture and Cost Stickiness: A Cross-country Study☆
Introduction
There has been considerable interest in the accounting literature in understanding how differences in national culture affect accounting outcomes and the capital markets. Much of the research in this area is focused on the effect of culture on broad managerial and reporting decisions, such as mergers and acquisitions and earnings management (e.g. Ahern et al., 2012, Han et al., 2010, Kanagaretnam et al., 2011). The aspect of how national culture influences managers' decision-making regarding ongoing activities such as managing resource levels, however, remains largely unexplored. In this paper, we aim to understand the effect of culture on managerial decision-making through the lens of cost stickiness.
Recent research documents that deliberate decisions made by managers alter the observed pattern of cost behavior, particularly when there are declines in firms' activity levels. When faced with a sales decline, if managers expect sales to rebound in the future, managers may choose to hold on to unutilized resources rather than dispose of them and incur adjustment costs associated with their disposal. This results in cost behavior that is “sticky.” That is, the cost response is smaller when activity decreases than the cost response when activity increases (Anderson et al., 2003, Weiss, 2010). Studies examining cost behavior document that sticky costs occur because managers' resource adjustment decisions are driven by economic reasons such as adjustment costs and demand uncertainty, as well as by managers' behavioral traits such as benchmark-beating behavior (Kama & Weiss, 2013)1 and the need for empire-building (Chen, Lu, & Sougiannis, 2012).
In this study, we consider five dimensions of national culture identified by Hofstede (1980) (i.e., individualism, uncertainty avoidance, power distance, long-term orientation, and masculinity) and examine how they affect resource management decisions.2 We argue that there are three channels through which culture affects the asymmetry in cost behavior. One channel is through culture's influence on the adjustment costs of resources, particularly with respect to societal attitudes towards workers. For instance, more feminine cultures place a higher weight on maintaining relationships. Thus, psychological adjustment costs related to firing workers could be higher in countries with more feminine cultural orientation. The other channel through which culture affects cost stickiness is via managers' expectations of future demand. In particular, managers in more uncertainty-avoidant cultures may place a smaller weight on signals of future demand, which is inherently uncertain, and place a higher weight on observed contemporaneous signals of demand. Thus, in more uncertainty-avoidant cultures, managers will be driven more by short-term sales expectations, as opposed to longer-term forecasts of future sales. Finally, differences in national culture are likely to affect cost stickiness patterns due to differences in compensation-related incentives which drive empire–building and benchmark-beating behavior of managers. For example, prior research documents that firms in more individualistic societies provide a greater proportion of incentive-based compensation to managers, while uncertainty-avoidant cultures give their managers proportionally less incentive-based compensation (Bryan, Nash, & Patel, 2014). The greater the extent of incentive-related compensation relative to fixed pay, the greater the incentives for empire-building (Chen et al., 2012, Kanniainen, 2000). Empire-building, in turn, has been shown to increase the amount of cost stickiness, since empire-building managers increase resources too rapidly when sales go up and decrease costs too slowly when sales go down (Chen et al., 2012). Thus, national culture is likely to affect such empire-building behavior and, in turn, affect cost stickiness.
We consider how each dimension of national culture is likely to affect cost stickiness through the three different channels described above. Using a sample of 245,348 firm-years (50,080 unique firms) across 39 countries, we find that cost stickiness is less pronounced in countries with higher uncertainty avoidance, masculinity, and long-term orientation.
Broadly, our study makes a contribution along the lines of a number of recent studies in economics, finance, and accounting that have provided evidence that individual managerial traits matter in firm operating, financing, and accounting decisions, calling into serious question a classical economics assumption that the agent's persona should not affect her decision-making. National culture affects many personal traits—for example, degree of risk aversion/risk taking or attitude towards personal perks consumption. We add to this literature by using asymmetric cost behavior to provide a lens through which we can observe how national culture affects management resource allocation decisions at the level of the firm. While we consider aggregate cost behavior at the firm-level, we acknowledge that for individual managers, cultural values could be attenuated by factors such as personal circumstances, education, and past experience.
More specifically, we contribute to the international accounting literature that examines how societal culture influences firm behavior across countries. Recent studies show that cultural traits are among the key determinants of various firm policies.3 Studies have shown that differences in culture affect several financial accounting issues such as earnings management and accounting quality (Kanagaretnam et al., 2013, Kanagaretnam et al., 2011), tax avoidance (Lee, Lim, Kanagaretnam, & Lobo, 2013), and investor perception of earnings news (Pevzner, Xie, & Xin, 2015). Similarly, the management accounting literature has considered the role of national culture in management control and incentive systems (e.g., Chow et al., 1999, Jansen et al., 2009, Salter and Sharp, 2001). Recent studies in management accounting examine differences in asymmetric cost behavior across various countries (Banker et al., 2013a, Banker et al., 2013b). These studies show that the legal and regulatory environment in a country explains some of the differences in cost behavior across countries. We contribute to this stream of work by focusing on a more primitive determinant of management decision-making, i.e., national culture (Gray, 1988, Hofstede, 1980). We propose that when managers make decisions, they are guided not just by laws and institutions, but by their own cultural traits that affect how they act under uncertainty and how they react to incentives. While laws and regulations set general boundaries for decision-making, individual cultural traits may have a direct effect on how managers make decisions. Thus, culture could affect decision-making in a direct manner, over and above its effect through laws and institutions. We show that cultural values help explain differences in how managers process external signals and adjust resources, after controlling for known effects of the legal and regulatory environment. This extends our understanding of how managers across countries make routine decisions, particularly during sales downturns, which in turn provides a useful lens for analyzing and forecasting accounting performance across firms in different countries.
Our paper proceeds as follows. In the next section, we review the literature and develop our hypotheses. In Section 3, we present our research design and describe our sample construction. Our empirical results are presented in Section 4. We include our concluding remarks in Section 5.
Section snippets
Literature review and hypotheses development
In this section, we review the literature on culture's effect on accounting systems, followed by a discussion of the literature on cost behavior. We develop our hypotheses based on a synthesis of this literature.
Empirical model
In our empirical tests, we examine the relationship between the dimensions of culture and cost stickiness. We follow the approach of Banker et al. (2013a) to derive our empirical model. We begin with the basic model of cost behavior that relates annual changes in operating costs (OPR) to contemporaneous changes in sales revenue (SALE) based on Noreen and Soderstrom (1997) and Anderson et al. (2003),5
Main results
We begin our analysis by estimating Eq. (3), which considers the role of culture in impacting cost stickiness. As mentioned earlier, we conduct a separate regression for each culture dimension to prevent any multi-collinearity problems. Our results from this analysis are presented in Table 4. Our main coefficient of interest in each regression is the coefficient on the interaction term (DEC ∗ ∆ lnSALE ∗ CULTURE) i.e., β9. The variable ∆ lnSALE measures the percentage change in operating costs for a
Concluding remarks
In this study, we extend prior research that looks at the impact of culture on accounting decisions. We consider how culture affects operating decisions of managers. Since operating decisions made by managers get reflected in the operating costs of firms, we examine the impact of national culture on the asymmetric cost behavior of firms in 39 countries. Research in management accounting shows that managerial discretion in making resource adjustments affects the symmetry of costs between sales
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We gratefully acknowledge comments from Asheq Rahman (the Editor), the anonymous reviewers, Mark Anderson, Phil Beaulieu, Dmitri Byzalov, Jim Cannon, Hussein Warsame, Rong Zhao, and workshop participants at the University of Calgary, European Accounting Association Annual Congress (2014), American Accounting Association Annual Meeting (2014), and Canadian Academic Accounting Association Annual Meeting (2014). Pevzner gratefully acknowledges the support of the EY Chair in Accounting at the University of Baltimore. Research assistance by Nilay Cakcak and Waffi Faezea is deeply appreciated.