Managerial Empire Building, Corporate Governance, and the Asymmetrical Behavior of Selling, General, and Administrative Costs

Abstract:     
Prior studies have documented the asymmetrical behavior of selling, general and administrative (SG&A) costs (i.e., SG&A costs increase more when activity rises than they decrease when activity falls), and have explained this phenomenon with economic factors. In this study, we draw on agency theory and argue that SG&A cost asymmetry is driven not only by economic factors but also by managerial empire-building incentives. Using data for the S&P 1500 firms over the period 1996-2005, we find that: 1) there is a positive association between managers' empire-building incentives and the degree of cost asymmetry; 2) there is a negative association between the strength of corporate governance and the degree of cost asymmetry, and this negative association is stronger in firm-years with a greater empire-building problem. Our findings suggest that the empire-building problem provides an additional explanation for SG&A cost asymmetry, and that corporate governance reduces cost asymmetry by preventing empire-building managers from over-spending on SG&A costs.

Keywords: Cost Behavior, Cost asymmetry, Sticky Costs, Managerial Empire Building, Corporate Governance

JEL Classification: G34, M41

working papers series