Flexible or Rigid? Evidence on Managerial Ability and Cost Structure

Abstract

This study investigates the association between cost rigidity and managerial ability. Cost rigidity refers to the relative proportion of fixed and variable costs. Traditional management accounting theory suggests that a less rigid cost structure with lower fixed costs and higher variable costs offers flexibility in resource planning. However, we hypothesize and find that higher-ability managers tend to adopt a more rigid cost structure, because they are more likely to realize unusually high demand and reduce congestion costs by retaining higher capacity with more fixed inputs. Using a textual analysis method, we further document that the positive association between cost rigidity and managerial ability is stronger for (1) managers speaking more future-oriented languages during conference calls; (2) managers issuing more accurate forecasts; (3) firms exhibiting greater demand uncertainty; and (4) firms possessing higher growth potential. Our results are robust to using a propensity score matching method, a CEO turnover subsample, and alternative measures of managerial ability. Taken together, our evidence challenges the traditional view on cost rigidity, suggesting that firms’ capacity management choices differ with the level of managerial ability.

Keywords: Managerial ability, cost structure, cost rigidity

JEL Classification: M40, M41