Cost Stickiness and Credit Risk

Abstract

We document that cost stickiness is priced in the CDS market. More specifically, we show that creditors require higher risk premiums for sticky firms consistent with stickiness increasing asset volatility. In addition, we find that creditors require lower or no risk premiums if stickiness is efficient and increases asset values. This is the case (1) if stickiness is based on strategic costs like R&D and SG&A rather than operating costs like COGS, (2) for sticky firms with higher cost adjustment flexibility signaling that costs are kept intentionally because sales growth expectations are favorable, (3) for sticky firms with higher managerial quality and (4) for sticky firms with fewer empire building possibilities. We contribute to the accounting literature on asymmetric cost behavior by documenting a new capital market consequence of sticky cost and to the finance and accounting literature on credit risk by identifying a new credit risk factor.

Keywords: Cost Stickiness, Cost Behavior, Credit Risk, Credit Default Swaps

JEL Classification: M41, G32