Evidence on the Trade-Off between Cost Stickiness and Income Smoothing
53 Pages Posted: 27 Jul 2016 Last revised: 14 Oct 2018
Date Written: October 8, 2018
This study investigates the relationship between cost stickiness and income smoothing. Both arise as a result of managerial discretion. However, an asymmetrical reaction of costs to changes in activity counteracts an ambition to report smooth income. Inversely, reducing costs during periods of declining sales, in order to secure a smooth income stream, aligns costs with activity and mitigates cost stickiness. Applying both a cross-sectional and a firm-specific model of cost stickiness, we find evidence for this negative relationship. We further separate the discretionary component from our aggregate income smoothing measure and show that the negative relation is primarily driven by opportunistic managerial motives. Our results corroborate the important role that managerial discretion plays in financial accounting as well as cost behavior.
Keywords: Asymmetric Cost Behavior; Income Smoothing; Managerial Discretion; Earnings Management
JEL Classification: D22; M41; M52
Suggested Citation: Suggested Citation