How Economically Significant Are Unused Capacity Costs? A Large-Scale Empirical Analysis

Abstract

This study uses a confidential Census sample of 151,900 U.S. manufacturing plant-years from 1974-2011 to investigate the impact of excluding the costs of unused capacity from measured product costs and gross margins. We estimate the magnitude of unused capacity cost as a percent of sales to be about 4.8 percent, which for Compustat manufacturing firms in 2016 amounts to $471 billion (by comparison, the well-researched topic of R&D expense totals to $557 billion). We find that excluding the cost of unused capacity decreases measured product costs by approximately 6 percent and increases measured gross margins by approximately 26 percent. These magnitudes are economically significant and pervasive across industries and over time. Excluding the cost of unused capacity also smooths the time-series variation in unitized product costs and gross margins, with the standard deviation of gross margins declining (significantly) by approximately 5 percent. We relate our findings to the strong corporate resistance to the SFAS 151 Exposure Draft and the ensuing FASB research agenda on the financial reporting treatment of unused capacity costs.