Managerial Ability and Cost Rigidity

48 Pages Posted: 17 May 2019 Last revised: 29 Aug 2019

See all articles by Rong Huang

Rong Huang

City University of New York (CUNY) - Stan Ross Department of Accountancy

Yan Yan

Fairleigh Dickinson University

Date Written: April 18, 2019

Abstract

This study investigates the association between cost rigidity and managerial ability. Cost rigidity refers to the percentage variation in costs relative to the percentage variation in sales, which can be captured by the relative proportion of fixed and variable costs. Traditional management accounting theory suggests that a less rigid cost structure with lower fixed costs offers companies flexibility in resource planning. However, we expect that higher-ability managers tend to adopt a more rigid cost structure. This is because higher-ability managers are more likely to realize unusually high demand and confront congestion if the fixed capacity is limited. To reduce congestion costs associated with higher future demand, more able managers will attempt to retain higher capacity and choose more fixed inputs, leading to a more rigid cost structure with higher fixed and lower variable costs. Consistent with our prediction, we find a positive association between managerial ability and the degree of cost rigidity. This association is stronger for firms with (1) sales increase; (2) greater demand uncertainty; and (3) lower capital intensity. Focusing on a subsample with CEO turnovers, we find an increase in cost rigidity when former CEOs are replaced with more capable CEOs. 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

Suggested Citation

Huang, Rong and Yan, Yan, Managerial Ability and Cost Rigidity (April 18, 2019). Baruch College Zicklin School of Business Research Paper No. 2019-05-01. Available at SSRN: https://ssrn.com/abstract=3374478 or http://dx.doi.org/10.2139/ssrn.3374478

Rong Huang

City University of New York (CUNY) - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
(646)312-3204 (Phone)

Yan Yan (Contact Author)

Fairleigh Dickinson University ( email )

1000 River Rd
Teaneck, NJ 07666
United States

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