Managerial Ability and Cost Rigidity
48 Pages Posted: 17 May 2019 Last revised: 29 Aug 2019
Date Written: April 18, 2019
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: Suggested Citation