The Managerial Perception of Uncertainty and Cost Behavior

42 Pages Posted: 17 Jun 2020

See all articles by Jason V. Chen

Jason V. Chen

University of Illinois at Chicago

Itay Kama

University of Michigan, Stephen M. Ross School of Business

Reuven Lehavy

University of Michigan, Stephen M. Ross School of Business

Date Written: May 18, 2020

Abstract

Extensive theoretical research demonstrates the pivotal role uncertainty plays in shaping a firm’s cost behavior. Our study contributes to this literature by conducting a comprehensive multivariate analysis of the inherent tension between the effects of price and demand uncertainty on cost elasticity and cost asymmetry. Using the occurrence of words implying uncertainty in forward-looking statements in the Management Discussion and Analysis section of 10-K reports to measure the managerial perception of the overall, price, and demand uncertainty, we provide evidence of a positive and significant association between price uncertainty and cost elasticity and a negative and significant association between demand uncertainty and cost elasticity. The former finding is consistent with managers’ desire to shift to a more elastic cost function in the face of high price uncertainty; the latter supports the hypothesis that firms facing demand uncertainty will increase their capacity of fixed resources to avoid disproportionately large production congestion costs associated with high demand realizations. We reconcile findings in prior studies by demonstrating that the association between demand uncertainty and cost elasticity is negative for manufacturing firms but is positive for firms in the healthcare sector. We also document that managerial perception of the overall uncertainty exacerbates the degree of cost asymmetry. Our empirical evidence supports the theoretical argument that the managerial perception of uncertainty and its components influences their resource allocation decisions, and suggests that any analysis of the relation between uncertainty and a firm’s cost behavior needs to be conducted in the context of a specific type of uncertainty and industry affiliation.

Keywords: uncertainty, demand, volume, price, cost elasticity, cost asymmetry, forward-looking statements, textual analysis

JEL Classification: M41, D24

Suggested Citation

Chen, Jason V. and Kama, Itay and Lehavy, Reuven, The Managerial Perception of Uncertainty and Cost Behavior (May 18, 2020). Available at SSRN: https://ssrn.com/abstract=3608218 or http://dx.doi.org/10.2139/ssrn.3608218

Jason V. Chen

University of Illinois at Chicago ( email )

1200 W Harrison St
Chicago, IL 60607
United States

Itay Kama (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-4538 (Phone)

Reuven Lehavy

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109
United States
734-763-1508 (Phone)
734-936-0282 (Fax)

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