Management Accounting Section Midyear Meeting

The Strategic Value of Rigid Cost Structures

• In Event: Operating leverage

Abstract

We study incumbent firms’ strategic use of rigid cost structures as a commitment device to a more aggressive product market stance targeted to protect profits from looming competitive threats by prospective rivals. Using large cuts in industry-level import tariff rates from 1974-2005, we examine whether increased competitive threats from foreign rivals prompt domestic firms to lever up their cost structure and make costs more rigid. Consistent with our prediction, difference-in-differences estimates reveal that domestic firms experience a decline in cost elasticity after a large cut in import tariff rates. We explore cross-sectional variation in the decline of cost elasticity and find that the effect is concentrated in industries with large inflow of foreign imports after the tariff cut, low import penetration, large producer surplus, and high cash reserves. To further substantiate the strategic motif behind the decrease in cost elasticity, we predict and find that the decline is more pronounced in industries where economies of scale are large and where firms compete as strategic substitutes. Overall, our findings provide a novel perspective on cost behavior that relate to the strategic advantage of making irreversible resource commitments.

Authors

• Martin Artz, University of Münster

• Martin Holzhacker, Michigan State University

• André Hoppe, University of Cologne