Management Accounting Section Midyear Meeting

The Role of Market Power in Cost Behavior

• In Event: Hospitals

Abstract

This study investigates how market power affects cost behavior using a nationwide sample of over 2,000 U.S. hospitals. Cost behavior, which is critical to firm performance, is characterized by cost elasticity and cost asymmetry. Since managers’ investment decisions are influenced by how a firm interacts with suppliers and rival firms (e.g., Grenadier 2002; Novy-Marx 2007; Trigeoris 1996), market power is a potentially important determinant of both cost elasticity and cost asymmetry. Yet, market power has received little attention from accounting researchers. Results indicate that market power does not directly affect cost elasticity; however, it moderates the relation between demand risk and cost elasticity. Consistent with evidence on real options theory, these results suggest that when demand is uncertain, market power enables firms to delay investment without threat of pre-emption by competitors, leading to a more elastic cost structure (Grenadier 2002; Bulan, Mayer, and Sommerville 2009). Firms facing intense competition must continue making investments to maintain their competitive positions even when demand is highly uncertain, resulting in a less elastic cost structure. We also find that market power determines whether hospital costs are asymmetric. Hospitals with market power have symmetric costs, while those without market power have sticky costs. These results suggest that market power enables firms to reduce their costs more easily during downturns in demand. Our findings contribute to literature streams on cost structure, cost asymmetry, real options, and hospital industry competition.

Authors

• Brian A Vansant, Auburn University

• Mina Pizzini, Texas State University