Management Accounting Section Midyear Meeting

Managerial Ability and Cost Rigidity

• In Event: Costing Systems and Cost Behavior (Mixed Methods)

Abstract

This study investigates the association between cost rigidity and managerial ability. Cost rigidity refers to the relative proportion of fixed and variable costs, which can be captured by the percentage variation in costs relative to the percentage variation in sales. Traditional management accounting theory suggests that a less rigid cost structure with lower fixed costs and higher variable costs offers companies flexibility in resource planning. However, we expect that higher-ability managers tend to adopt a more rigid cost structure because they are more likely to realize unusually high demand and reduce congestion costs by retaining higher capacity and choosing more fixed inputs. 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) greater demand uncertainty; (2) higher growth potential; (3) less financial constraints; and (4) higher forecasting-ability managers. We further document that higher-ability managers increase cost rigidity by hiring more permanent employees and investing more in fixed assets. Our results are robust to using a propensity score matching method, a CEO turnover subsample, and alternative measures of managerial ability. Taken together, our evidence challenges the traditional view on cost rigidity, suggesting that firms’ capacity management choices differ with the level of managerial ability.

Authors

• Rong Huang, Fudan University

• Yan Yan, Fairleigh Dickinson University