We investigate the relationship between management control mechanisms, specifically risk-taking incentives targeted at mitigating moral hazard, and cost behavior during periods of sales declines relative to periods of sales growth. We find that incentive vega of both chief executive officers and top five paid executives is associated with expedited reductions in selling, general, and administrative cost in periods of sales declines. These results are consistent with the Sedatole et al. (J Account Res 50(2):553–592, 2012) finding that incentive vega induces managers to adopt a more elastic cost structure, presumably because managerial operational decisions, particularly outsourcing, increase firms’ total risk. We conduct an additional analysis to rule out an alternative explanation that the expedited cost cuts may be driven by incentives to manage earnings. Finally, our results are robust to alternative measures of risk-taking incentives. Overall, our findings support the view that management control mechanisms through risk-taking incentives are an important determinant of management cost adjustment decisions in periods of demand declines relative to periods of demand growth.
This is a preview of subscription content, log in to check access.
Buy single article
Instant access to the full article PDF.
Price includes VAT for USA
Subscribe to journal
Immediate online access to all issues from 2019. Subscription will auto renew annually.
This is the net price. Taxes to be calculated in checkout.
In general, transactions risks associated with outsourcing include loss of control, diminishing organizational trust, unexpectedly high transaction costs, and deterioration in innovation. Examples are (1) potential interruptions of the flow of product or service between a firm and its suppliers or customers in cases of production or distribution outsourcing, (2) lower quality of hired employees in cases of human resources outsourcing, (3) possible impediments of information security in cases of payroll outsourcing, and (4) declines in innovation in cases of information technology outsourcing.
In untabulated robustness tests, we allow SUC_DECit to affect the change in SG&A costs in response to sales increases. Results are not sensitive to the inclusion of the interaction variable between SUC_DECit and ΔlnSALEit.
In cases where none of the top five executives are labeled as CEO, or where the CEO is not among the top five executives with highest total compensation, we keep these cases as firm-year observations in the TOP5 sample. However, these instances are excluded from the CEO sample. Consequently, the number of observations in the TOP5 sample is greater than that in the CEO sample.
Aboody D, Levi S, Weiss D (2018) Managerial incentives, options, and cost-structure choices. Rev Account Stud 23(2):422–451
Abowd JM, Kramarz F (2003) The costs of hiring and separations. Labor Econ 10(5):499–530
Abowd JM, Corbel P, Kramarz F (1999) The entry and exit of workers and the growth of employment: an analysis of French establishments. Rev Econ Stat 81(2):170–187
Anderson SW, Lanen WN (2009) Understanding cost management. What can we learn from the empirical evidence on “sticky costs”? Working paper, University of Michigan
Anderson M, Banker R, Janakiraman S (2003) Are selling, general, and administrative costs “sticky”? J Account Res 41:47–63
Armstrong CS, Vashishtha R (2012) Executive stock options, differential risk-taking incentives, and firm value. J Financ Econ 104(1):70–88
Armstrong CS, Larcker DF, Ormazabal G, Taylor DJ (2013) The relation between equity incentives and misreporting: the role of risk-taking incentives. J Financ Econ 109:327–350
Atasoy H, Banker RD, Byzalov D (2016) Production outsourcing and demand uncertainty. Working paper, Temple University
Balakrishnan R, Labro E, Soderstrom N (2014) Cost structure and sticky costs. J Manag Account Res 26:91–116
Banker R, Byzalov D, Chen L (2013) Employment protection legislation, adjustment costs and cross-country differences in cost behavior. J Account Econ 55:111–127
Banker R, Byzalov D, Ciftci M, Mashruwala R (2014a) The moderating effect of prior sales changes on asymmetric cost behavior. J Manag Account Res 26:221–242
Banker RD, Byzalov D, Plehn-Dujowich JM (2014b) Demand uncertainty and cost behavior. Account Rev 89(3):839–865
Banker R, Byzalov D, Fang S, Jin B (2020) Operating asymmetries and non-linear spline correction in discretionary accrual models. Rev Quant Finance Account 54:803–850
Brüggen A, Zehnder JO (2014) SG&A cost stickiness and equity-based executive compensation: does empire building matter. J Manag Control 25:169–192
Burgstahler D, Dichev I (1997) Earnings management to avoid earnings decreases and losses. J Account Econ 24:99–126
Calleja K, Steliaros M, Thomas DC (2006) A note on cost stickiness: some international comparisons. Manag Account Res 17:127–140
Casavecchia L, Suh JY (2017) Managerial incentives for risk-taking and internal capital allocation. Aust J Manag 42(3):428–461
Chang X, Fu K, Low A, Zhang W (2015) Non-executive employee stock options and corporate innovation. J Financ Econ 115:168–188
Chava S, Purnanandam A (2007) Determinants of the floating-to-fixed rate debt structure of firms. J Financ Econ 85:755–786
Chen C, Lu H, Sougiannis T (2012) The agency problem, corporate governance, and the asymmetric behavior of selling, general, and administrative costs. Contemp Account Res 29:252–282
Chung C, Hur S, Liu C (2019) Institutional investors and cost stickiness: theory and evidence. North Am J Econ Finance 47:336–350
Cohen D, Dey A, Lys T (2008) Real and accrual-based earnings management in the pre- and post-Sarbanes–Oxley periods. Account Rev 83:757–787
Coles JL, Daniel ND, Naveen L (2006) Managerial incentives and risk-taking. J Financ Econ 79:431–468
Coles JL, Daniel ND, Naveen L (2013) Calculation of compensation incentives and firm-related wealth using Execucomp: data, program, and explanation. Working paper. http://ssrn.com/abstract=2296381
Dierynck B, Landsman W, Renders A (2012) Do managerial incentives drive cost behavior? Evidence about the role of zero earnings benchmarks for labor cost behavior in private Belgian firm. Account Rev 87:1219–1246
Espahbodi R, John T, Vasudevan G (2000) The effects of downsizing on operating performance. Rev Quant Finance Account 15:107–126
Fung MK (2013) A trade-off between non-fundamental risk and incentives. Rev Quant Finance Account 41:29–51
Glover B, Levine O (2017) Idiosyncratic risk and the manager. J Financ Econ 126:320–341
Gu T, Venkateswaran A (2018) Firm-supplier relations and managerial compensation. Rev Quant Finance Account 51:621–649
Guay WR (1999) The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants. J Financ Econ 53:43–71
Guo L, Jalal A, Khaksari S (2015) Bank executive compensation structure, risk taking and the financial crisis. Rev Quant Finance Account 45:609–639
Haugen RA, Senbet LW (1981) Resolving the agency problems of external capital through options. J Finance 36:629–647
Hayes RM, Lemmon M, Qiu M (2012) Stock options and managerial incentives for risk taking: evidence from FAS 123R. J Financ Econ 105:174–190
Holzhacker M, Krishnan R, Mahlendorf MD (2015) Unraveling the black box of cost behavior: an empirical investigation of risk drivers, managerial resource procurement, and cost elasticity. Account Rev 90(6):2305–2335
Horngren CT, Sundem GL, Burgstahler D, Schatzberg J (2014) Introduction to management accounting, 16th edn. Pearson Education Inc, London
Hu C, Jiang W (2019) Managerial risk incentives and accounting conservatism. Rev Quant Finance Account 52:781–813
Iqbal J, Vähämaa S (2019) Managerial risk-taking incentives and the systematic risk of financial institutions. Rev Quant Finance Account 53:1229–1258
Jensen M, Meckling W (1976) Theory of the firm: managerial behavior, agency costs, and capital structure. J Financ Econ 3:305–360
Kallapur S, Eldenburg L (2005) Uncertainty, real options, and cost behavior: evidence from Washington state hospitals. J Account Res 43(5):735–752
Kama I, Weiss D (2013) Do earnings targets and managerial incentives affect sticky costs? J Account Res 51:201–224
Kim K, Patro S, Pereira R (2017) Option incentives, leverage, and risk-taking. J Corp Finance 43:1–18
Kramarz F, Michaud ML (2010) The shape of hiring and separation costs in France. Labor Econ 17(1):27–37
Kuo HC, Wang LH (2005) The effect of the degree of internationalization on capital structure for listed multinational corporations in Taiwan during the Asian financial crisis. Rev Pac Basin Financ Mark Policies 8(3):447–466
Lev B (1974) On the association between operating leverage and risk. J Financ Quant Anal 9:627–642
Li W, Zheng K (2017) Product market competition and cost stickiness. Rev Quant Finance Account 49(2):283–313
Noreen EW, Brewer PC, Garrison RH (2018) Managerial accounting for managers, 4th edn. McGraw-Hill Education, New York
Panousi V, Papanikolaou D (2012) Investment, idiosyncratic risk, and ownership. J Financ 67(3):1113–1148
Petersen M (2009) Estimating standard errors in finance panel data sets: comparing approaches. Rev Financ Stud 22:435–480
Rajgopal S, Shevlin T (2002) Empirical evidence on the relation between stock option compensation and risk taking. J Account Econ 33:145–171
Rouxelin F, Wongsunwai W, Yehuda N (2018) Aggregate cost stickiness in GAAP financial statements and future unemployment rate. Account Rev 93(3):299–325
Roychowdhury S (2006) Earnings management through real activities manipulation. J Account Econ 42:335–370
Sedatole KL, Vrettos D, Widener SK (2012) The use of management control mechanisms to mitigate moral hazard in the decision to outsource. J Account Res 50(2):553–592
Shaw KW (2012) CEO incentives and the cost of debt. Rev Quant Finance Account 38:323–346
Smith C, Stulz R (1985) The determinants of firms’ hedging policies. J Financ Quant Anal 20(4):391–405
We appreciate the comments from workshop participants at University of Wyoming College of Business and Weber State University Goddard School of Business AND Economics as well as conference participants at the 2017 American Accounting Association Western Region Meeting and the 4th AIMA World Conference on Management Accounting Research.
No funding is associated with this study.
Conflict of interest
The authors declare that they have no conflict of interest.
This article does not contain any studies with human participants or animals performed by any of the authors.
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
About this article
Cite this article
Li, W., Natarajan, R., Zhao, Y. et al. The effect of management control mechanisms through risk-taking incentives on asymmetric cost behavior. Rev Quant Finan Acc (2020). https://doi.org/10.1007/s11156-020-00891-z
- Risk-taking incentives
- Demand uncertainty
- Cost behavior
- Cost stickiness
- Cost elasticity