Asymmetric cost behavior and financial distress

Abstract

This study explores the effect of financial distress on the intensity of asymmetric cost behavior. Cost asymmetry refers to the different (i.e., asymmetric) response of variable costs between increases or decreases in the level of a firm’s operating activity due to deliberate managerial resource commitment decisions to maintain idle resources when the activity volumes decline. High levels of financial distress increase the cost of maintaining idle resource capacity, decrease the intensity of the managerial building behavior and managerial optimism for future sales revenues. As a result, financial distress is negatively associated with the intensity of cost asymmetry. Our data sample consists of 88,624 firm-year observations for US listed firms over the period 1990–2020. We provide evidence that, on average, financial distress decreases the intensity of cost asymmetry of SG&A and operating expenses. Additional analysis corroborates the generalization of our main empirical findings including: (i) determinants of cost asymmetry, (ii) earnings management, (iii) additional firm-specific characteristics and (iv) multidimensionally of text-based analysis. Robustness tests confirm the negative relationship of financial distress with cost asymmetry under: (i) endogeneity issues, (ii) alternative econometric specifications, (iii) different levels of corporate governance and (iv) alternative measures of financial distress and cost asymmetry.

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ORCID for Dimitrios Ntounis: orcid.org/0000-0003-1819-0941

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