Cost Stickiness as a Consequence of Capital Market Signaling

Abstract

Ample empirical evidence documents the tendency of costs to increase more when revenues rise than to decrease when revenues fall by an equivalent amount. The study offers a capital market oriented explanation for this asymmetric cost behavior, which is known in the literature as cost stickiness, by highlighting the informational role of managerial decisions regarding resource adjustment in response to demand shocks. The suggested explanation is established within a theoretical framework that demonstrates how capital market considerations induce managers of publicly traded firms to utilize their observable resource adjustment decisions as a signaling device through which they convey their private information to the capital market investors. Our analysis indicates that this signaling mechanism serves managers to promote the stock price of their firm at the expense of distorting the optimal cost structure of the firm in a way that triggers a cost stickiness pattern.