Abstract
The mix of fixed and variable costs in response to environmental changes is important for the sustainability of a firm. This study examines how demand uncertainty affects managers’ cost structure decisions. Using data on Korean firms from 1982 to 2015, my study provides evidence that cost rigidity increases in demand uncertainty. This finding implies that managers under higher uncertainty will increase the committed capacity to reduce congestion costs, resulting in a more rigid (less elastic) cost structure with higher fixed and lower variable costs in the short term. I also investigate the effect of the 1997 Asian financial crisis on cost rigidity. I predict that the massive structural changes entailed by the crisis, such as the deteriorated access to external funds, increase in the tendency of loss aversion, and expansion of outsourcing and temporary job positions, will reduce the magnitude of cost rigidity following greater demand uncertainty. Consistent with the prediction, the positive relation between demand uncertainty and cost rigidity becomes weaker in the period following the crisis, compared to the pre-crisis period.
Highlights
This study examines the effect of demand uncertainty on cost behavior using Korean firms’ data
Banker et al (2014b) [10] refutes the conventional perspective, by empirically and theoretically demonstrating that managers under higher uncertainty will increase the input in fixed costs to reduce congestion costs, resulting in a more rigid cost structure in the short term. This study examines this ongoing debate by examining the influence of demand uncertainty on cost behavior for firms in Korea
This study builds upon this line of literature, and examines the relation between demand uncertainty and the mix of fixed and variable costs using the dataset of the listed firms in the Korean stock market, which have been subject to dynamic changes in the business environment
Summary
This study examines the effect of demand uncertainty on cost behavior using Korean firms’ data. Cost structure decisions in response to environmental changes are important for the sustainability of a firm. When the proportion of fixed costs is high, a change in quantity induces a lower change in costs, which is referred to as higher cost rigidity, whereas relatively less fixed costs entail a less rigid short-run cost structure. This relative proportion of fixed and variable costs is set through a decision process that incorporates various aspects, with uncertainty as one of the main factors. An extensive line of literature has examined cost behavior, with the examples of Anderson et al (2003) [1], Noreen and Soderstrom (1994, 1997) [2,3], Weiss (2010) [4], Chen et al (2012) [5], Dierynck et al (2012) [6], and Kama and Weiss (2013) [7], but not many studies have questioned the role of uncertainty in cost behavior
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