Skip to main content
SpringerLink
Log in

The effect of management control mechanisms through risk-taking incentives on asymmetric cost behavior

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

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 via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. 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.

  2. 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.

  3. Professor Naveen makes the data available on her website at http://sites.temple.edu/lnaveen/data/. For a detailed description on how she calculates the incentives data, please refer to Coles et al. (2013) available at http://ssrn.com/abstract=2296381.

  4. 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.

References

  • Aboody D, Levi S, Weiss D (2018) Managerial incentives, options, and cost-structure choices. Rev Account Stud 23(2):422–451

    Google Scholar 

  • Abowd JM, Kramarz F (2003) The costs of hiring and separations. Labor Econ 10(5):499–530

    Google Scholar 

  • 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

    Google Scholar 

  • 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

    Google Scholar 

  • Armstrong CS, Vashishtha R (2012) Executive stock options, differential risk-taking incentives, and firm value. J Financ Econ 104(1):70–88

    Google Scholar 

  • 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

    Google Scholar 

  • 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

    Google Scholar 

  • 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

    Google Scholar 

  • 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

    Google Scholar 

  • Banker RD, Byzalov D, Plehn-Dujowich JM (2014b) Demand uncertainty and cost behavior. Account Rev 89(3):839–865

    Google Scholar 

  • 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

    Google Scholar 

  • Brüggen A, Zehnder JO (2014) SG&A cost stickiness and equity-based executive compensation: does empire building matter. J Manag Control 25:169–192

    Google Scholar 

  • Burgstahler D, Dichev I (1997) Earnings management to avoid earnings decreases and losses. J Account Econ 24:99–126

    Google Scholar 

  • Calleja K, Steliaros M, Thomas DC (2006) A note on cost stickiness: some international comparisons. Manag Account Res 17:127–140

    Google Scholar 

  • Casavecchia L, Suh JY (2017) Managerial incentives for risk-taking and internal capital allocation. Aust J Manag 42(3):428–461

    Google Scholar 

  • Chang X, Fu K, Low A, Zhang W (2015) Non-executive employee stock options and corporate innovation. J Financ Econ 115:168–188

    Google Scholar 

  • Chava S, Purnanandam A (2007) Determinants of the floating-to-fixed rate debt structure of firms. J Financ Econ 85:755–786

    Google Scholar 

  • 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

    Google Scholar 

  • Chung C, Hur S, Liu C (2019) Institutional investors and cost stickiness: theory and evidence. North Am J Econ Finance 47:336–350

    Google Scholar 

  • 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

    Google Scholar 

  • Coles JL, Daniel ND, Naveen L (2006) Managerial incentives and risk-taking. J Financ Econ 79:431–468

    Google Scholar 

  • 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

    Google Scholar 

  • Espahbodi R, John T, Vasudevan G (2000) The effects of downsizing on operating performance. Rev Quant Finance Account 15:107–126

    Google Scholar 

  • Fung MK (2013) A trade-off between non-fundamental risk and incentives. Rev Quant Finance Account 41:29–51

    Google Scholar 

  • Glover B, Levine O (2017) Idiosyncratic risk and the manager. J Financ Econ 126:320–341

    Google Scholar 

  • Gu T, Venkateswaran A (2018) Firm-supplier relations and managerial compensation. Rev Quant Finance Account 51:621–649

    Google Scholar 

  • Guay WR (1999) The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants. J Financ Econ 53:43–71

    Google Scholar 

  • Guo L, Jalal A, Khaksari S (2015) Bank executive compensation structure, risk taking and the financial crisis. Rev Quant Finance Account 45:609–639

    Google Scholar 

  • Haugen RA, Senbet LW (1981) Resolving the agency problems of external capital through options. J Finance 36:629–647

    Google Scholar 

  • 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

    Google Scholar 

  • 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

    Google Scholar 

  • Horngren CT, Sundem GL, Burgstahler D, Schatzberg J (2014) Introduction to management accounting, 16th edn. Pearson Education Inc, London

    Google Scholar 

  • Hu C, Jiang W (2019) Managerial risk incentives and accounting conservatism. Rev Quant Finance Account 52:781–813

    Google Scholar 

  • Iqbal J, Vähämaa S (2019) Managerial risk-taking incentives and the systematic risk of financial institutions. Rev Quant Finance Account 53:1229–1258

    Google Scholar 

  • Jensen M, Meckling W (1976) Theory of the firm: managerial behavior, agency costs, and capital structure. J Financ Econ 3:305–360

    Google Scholar 

  • Kallapur S, Eldenburg L (2005) Uncertainty, real options, and cost behavior: evidence from Washington state hospitals. J Account Res 43(5):735–752

    Google Scholar 

  • Kama I, Weiss D (2013) Do earnings targets and managerial incentives affect sticky costs? J Account Res 51:201–224

    Google Scholar 

  • Kim K, Patro S, Pereira R (2017) Option incentives, leverage, and risk-taking. J Corp Finance 43:1–18

    Google Scholar 

  • Kramarz F, Michaud ML (2010) The shape of hiring and separation costs in France. Labor Econ 17(1):27–37

    Google Scholar 

  • 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

    Google Scholar 

  • Lev B (1974) On the association between operating leverage and risk. J Financ Quant Anal 9:627–642

    Google Scholar 

  • Li W, Zheng K (2017) Product market competition and cost stickiness. Rev Quant Finance Account 49(2):283–313

    Google Scholar 

  • Noreen EW, Brewer PC, Garrison RH (2018) Managerial accounting for managers, 4th edn. McGraw-Hill Education, New York

    Google Scholar 

  • Panousi V, Papanikolaou D (2012) Investment, idiosyncratic risk, and ownership. J Financ 67(3):1113–1148

    Google Scholar 

  • Petersen M (2009) Estimating standard errors in finance panel data sets: comparing approaches. Rev Financ Stud 22:435–480

    Google Scholar 

  • Rajgopal S, Shevlin T (2002) Empirical evidence on the relation between stock option compensation and risk taking. J Account Econ 33:145–171

    Google Scholar 

  • Rouxelin F, Wongsunwai W, Yehuda N (2018) Aggregate cost stickiness in GAAP financial statements and future unemployment rate. Account Rev 93(3):299–325

    Google Scholar 

  • Roychowdhury S (2006) Earnings management through real activities manipulation. J Account Econ 42:335–370

    Google Scholar 

  • 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

    Google Scholar 

  • Shaw KW (2012) CEO incentives and the cost of debt. Rev Quant Finance Account 38:323–346

    Google Scholar 

  • Smith C, Stulz R (1985) The determinants of firms’ hedging policies. J Financ Quant Anal 20(4):391–405

    Google Scholar 

Download references

Acknowledgements

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.

Funding

No funding is associated with this study.

Author information

Authors and Affiliations

  1. Division of International Banking and Finance Studies, Texas A&M International University, Laredo, TX, USA

    Wulung Li & Yan Zhao

  2. Naveen Jindal School of Management, University of Texas at Dallas, Richardson, TX, USA

    Ramachandran Natarajan

  3. Department of Accounting and Finance, College of Business, University of Wyoming, 1000 E. University Ave. Dept. 3275, Laramie, WY, 82071-2000, USA

    Kenneth Zheng

Authors
  1. Wulung Li
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Ramachandran Natarajan
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Yan Zhao
    View author publications

    You can also search for this author in PubMed Google Scholar

  4. Kenneth Zheng
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Kenneth Zheng.

Ethics declarations

Conflict of interest

The authors declare that they have no conflict of interest.

Ethical approval

This article does not contain any studies with human participants or animals performed by any of the authors.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

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 56, 219–243 (2021). https://doi.org/10.1007/s11156-020-00891-z

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-020-00891-z

Keywords

JEL Classification

Search

Navigation