Article

The Managerial Perception of Uncertainty and Cost Behavior

Authors:
To read the full-text of this research, you can request a copy directly from the authors.

No full-text available

Request Full-text Paper PDF

To read the full-text of this research,
you can request a copy directly from the authors.

ResearchGate has not been able to resolve any citations for this publication.
Article
Full-text available
We examine the effect of managerial expectations on asymmetric cost behavior in the context of resource adjustment costs and unused resource constraints. Our results show that the incremental impact of managerial expectations on cost asymmetry is the strongest when adjustment costs and unused resources are high. Conversely, when both are low, expectations have no impact on the degree of cost asymmetry. Furthermore, when the degree of unused resources is high, managerial pessimism is associated with anti-sticky cost behavior but managerial optimism reverses this relation and results in cost stickiness. Finally, we find the strongest cost stickiness under the following: a low degree of unused resources, a high magnitude of adjustment costs, and optimistic managerial expectations; by contrast, the strongest cost anti-stickiness occurs when all three drivers operate in the opposite direction. Our study suggests that additional economic determinants should be considered when assessing the impact of managerial expectations on cost behavior.
Article
Full-text available
This paper investigates analytically and empirically the relation between demand uncer-tainty and cost behavior. We characterize cost behavior in terms of cost elasticity, which we de…ne as the percentage change in deated costs for a one-percent change in deated sales. We hypothesize that, if …rms have to commit to initial capacities for current period prior to observing the realization of demand, then higher demand uncertainty should be associated with lower cost elasticity, i.e., a less exible cost structure. The reason is that, if exceeding initial capacities is su¢ ciently costly, then the optimal level of initial capacities is increasing in de-mand uncertainty, since higher demand uncertainty increases the likelihood of unusually high realizations of demand. Thus, higher demand uncertainty will increase the …xed costs associated with initial capacities, which in turn will reduce cost elasticity. We formalize this argument in a simple analytical model of optimal capacity choice under uncertainty. We examine the relation between demand uncertainty and cost elasticity empirically for the manufacturing sector, using …rm-level data from Compustat, and industry-level data from the NBER-CES Industry Data-base. We …nd strong support for our hypothesis, i.e., we …nd that higher demand uncertainty is associated with lower cost elasticity in our data. This …nding holds for multiple cost categories in both datasets (SG&A costs, COGS, and number of employees in the Compustat sample; number of employees, number of production workers, number of production hours, number of non-production employees, and costs of energy in the NBER-CES sample), and is robust to alternative model speci…cations and measures of demand uncertainty.
Article
Full-text available
Although leading indicators are becoming increasingly important for equity valuation, disclosures of such indicators suffer from the absence of GAAP related guidance on content and presentation. We explicitly examine (i) whether one leading indicator—order backlog—predicts future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings, and a hedge strategy that exploits such overweighting generates significant future abnormal returns. However, such mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.
Article
Full-text available
This paper studies the optimal timing of investment in an irreversible project where the benefits from the project and the investment cost follow continuous-time stochastic processes. The optimal investment rule and an explicit formula for the value of the option to invest are derived, assuming that the option is valued by risk-averse investors who are well diversified. The same analysis is applied to the scrapping decision. Simulations show that this option value can be significant, and that for reasonable parameter values it is optimal to wait until benefits are twice the investment costs.
Article
We identify forward-looking statements (FLS) in firms' disclosures to distinguish between "forecast-like" (quantitative statements about earnings) and "other", or non-forecast-like, FLS. We show that, like earnings forecasts, other FLS generate significant investor and analyst responses. Unlike earnings forecasts, other FLS are issued more frequently when uncertainty is higher. We then show that earnings-related FLS are more sensitive to uncertainty than quantitative statements, suggesting that managers are more likely to alter the content than the form of FLS when uncertainty is higher. Our study indicates that incorporating other FLS into empirical measures provides a more comprehensive proxy for firms' voluntary disclosures.
Article
This paper investigates the impact of a firm’s annual report readability and ambiguous tone on its borrowing costs. We find that firms with larger 10-K file sizes and a higher proportion of uncertain and weak modal words in 10-Ks have stricter loan contract terms and greater future stock price crash risk. Our results suggest that the readability and tone ambiguity of a firm’s financial disclosures are related to managerial information hoarding. Shareholders of firms with less readable and more ambiguous annual reports not only suffer from less transparent information disclosure but also bear the increased cost of external financing.
Article
Relative to quantitative methods traditionally used in accounting and finance, textual analysis is substantially less` precise. Thus, understanding the art is of equal importance to understanding the science. In this survey, we describe the nuances of the method and, as users of textual analysis, some of the tripwires in implementation. We also review the contemporary textual analysis literature and highlight areas of future research. © 2016 University of Chicago on behalf of the Accounting Research Center
Article
We use computer-intensive techniques to study the informational properties of forward-looking disclosures in the management discussion and analysis (MD&A) sections of 10-K filings made with the Securities and Exchange Commission. We find that firms make more forward-looking MD&A disclosures when their stock prices have lower informational efficiency, i.e., when their stock prices poorly reflect future earnings information. The greater levels of forward-looking MD&A disclosures help improve yet are unable to completely mitigate the lower informational efficiency of stock prices for such firms. These findings are stronger for operations-related forward-looking disclosures, disclosures that are made prior to 2000, and disclosures made by loss firms. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2014.1921 . This paper was accepted by Mary Barth, accounting.
Article
This study examines whether introduction of fixed-price regulation influences firms to increase the elasticity of their cost structures and to reduce the asymmetric behavior of cost in response to changes in volume. It also examines variations in the extent of such responses arising from differences in institutional constraints on the flexibility to make adjustments. We posit that introduction of fixed-price regulation results in cost pressures and a concomitant increase in the operating risk faced by firms. In response, firms will attempt to influence their cost structures by increasing their cost elasticity (i.e., the response of cost to changes in volume) and by reducing their cost asymmetry (i.e., the differential response of cost to decreases in volume relative to increases in volume). We empirically test these predictions using 16,186 hospital-year observations from the German hospital industry for the years 1993–2008. Our results indicate that fixed-price regulation increases cost elasticity and decreases cost asymmetry. Consistent with the tenets of institutional theory, the strength of response to regulation is stronger in for-profit hospitals, which have greater flexibility to make adjustments to their cost structures, compared to nonprofit or government hospitals. These results hold after controlling for economic and hospital-specific factors. Thus, economic as well as sociological aspects influence cost structure responses to regulatory changes. This article is protected by copyright. All rights reserved.
Article
This paper examines the impact of corporate governance on the level of voluntary disclosures of forward-looking statements in the narrative sections of annual reports. It also examines whether the forward-looking statements that are driven by governance are informative about future earnings. This analysis is drawn from a large-scale sample of UK FTSE All-Share companies for financial years ending within the period January 1996–December 2007. We find that corporate governance influences companies’ decisions to voluntarily disclose these statements. The main drivers are directors’ ownership, board size, board composition, and the duality of the CEO’s role. These results suggest that better corporate governance improves reporting practice. We further find that the forward-looking statements of well governed firms improve the stock market’s ability to anticipate future earnings. Our findings have important implications for policy makers and regulators because they confirm that the effectiveness of corporate governance in the practice of disclosure is a function of certain characteristics and that the voluntary forward-looking statements of well governed firms contain value relevant information for investors.
Article
Accounting-based stock price anomalies are often attributed to investors’ misconceptions concerning the persistence of earnings and in particular the differential persistence of earnings components. Also, empirical evidence suggests that the market reaction to an accounting variable depends not on its unconditional persistence (a variable’s autocorrelation coefficient), but on its conditional persistence (the power of a variable’s persistence to explain the persistence of a variable higher in the hierarchy). We argue that investors’ over-emphasis on a variable’s unconditional persistence, rather than on its conditional persistence, partially explains the three accounting-based stock price anomalies that we examine. We find that when the conditional persistence of operating profit margin (OPM) is relatively low, the post-earnings-announcement drift decreases substantially, and the post-revenue-announcement drift vanishes. Furthermore, the accrual anomaly is also related to the conditional persistence of accruals (the power of the persistence of the accrual component of earnings to explain the persistence of earnings); it largely disappears when the conditional persistence of accruals is relatively high. In addition, we find that the attributes of analysts’ forecasts are associated with the conditional persistence of both OPM and accruals. Overall, our findings suggest that the misperception of conditional persistence, rather than the misperception of unconditional persistence, is an important driver of accounting-based stock price anomalies.
Article
This paper reviews and proposes additional research concerning the textual analysis of corporate disclosures in large-sample settings. I first discuss the motivations and methodology issues for this research area. I then review the recent papers that explore corporate textual disclosures to test economic hypotheses. I also discuss the challenges facing this literature and propose some future research opportunities.
Article
This paper examines the information content of the forward-looking statements (FLS) in the Management Discussion and Analysis section (MD&A) of 10-K and 10-Q filings using a Naïve Bayesian machine learning algorithm. I find that firms with better current performance, lower accruals, smaller size, lower market-to-book ratio, less return volatility, lower MD&A Fog index, and longer history tend to have more positive FLSs. The average tone of the FLS is positively associated with future earnings even after controlling for other determinants of future performance. The results also show that, despite increased regulations aimed at strengthening MD&A disclosures, there is no systematic change in the information content of MD&As over time. In addition, the tone in MD&As seems to mitigate the mispricing of accruals. When managers “warn” about the future performance implications of accruals (i.e., the MD&A tone is positive (negative) when accruals are negative (positive)), accruals are not associated with future returns. The tone measures based on three commonly used dictionaries (Diction, General Inquirer, and the Linguistic Inquiry and Word Count) do not positively predict future performance. This result suggests that these dictionaries might not work well for analyzing corporate filings.
Article
Previous research uses negative word counts to measure the tone of a text. We show that word lists developed for other disciplines misclassify common words in financial text. In a large sample of 10-Ks during 1994 to 2008, almost three-fourths of the words identified as negative by the widely used Harvard Dictionary are words typically not considered negative in financial contexts. We develop an alternative negative word list, along with five other word lists, that better reflect tone in financial text. We link the word lists to 10-K filing returns, trading volume, return volatility, fraud, material weakness, and unexpected earnings.
Article
Assistant Professor of Finance, New York University. The author acknowledges the helpful suggestions and comments of Keith V. Smith, Edward F. Renshaw, Lawrence S. Ritter and the Journal' reviewer. The research was conducted while under a Regents Fellowship at the University of California, Los Angeles.
Article
This paper builds on the theory of irreversible choice under uncertainty to give an explanation of cyclical investment fluctuations. The key observation is that, when individual projects are irreversible, agents must make investment timing decisions that trade off the extra returns from early commitment against the benefits of increased information gained by waiting. In an environment in which the underlying stochastic structure is itself subject to random change, events whose long-run implications are uncertain can create an investment cycle by temporarily increasing the returns to waiting for information.
Article
The authors estimate the impact of price uncertainty on investment using a panel of U.S. manufacturing industries. Pooling the data for all industries, uncertainty has no impact on current investment. However, for industries that have low levels of seller concentration and, thus, are likely to be highly competitive, the estimated impact is negative and statistically significant, while for industries with high levels of seller concentration, the impact is always small and not significantly different from zero. The finding of a negative relationship between investment and price uncertainty in competitive industries is broadly consistent with models that incorporate irreversibility of capital investment. Copyright 1996 by Blackwell Publishing Ltd.
IPO first-day returns offer price revisions, volatility, and form S-1 language
  • T Loughran
Estimating standard errors in finance panel data sets: Comparing approaches
  • M Petersen
Information Environment and the Investment Decisions of Multinational Corporations
  • N Shroff
Mahlendorf. 2015a. Unraveling the black box of cost behavior: An empirical investigation of risk drivers, managerial resource procurement, and cost elasticity
  • M Holzhacker
Uncertainty, real options, and cost behavior: Evidence from Washington state hospitals
  • S Kallapur