Expectation Accuracy, Cost Behavior, and Slippery Prices

Abstract

This study investigates the relation between the accuracy of managerial demand expectations and cost behavior. Based on a unique dataset of 4,107 firm-year observations from 737 companies in Denmark, this paper first shows that cost stickiness is substantially stronger for unforeseen negative demand shocks than for expected demand shocks, which is in line with the argument that adjustment costs are typically higher when the time horizon for making the adjustments is shorter. Second, we find empirical evidence that omitting selling price changes can mislead researchers’ inferences about resource adjustments and cost stickiness when sales are used as a proxy for activity level, which is a common practice in the existing literature. Finally, we show a moderating effect of managerial expectation accuracy on the relationship between demand volatility and cost elasticity. This helps reconciling the ongoing debate on whether companies increase or decrease cost elasticity in response to demand volatility.