The impact of cost stickiness on financial reporting: evidence from income smoothing

Abstract

This study investigates the impact of cost stickiness on income smoothing. Prior literature at the intersection between management and financial accounting has understood changes in cost behaviour as mere consequences of short‐term earnings management incentives. By considering income smoothing as the more complex earnings management strategy, we argue that resource adjustment strategies underlying cost behaviour might also have an impact on long‐term financial reporting choices. Specifically, asymmetric reactions of costs to sales changes should increase earnings volatility and thus restrict managers’ capabilities to report smooth income streams, which is supported by our empirical results. Additional tests reveal that cost stickiness primarily restricts opportunistic income smoothing and that the relationship depends on other factors such as the level of adjustment costs.

Inflationary Pressures Surrounding COVID – Are Price Increases Consistent With Changes in Costs

“…Costs are fundamental to accounting earnings (Hartlieb and Loy, 2022). Financial reporting decisions can potentially influence cost behavior and vice versa (Hartlieb and Loy, 2022).…”

“…Costs are fundamental to accounting earnings (Hartlieb and Loy, 2022). Financial reporting decisions can potentially influence cost behavior and vice versa (Hartlieb and Loy, 2022). A stream of literature identifies the asymmetric cost behavior termed "cost stickiness", i.e., costs decrease less when sales fall than when sales rise (Anderson et al, 2003;Kallapur and Eldenburg, 2005;Banker et al, 2011).…”

Cost stickiness and firm value

“…Similar to analysts, managers are also unable to incorporate cost stickiness in their forecasts, and this failure results in higher management earnings forecast errors (Ciftci & Salama, 2018). Hartlieb and Loy (2022) document that cost stickiness has a negative impact on garbling component of income smoothing.…”

Quality of audit and cost stickiness empirical evidence from emerging markets

“…Cost-sticky behavior reflects the operation competence of companies' assets (Gong et al, 2010). It also refers to decisions of managers that are taken deliberately to manage the organization's resources inappropriately due to decreased activity volume of a company (Venieris et al, 2015;Salehi et al, 2018;Hartlieb & Loy, 2022).…”