Cost Stickiness and Future Earnings Response Coefficient

Abstract

[Purpose] This paper examines whether sticky cost behavior reduces the information about future earnings reflected in current stock returns. Despite predicting cost behavior is essential part of earnings prediction (Weiss 2010), the effects of cost stickiness on the information environment are nearly unknown. Thus this study investigates whether the FERC which indicates the informativeness of realized earnings about future earnings varies with the degree of cost stickiness. [Methodology] This paper uses the approach of Collins et al. (1994) to measure the future earnings response coefficient and estimates firm－ and year－ specific cost stickiness following Via and Perego (2013). [Findings] Firms with greater cost stickiness have lower FERC and the negative effect of current sticky cost behavior on the FERC persist over at least future two－years of aggregation period of earnings. These findings indicate that sticky cost behavior reduces the information of two －year－ahead earnings reflected in current stock price. That is, this implies that investors do not view sticky cost behavior as the rational decision making of managers. Next, the negative relationship between cost stickiness and the FERC is more pronounced when firms’ asset intensity or employee intensity is low. These results support the main argument that sticky cost behavior exacerbates the informativeness of earnings because firms with low asset intensity or employee intensity bear relatively lower adjustment cost. [Implications] This study provides evidence on the effect of sticky cost behavior on the informativeness of accounting earnings.