Rigidity of Selling, General, and Administrative Costs and Managerial Incentives to Meet Earnings Thresholds: Evidence from Conglomerates

Does the conventional wisdom of decreasing marginal cost in economics hold in the real world? Surprisingly, previous accounting literature has found opposite evidence and documented cost stickiness. This paper examines the effect of managerial incentives to avoid loss and earnings decrease on rigidity of selling, general, and administrative (SG&A) costs for conglomerates and parent companies, and the resultant implication for parent company¡¯s cost management decisions. The results show that the estimates of cost rigidity are negatively significant in the absence of managerial incentives to meet earnings thresholds for both parent company and conglomerate. In the presence of such managerial incentives for both parties, the estimates are significantly positive and indicate disappearance of cost rigidity. The results hold after controlling for asset intensity, employee intensity, ROA, and GDP growth. Additionally, parent company cuts its cost more aggressively to avoid either party¡¯s loss, but cuts conglomerate¡¯s cost more aggressively to avoid either party¡¯s decrease in earnings. This suggests that parent company is more concerned about its performance in cost management than for the conglomerate¡¯s. Overall, the evidence suggests that the decreasing marginal cost concept is conditional on managerial incentives to meet earnings thresholds and that parent company makes selective SG&A cost reduction decisions to meet earnings thresholds.