IDEAS home Printed from https://ideas.repec.org/a/inm/ormnsc/v67y2021i3p1956-1974.html
   My bibliography  Save this article

How Economically Significant Are Unused Capacity Costs? A Large-Scale Empirical Analysis

Author

Listed:
  • Merle Ederhof

    (Graduate School of Business and School of Medicine, Stanford University, Stanford, California 94305)

  • Venky Nagar

    (Ross School of Business, University of Michigan, Ann Arbor, Michigan 48109)

  • Madhav Rajan

    (Booth School of Business, University of Chicago, Chicago, Illinois 60637)

Abstract

This study uses a confidential Census sample of 151,900 U.S. manufacturing plant-years from 1974 to 2011 to investigate the impact of excluding the cost of unused capacity from key financial indicators, namely, product costs and gross margins. We estimate the magnitude of unused capacity cost as a percentage of sales to be about 4.8%, which for Compustat manufacturing firms in 2011 amounts to $142 billion (by comparison, the well-researched topic of research and development expenses totals to $223 billion). We find that excluding the cost of unused capacity decreases product costs by approximately 6% and increases gross margins by around 26%. These magnitudes are economically significant and pervasive across industries and over time. Excluding the cost of unused capacity also smooths the time-series variation in unitized product costs and gross margins, with the standard deviation of gross margins declining (significantly) by 5%. Additional analyses indicate the presence of congestion and other costs at high capacity utilization levels, as predicted by the operations literature. This paper was accepted by Suraj Srinivasan, accounting.

Suggested Citation

  • Merle Ederhof & Venky Nagar & Madhav Rajan, 2021. "How Economically Significant Are Unused Capacity Costs? A Large-Scale Empirical Analysis," Management Science, INFORMS, vol. 67(3), pages 1956-1974, March.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:3:p:1956-1974
    DOI: 10.1287/mnsc.2019.3502
    as

    Download full text from publisher

    File URL: https://doi.org/10.1287/mnsc.2019.3502
    Download Restriction: no
    File URL: https://libkey.io/10.1287/mnsc.2019.3502?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Ian D. Gow & David F. Larcker & Peter C. Reiss, 2016. "Causal Inference in Accounting Research," Journal of Accounting Research, Wiley Blackwell, vol. 54(2), pages 477-523, May.
    2. Foster, George & Gupta, Mahendra, 1990. "Manufacturing overhead cost driver analysis," Journal of Accounting and Economics, Elsevier, vol. 12(1-3), pages 309-337, January.
    3. Manju Puri & Rebecca Zarutskie, 2012. "On the Life Cycle Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms," Journal of Finance, American Finance Association, vol. 67(6), pages 2247-2293, December.
    4. Lucia Foster & Cheryl Grim & John Haltiwanger, 2016. "Reallocation in the Great Recession: Cleansing or Not?," Journal of Labor Economics, University of Chicago Press, vol. 34(S1), pages 293-331.
    5. Gow, Ian D. & Larcker, David F. & Reiss, Peter C., 2016. "Causal Inference in Accounting Research," Research Papers 3393, Stanford University, Graduate School of Business.
    6. Banker, Rajiv D. & Datar, Srikant M. & Kekre, Sunder, 1988. "Relevant costs, congestion and stochasticity in production environments," Journal of Accounting and Economics, Elsevier, vol. 10(3), pages 171-197, July.
    7. Banker, Rajiv D. & Potter, Gordon & Schroeder, Roger G., 1995. "An empirical analysis of manufacturing overhead cost drivers," Journal of Accounting and Economics, Elsevier, vol. 19(1), pages 115-137, February.
    8. Banker, Rajiv D. & Byzalov, Dmitri & Chen, Lei (Tony), 2013. "Employment protection legislation, adjustment costs and cross-country differences in cost behavior," Journal of Accounting and Economics, Elsevier, vol. 55(1), pages 111-127.
    9. Alexander Brüggen & Ranjani Krishnan & Karen L Sedatole, 2011. "Drivers and Consequences of Short†Term Production Decisions: Evidence from the Auto Industry," Contemporary Accounting Research, John Wiley & Sons, vol. 28(1), pages 83-123, March.
    10. Lucia Foster & John Haltiwanger & Namsuk Kim, 2006. "Gross Job Flows for the U.S. Manufacturing Sector: Measurement from the Longitudinal Research Database," Working Papers 06-30, Center for Economic Studies, U.S. Census Bureau.
    11. Mark T. Bradshaw & Richard G. Sloan, 2002. "GAAP versus The Street: An Empirical Assessment of Two Alternative Definitions of Earnings," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 41-66, March.
    12. Core, John E. & Guay, Wayne R. & Verdi, Rodrigo, 2008. "Is accruals quality a priced risk factor?," Journal of Accounting and Economics, Elsevier, vol. 46(1), pages 2-22, September.
    13. Robert H Mcguckin & George A Pascoe, 1988. "The Longitudinal Research Database (LRD): Status And Research Possibilities," Working Papers 88-2, Center for Economic Studies, U.S. Census Bureau.
    14. Zimmerman, Jerold L., 2001. "Conjectures regarding empirical managerial accounting research," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 411-427, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Merle Ederhof & Venky Nagar & Madhav Rajan, 2017. "An Empirical Analysis of Capacity Costs," Working Papers 17-26, Center for Economic Studies, U.S. Census Bureau.
    2. Laurion, Henry, 2020. "Implications of Non-GAAP earnings for real activities and accounting choices," Journal of Accounting and Economics, Elsevier, vol. 70(1).
    3. William S. Lovejoy & Kannan Sethuraman, 2000. "Congestion and Complexity Costs in a Plant with Fixed Resources that Strives to Make Schedule," Manufacturing & Service Operations Management, INFORMS, vol. 2(3), pages 221-239, February.
    4. Max Schreder & Pawel Bilinski, 2022. "Information Quality and the Expected Rate of Return: A Structural Equation Modelling Approach," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 29(2), pages 139-170, June.
    5. Christian Leuz & Peter D. Wysocki, 2016. "The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research," Journal of Accounting Research, Wiley Blackwell, vol. 54(2), pages 525-622, May.
    6. Suman Banerjee & Saul Estrin & Sarmistha Pal, 2022. "Corporate disclosure, compliance and consequences: evidence from Russia," The European Journal of Finance, Taylor & Francis Journals, vol. 28(17), pages 1770-1802, November.
    7. Byzalov, Dmitri & Basu, Sudipta, 2024. "The misuse of regression-based x-Scores as dependent variables," Journal of Accounting and Economics, Elsevier, vol. 77(2).
    8. Thomas R. Dyckman & Stephen A. Zeff, 2019. "Important Issues in Statistical Testing and Recommended Improvements in Accounting Research," Econometrics, MDPI, vol. 7(2), pages 1-11, May.
    9. Li, Tongxia & Ang, Tze Chuan ‘Chewie’ & Lu, Chun, 2023. "Employment protection and the provision of trade credit," Journal of Banking & Finance, Elsevier, vol. 155(C).
    10. Huang, Minjie & Kubick, Thomas R. & Tseng, Kevin, 2021. "Technology spillovers and the duration of executive compensation," Journal of Banking & Finance, Elsevier, vol. 131(C).
    11. Eric Floyd & John A. List, 2016. "Using Field Experiments in Accounting and Finance," Journal of Accounting Research, Wiley Blackwell, vol. 54(2), pages 437-475, May.
    12. Diana Filipa Cruz Costa & Samuel Cruz Alves Pereira & Elísio Fernando Moreira Brandão, 2018. "Cost Behaviour – An Empirical Investigation For Euro Area Countries," FEP Working Papers 609, Universidade do Porto, Faculdade de Economia do Porto.
    13. Byard, Donal & Darrough, Masako & Suh, Jangwon, 2019. "There is No Evidence that Mandatory IFRS Adoption Significantly Decreased IPO Underpricing," SocArXiv b56u2, Center for Open Science.
    14. Anastasia A. Zakolyukina, 2018. "How Common Are Intentional GAAP Violations? Estimates from a Dynamic Model," Journal of Accounting Research, Wiley Blackwell, vol. 56(1), pages 5-44, March.
    15. Tobias Steindl, 2021. "Cultural rule orientation, legal institutions, and the credibility of corporate social responsibility reports," Corporate Social Responsibility and Environmental Management, John Wiley & Sons, vol. 28(1), pages 310-332, January.
    16. Asher Curtis & Valerie Li & Paige H. Patrick, 2021. "The use of adjusted earnings in performance evaluation," Review of Accounting Studies, Springer, vol. 26(4), pages 1290-1322, December.
    17. Ormazabal, Gaizka, 2018. "The Role of Stakeholders in Corporate Governance: A View from Accounting Research," CEPR Discussion Papers 12775, C.E.P.R. Discussion Papers.
    18. Olson, Adam J. & Yust, Christopher G. & Christensen, Brant E., 2023. "Are public health policies associated with corporate innovation? Evidence from U.S. nonsmoking laws," Research Policy, Elsevier, vol. 52(10).
    19. Hariom Manchiraju & Shivaram Rajgopal, 2017. "Does Corporate Social Responsibility (CSR) Create Shareholder Value? Evidence from the Indian Companies Act 2013," Journal of Accounting Research, Wiley Blackwell, vol. 55(5), pages 1257-1300, December.
    20. Wei Chen & Paul Hribar & Samuel Melessa, 2018. "Incorrect Inferences When Using Residuals as Dependent Variables," Journal of Accounting Research, Wiley Blackwell, vol. 56(3), pages 751-796, June.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:67:y:2021:i:3:p:1956-1974. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.