Capacity U tilization and SG&A Cost S tickiness

1. Capacity Utilization and SG&A Cost Stickiness Rajiv Banker (Temple University) Iny Hwang (Seoul National University) Hyunjin Oh (Temple University)

2. Deliberate Managerial Decisions Drive Costs  Magnitude of resource adjustment costs • Internal resources versus external acquisition (Anderson et al., JAR 2003) • Employee protection legislation (Banker, Bazalov and Chen, JAE 2013) • Core versus support services (Balakrishnan and Gruca, CAR 2008) • Upstream vs. Downstream Industries ~ This study • Prior Capacity Utilization - This study  Managerial expectations • “Prior Sales Changes” & “Growth Perspectives” (Banker, Byzalov, Ciftci, and Mashruwala, JMAR 2014) • “Prior Capacity Utilization” ~ This study ~ Interaction between sales signal and production signal  Managerial incentives • Empire building (Chen, Lu, and Sougianni, CAR 2012) • Earnings targets (Dierynck, Landsman, and Renders, TAR 2012) • Loan approval (Banker and Fang, 2013)

3. Research Question Two drivers of managers’ optimism about future sales Prior Sales Change Prior Capacity Utilization Information from the production side High utilization to optimism Low utilization to pessimism • Information from the revenue generation side • Sales increase to optimism • Sales decrease to pessimism Industry characteristic in supply chain Upstream Industry • Downstream Industry • Demand variability • Bullwhip effect • Outsourcing • Flexible cost structure

4. Sample Data • Korean manufacturing companies have to provide capacity utilization rates in their annual reports. • Korean manufacturing firm data for fiscal years 2002-2012 • 7,930 observations • Lagged Capacity Utilization Rates • Drivers of adjustment costs, managerial optimism and decision making in the current period. • Not proper to use current utilization rates due to endogeneityissues

5. Hypothesis 1. Capacity Utilization and Cost Behavior H1: SG&A costs are anti-sticky (sticky) when capacity utilization is slack (strained). • ABJ’s (2003) log-change model • Partition the sample into trisections (Slack / Normal / Strained capacity utilization) Anti-stickiness Stickiness 5

6. Robustness Check (Prior Period Sales Change) Results hold after controlling for prior sales changethat signals optimism Two period model in Banker, Byzalov, Ciftci, and Mashruwala (2014) • Capacity Utilization moderates the impact of sales change directions.

7. Hypothesis 2. Supply Chain Relationship H2: Stickiness of SG&A costs is higher in upstream industries than downstream industries after controlling for the effect of capacity utilization. • Higher demand variability in upstream than in downstream • More outsourcing opportunities available in upstream, therefore lower resource adjustment costs • Upstream vs. Downstream Industry Classification • Industry classification according to the input-output relationship • Kenessey [1987] : primary and the secondary industries of manufacturing sector • Categorize Fama-French 48 Industries into downstream and upstream industries. • E.g. [36] Chips: upstream, [35] Computers: downstream [19] Steel: upstream, [18] Construction: downstream

8. Test of H2. Downstream vs. Upstream Downstream Upstream Anti-stickiness Symmetry (Smaller) Stickiness Stickiness

9. Robustness Check (Prior Period Sales Change) BBCM model Downstream Upstream Anti-stickiness Symmetry Stickiness Stickiness

10. Conclusion This study • Examines the impact of interaction between the prior sales change and the capacity utilization on asymmetric cost behavior • Shows that the capacity utilization serves as a complementary signal for the manager’s expectation about resource adjustment cost • Shows that the stickiness of SG&A costs is lower in downstream industries than in upstream industries • Provides large-sample evidence on the role of capacity utilization in cost behavior