The Effect of Sales Downside Risk on Cost Stickiness

Understanding the behavior of cost is essential in managing the company. This paper isabout managers’ cost decisions under uncertainty, specifically whether managersunderstand risk on sales and incorporate such risk into cost decisions. Following method ofcalculating earnings downside risk, I constructed a sales expectation model and measuredsales downside risk, and evaluated how managers react to sales downside risk. I find that:(1) under sales downside risk, managers have cost structure with lower fixed costs andhigher variable costs, resulting in less sticky cost behavior; (2) under sales overall risk,managers have cost structure with higher fixed costs and lower variable cost, resulting inmore sticky cost behavior; (3) managers care more about risk on sales than risk on earningswhen they make cost decisions; and (4) high-ability managers better understand such risksthan low-ability managers.