The Effect of Cost Stickiness on Firm Value by Considering the Resource Adjustment Cost and Agency Problem

Document Type : Research Paper

Authors

1 Ph.D.Candidate. Department of accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran

2 Prof. Department of accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran

3 Associate prof. Department of accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran

Abstract

Introduction

Costs are the main driver of company profitability and therefore company value. Therefore, it is important to understand how cost asymmetry affects firm value, since maximizing firm value is considered the primary objective of the firm. During a sales downturn, holding stagnant resources reduces the present value of sales and increases the opportunity cost of holding unused resources, thereby reducing the firm's profitability and negatively affecting firm value. Firms with higher cost stickiness will have lower profits because cost stickiness causes less inventory adjustment when sales decline. This further reduction in profit when activity levels decrease increases the variability of the profit distribution, resulting in lower profit forecasts. Firms with stickier costs have less analyst coverage, and investors rely less on the realized earnings of such firms due to their lower predictive power. Cost stickiness has been shown to increase credit risk. This increase in credit risk leads to an increase in costs and a decrease in profit, which leads to a decrease in the value of the company.
Two currents that increase the intensity of cost stickiness are resource adjustment costs and agency problems. When the demand decreases, the manager can adjust the company's resources according to the changes in the demand level, but this creates adjustment costs, such as the adjustment costs related to labor and equipment. In fact, companies are forced to bear adjustment costs in order to set aside resources and replace the same resources if the demand returns to the original situation. Adjustment costs include such things as compensation for laid-off employees and the costs of searching and training new employees. The authority of the management to determine the level of resources, when the demand decreases, is one of the factors of creating the stickiness of the costs related to these resources. The cost of resource adjustment affects the degree of cost stickiness.
The agency problem occurs due to the mismatch of interests between principals (shareholders) and agents (managers). One consequence of the agency problem is that managers who engage in empire-building activities over represent the firm by retaining unused resources in order to gain base, power, compensation, and prestige. For example, overinvestment in labor (over-hiring or under-firing) can result from managers' desire to engage in empire-building activities while retaining low-performing projects. According to previous literature on agency theory, unused resources are conserved because managers obtain monetary and non-monetary benefits from managing large and complex organizations and try to avoid difficult and time-consuming decisions about discarding unused resources.  Therefore, companies that have a specific agency problem have more opportunities to sell costs in operational costs such as administrative costs, which lead to cost stickiness and intensify the effect of it. Cost stickiness is one of the factors affecting the value of the firm, which can be caused by resource adjustment costs or agency problems, and this was the main motivation of this study.
 

Hypotheses

According to the theoretical foundations and objectives of the research, the hypotheses of the research are as follows:
H1: Cost stickiness has a negative effect on firm value.
H2: The resource adjustment cost increases the intensity of the cost stickiness effect on the firm's value.
H3: Agency problems increase the intensity of cost stickiness effect on firm value.
 

Method

The statistical population of this study are all companies listed in Tehran Stock Market, in which 102 companies in the period 2013 to 2022 have been selected by systematic elimination method. For data analysis and hypothesis testing, multivariate regression model based on compound data is used.
 

Result

The research results showed that cost stickiness has a negative effect on firm value. Also, the findings showed that when the resource adjustment cost is high, the effect of cost stickiness on the value of the firm increases. In addition, agency problems do not affect the relationship between costs and firm value.
 

Discussion and Conclusion

 This study, therefore, provides insight and understanding into how managers’ deliberate resource adjustment decisions affect overall financial health and firm value. Perhaps managers need to be more transparent about their resource adjustment decisions, so that investors can incorporate both resource adjustment costs and managerial expectations of future demand, when doing risk assessments related to their investment decisions.
 
Keywords: Firm Value, Cost Stickiness, Resource Adjustment Cost, Agency Problem.
 
 

Keywords

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History

  • Receive Date: 06 February 2023
  • Revise Date: 28 June 2023
  • Accept Date: 24 June 2023

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