Costs of operating with unutilized capacity or reduce

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Unformatted text preview: maintain committed resources and bear the costs of operating with unutilized capacity or reduce committed resources and incur the adjustment costs of retrenching and, if volume is restored, replacing committed resources at a later date. This suggests that stickiness would be stronger in circumstances where the assessed probability that a demand decline is permanent is lower or where the costs of adjusting committed resources are higher. We estimate an expanded version of the sticky costs model and find empirical support for these economic arguments. 2. Stickiness of SG&A Costs The traditional model of cost behavior relates costs to different levels of activity without considering how managerial intervention affects the resource-adjustment process. Managers make discrete changes to committed resources because some costs are lumpy; that is, committed resources cannot be added or subtracted in sufficiently small increments or quickly enough to match resource changes to small changes in demand. By itself, cost lumpiness may lead to excess or insufficient capacity but it does not lead to sticky costs. Sticky costs occur because there are asymmetric frictions in making resource adjustments—forces acting to restrain or slow the downward adjustment process more than the upward adjustment process. Firms must incur adjustment costs to remove committed resources and to replace those resources if demand is restored. Adjustment costs include such things as severance pay when employees are dismissed and search and training costs when new employees are hired. In addition to out-of-pocket costs, adjustment costs include organizational costs such as loss of morale among remaining employees when associates are terminated or erosion of human capital when work teams are disrupted. When demand increases, managers increase committed resources to the extent necessary to accommodate additional sales. When volume falls, however, some committed resources will not be utilized unless managers make the deliberate decision to remove them. Because demand is stochastic, managers must evaluate the likelihood that a drop in demand is temporary when deciding whether to adjust committed resources downward. Stickiness of SG&A costs occurs if managers decide to retain unutilized resources rather than incur adjustment costs when volume declines. Managers’ decisions to maintain unutilized resources may also be caused by personal considerations and result in a form of agency costs. Agency M. C. ANDERSON, R. D. BANKER, AND S. N. JANAKIRAMAN 50 costs are costs incurred by the firm because self-interested managers make decisions that maximize their personal utility but are not optimal from the perspective of the firm’s stockholders (Jensen and Meckling [1976]). Managers may retain unutilized resources to avoid personal consequences of retrenchment, such as loss of status when a division is downsized or the anguish of dismissing familiar employees, contributing to sticky co...
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