Dmitri Byzalov

The Moderating Effect of Prior Sales Changes on Asymmetric Cost Behavior

Recent research documents the empirical phenomenon of “sticky costs�? and attributes it to a theory of deliberate managerial decisions in the presence of adjustment costs. We refine this theoretical explanation and show that it gives rise to a more complex pattern of asymmetric cost behavior that combines two opposing processes: cost stickiness conditional on a prior sales increase and cost anti-stickiness conditional on a prior sales decrease. These predictions reflect the structure of optimal decisions with adjustment costs and the impact of prior sales changes on managers’ expectations about future sales changes. Empirical estimates for Compustat data support our hypotheses. We further verify our predictions using additional proxies for managers’ expectations, and show that our model offers important new insights.

The Risk Reduction Role of Advertising

This study shows theoretically and empirically that exposure to advertising increases consumers’ tendency to purchase the promoted product because the informative content of advertising resolves some of the uncertainty that the risk averse consumers face and thus reduces the risk associated with the product. We call this effect the “risk-reduction” role of advertising. The risk-reduction model implies that advertising effectiveness depends on (a) the risk preference parameter, (b) the precision of the advertising message, (c) the familiarity of the consumer with the product, (d) the consumer’s sensitivity to products’ attributes (and thus, her involvement level with the product), and (e) the diversity of products offered by multiproduct firms. These findings suggest that ads spending should be higher (a) for new and relatively unknown products, (b) for high-involvement products, (c) when ads can be quite precise, and (d) when the firm offers a diverse product-line. It also implies that ads should target consumers (a) who are more sensitive to risk, (b) who are more involved, and (c) those who are not familiar with the promoted product. The model allows ads to affect choices also through a direct effect on the utility (i.e., the standard approach to formulate the effect of advertising). In our empirical example (where the products are television shows) the risk-reduction effect is significant and strong and the direct effect is negligible behaviorally. We discuss the welfare implications of these findings, and illustrate the quantitative differences in managerial implications between our model and the traditional one. Copyright Springer Science+Business Media, Inc. 2004

R&D Intensity, Ability Indicators, and Executive Compensation

We examine the relation between R&D intensity and the weights on ability indicators and financial performance measures in CEO compensation. The CEO’s technology-related ability is likely more important in R&D intensive firms. Therefore, we predict that these firms place higher weights on indicators of technology-related ability, using the compensation contract as a screening device to mitigate the adverse selection problem. Both accounting and market performance measures are likely noisier in R&D intensive firms. Therefore, we predict that these firms rely less on short-term incentives tied to concurrent earnings and stock returns and rely more on long-term equity incentives. We test these predictions using hand-collected data on the education and professional background of the CEOs in Execucomp during 1992-2006. The results support our predictions and are robust. While prior research examined performance compensation in the context of moral hazard, our findings suggest that compensation based on ability indicators plays a screening role in the context of adverse selection.

Production Outsourcing and Demand Variability

We examine the relation between demand uncertainty and firms’ production outsourcing decisions. Contrary to the traditional view on make-or-buy decisions discussed in management accounting textbooks, we predict that demand uncertainty has a negative impact on outsourcing by a manufacturer from a supplier. Research in operations management suggests that outsourcing can increase the production lead time and can result in excessive production variability due to lack of incentive alignment between the manufacturer and the supplier. These adverse effects increase the production costs to a greater extent when the demand is more variable, leading to a negative relation between demand uncertainty and outsourcing. We test this prediction using a large sample of manufacturing firms in Turkey. As predicted, we find that when firms face more variable demand, they outsource a smaller proportion of their manufacturing costs on average, and are less likely to engage in outsourcing. The results are significant both statistically and economically and are robust to alternative specifications.