Mustafa Ciftci

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.

Market Underestimation of the Implications of R&D Increases for Future Earnings: The US Evidence

This study shows that future abnormal returns to R&D increases are concentrated around subsequent earnings announcements. It further shows that market expectations, implied from stock prices, underestimate the future earnings benefits of increase in R&D. Finally, it documents that in their forecasts of future earnings, security analysts also underestimate the effect of increase in R&D spending. These results suggest that future abnormal returns following R&D increases are at least in part due to the market’s underestimation of the earnings benefits of R&D increases. The finding in this study contributes to the longstanding debate in accounting on whether the U.S GAAP requirement to expense R&D costs when incurred causes investors to underestimate the benefits of R&D.

Managerial Optimism, Prior Period Sales Changes, and Sticky Cost Behavior

The traditional view of cost accounting assumes that costs are solely driven by the magnitude of changes in the level of activity. However, Anderson, Banker and Janakiraman (2003) (hereafter ABJ), argue that since costs are a manifestation of managers’ deliberate decision-making, they are also affected by the direction of change in the activity. They show that costs decrease less when activity levels decline than they rise when activity levels increase, which they refer to as the ‘sticky’ behavior of costs. In this paper we explore the role of managers’ optimism in the theory describing managerial decisions regarding capacity of activity resources that lead to costs. We consider changes in SG&A costs to infer how managers make capacity decisions in response to sales changes witnessed in current and prior periods. We analyze signals, such as consecutive changes in the same direction, order backlogs and GDP growth, that managers may utilize in judging future demand uncertainty. When the signals point towards greater optimism about future demand, we predict and find that this accentuates cost changes in the upward direction and slows changes in the downward direction. Specifically, we find that the direction of the ABJ predictions is reversed when sales have declined in the prior periods.

Implications of Cost Behavior for Analysts’ Earnings Forecasts

Recent work in management accounting offers several novel insights into firms’ cost behavior. This study explores whether financial analysts appropriately incorporate information on two types of cost behavior in predicting earnings - cost variability and cost stickiness. Since analysts’ utilization of information is not directly observable, we model the process of earnings prediction to generate empirically testable hypotheses. The results indicate that analysts “converge to the average�? in recognizing both cost variability and cost stickiness, resulting in substantial and systematic earnings forecast errors. Particularly, we find a clear pattern - inappropriate incorporation of available information on cost behavior in earnings forecasts leads to larger errors in unfavorable scenarios than in favorable ones. Overall, enhancing analysts’ awareness of the expense side is likely to improve their earnings forecasts, mainly when sales turn to the worse.

Value Relevance of Accounting Information for Intangible-Intensive Industries and the Impact of Scale: The US Evidence

Abstract The structural shift in the USA from a tangible- to an intangible-intensive economy raises a concern that reporting based on generally accepted accounting principles (GAAP) might have lost its usefulness to investors. Amir and Lev [(1996) Value relevance of nonfinancial information: the wireless communications industry, Journal of Accounting and Economics, 22(1–3), pp. 3–30] argue that accounting information is not useful for intangible-intensive firms. In contrast, Collins et al. [(1997) Changes in the value relevance of earnings and book values over the past forty years, Journal of Accounting and Economics, 24(1), pp. 39–67] find that the value relevance (measured by R-squared) of accounting information has increased over time and that value relevance for intangible-intensive industries is as high as that for tangible-intensive industries. In this article, we attempt to resolve the above discrepancy by examining the impact of scale on R-squared (Brown, S., Lo, K. and Lys, T. (1999) Use of R2 in accounting research: measuring changes in value relevance over the last four decades, Journal of Accounting and Economics, 28(2), pp. 83–115). We find that, after controlling for scale, R-squared is lower for intangible-intensive industries than for non-intangible-intensive industries and has declined over time for intangible-intensive industries but remained stable for non-intangible-intensive industries. Interestingly, the declining trend ended with the demise of the ‘New Economy’ period (NEP) (Core, J. E., Guay, W. R. and Van Buskirk, A. (2003) Market valuations in the New Economy: an investigation of what has changed, Journal of Accounting and Economics, 34(2–3), pp. 43–67), and value relevance for both industry groups appears to be restored in the post-NEP to the pre-NEP level. We also find that R&D capitalisation increases value relevance for intangible-intensive industries, but does not completely eliminate the gap between the two groups.

What Explains the Valuation Difference between Intangible-intensive Profit and Loss Firms?

Prior research suggests that loss firms are valued based on their abandonment/adaptation option values, while profit firms are valued as going concerns. However, conservative accounting treatment of expensing of R&D leads many R&D�?intensive firms to report losses even though they are not in financial distress. In this paper we investigate the difference in valuation of profit and loss firms that invest in intangibles, either through internal development (R&D) or purchases. The accounting treatment for internally developed intangibles is conservative in that US GAAP requires immediate expensing. Yet, it allows recognition of purchased intangibles. We find that in valuation of firms with high recognized�?intangible assets, book value has more prominence in loss firms than profit firms, while that is not the case for firms with high R&D expenditures. This suggests that their abandonment/adaptation option explains the difference in valuation between profit and loss firms with high recognized�?intangibles, while conservative accounting explains the valuation difference between profit and loss firms with high R&D intensity. This result suggests that recognition of intangibles in financial statements might mitigate the conservative bias in accounting numbers.

Future Excess Returns to High R&D Firms and Firm Size

Prior research documented that high R&D intensity firms generate future positive excess returns. We explore the magnitude of future excess returns to small and large capitalization firms within the high R&D intensity group. Our inquiry is motivated by arguments in the innovation literature that technical and commercial uncertainty associated with R&D is larger for small than large R&D firms. Using data over the period 1975 to 2005, we find average excess returns over the three-year post portfolio formation period of 6.40% for the high R&D intensity portfolio. However, the excess returns are 7.15% and 3.15% for the small and large high R&D intensity firms, respectively. Small firms constitute only 8.57% of the total market value of the high R&D intensity portfolio, while large firms constitute 78.20%. Taken together, the results suggest that the large magnitude of future excess returns to small high R&D intensity firms do not imply large gains for investors. We also find that the spread in uncertainty (future profitability) between large and small firms within high R&D intensity firms is larger (smaller) than the spread in low and non-R&D firms, suggesting that uncertainty (future profitability) is disproportionately high (low) for small, high R&D firms. These results suggest that the larger magnitude of future excess returns to small, high R&D intensity firms are likely due to greater risk associated with them.