Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
Relationship between Agency Problem and Cost Stickiness:
A Direct Test
Jeong-Ho, Koo* and Tae-Young, Paik**
Many research works have shown the downward stickiness of costs with
decreased sales. The cost stickiness could result from managers’ decisions
for their own interests, the agency problem. This study showed directly the
association between the agency problem and the cost stickiness whereas
the previous works did indirectly. It developed the estimation model for the
normal SG&A amounts based on the firm- and industry-specific
determinants. The abnormal (excess) SG&A amounts are taken as proxies
for agency problem. It was found that the bigger this measure of the agency
problem was, the stickier costs were. It was also shown that in the firms of
major corporate groups presumed with less serious agency problem due to
tight control systems, the association between agency costs and cost
stickiness diminished. The association got weaker in the firms with bigger
ownership shares of large shareholders and with hence stronger influence
of large shareholders, too.
I. Introduction
The earlier works have shown that the cost stickiness, the inelastic cost change with
the sales reduction is caused by the balancing of the resource adjusting costs and
the idle resource carrying costs. Other later studies indirectly documented that the
asymmetric cost behavior might result from the managers’ self-interest seeking, too.
We show directly the relationship between the managers’ opportunistic behavior and
the cost stickiness.
Managers of firms as agents of their owners are supposed to make decisions
maximizing their firm profits and values. Managers, however, might have incentives
to expand their operations too much for their own interests, reputation, and power. It
has been shown that these opportunistic behaviors got bigger with higher growth
rates and higher surplus cash flow of firms (Jensen and Meckling 1976; Jensen 1986,
1988; Rechardson 2006). Chen et al (2008) showed that costs got stickier as the
managers’ self-interests in empire-building or so were bigger. These results imply
that the agency problem causes cost stickiness.
The previous studies used as proxies for measures of agency problem, ownership
share of managements and the ratio of SG&A expenses on sales. The ownership
share of managements represents the degree of separation between owners and
management and hence is used as proxy for agency problem. Excessive SG&A
expenses might be caused by wasteful spending for management perquisites. SG&A
expenses consist of major discretionary expenditures of R&D, advertising, promotion,
training, and executive compensations. It is, however, not easy to judge the
excessiveness of the SG&A expenses without a proper benchmark.
*Assistant Professor. Jeong-Ho, Koo, Department of Business Administration, Kumoh National
Institute of Technology, Korea. Email : jhk2001@kumoh.ac.kr
** Professor, Tae-Young, Paik, Department of Business Administration, Sungkunkwan University,
Korea. Email : typaik@skku.edu.
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Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
We develop the benchmark to separate the normal amount and abnormal (excess)
amount of SG&A expenses for each sample. We then use the abnormal SG&A
amounts as a proxy for agency problem and show directly the association between
this proxy and cost stickiness. The normal SG&A amount of a firm may depend on its
firm-specific factors like sales, firm size, debt ratio, growth, and profitability. It is also
affected by industry-specific factors such as industry size, entry barrier, and degree
of competition.
This paper first shows that the abnormal SG&A expenses are positively related to the
cost stickiness measure of Homburg and Nasev(2008). It next shows that the
abnormal SG&A expenses in the firms of the big 30 company groups in Korea are
not positively related to these cost stickiness measures, implying that the cost
stickiness of those firms presumably with well designed monitoring systems does not
result from agency problem. It finally shows that the positive association between the
abnormal SG&A and the cost stickiness is stronger in firms with small ownership
shares of large shareholders than those of large shares. It implies that the cost
stickiness of firms with stronger influence of large shareholders is caused less by
agency problem. The main contribution of this paper is to derive as a proxy of
agency problem, the measure of abnormal SG&A expenses, controlling their firmand industry-specific determinants, and to show its positive association with direct
measures of cost stickiness.
The remainder of this paper is organized into five sections. Section II outlines the
prior research and our hypothesis. Section III describes our empirical design for
analysis. Section IV reports our results and Section V concludes with comments on
limitations.
II. Prior Research and Hypothesis
Recent research works point the agency problem as a cause of cost stickiness
(Anderson et al. 2003; Chen et al 2007; Jung 2007; Koo 2011a, 2011b). They said
that when firm sales go down, their managers do not actively cut their costs down for
their own interests, not for their firms’ interests. The pioneering paper in cost
stickiness, Anderson et al. (2003) stated without tests that 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 cost behavior. Chen et al. (2008) conjectured that
managers’ empire-building incentives contribute to the asymmetrical behavior of
SG&A costs. They showed that strong corporate governance mitigates asymmetric
SG&A cost adjustment. Jung(2007) examined the effect of large shareholders
ownership on the cost stickiness and found that the larger their ownership is, the
weaker the cost stickiness is.
Koo(2011b) found that firms reporting different levels of profits(losses) have different
incentive for earnings management and their incentives influence cost behaviors.
Firms reporting report small earnings and believed to have upward earnings
management incentives show relatively weaker cost stickiness. On the other hand,
costs reduction rates of firms reporting large profits were smaller when sales decline.
It implies that managers with large incomes do not cut costs enough in order to
smooth earning by reducing earning fluctuation with sales reduction. Finally, costs of
firms with relatively large losses are very sticky, implying that managers in large loss
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Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
firms are taking big-baths instead of saving costs for future performance.
This paper measures directly the agency problem with the abnormal SG&A
expenses while previous research works did not use direct measures of agency
problem. This work then shows the positive association between the direct measure
of agency costs and recently developed direct measures of cost stickiness. The
hypothesis to test is as follows:
Hypothesis: The bigger the agency problem is, the stickier the SG&A expenses are.
III.
Research Design
3.1 Proxy for Cost Stickiness
This paper uses the direct measures of cost stickiness in Weiss(2010) and Homburg
and Nasev(2008). In Anderson et al. (2003) and its expansion papers, firm level cost
stickiness could not be measured directly, limiting follow-up research. Weiss(2010)
came up with a firm level measure of cost stickiness and it is defined as an
estimated difference between the rate of cost decrease for recent quarters with
decreasing sales and the corresponding rate of cost increase for recent quarters with
increasing sales, STICKY :
……………….. (1)
–
where is the most recent of the last four quarters with a decrease in sales and is
the most recent of the last four quarters with an increase in sales, ΔSALEit =
SALEit − SALEi,t−1 and ΔCOSTit = COSTit − COSTi,t−1 .
STICKY is defined as the difference in the cost function slope between the two most
recent quarters from quarter t−3 through quarter t, such that sales decrease in one
quarter and increase in the other. If costs are sticky, meaning that they increase
more when activity rises than they decrease when activity falls by an equivalent
amount, then the proposed measure has a negative value. A lower value of STICKY
expresses more sticky cost behavior. That is, a negative (positive) value of STICKY
indicates that managers are less (more) inclined to respond to sales drops by
reducing costs than they are to increase costs when sales rise.
We define our first measure of cost stickiness STICKY1 = - STICKY to avoid the
confusion in the direction. Now bigger STICKY1 means stronger stickiness.
Following Anderson and Lanen(2007), those samples with the opposite directions of
changes in sales and costs are excluded.
Homburg and Nasev(2008) measure cost stickiness as the SG&A ratio increase
conditional on decreasing sales and increasing SG&A costs ratio on sales:
STICKY 2 it = ΔCostRatioit · DSaleit · DCostRatioit ……………….. (2)
where
ΔCostRatioit = [
𝑜𝑠
𝑎𝑙𝑒
]
[
𝑜𝑠
𝑎𝑙𝑒
3
]
−1
………………………… (3)
Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
DSaleit = 1
DCostRatio it = 1
if Saleit < Saleit-1 ,
if ΔCostRatioit > 0 ,
0 otherwise
0 otherwise
When sales go down, stickier costs go down much less than in proportion, making
STICKY 2 bigger. We use both STICKY 1 and 2 as proxies for cost stickiness at firm
level.
3.2
Proxy for Agency Problem
Prior works used the ratio of SG&A expenses on sales as a proxy for agency costs
since SG&A expenses have a large portion of discretionary expenditures which
might be over-spent due to agency costs (Singh and Davison III 2003). However,
SG&A expenses depend not only on sales and other firm-specific characteristics
such as firm size, growth rate, debt ratio, and profitability, but also on industryspecific ones such as industry size, degree of competition, and entry barrier (Choi
1994; Park and Paik 2006; Hong 2010; Bhagat and Welch 1995; Karuna 2007).
Based on prior works on SG&A determinants, we derive a model for the normal level
of SG&A expenses to compute the abnormal SG&A amounts as a proxy for agency
costs. First, sales in current and previous periods are primary firm-specific
determinants. Second, high debt ratio represents the financial pressure through high
interest expenses for SG&A saving. Third, growing firms might spend more SG&A
expenses to keep up with the growth rate. The growth rate of total assets is used.
Fourth, profitable firms are willing to spend more SG&A expenses for future benefits.
SG&A spending is expensed, not capitalized in conservative accounting. But we all
know discretionary expenditures like R&D, advertisements, and training costs
provide economic (not accounting) intangible assets for future. Return on assets is
used. Fifth, firm size is included for potential omitted variables.
The first industry-specific determinant to consider is market size. Firms with big
markets might spend SG&A more to capture a big pie of the market. On the other
hand, firms with big markets might spend less, believing they can achieve the target
sales without lots of SG&A expenses. Market size is measured by taking log on the
sum of all the firm sales in an industry. Second, higher competition may require high
SG&A spending. The degree of existing competition in industries is measured by the
number of firms in an industry (Bova and Pereira 2008). Firms with fewer than four
competing firms are excluded in the sample. Third, high entry barrier means low
potential competition in the future and leads to saved SG&A expenses. Degree of
entry barrier is measured by the average tangible assets size of firms in an industry
weighted with their sales (Karuma 2007).
The abnormal SG&A as a proxy for agency cost (AC) is the residual of the following
SG&A estimation model :
log(COST) it = a + b1 log(SALES)it + b2 log(SALES)it-1 + b3 log(SIZE) it + b4 ROA it
+ b5 LEV it + b6 GROWTH it + b7 MKSIZE it + b8 EB
+ b10YD + AC it
…………. (4)
4
it
+ b9 COMPTit
Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
where
COST it
: SG&A of firm i, year t
SALES it
: Sales of firm i, year t
SIZE it
ROA it
LEV it
: Beginning balance of Total Assets of firm i, year t
: Return of Assets of firm i, year t
: Total Liabilities / Total Assets of firm i, year t
GROWTH it : Growth rate of Total Assets of firm i, year t
MKSIZE it : Market Size, log (sum of firm sales in the industry) of firm i, year t
EB it
: Entry Barrier, weighted average of Tangible Assets in the industry of firm i, year t
COMPTit : Competition, the number of firms in the industry of firm i, year t
YD
: Year Dummy
3.3 Empirical Model and Sample
The model for association between agency cost and cost stickiness is as follows:
STICKY 1 (or 2)it = b0 + b1 AC it + b2 AST it + b3 PST it + b4 EST it + Ɛ it
---------(5)
where STICKY 1(or 2) it
: Cost Stickiness of firm i, year t
AC it : Agency Costs of firm i, year t
AST it
: Asset Intensity, log(Total Assets / Sales)
of firm i, year t
PST it
: Tangible Assets Intensity, log(Total Tangible Assets / Sales) of firm i, year t
EST it
: Employee Intensity, log(Number of employees / Sales) of firm i, year t
The dependent variable is either STICKY 1 developed in Weiss(2010) or STICKY 2
in Homburg and Nasev(2008). The control variables are intensities of total assets,
intangible assets, and employee against sales, which are found to be related to cost
stickiness in prior works.
The samples consist of publicly listed non-financial companies data from 2004 to
20071 satisfying the following requirements :
1)
SG&A expenses are less than sales
2)
Data are available in KIS VALUE II.
Total 1,170 firm-year data are used in this paper
1
Year 2004 is the earliest year with quarterly financial data and year 2007 is the last year before
the recent financial crisis.
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Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
IV.
Results
4.1 Descriptive Statistics
<Table 1> shows the descriptive statistics of main variables. The mean of AC is
0.025 and its median is 0.035. The mean and median of STICKY 1 are 0.265 and
0.304 respectively. The mean of STICKY 2 is 0.006. The large shareholders share is
on average 35% and has median of 34%.
<Table 2> reports the correlation coefficients of main variables. The agency costs
proxy AC has positive correlation with STICKY 2. Multicollinearity between variable
is not a problem having VIF(variance inflation factor) less than 10.
<Table 1> Descriptive Statistics
Variables
Mean
Std Deviation
Median
Min
Max
AC
0.025
0.474
0.035
-1.715
2.048
STICKY1
0.265
2.314
0.304
-8.829
13.392
STICKY2
0.006
0.046
0
0
1.048
log(SIZE)
26.243
1.385
26.002
23.118
31.411
LEV
0.447
0.199
0.457
0.02
1.407
GROWTH
0.098
0.393
0.054
-0.875
9.816
ROA
0.087
1.503
0.04
-4.626
49.495
35.306
18.455
33.87
0
100
AST
0.134
0.637
0.069
-2.285
5.405
PST
-1.226
1.081
-1.108
-7.427
4.468
EST
-20.071
0.919
-19.94
-25.759
-14.65
SALES
973,160,910
3,442,328,900
1,838,130,000
778,594
57,632,359,000
SG&A
104,810,911
459,971,323
219,884,000
344,461
9,239,745,000
Large
Shareholders(%)
<Table 2> Pearson Correlation Coefficients
AC
STICKY1 STICKY2
AST
STICKY1
0.01
STICKY2
0.108***
-0.005
AST
0.003
-0.054*
0.342***
PST
0.031
-0.005
0.130***
0.571***
EST
0.179***
0.026
0.212***
0.417***
6
PST
0.414***
Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
4.2 Test Results
4.2.1 Main Results
<Table 3> shows the results of SG&A estimation. As current and past sales, firm
size, growth rate, and industry competition are bigger, the SG&A expenses get
bigger as expected. As leverage and entry barrier are bigger, the SG&A expenses
get smaller as expected. The profitability measured by ROA was an insignificant
determinant. The market size showed negative influence on SG&A amounts.
<Table 3>
SG&A Estimation Results
Coeff.
t-value
Intercept
6.371***
13.69
Sales t
0.662***
13.01
Sales t-1
0.102**
2.13
SIZE
0.259***
8.89
LEV
-0.274***
-3.44
GROWTH
0.096***
2.95
ROA
-0.018
-0.82
MKSize
-0.218***
-13.59
EB
-0.106***
-3.84
Compt
0.01***
7.28
Adj. R2
0.757
**, *** Significant at the 5 percent and 1 percent levels, respectively.
<Table 4> shows the results on the association between the agency problem and
cost stickiness. AC has the positive relationship with STICKY 2, not with STICKY 1,
partly supporting H1.
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Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia, ISBN: 978-1-922069-64-1
<Table 4> Agency Problem and Cost Stickiness : full sample
STICKY 1(or 2)i,t = b0 + b1ACi,t + b2 ASTi,t + b3PSTi,t + b4ESTi,t + εi,t
STICKY1
STICKY2
coeff.
t-value
coeff.
t-value
Intercept
-2.743*
-1.62
0.086***
2.73
AC
-0.099
-0.68
0.010***
3.83
AST
-0.330**
-2.47
0.027***
11.04
PST
0.05
0.63
-0.005***
-3.67
EST
0.145**
1.7
0.004***
2.81
Adj. R2
0.036
0.141
N
1,170
1,170
*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively.
4.2.2 Additional Tests
Since the Asian financial crisis in 1990’s, major corporate groups in Korea like
Samsung and Hyundai Motors have improved their accounting transparency, internal
control systems, governance structures, hence mitigating agency problems.
Koo(2011a) showed that firms in major corporate groups have less severe cost
stickiness. To see the interactive effect of corporate groups on the cost stickiness,
we add a dummy variable, BSIZE for firm membership. BSIZE is 1 if the firm belongs
to the top 30 corporate groups announced by the Korea Fair Trade Commission and
0 otherwise.
<Table 5> shows that the positive association between the agency problem measure
AC and cost stickiness measure STICKY 2 disappears in the member firms of major
groups since the coefficients of AC and AC*BSIZE are the same (0.014) with the
opposite signs.
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Proceedings of 29th International Business Research Conference
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<Table 5> Agency Problem and Cost Stickiness: major corporate groups
STICKY 1(or 2)i,t = b0 + b1ACi,t + b2 AC*BSIZEi,t + b3 ASTi,t + b4PSTi,t + b5ESTi,t + εi,t
STICKY1
STICKY2
Coeff
t-value
Coeff
t-value
Intercept
2.653
1.56
0.079**
2.52
AC
-0.051
-0.3
0.014***
4.46
AC*BSIZE
-0.194
-0.58
-0.014**
-2.26
AST
-0.332**
-2.49
0.027***
11
PST
0.055
0.7
-0.005***
-3.38
EST
0.140*
1.64
0.004***
2.57
Adj. R2
0.024
0.144
N
1,170
1,170
*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively.
As the ownership share of large shareholders in a firm increases, they might
exercise stronger influence on their management, reducing agency problem in the
firm. To test this possibility, we separated the samples into the two groups of high
large shareholders’ ownership shares and low ones. <Table 6> and <Table 7> report
the regression results for the low and high share groups, respectively. The low share
group has the bigger significant coefficient for AC against STICKY 2 than the high
one, implying the controlling effect of large shareholders on agency problem.
<Table 6> Agency Problem and Cost Stickiness: low share group of large
shareholders
STICKY1
STICKY2
Coeff
Intercept
t-value
0.852
0.36
Coeff
0.165
t-value
***
2.87
**
2.03
AC
-0.071
-0.32
0.011
AST
-0.334*
-1.76
0.035***
7.55
PST
0.039
0.32
-0.009***
-3.18
0.41
***
2.97
EST
Adj. R
N
0.048
2
0.009
0.061
0.145
548
548
*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively.
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Proceedings of 29th International Business Research Conference
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<Table 7>
Agency Problem and Cost Stickiness: high share group of
large shareholders
STICKY1
STICKY2
Coeff
t-value
Coeff
t-value
Intercept
4.659*
1.91
0.014
0.53
AC
-0.116
-0.59
0.008***
3.83
AST
-0.330*
-1.74
0.020***
9.93
PST
0.042
0.4
-0.002*
-1.87
EST
0.243**
1.98
0.001
0.51
Adj. R2
0.024
0.187
N
622
622
*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively.
We could not find any significant result on STICKY 1, the measure in Weiss(2010)
above. Noticing firms reporting incomes close 0 have strong incentive for earnings
management, we used a dummy variable EM for firms with ROA (net incomes over
beginning total assets) between 0 and 0.01. To capture the strong effect of AC, we
used for test the subsample group with high agency problem, positive AC (excessive
SG&A). <Table 8> shows the test results on the association between the agency
problem and cost stickiness in this subgroup with EM included. Interestingly, AC has
the positive relationship with STICKY 1 in the firms with their incomes slightly greater
than 0 but the negative relationship in other firms.
<Table 8> Agency Problem and Cost Stickiness : excessive SG&A sample
STICKY 1(or 2)i,t = b0 + b1ACi,t + b2 AC*EMi,t + b3 ASTi,t + b4PSTi,t + b5ESTi,t + εi,t
STICKY1
STICKY2
Coeff
t-value
Coeff
t-value
Intercept
-0.439
-0.18
0.093
1.71
AC
-0.612**
-2.03
0.025***
3.64
AC*EM
1.731**
1.99
-0.016
-0.84
AST
-0.324
-1.73
0.046***
10.89
PST
-0.068
-0.59
-0.009***
-3.45
EST
-0.02
-0.16
0.005
1.98
2
Adj. R
0.09
0.205
N
620
620
*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively.
- EM: 1 if firms with ROA (net income over beginning total assets) between 0 and 0.01 and 0
otherwise
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Proceedings of 29th International Business Research Conference
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V. Conclusions
This study derived the benchmark to separate the normal amount and abnormal
(excess) amount of SG&A expenses for each sample. Using the abnormal SG&A
amounts as a proxy for agency problem, it showed directly the association between
this proxy and cost stickiness. The normal SG&A amounts of a firm are found to
depend on its firm-specific factors like sales, firm size, debt ratio, and growth. They
were also determined by industry-specific factors such as industry size, entry barrier,
and degree of competition.
It was first shown that the abnormal SG&A expenses are positively related to the
cost stickiness measure of Homburg and Nasev(2008), not to that of Weiss(2010). It
was next shown that the abnormal SG&A expenses in the firms of large corporate
groups are not positively related to the cost stickiness measure of Homburg and
Nasev(2008) and Weiss(2010). This implies that the cost stickiness of these firms
presumably with well designed monitoring systems does not result from agency
problem.
It was finally shown that the positive association between the abnormal SG&A and
the cost stickiness is stronger in firms with small ownership shares of large
shareholders than that of large shares. It implies that the cost stickiness of firms
under high influence of large shareholders is caused less by agency problem. The
main contribution of this paper is to derive as a proxy of agency problem, the
measure of abnormal SG&A expenses, controlling their firm- and industry-specific
determinants, and to show its positive association with direct measures of cost
stickiness.
There are several limitations in the paper. First, we could not find consistent results
with the two direct measures of cost stickiness in previous works. These two
measures do not seem to be correlated to each other. Second, the factors
determining SG&A expenses should be further analyzed to develop a better
estimation model. Third, the extended control variables for cost stickiness might be
needed for future studies.
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