Labor Unemployment Risk and Sticky Cost Behavior

Abstract

This paper presents large-sample evidence that firms consider labor unemployment risk when setting their resource adjustment policies. Prior studies find that costs rise more in response to sales increases than they fall in response to sales decreases. Anderson, Banker, and Janakiraman (2003) term this phenomenon “cost stickiness” and attribute it to managers’ deliberate adjustment to committed resources in the existence of adjustment costs. We argue that workers’ unemployment costs constitute non-trivial costs of downsizing labor forces in particular and adjusting resources downward in general. To the extent that state unemployment insurance benefits offset the costs borne by involuntarily displaced workers, the generosity of unemployment insurance can inversely capture the heterogeneous levels of workers’ unemployment costs and in turn firms’ downward adjustment costs. We predict and find that more generous unemployment insurance benefits lead to lower stickiness of selling, general, and administrative (SG&A) costs. This finding is robust to controlling for firm-level determinants of cost stickiness, state-wide economic conditions, and unobservable time-invariant state characteristics. Additional analysis shows that the results for SG&A costs are also applicable to other cost accounts. Overall, our study enriches the understanding of sticky cost behavior and takes an early step to examine the accounting implications of labor unemployment risk.

Keywords: unemployment risk, sticky costs, unemployment insurance, resource adjustment, adjustment costs

JEL Classification: J65, M41