Persistent firm-level political risk and asymmetric cost adjustments

Abstract

This study explores how the intensity and duration of political risk persisting at the firm level affect managers' cost adjustment decisions. Prior studies that investigate managers' resource adjustment decisions document that managers respond to the current year's sales change in an asymmetric manner. Managers tend to hold on to slack resources (i.e., exhibiting cost stickiness) even when current sales decline if they anticipate sales decrease to be temporary with lower demand uncertainty in the future. Prior studies find that aggregate political risk affects resource allocation. By contrast, this study delineates how political risk at the firm level affects managers' decisions to retain or curtail slack resources in response to sales decline as influenced by the duration and intensity of such risk. We find that persistently high firm-level political risk is associated with higher-cost anti-stickiness (or lower-cost stickiness). Our cross-sectional tests demonstrate that the association between political risk and cost stickiness is further moderated by various managerial traits such as CEO's delta, managerial ability, and managerial overconfidence. We address the possible endogeneity issue by examining the exogenous shock to political risk due to the redistricting of U.S. Congressional districts. Our baseline results remain unchanged in several robustness tests, such as using an alternative measure developed from MD&A section of the annual report, adding more control variables, using quarterly data, using SG&A expenses in place of total operating costs as the dependent variable, and using a continuous measure of political risk in terms of risk dispersion.