PHD, Kent State University, 2022, College of Business and Entrepreneurship, Ambassador Crawford / Department of Accounting
This dissertation consists of two essays on the impact of negative prospects on firm cost structures. It focuses on cost behavior for two reasons. First, cost structures, also known as operating leverage, play an important role in the level and the risk of a firm's profitability, and second, a firm's cost structure is largely determined by its managers' decisions and mirrors a vast range of operating decisions. The prospect theory argues that people may exhibit different behaviors on the same issue depending on whether these people frame the results as gains or losses. Specifically, based on prospect theory, people are risk-averse in the gain frame, preferring a sure gain to a speculative gamble, but are risk-seeking in the loss frame, tending to choose a risky gamble rather than a sure loss. It is important to investigate whether negative prospects can cause firms' risk-taking behavior because such risk-taking behaviors are usually value-destroying and associated with inferior subsequence performance. Given the evidence provided by the prospect theory literature, I conjecture and prove a controversial argument that when firms and their executives face negative prospects, these firms will adopt a rigid cost structure.
In this dissertation, I examine two examples of negative prospects. The first essay examines the association between earnings or demand downside risks and firms' cost behavior and argues that firms may adopt rigid cost structures when they face earnings or demand downside risks. Traditional wisdom believes that when firms face high risk, especially high downward risk, they should adopt a flexible cost structure. Konchitchki et al. (2016) estimate a firm's earnings downside risk by comparing the realized earnings with the expected ones. Following their method, this essay develops an estimate for demand downside risk and proves that it is associated with firms' subsequent demand as well as subsequent operating performance. According to the prospect the (open full item for complete abstract)
Committee: Shunlan Fang (Committee Co-Chair); Dandan Liu (Committee Member); Pervaiz Alam (Committee Co-Chair)
Subjects: Accounting