Demand Change Predictability and Cost Structure

Abstract

　Management and cost accounting textbooks explain that adopting higher operating leverage（i.e., cost structure with higher fixed costs） increases firm risk in that profits become more volatile. Consistent with these explanations, there is a traditional view that firms facing higher demand uncertainty prefer a more variable cost structure with lower fixed and higher variable costs. However, some recent empirical studies argue that such firms choose a more rigid cost structure with higher fixed and lower variable costs. Thus, there are two conflicting views on how demand uncertainty affects a firm's cost structure. Therefore, we investigate empirically the relationship between demand forecasts by managements and a firm's cost structure. The results show that firms with higher volatility in demand forecasts adopt a more variable cost structure, and that firms with lower predictability of demand change adopt a more rigid cost structure.