Improving Predictions of Upward Cost Adjustment and Cost Asymmetry at the Firm-Year Level

ABSTRACT This study introduces a new method for predicting cost elasticity with respect to changes in sales that incorporates cost asymmetry at the firm-year level. The new method is based on widely available factors that are expected to influence cost behavior. The new method is subject to fewer data restrictions than the method proposed by Weiss (2010). By extending the cost variability and cost stickiness (CVCS) model of Banker and Chen (2006), we find that incorporating firm-year-specific proxy measures for upward cost adjustment and cost asymmetry significantly enhances earnings forecasts. However, this improvement in forecast accuracy is not reflected in contemporaneous stock returns, pointing toward a partial understanding of cost behavior by capital markets. We further find that predicted cost stickiness is associated with lower analysts' forecast accuracy and a weaker effect of earnings surprises on market reactions, confirming the results reported in Weiss (2010) for his measure of cost asymmetry. JEL Classifications: M41; G12.