The Agency Problem, Corporate Governance, and the Asymmetrical Behavior of Selling, General, and Administrative Costs

Prior studies have documented the asymmetrical behavior of selling, general and administrative (SGamp;A) costs (i.e., SGamp;A costs increase more when activity rises than they decrease when activity falls), and have explained this phenomenon primarily with economic factors. Drawing on agency theory, we argue that SGamp;A cost asymmetry is driven not only by economic factors but also by the agency problem which causes a shift in SGamp;A cost asymmetry away from its optimal level. Using data for Samp;P 1500 firms over the period 1996ndash;2005, we find that the degree of SGamp;A cost asymmetry is positively associated with managers' empire building incentives due to the agency problem (measured by free cash flow and CEO horizon, tenure, and compensation structure), suggesting that the agency problem provides an additional explanation for SGamp;A cost asymmetry. Moreover, we find that strong corporate governance mitigates the positive association between the agency problem and the degree of SGamp;A cost asymmetry. In additional analyses, we also find that the agency problem influences cost stickiness to a greater extent in mature firms and in firms where SGamp;A costs create low future value