Competition and slack: The role of tariffs on cost stickiness

Abstract

Abstract Slack exists when entities hold resources in excess of those required to support current operations. “Sticky” spending is a specific type of slack spending that occurs when a firm reduces spending by less when sales fall than it increases spending when sales rise by an equivalent amount. Changes in a firm's environment affect its propensity to engage in sticky spending. We examine how competition influences sticky spending, positing two hypotheses. First, we hypothesize that competition will be positively associated with firms' investment in sticky spending both for cost of goods manufactured (COGM) and selling, general, and administrative (SG&A). Second, we hypothesize that competition moderates the relation between sticky spending and firm performance. Utilizing variations of tariff rates as exogenous shocks to reflect competition, we measure sticky spending in the firm's COGM and SG&A spending. To empirically verify our hypotheses, we draw data from three different sources, industry‐level tariff data, Compustat, and the Hoberg–Phillips data library, for firms in the manufacturing sector from 1974 through 2017. Our regression analyses confirm that managers maintain more stickiness in spending as competition increases. The market's assessment of firm performance (as measured by Tobin's Q) is largely positively associated with sticky spending as competition increases. This expectation of higher performance is evidenced by immediate improvements in the firm's return on assets (ROA) when we consider COGM spending, but not when we consider SG&A spending.

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