Abstract

This paper investigates whether managers’ incentive to avoid losses affects labor cost behavior. CEOs have incentive to avoid losses since CEOs reporting losses are penalized in various ways and thus CEOs attempt to manage earnings to meet or beat zero earnings. Meanwhile, Labor costs are one of the most important earnings management tool since labor costs, to a great extent, account for firms’ total costs and managers have discretion over labor costs. Small－profit of firms is ex post proxy of earnings manipulation and indicates managers’ incentive to avoid losses. Thus, we expect that labor costs of small－profit firms demonstrate less－sticky or anti－sticky behavior of labor costs. Using Korean stock－exchange listed firms, we find a strong evidence of small－profit firms showing anti－stickiness behavior in labor costs. In addition, we relate labor cost’s anti－sticky behavior of small－profit firms with CEO characteristics. Incurring labor costs is an investment in human resources, which affect firm performance in the long－run. Able CEOs likely understand the value of labor investment well relative to less able CEOs. Hence, we expect that able CEOs do not use labor costs as a mechanism to avoid reporting losses. Empirical results support our prediction, showing that small－profit firms show anti－sticky behavior of labor costs only when CEOs have low ability. In addition, young CEOs have greater career concerns than old CEOs since they have longer career horizon left and the initial perception or reputation about their ability in the labor market affects their future compensation and job retention. Thus, young CEOs have greater cost－saving incentive to meet or beat the zero benchmark. Consistent with our career concern story, anti－sticky labor cost behavior of small－profit firms is pronounced only in young CEO firms. Overall, our study provides evidence that managers’ incentive to manipulate earnings affects labor cost behavior. In addition, we find that given CEOs’ significant role in making decision, CEO characteristics matter in the relation between cost－saving incentives and labor cost behavior.

Keywords

• Small－profit firm
• asymmetric cost behavior
• labor cost
• CEO ability
• CEO age

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