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Asymmetric cost behaviour and earnings quality in the European context

Asymmetric cost behaviour and earnings quality in the European context

Preprint · November 2020

DOI: 10.13140/RG.2.2.25187.37922

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 Asymmetric cost behaviour and earnings quality
in the European context

Apostolos Ballas,
Athens University of Economics and Business,
Department of Accounting and Finance

Dimosthenis Hevas,
Athens University of Economics and Business,
Department of Accounting and Finance

Nikolaos Karampinis,
Athens University of Economics and Business,
Department of Accounting and Finance

Orestes Vlismas,
Athens University of Economics and Business,
Department of Accounting and Finance

Corresponding author: Apostolos Ballas, Department of Accounting & Finance, 2, Troias Str., BAVAL
Laboratory, GR-11362 Athens. Greece. Tel: +30 210 82 03 463, e-mail: aballas@aueb.gr

Funding: The authors gratefully acknowledge funding by the H.F.R.I (Hellenic Foundation for
Research & Innovation)

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 Asymmetric cost behaviour and earnings quality
in the European context

Abstract
This study investigates the relationship of asymmetric cost behaviour with earnings quality for European
listed firms. We employ a sample that consists of 11,416 firm-year observations of European listed firms
over the period 2005-2019 to explore the relationship of asymmetric cost behaviour with (i) the
managerial incentives to meet earnings targets, (ii) conditional conservatism, (iii) the level of operating
accruals, and (iv) earnings smoothing. Our empirical evidence indicates that the presence of managerial
incentives to meet earnings targets decreases the intensity of SG&A cost stickiness. We also document
that asymmetric timeliness estimates in the conditional conservatism estimation models have an upward
bias unless these models do not control for asymmetric cost behaviour. Finally, it seems that the levels
of operating accruals and earnings smoothing are more sensitive to sales decreases than sales increases.

Key words: Asymmetric Cost behaviour, Earnings Quality, Conditional Conservatism,

Earnings Smoothing, Operating Accruals

JEL Classification: L10, M10, M41

Data availability: Data are publicly available

1. Introduction
This study attempts to expand our knowledge to a relatively unexplored area of earnings management
literature, that is, the extent that the accounting information reflects the qualities of real economic
performance (Dechow, Weili, & Schrand, 2010). We focus on asymmetric cost behaviour phenomenon
and we examine its relationship with various instances of earnings quality. Asymmetric cost behaviour
phenomenon is attributed to managerial resource allocation decisions which are made with
The available empirical evidence for the relation of asymmetric cost behaviour and earnings
quality is limited within the context of US listed firms. We intend to examine the relationship of
asymmetric cost behaviour with various instances of earnings quality for European listed firms (i.e.,
EU27 and the United Kingdom). More specifically, we seek for additional empirical evidence from the
European listed firms to validate prior empirical evidence from US listed firms for (i) the effects of
managerial incentives to meet earnings targets on cost stickiness, and (ii) the effects of cost asymmetry
on conditional conservatism (e.g., Kama, & Weis, 2013; Banker, Basuk, Byzalov, & Chen, 2016). We,
also, examine the relation of cost asymmetry with the level of operating accruals and earnings
persistence.

2
 We employ a sample that consists of 11,416 firm-year observations of European listed firms
over the period 2005–2019. We documented that in the case of European listed firms the SG&A expenses
(i) exhibit asymmetric cost behaviour, and (ii) when managerial incentives to meet earnings targets are
present, the intensity of asymmetric cost behaviour of SG&A expenses decreases significantly. This is
consistent with similar empirical evidence provided by Kama and Weiss (2013) in the case of US listed
firms. We conclude that the negative relationship of cost stickiness with managerial incentives to meet
earnings targets is caused by the fact that (a) the managerial pressure on reporting missing earnings
targets is more intense if it is accompanied with sales declines (Graham, Harvey, & Rajgopal, 2005),
and (b) firms reporting small earnings are more likely to have experienced losses in the prior year and
to have already reduced the amount of slack resources in the prior year (Kama, & Weiss, 2013).
Conditional conservatism implies a more timely (asymmetric timeliness) recognition of
contemporaneous economic losses than economic gains in accounting earnings. The primary measure
of asymmetric timeliness is a regression analysis of earnings on stock returns with different slopes for
positive and negative returns (Basu, 1997). Banker et al. (2016) provide evidence that, in the case of
listed US firms, there is an average bias in conservatism estimates in the Basu (1997) model, of more
than 25% due to the confounding effect of cost stickiness on earnings behaviour. This issue raises a
significant question about whether and how much there is a bias in the conservatism estimated outside
the US stock market. We confirm that, in the case of European listed firms, asymmetric timeliness
estimates in the conditional conservatism estimation models have an upward bias unless these models
do not control for asymmetric cost behaviour. In addition, it seems that the primary determinants of the
intensity of cost asymmetry, that is, asset intensity, employee intensity and free cash flows, cause
variations in the asymmetric cost-driven behavior of earnings.
Existing econometric approaches that estimate the normal level of accruals ignore that earnings
respond more to sales decreases than to sale increases, as cost asymmetry suggests. However, we expect
that the accrual component of earnings exhibits asymmetric behaviour. This should be considered during
the estimation of the normal level of accruals to avoid an omitted variable problem. Our empirical
evidence documents that (i) the firm-years with sales declines reduce the level of operating accruals,
and (ii) the response of operating accruals is more sensitive to downsizing demand realizations than to
sale increases.
Earning smoothness is assumed to improve decision usefulness because the accrual based
reported earnings smooth random fluctuations in the timing of cash flows (Dechow et al., 2010).
Earnings smoothness can result from variations in (i) the smoothness of real economic performance,
(ii)the accrual-based information system to report unbiased information, and (iii)accounting choices and
distortions. Especially during time periods of increased sales revenues volatility, the presence of cost
asymmetry might increase the volatility of accrual-based calculated earnings, reduce their smoothness
and informativeness. Our study empirically documents that the presence of asymmetric cost
phenomenon affects earnings smoothing because the level of earnings smoothing decreases as the level

3
of cost asymmetry increases and earnings smoothing is more sensitive to sale decreases than to sale
increases.
The rest of the paper is organized as follows. First, we present the theoretical background and
the research hypotheses of the study. Next, we illustrate the data selection process and the econometric
specifications. Finally, we exhibit the empirical results of our study and conclude.

2. Theory and hypotheses development

Asymmetric cost behaviour is an economic phenomenon concerning the variable costs and the observed
differences in their behavior between increases or decreases in the level of a firm’s operating activity
(Anderson, Banker, & Janakiraman, 2003; Weiss, 2010; Chen, Lu, & Sougiannis, 2012). The
mainstream cost analysis classifies costs as either fixed or variable considering the observed changes in
their total level as the level of operating activity changes. A main assumption is that variable costs
exhibit a mechanistic and symmetric behaviour for both increases and decreases observed in the level
of operating activity.
In stark contrast to the traditional textbook analysis, a growing number of empirical studies
document the presence of the asymmetric cost behaviour for various variable costs which are further
classified as sticky (or anti-sticky) (Anderson, Banker, & Janakiraman, 2003; Balakrishnan, & Gruca,
2008; Chen, Lu, & Sougiannis, 2012; Banker, & Byzalov, 2014). A variable cost is characterized as
sticky (anti-sticky) if its increase (in absolute terms) associated with an increase in the level of economic
activity, is higher (lower) than its decrease (in absolute terms) associated with an equivalent decrease in
the level of economic activity. Asymmetric cost behaviour is attributed to deliberate short run
managerial resource commitment decisions to maintain utilized capacity when the level of operating
activities declines (Balakrishnan, Labro, & Soderstrom, 2014; Banker, & Byzalov, 2014). Prior
empirical studies provide insights that the intensity and the direction of the asymmetric cost behaviour
are associated with a wide range of factors, such as the level of adjustment costs (Banker, Byzalov, &
Chen, 2013; Calleja, Steliaros, & Thomas, 2006), managerial expectations for future sales
(Balakrishnan, Peterson, & Soderstrom, 2004;), the presence of empire building behaviour (Chen, Lu,
& Sougiannis, 2012), the intensity of intangible investments (Venieris, Naoum, & Vlismas, 2015), and
strategic orientation (Ballas, Naoum, & Vlismas, 2020).
Asymmetric cost behaviour is associated with the level of earnings quality. Earnings quality
refers to the ability of a firm’s accounting system to measure and report earnings that are informative
about a firm’s real operating performance with reference to a specific decision-making model (Dechow,
Weili, & Schrand, 2010). This definition implies that earnings quality is a function of (i) the decision-
making model that utilizes the accounting information concerning earnings quality, (ii) the extent that
such information reflects the qualities of the real economic performance, and (iii) the efficiency of a
firm’s accounting system to provide unbiased and free-of-errors accounting information. Since the

4
asymmetric cost behaviour is a significant attribute of a firm’s real economic performance, it should be
a critical parameter of any decision-making model.
Asymmetric cost behaviour is a significant factor of real economic performance that it seems to
be related with the level of earnings quality. Exploring the relation of cost asymmetry with earnings
quality will expand our understanding towards relatively unexplored areas of the field earnings quality.
Dechow et al. (2010) argues that earnings management literature focuses on how the earnings quality
will be affected by the efficiency of a firm’s accounting system to provide reliable information without
errors and bias (i.e. emphasis on the measurement issue) leaving relatively unexplored to what extent
the accounting information reflects the qualities of the real economic performance (i.e. emphasis of the
performance issue). In addition, the available empirical evidence for the relation of asymmetric cost
behaviour and earnings quality is limited within the context of US listed firms (e.g., Kama, & Weis,
2013; Banker, Basuk, Byzalov, & Chen, 2016). We intend to examine the relation of asymmetric cost
behaviour with various instances of earnings quality within the European context (i.e., EU27 and the
United Kingdom).
Kama and Weiss (2013) provide evidence that managerial incentives to meet earnings targets
affect resource allocation decisions and cost behaviour. If managers face incentives to avoid losses or
earning decreases, they attempt to reduce the level of idle capacity when their firms experience sales
declines and, thus, the intensity of cost stickiness decreases. The negative relationship of incentives to
meet earnings losses or decreases with cost stickiness is rationalized on the basis that (i) the managerial
pressure on reporting missing earnings targets is more intense if it is accompanied with sales declines
(Graham, Harvey, & Rajgopal, 2005), and (b) firms reporting small earnings are more likely to have
experienced losses in the prior year and to have already reduced the amount of slack resources in the
prior year (Kama, & Weiss, 2013). A plausible assumption is that similar behavioural factors drive the
managerial resource allocation decisions of European firms. We will attempt to confirm this assumption
by testing the following hypothesis:
H1: In the case of European firms and when sales decline, managers reduce costs more aggressively
in the presence of incentives to meet earnings targets than in their absence.
Conditional conservatism implies a more timely (asymmetric timeliness) recognition of bad
news than good news in accounting earnings and the primary measure of asymmetric timeliness is a
regression analysis of earnings on stock returns with different slopes for positive and negative returns
(Basu, 1997). Conditional conservatism is verified when the slope for negative returns is positive and
significant (Basu, 1997). Banker, Basu, Byzalov and Chen (2016) argue that the mainstream
econometric modelling for the empirical investigation of asymmetric timeless should consider the
presence of asymmetric cost behaviour to ensure accurate inferences. Earnings respond more to sales
decreases than to sales increases due to cost asymmetry. Therefore, the asymmetric timeliness models
should incorporate asymmetric cost behaviour to avoid an omitted variable problem. Unless the effect

5
of cost stickiness on earnings behaviour is not controlled, the conditional conservatism effects on
earnings appear to be biased upward.
Banker et al. (2016) provide evidence that in the case of listed US firms, there is an average bias
in conservatism estimates, in the Basu (1997) model, of more than 25% due to the confounding effect
of cost stickiness on earnings behaviour. Further, the effects of asymmetric timeless on earnings
behaviour is distinct from the effects of cost stickiness on earnings. This issue raises a significant
question about whether and how much there is a bias in the conservatism estimated outside the US stock
market. Asymmetric cost behaviour has been confirmed in country-specific studies besides the US
setting (e.g., He, Teruya, & Shimizu, 2010; Calleja, Steliaros, Thomas, 2006). Thus, one might expect
that the confounding effect of cost stickiness on conditional conservatism estimates is also present in
the European capital markets. Therefore, the second testable hypothesis is the following:
H2: In the case of European firms, asymmetric timeliness estimates in the conditional conservatism
estimation models have an upward bias unless these models do not control for asymmetric cost
behaviour.
Discretionary accruals have been a central topic within the context of empirical inquiry for
earnings quality because they are perceived as a induced by the application of the accounting rules or
earnings management initiatives (Dechow et al., 2010). The calculation of discretionary accruals is
based on accrual models that estimate the normal level of accrual based on the level or real economic
performance. Jones (1991) proposes a model for accrual process that the level of accruals is function of
sales growth and the level of plant, property, and equipment. Dechow, Sloan and Sweeney (1996)
modifies Jones model to adjust for growth in credit sales, Kaznik (1999) for growth in cash flows from
operations, and Kothari, Leone and Wesley (2005) suggest to control for the level of operating
performance (i.e., return on assets).
However, extant empirical models estimate the normal level of accruals under the assumption
that the cost behaviour is symmetric. This indicates that accruals respond symmetrically to sales changes
regardless the direction of sales growth. Ignoring the presence of asymmetric cost behaviour indicates
that standard econometric approaches for measuring discretionary accruals ignore that earnings respond
more to sales decreases than to sales increases due to cost asymmetry. We expect that the accrual
component of earnings may exhibit asymmetric behaviour which should be considered during the
estimation of the normal level of accruals to avoid omitted variable problem. To examine to what extent
the asymmetric responses of the accrual component of earnings due to the presence of cost asymmetry
affects the estimation of discretionary accruals, we test the following hypothesis:
H3: In the case of European firms, asymmetric cost behaviour affects the level of discretionary
accruals.
Earning smoothness is a desired outcome of the accrual-based accounting that it is assumed to
improve decision usefulness because the accrual based reported earnings smooth random fluctuations
in the timing of cash flows (Dechow et al., 2010). Yet, it is rather complicated to access smoothness as

6
a proxy of earnings quality because variation in earnings smoothness can result from variations (i) in
the smoothness of real economic performance, (ii) in the accrual-based information system to report
unbiased information, and (iii) in accounting choices and distortions.
Asymmetric cost behaviour is a source of variation in the smoothness of earnings quality.
Especially during time periods of increased sales revenues volatility, the presence of cost asymmetry
might increase the volatility of accrual-based calculated earnings, reduce their smoothness and
informativeness. For instance, Banker and Chen (2006) document that earnings are more sensitive to
sales decreases than sales increases when costs are sticky. Thus, during time periods of alternating sales
increases and sale decreases, a firm’s earnings is high volatile reducing the smoothness of earnings.
Thus, our fourth testable hypothesis concerns earnings smoothness:
H4: During time periods of high sales volatility, asymmetric cost behaviour reduces the smoothing
of earnings.

3. Data and models

3.1. Data
The data selection process is summarized in Panel A of Table 1. We obtain a Thomson Reuters
Datastream annual data sample of Eurozone listed firms from 2005 to 2019. We, also, include UK listed
firms to enrich our data sample with firms that operate in a large economy under a common law
jurisdiction regime to capture the variability of intensity of cost asymmetry between common and code
law countries (Calleja et al., 2006).
We exclude financial firms (SIC codes 6000-6999) and firm-year observations with missing or
invalid data. Following the standard data elimination methodology of the asymmetric cost behaviour
literature (Anderson, & Lanen, 2009; Chen et al., 2012), we discard the firm-year observations where
(i) the annual change of sales revenues exceeds 50% in absolute terms to eliminate either large
acquisitions or large divestitures, (ii) the annual change of sales revenues and the annual change of the
primary cost variable (SG&A expenses or cost of goods sold) have opposite direction, and (iii) the level
of primary cost variable (SG&A expenses or cost of goods sold) exceeds the level of sales revenues. All
continuous variables are winsorized at the top and bottom 1%.
- Insert Table 1 -

3.2. Asymmetric cost behaviour and managerial incentives to meet earnings targets
Initially, we test the hypothesis H1 which states that when sales revenues decline, managers reduce costs
more aggressively in the presence of incentives to meet earnings targets than in their absence. We apply
the extended model for the asymmetric cost behaviour reviewed by Banker and Byzalov (2014)
expanded in two ways. First, we include interactions of observable determinants of cost asymmetry with
both sales increases and decreases. Second, following the approach proposed by Kama and Weiss

7
(2013), amongst the observable determinants of cost asymmetry a variable, that signifies the firm-years
associated with more intense managerial incentives to meet earnings targets, is included. Thus, the
following econometric specification of Eq. (1a) is estimated:
j j j j j j j
log(SGAi,t ⁄SGAi,t−1 ) = a0 + a1 SUC_DSi,t + a2 L_INT_TASi,t + a3 L_INT_EMPi,t + a4 GDPi,t + a5 FCFSHi,t +
j j j j j j
a6 TARGETi,t + {b1 + b2 SUC_DSi,t + b3 L_INT_TASi,t + b4 L_INT_EMPi,t + b5 GDPi,t + b6 FCFSHi,t +
j j j j j j j Eq. (1a)
b7 TARGETi,t }log(Si,t ⁄Si,t−1 ) + {c1 + c2 SUC_DSi,t + c3 L_INT_TASi,t + c4 L_INT_EMPi,t + c5 GDPi,t +
j j j j j j
c6 FCFSHi,t + c7 TARGETi,t }DSi,t log(Si,t ⁄Si,t−1 )+ ei,t

The primary variables of the econometric specification of Eq. (1a) are the annual log change of
either selling, general and administrative expenses (S𝐺𝐴ji,t ) and the annual log change of sales revenues
j j
(Si,t ). The dummy variable DSi,t equals 1 if sales revenues decreased in year t and 0 otherwise and it aims
to separate the effects of sales increases on cost behaviour from the corresponding effects of sale
decreases. The empirical testing of cost asymmetry in the context of the European listed firms implies
either b1 > 0 and b1 > b1 + c1 in the case of cost stickiness, or b1> 0 and b1 < b1 + c1 in the case of cost
anti-stickiness.
j
We also include the log ratio of total assets to sales (L_INT_TASi,t ) and the log ratio of number of

employees to sales (L_INT_EMPi,tj) to capture the asset and employee intensity according to Anderson et
al. (2003). Other determinants of the intensity of cost asymmetry are the level of macroeconomic activity
and the managerial expectations for future sales. The macroeconomic activity is modelled with the
variable GDPi,tj, which is the percentage growth in real Gross Domestic Product during year t, and the
j
managerial expectations for future sales with the dummy variable SUC_DSi,t which takes the value of 1 if
firm’s sales revenue decreases for two consecutive periods, and 0 otherwise. Finally, we include the
j
level of free cash flows per share (FCFSHi,t ) to capture the effects of managerial empire building
behaviour (Chen et al., 2012). Subscripts i and t denote the firm and the time dimension. Superscript j
denotes the industry dimension.

The main variable of interest for testing H1 is the variable TARGETi,tj which is proposed by Kama
and Weiss (2013) to capture the years that the managerial incentives to meet earnings targets are more
intense. More specifically, the econometric specification of the Eq. (1a) will be estimated in the
following three cases: (i) replacing the variable TARGETi,tj with the variable LOSSi,t
j
which is a dummy
variable that takes the value of 1 if firm’s annual earnings deflated by market capitalization of
shareholders’ equity at prior end is in the interval (0, 0.01), and 0 otherwise, (ii) replacing the variable
j j
TARGETi,t with the variable CEARNi,t which is a dummy variable that takes the value of 1 if the change in
firm’s annual earnings deflated by market capitalization of shareholders’ equity at prior end is in the
interval (0, 0.01), and 0 otherwise, and (iii) with the variable TARGETi,tj which integrates the variables
j j j j
LOSSi,t and CEARNi,t and takes the value of 1 if LOSSi,t = 1 or CEARNi,t = 1, and 0 otherwise. The empirical
testing of H1 implies that c7>0 και b7 + c7> b7.

8
 Expanding the time horizon of the analysis, Kama and Weiss (2013) argued that prior and
current incentives are likely to have opposite effects on current cost asymmetry because if managers
faced incentives to meet an earnings target in the prior period and, thus, already cut slack resources, then
there is less slack of idle resources to reduce current cost stickiness. To test the effects of managerial
incentive to meet earnings targets in consecutive periods within context of the European listed firms, we
add lagged TARGETi,tj in the Eq. (1a) to obtain the following Eq. (1b):
j j j j j j
log(SGAi,t ⁄SGAi,t−1 ) = a0 + a1 SUCDS ji,t + a2 L_INT_TASi,t + a3 L_INT_EMPi,t + a4 GDPi,t + a5 FCFSHi,t +
j j j j j j
a6 TARGETi,t + a7 TARGETi,t−1 + {b1 + b2 SUC_DSi,t + b3 L_INT_TASi,t + b4 L_INT_EMPi,t + b5 GDPi,t +
j j j j j j j Eq. (1b)
b6 FCFSHi,t + b7 TARGETi,t +b8 TARGETi,t−1 }log(Si,t ⁄Si,t−1 ) + {c1 + c2 SUC_DSi,t + c3 L_INT_TASi,t +
j j j j j j j j j
c4 L_INT_EMPi,t + c5 GDPi,t + c6 FCFSHi,t + c7 TARGETi,t +c8 TARGETi,t−1 }DSi,t log(Si,t ⁄Si,t−1 )+ ei,t

If current period’s managerial incentives to meet earnings targets diminish the intensity of
current period’s cost stickiness (regardless of prior period’s managerial incentives to meet earnings
targets), then c7 > 0. If prior period’s managerial incentives to meet earnings targets increase the intensity
of current period’s cost stickiness, then c8 < 0, otherwise c8 > 0.

3.3. Asymmetric cost behaviour and conditional conservatism estimations

The second research hypothesis states that within the context of the European listed firms the presence
of asymmetric cost behaviour introduces an upward bias in the estimated asymmetric timeliness
coefficient of the conditional conservatism regression models. Following, the approach of Banker et al.
(2016), we test the second research hypothesis estimating (i) the Basu (1997) asymmetric timeliness
model, (ii) the cost driven earnings behaviour model (Banker, & Chen, 2006), and (iii) a full model that
integrates the asymmetric timeliness model and the cost driven earnings behaviour model.
Τhe Basu (1997) asymmetric timeliness model is defined by Eq. (2a):
j j j j j j j
NIi,t ⁄MVi,t−1 = a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t + ηi,t Eq. (2a)
j j j
Where NIi,t ⁄MVi,t−1 is the level of earnings (NIi,t ) scaled with the market value of equity at the beginning
j
of the fiscal year (MVi,t−1 ), RETi,tj is the market-adjusted stock return, and DRji,t is a dummy variable which
equals 1 if the market-adjusted stock return is negative, and 0 otherwise. Subscripts i and t denote the
firm and the time dimension. Superscript j denotes the industry dimension.
The cost driven earnings behaviour model is specified as:
j j j j j j j j j
NIi,t ⁄MVi,t−1 = a0 + b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1 + b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + εi,t Eq. (2b)
j
Where DSi,t is a dummy variable equals 1 if sales revenues decreased in year t and 0 otherwise and it
aims to separate the effects of sales increases on earnings from the corresponding effects of sale
j
decreases. ΔSi,t is the annual change on the level of sales revenues. Subscripts i and t denote the firm and
the time dimension. Superscript j denotes the industry dimension.
We will compare the explanatory power of the econometric specifications of Eq. (2a) and Eq.
(2b). in addition, we will estimate the full model of Eq. (2c):

9
 j j j j j j j j j
NIi,t ⁄MVi,t−1 = a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t +b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1
j j j j Eq. (2c)
+ b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + υi,t

The empirical testing of H2 suggests that the estimated coefficient of DRji,t RETi,tj in the Basu
model of Eq. (2a) will be more that the corresponding coefficient in the full model of Eq. (2c). Further,
if costs exhibit cost stickiness, earnings are expected to decline to a greater degree when sales decreases
than they rise for the equivalent sales increases, and for this reason the estimated coefficient b 3 is
expected to have positive sign.

In a similar stream of reasoning, we conjecture that the determinants of the intensity of cost
asymmetry have a positive effect on the upward bias in the estimated asymmetric timeliness coefficient
of the conditional conservatism regression models. For this reason, we extend the regression model of
Eq. (2c):
j j j j j j j j j
NIi,t ⁄MVi,t−1 = a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t +b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1
j j j j j j j j
+ b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + INT_TASi,t−1 {a4 DR i,t + a5 RETi,t + a6 DR i,t RETi,t }
j j j j j j j
+ INT_TASi,t−1 {b4 DSi,t + b5 ΔSi,t ⁄MVi,t−1 + b6 DSi,t (ΔSi,t ⁄MVi,t−1 )}
j j j j j
+ INT_EMPi,t−1 {a7 DR i,t + a8 RETi,t + a9 DR i,t RETi,t }
j j j j j j j Eq. (2d)
+ INT_EMPi,t−1 {b7 DSi,t + b8 ΔSi,t ⁄MVi,t−1 + b9 DSi,t (ΔSi,t ⁄MVi,t−1 )}
j j j j j
+ FCFSHi,t−1 {a10 DR i,t + a11 RETi,t + a12 DR i,t RETi,t }
j j j j j j j
+ FCFSHi,t−1 {b10 DSi,t + b11 ΔSi,t ⁄MVi,t−1 + b12 DSi,t (ΔSi,t ⁄MVi,t−1 )}
j j j j
+ γ1 INT_TASi,t−1 + γ2 INT_EMPi,t−1 + γ3 FCFSHi,t−1 + μi,t
j
Where INT_TASi,t is the ratio of total assets to sales, INT_EMPi,tj is the ratio of number of employees to sales,
j
and FCFSHi,t is the level of free cash flows. The estimated coefficients b6, b9 and b12 are expected to be
positive.

Finally, following Banker et al. (2016), we attempt to validate if sales changes captures the
effects of asymmetry cost behaviour or conservatism on earnings. If sales changes contain incremental
information for the future cash flows generated by booked assets, then sale declines trigger asset
devaluations (Banker et al. 2014a) which could generate disruptions on the linear relationship between
earnings and sale changes even if cost asymmetry is absent. We expand the model of Eq. (2c) by adding
interactions with lagged sales decreases and lagged negative returns:
j j j j j j j j j
NIi,t ⁄MVi,t−1 = a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t + b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1
j j j j j j j j
+ b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + a4 DR i,t−1 + a5 RETi,t−1 + a6 DR i,t−1 RETi,t−1 + b4 DSi,t−1
j j j j j
+ b5 ΔSi,t−1 ⁄MVi,t−1 + b6 DSi,t−1 (ΔSi,t−1 ⁄MVi,t−1 ) Eq. (2e)
j j j j j j
+ DR i,t−1 {a7 DR i,t + a8 RETi,t + a9 DR i,t RETi,t b1 DSi,t }
j j j j j j j j
+ DSi,t−1 {b7 DSi,t + b8 ΔSi,t ⁄MVi,t−1 + b9 DSi,t (ΔSi,t ⁄MVi,t−1 )} + μi,t

If the piecewise linear effect of sales changes represents cost stickiness (conservatism), then the
coefficient b9 is expected to be negative (positive). All the variables are as defined previously.

10
3.4. Asymmetric cost behaviour and accruals

The relationship of asymmetric cost behaviour with the level of accruals will be examined within the
context standard econometric approach for separating discretionary from non-discretionary accruals.
More specifically, the grounds of our econometric approach rely on the Jones model modified by Kothari
et al. (2005):
j j j j j j j j j
OP_ACCR i,t⁄TASi,t−1 = a0 + a1 (1⁄TASi,t−1 ) + a2 (ΔSi,t ⁄TASi,t−1 ) + a3 (PPEi,t⁄TASi,t−1 ) + a4 ROAi,t +ei,t Eq. (3a)

Where OP_ACCRji,t⁄TASi,t−1
j
is the level of operational accruals (OP_ACCRji,t) scaled with the level of
j
total assets at the beginning of the fiscal period (TASi,t−1 ). ROAji,t is the level of return on assets, PPEi,t
j
the
j
level of plant, property, and equipment, and ΔSi,t is the annual change of sale revenues. Subscripts i and
t denote the firm and the time dimension. Superscript j denotes the industry dimension. The level of
discretionary accruals (D_OP_ACCRji,t ) is measured as the residual of the estimated model of Eq. (3a).

To investigate the effects of cost asymmetry on the level of accruals, we modify the regression
model of the Eq. (3a) in two ways. The first one is operationalized by introducing in Eq. (3a) a variable
that ranks our firm-years observations according to the intensity of the effects of asymmetric cost
behaviour on earnings. A desire attribute of the measurement variable of the intensity of asymmetric
cost behaviour is to rank firms according to the effects of their cost behaviour on earnings. Following
j
Banker et al. (2016), we define the asymmetric behaviour score (AS_B_SCi,t ) for measuring the intensity

of the effects of cost asymmetry on earnings1:

j j j j
AB_B_SCi,t = b3 + b6 INT_TASi,t−1 + b9 INT_EMPi,t−1 + b9 FCFSHi,t−1 Eq. (3b)

Where the parameters b3, b6, b9 and b12 are the estimated coefficients of Eq. (2d). Introducing
j
the asymmetric behaviour score (AS_B_SCi,t ) as independent variable in the regression model of Eq. (3a),

we obtain the regression model of Eq. (3c):

j j j j j j j j
OP_ACCR i,t⁄TASi,t−1 = 𝑎0 + a1 (1⁄TASi,t−1 ) + a2 (ΔSi,t ⁄TASi,t−1 ) + a3 (PPEi,t⁄TASi,t−1 ) + a4 ROAi,t
j j Eq. (3c)
+ 𝑎5 AS_B_SCi,t + ei,t

The second modification of the regression model of the Eq. (3a) attempts to separate the effects
of sales increases on accruals from the corresponding effects of sale decreases. For this reason, we

1. The asymmetric cost behavior is driven by the managerial resource allocation decision-making process. The
managerial resource allocation decision making process is rather difficult to be modelled since it represents a latent
behavioral process. As a result, literature assumes that factors which might affect resource allocation decision
making process, also, affect the intensity of cost stickiness (i.e., asset intensity, employee intensity, managerial
empire building behavior, etc.). Yet, it seems rather difficult to identify the whole spectrum of factors that might
affect the resource allocation decision making process and though this mapping of factors to model the decision-
making process governing the manifestation of the cost asymmetry. Thus, our principal methodological concern
j
in our empirical analysis when we adopt the asymmetric behavior score (AS_B_SCi,t ) is to order the firms for our
data sample in ascending sequence according to the effects of the asymmetric cost behavior on a firm’s earnings
based on selective indicators of its financial profile that might affect the resource allocation decision process. We
do not intent and our empirical analysis does not require to have a precise measure of the effects of the intensity
of asymmetric cost behavior on earnings.

11
 j
introduce the dummy variable DSi,t that equals 1 if sales revenues decreased in year t and 0 in the
econometric specification of the Eq. (3a):
j j j j j j j j j
OP_ACCR i,t⁄TASi,t−1 = 𝑎0 + a1 (1⁄TASi,t−1 ) + b1 DSi,t + a2 (ΔSi,t ⁄TASi,t−1 ) + b2 DSi,t (ΔSi,t ⁄TASi,t−1 )
j j j j Eq. (3d)
+ a3 (PPEi,t⁄TASi,t−1 ) + a4 ROAi,t +ei,t

Since accruals is a primary component of the operating income, we expect in a similar way as
in the case of the cost driven earnings behaviour model (Banker, & Chen, 2006), the estimated
coefficient b2 of the Eq. (3d) to be positive. The cost driven earnings behaviour model implies that the
presence of cost asymmetry increases the magnitude of the effects of sale decreases on earnings, and for
this reason it causes a greater (in absolute terms) earnings decrease in the case of sales decline than the
earning increase in the case of an equivalent sales increase. We expect a similar pattern of behaviour in
the case of accruals.

3.5. Asymmetric cost behaviour and earnings smoothing

We employ two measures of earnings smoothing. The first one (EARN_S_1ji,t) emphasizes on total accrual
smoothing (e.g., Francis et al., 2004; McInnis, 2010) and it compares the volatility of earnings with
respect to the volatility of cash flows from operations. The higher the earnings smoothing, the higher
the variability of cash flows with respect to the variability of income, and, thus the higher the ratio the
standard deviation of cash flows from operations (CFOji,t ) over the standard deviation of earnings (NIi,t
j
),
in three-year rolling window. The second measure (EARN_S_2ji,t) relies on the discretionary accruals
reflecting that the variability of cash flows is smoothed through the usage of accruals (Leuz et al. 2003,
Tucker, & Zarowin 2006 Myesr et al., 2007). It is calculated as the negative correlation of a firm’s
change in discretionary accruals (D_OP_ACCRji,t ) and its change in pre-discretionary income (P_NIi,t
j
), in a
three-year rolling window:
j j j
EARN_S_2i,t= -Corr [𝛥(D_OP_ACCR i,t ), 𝛥(P_NIi,t )] Eq. (4a)

A more negative correlation signifies a smoother income stream in the relationship to the
underlying fundamental. The level of discretionary accruals (D_OP_ACCRji,t ) is the residuals of the
regression model of the Eq. (3a).

We examine the relation of asymmetric cost behaviour with earnings smoothing by estimating
the following regression models of Eq. (4b) and Eq. (4c):
j j j j j j j
EARN_S_1i,t = a0 + α1 AS_B_SCi,t + α2 BtMi,t + α3 LEVi,t + α4 SIZEi,t + α5 M_ROAi,t + ei,t
Eq. (4b)
j j j j j j j
EARN_S_2i,t = a0 + α1 AS_B_SCi,t + α2 BtMi,t + α3 LEVi,t + α4 SIZEi,t + α5 M_ROAi,t + ei,t Eq. (4c)

In the regression models of of Eq. (4b) and Eq. (4c), the main variable for examining the relation
j
of asymmetric cost behaviour with earnings smoothing is the asymmetric behaviour score (AS_B_SCi,t ) of

Eq. (3b). In the regression models of the Eq. (4b) and (4c) we included various control variables to
capture time variant firm characteristics as suggested by prior literature (Dechow, & Dichev, 2002;

12
Hribar, & Nichols, 2007; Demerjian, Lewis-Western, & McVay, 2020), such as: the book-to-market
j j j
ratio (BtMi,t ), the level of leverage (LEVi,t ), the logarithm of the market value of equity (SIZEi,t ) and the

mean return on assets calculated over three years rolling window (M_ROAji,t). Subscripts i and t denote the
firm and the time dimension. Superscript j denotes the industry dimension.

4. Results

4.1. Asymmetric cost behaviour of SG&A expenses and managerial incentives to meet earnings
targets

Table 2 exhibits the estimation results of the regression models of Eq. (1a) and Eq. (1b). The models are
estimated with robust standard errors, clustered by firm, to control for heteroscedasticity and
autocorrelation (Petersen, 2009). Country and year dummies are included.

Initially, the regression models of Eq. (1a) and Eq. (1b) are estimated by setting the variable
j
TARGETi,t be equal to 1 if firm’s annual earnings deflated by market capitalization of shareholders’ equity
at prior end is in the interval (0, 0.01) or if the change in firm’s annual earnings deflated by market
capitalization of shareholders’ equity at prior end is in the interval (0, 0.01), and 0 otherwise. In this
case, the coefficient b1 of the regression model of the Eq. (1a) has an estimated value of 0.919 and the
corresponding estimated coefficient b1 of the regression model of Eq. (1b) has an estimated value of
0.932, which indicate that the level of SG&A expenses increases, respectively, by 0.919% or 0.932%
per 1% annual increase in sales revenues. The SG&A expenses exhibit cost stickiness because in both
estimated regression models of Eq. (1a) and Eq. (1b) the estimated value of coefficient c 1 is negative
and significant. As in the case of US listed firms (Kama, & Weiss, 2013), the resource allocation
decisions of managers of firms operating in the European landscape are affected by their incentives to
meet earnings targets. In the case of the regression model of the Eq. (1a), the estimated coefficient c7 is
positive and significant which indicates that the presence of managerial incentive meet earnings targets
decreases the intensity of SG&A cost stickiness. In addition, prior period’s managerial incentives to
meet earnings targets decreases the intensity of current period’s cost stickiness, since in the case of the
regression model of the Eq. (1a), the estimated coefficient c8 is positive and significant.
- Insert Table 2 –

Similar pattern of results appear in the case that the regression models of Eq. (1a) and Eq. (1b)
are estimated by setting the variable TARGETi,tj to be equal to 1 if firm’s annual earnings deflated by market
capitalization of shareholders’ equity at prior end is in the interval (0, 0.01), and in the case that the
variable TARGETi,tj equals to 1 if the change in firm’s annual earnings deflated by market capitalization of
shareholders’ equity at prior end is in the interval (0, 0.01). In both cases the SG&A expense exhibit
asymmetric cost behaviour and it seems that managers reduce costs more aggressively in the presence
of (current or prior period’s) incentives to meet earnings targets than in their absence.

13
4.2. Asymmetric cost behaviour and conditional conservatism

In section 4.1., we provide evidence that the SG&A expenses exhibit cost stickiness within the context
of European listed firms. The presence of cost asymmetry implies that earnings might exhibit
asymmetric cost driven behaviour and as Banker et al. (2016) documented in the case of the US listed
firms the presence of asymmetric cost behaviour phenomenon causes an upward bias in the estimated
asymmetric timeliness coefficient of the conditional conservatism regression models.

Table 3 exhibits the estimation results for the Basu model, the sticky cost model, and the full
model. The models are estimated with robust standard errors, clustered by firm, to control for
heteroscedasticity and autocorrelation (Petersen, 2009). Country and year dummies are included. In the
case of Basu model, the estimated coefficient a3 is positive and significant which indicates the presence
of conditional conservatism and in the case of sticky cost model the estimated coefficient b3 is positive
and significant which indicates that earnings exhibit asymmetric cost driven behaviour. In the case of
full model, both the asymmetric timeless coefficient and the asymmetric cost behaviour coefficient have
positive, as expected, and statistically significant values. The adjusted R2 of Basu model is 12.82%, of
the sticky cost model is 24.87% and of the full model is 29.13%. Both Basu model and sticky cost model
are rejected in favour of full model (F=873.98 and F=228.54, respectively).
- Insert Table 3 -

The asymmetric timeless coefficient a3 is the main parameter of interest for testing to what
extent the asymmetric cost behaviour causes an upward estimation bias in the asymmetric timeliness
coefficient of the conditional conservatism regression models. The estimated value asymmetric timeless
coefficient a3 in the Basu model is 0.072 and in the full model is 0.047. The difference is statistically
significant, indicates as substantial upwards bias of 53.19% (0.072/0.047-1) and provides evidence in
favour of hypothesis H2.

We expect that the determinants of the intensity of cost asymmetry have a positive effect on the
upward bias in the estimated asymmetric timeliness coefficient of the conditional conservatism
regression models. The estimation results of the regression model of the Eq. (2d) are illustrated in Table
4. Both the asymmetric timeless coefficient and the asymmetric cost behaviour coefficient have positive,
as expected, and statistically significant values. It seems that asset intensity, employee intensity and free
cash flows cause variations in the asymmetric cost driven behaviour of earnings. The estimated
coefficients b6 and b9 are positive and significant indicating the magnitude of asset intensity and
employee intensity increase the intensity of asymmetric cost driven behaviour of earnings.
- Insert Table 4 -

Finally, Table 5 exhibits the estimation results of the regression model of Eq. (2e) which
attempts to validate if sales changes captures the effects of asymmetry cost behaviour or conservatism

14
on earnings (Banker et al., 2016). The regression model of Eq. (2e) expands the model of Eq. (2c) by
adding interactions with lagged sales decreases and lagged negative returns. If sales changes contain
incremental information for the future cash flows generated by booked assets, then sale declines trigger
asset devaluations (Banker et al. 2014a) which could generate disruptions on the linear relationship
between earnings and sale changes even if cost asymmetry is absent. If the piecewise linear effect of
sales changes represents cost stickiness (conservatism), then the coefficient b9 is expected to be negative
(positive). Indeed, the estimated value of the coefficient b9 of the regression model of Eq. (2e) is negative
and significant.
- Insert Table 5 -

4.3. Asymmetric cost behaviour and accruals

Table 6 illustrates the estimation results of the regression models of Eq. (3c) and Eq. (3d). The models
are estimated with robust standard errors, clustered by firm, to control for heteroscedasticity and
autocorrelation (Petersen, 2009). Country and year dummies are included.

j
The estimate coefficient of the asymmetric behaviour score (AS_B_SCi,t ) in the regression model

of the Eq. (3c) is negative the significant. It seems that as the intensity of asymmetric cost behaviour
increases the average level of operating accruals decreases in the case of listed firms operating within
the European context. A plausible explanation is that the level of operating accrual depends on the level
of operating income and the presence of cost asymmetry increases operating income’s responses to
downsizing demand realizations (Banker, & Chen, 2006, Collins, Hribar, & Tian, 2014).
- Insert Table 6 -

We can obtain empirical evidence for the responses of operating accruals to downsizing demand
realizations from the estimation results of the regression model to the Eq. (3d) that it separates the effects
of sales increases on accruals from the corresponding effects of sale decreases. The estimated coefficient
j
b1 of the dummy variable DSi,t is negative and significant. It seems that the firm years anchored with
sales declines reduce the level of operating accruals. Further, the value of the estimated coefficients a 2
and b2 are positive and significant. Thus, in case of a sales decrease the level of operating accrual
response more than in the case of an equivalent in absolute terms sales decrease.

4.4. Asymmetric cost behaviour and earnings smoothing

This section analyses the relationship between asymmetric cost behaviour and earnings smoothing. In
the estimated regression models of Eq. (4a) and Eq. (4b) the primary variable of interest is asymmetric
j
behaviour score (AS_B_SCi,t ), that is the measure of the intensity of cost stickiness of our research design.

The models are estimated with robust standard errors, clustered by firm, to control for heteroscedasticity
and autocorrelation (Petersen, 2009). Country and year dummies are included.

15
 It seems that the estimated value of the coefficient α1 is negative and significant in both Eq. (4a)
and Eq. (4b) which indicates that the level of earnings smoothing decreases as the level of cost
asymmetry increases. In the previous sections, we provide evidence that (i) earnings response more in
years signified with sales decrease, (ii) cost asymmetry decreases the average level of operating accruals,
and (iii) in case of a sales decrease the level of operating accruals response more than in the case of an
equivalent (in absolute terms sales) decrease. Thus, within time frames with sales decreases, operating
income and accruals exhibit increased variability which reduces the earnings smoothing.

5. Conclusions

This research initiative attempts to evaluate the role of cost asymmetry in the formulation of
various attributes of earnings quality within the context of European listed firms. Initially, we examined
if managerial incentives to meet earnings targets affect the intensity of asymmetric cost behaviour. We
documented that in the case of European listed firms the SG&A expenses (i) exhibit asymmetric cost
behaviour, and (ii) the intensity of asymmetric cost behaviour of SG&A expenses decreases when
managerial incentives to meet earnings targets are present. This is consistent with similar empirical
evidence provided by Kama and Weiss (2013) in the case of US listed firms.

In a similar line of reasoning with Baker et al. (2013), we documented that, in the case of
European listed firms, asymmetric timeliness estimates in the conditional conservatism estimation
models have an upward bias unless these models do not control for asymmetric cost behaviour. It, also,
seems that the primary determinants of the intensity of cost asymmetry, that is asset intensity, employee
intensity and free cash flows, cause variations in the asymmetric cost driven behaviour of earnings.

We, also, provide evidence that (i) the firm years anchored with sales declines reduce the level
of operating accruals, and (ii) the responses of operating accruals are more sensitive to downsizing
demand realizations than to sale increases. Finally, we document that the presence of asymmetric cost
phenomenon affects earnings smoothing because the level of earnings smoothing decreases as the level
of cost asymmetry increases and earnings smoothing is more sensitive to sale decreases than to sale
increases.

The contribution of this study is that attempts to explore the relation of a specific instance of
real economic performance with earnings quality and to expand existing knowledge on relatively
unexplored aspects of earnings management literature (Dechow et al., 2010). More specifically, we
focus on asymmetric cost phenomenon, which is a managerial resource allocation driven phenomenon
of real economic performance, and we investigate its effects on intensity of conditional conservatism,
the level of accruals and the extent of earnings smoothing. This spectrum or relationships is explored
within the context of European listed firms confirming (e.g. Banker et al., 2013; Kama, & Weiss 2013)
and expanding prior relevant empirical evidence from the US listed firms.

16
Appendix A: Variables definition
Continuous variables:
Variable Description Data source or computation:
j
SGAi,t The level of selling, general and administrative Worldscope data item # WC08510
expenses.
j
Si,t The level of sales revenues. Worldscope data item # WC01001
j
TASi,t The level of total assets. Worldscope data item # WC02999
j
EMPi,t The number of employees. Worldscope data item # WC07011
j
L_INT_TASi,t The log ratio of total assets to sales. j
Log(TASi,t⁄Si,t )
j

L_INT_EMPi,t
j
The log ratio of number of employees to sales. Log(EMPi,t ⁄Si,t )
j j

INT_TASi,t
j
The ratio of total assets to sales. j
TASi,t⁄Si,t
j

INT_EMPi,t
j
The ratio of number of employees to sales. j
EMPi,t ⁄Si,t
j

j
GDPi,t The percentage growth in real Gross Domestic SOURCE???
Product during year t.
j
FCFSHi,t The level of free cash flowsper share. Worldscope data item # WC05507
j
NIi,t The level of earnings. Worldscope data item # WC01551
j j
D_NIi,t The standard deviation of earnings. The standard deviation of earnings (NIi,t )
over a three-year rolling window.
j
P_NIi,t The level of pre-discretionary earnings. Worldscope data item # WC01551 -
j
D_OP_ACCR i,t
j
CFOi,t The level of cash flows from operations. Worldscope data item # WC04860
j
D_CFOi,t The standard deviation of cash flows from The standard deviation of cash flows from
operations. operations (CFOji,t ) over a three-year rolling
window.
j
RETi,t The market-adjusted stock return. Datastream item RI adjusted for the return of
a value-weighted return of each country-
year.
j
MVi,t The market value of equity. Worldscope data item # WC08001
j
CEQi,t The book value of common equity. Worldscope data item # WC03501
j
BtMi,t The book-to-market ratio. Worldscope data item # WC03501/
Worldscope data item # WC08005
j
LEVi,t The level of leverage. Worldscope data item # WC08221
j
OP_ACCR i,t The level of operating accruals. Worldscope data item # WC01250 -
Worldscope data item # WC04860
j
D_OP_ACCR i,t The level of discretionary operating accruals. The residuals of the estimated regression
model of the Eq. (4a).
j j
SIZEi,t The logarithm of the market value of equity. Log(MVi,t )
j
AC_REi,t The level of accounts receivables. Worldscope data item # WC02051
j
DEPR i,t The level of depreciation. Worldscope data item # WC01151
j
PPEi,t The level of plant, property and equipment. Worldscope data item # WC02501
j
ROAi,t The return on assets. Worldscope data item # WC08326
j
M_ROAi,t The mean return on assets. The mean return on assets (M_ROAji,t )
calculated over a three-year rolling window.
j j j j
𝐴𝑆_B_SCi,t The level of AS_B_SC for measuring the AS_B_SCi,t = b3 + 𝑏6 BtMi,t + 𝑏9 LEVi,t +
intensity of the effects of cost asymmetry on j
𝑏12 SIZEi,t , where the parameters b3, b6, b9 and b12
earnings. are the estimated coefficients of Eq. (3c).
j
EARN_S_1i,t The level of earnings smoothing calculated as
the standard deviation of cash flows from j j
operations (CFOji,t ) over the standard deviation Std.Dev(CFOi,t )/Std.Dev.(NIi,t ).)
j
of earnings (NIi,t ), in three-year rolling window.

17
 j
EARN_S_2i,t The level of earnings smoothing calculated as
the negative correlation of a firm’s change in
discretionary accruals (D_OP_ACCRji,t) and its -Corr [𝛥(D_OP_ACCRji,t ), 𝛥(P_NIi,t j
)]
j
change in pre-discretionary income (P_NIi,t ), in
three-year rolling window.
Dummy variables:
Variable Description
j
DSi,t A dummy variable which equals 1 if sales revenues decreased in year t and 0 otherwise.
SUC_DSi,t
j
A dummy variable that takes the value of 1 if firm’s sales revenue decreases for two
consecutive periods, and 0 otherwise.
LOSSi,t
j
A dummy variable that takes the value of 1 if firm’s annual earnings deflated by market
capitalization of shareholders’ equity at prior end is in the interval (0, 0.01), and 0 otherwise.
CEARNi,t
j
A dummy variable that takes the value of 1 if the change in firm’s annual earnings deflated by
market capitalization of shareholders’ equity at prior end is in the interval (0, 0.01), and 0
otherwise.
j j j
TARGETi,t A dummy variable that takes the value of 1 if 𝐿𝑂𝑆𝑆i,t = 1 or 𝐶𝐸𝐴𝑅𝑁i,t = 1, and 0 otherwise.
j
DR i,t A dummy variable which equals 1 if the market-adjusted stock return is negative, and 0
otherwise.
Notations:
i Firm dimension.
t Time dimension.
j Industry dimension.
Δ(.) Annual change operator.

18
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20
Tables

Table 1. Sample selection process and descriptive statistics

Panel A: Sample selection process
Sample Observations Observations
Deleted Remaining
Initial sample: Firm-year observations with valid data Thomson Reuters
Datastream (2005-2019) 20,967
Exclude financial firms -2,776 18,191
Exclude the observations where SG&A expenses are greater than sales
revenue and observations for firms that have no positive sales revenues and -1,176 17,015
SG&A costs
Eliminate those firm-years in which the revenue changes by more than 50%
from one year to the next -1,627 15,388
Discard observations where SG&A expenses move in the opposite direction
to sales -3,972 11,416
Panel B: Descriptive statistics of main variables

Variable Obs. Mean Std. Dev. Min Max Median

j j
log(𝑆𝐺𝐴i,t ⁄𝑆𝐺𝐴i,t−1 ) 11,416 0.028 0.236 -0.846 1.067 0.037
j
L_INT_TASi,t 11,416 0.077 0.643 -1.413 2.398 0.041
j
L_INT_EMPi,t 11,416 -5.426 0.761 -8.197 -3.487 -5.371
j
GDPi,t 11,416 0.011 0.085 -0.175 0.174 0.023
j
FCFSHi,t 11,416 0.530 3.384 -15.487 32.769 0.124
j j
log(Si,t ⁄Si,t−1 ) 11,416 0.015 0.169 -0.561 0.383 0.036
j j
NIi,t ⁄MVi,t−1 11,416 -0.005 0.266 -2.023 0.476 0.045
j
RETi,t 11,416 -0.044 0.689 -4.181 1.042 0.062
j j
ΔSi,t ⁄MVi,t−1 11,416 -0.046 0.576 -3.475 1.764 0.028
j
INT_TASi,t 11,416 1.334 1.150 0.244 8.607 1.038
j
INT_EMPi,t 11,416 0.006 0.004 0.000 0.028 0.005
j
FCFSHi,t 11,416 0.512 3.328 -12.867 33.248 0.107
j j
OP_ACCR i,t⁄TASi,t−1 11,416 -0.019 0.075 -0.312 0.267 -0.015
j j
ΔSi,t ⁄TASi,t−1 11,416 0.026 0.203 -0.677 0.810 0.029
j j
PPEi,t⁄TASi,t−1 11,416 0.244 0.217 0.003 0.997 0.185
j
ROAi,t 11,416 4.242 9.653 -44.300 33.570 4.830
j
AS_B_SCi,t 11,416 0.584 0.539 -3.538 3.844 0.520
j
BtMi,t 11,416 0.814 0.940 -1.724 6.250 0.571
j
LEVi,t 11,416 33.122 27.186 0.000 159.570 31.000
j
SIZEi,t 11,416 12.479 2.331 6.965 17.962 12.377
j
M_ROAi,t 11,416 4.681 8.327 -34.350 31.720 4.940
j
EARN_S_1i,t 11,416 2.666 4.244 0.057 30.645 1.349
j
EARN_S_2i,t 7,793 0.712 0.548 -1.000 1.000 0.972
Notes: Panel A describes the sample selection process and Panel B illustrates the descriptive statistics of the
main variables. Firm level variables are defined in Appendix A

21
Table 2. Asymmetric cost behaviour of SG&A and managerial incentives to meet earnings targets
j j
Dependent variable = annual log change of SG&A expenses - log(Ci,t ⁄Ci,t−1 )
j j j j j j j
TARGETi,t =1 if LOSSi,t = 1 or CEARNi,t =1 TARGETi,t =1 if LOSSi,t =1 TARGETi,t =1 if CEARNi,t= 1
Model of Eq. (1a) Model of Eq. (1b) Model of Eq. (1a) Model of Eq. (1b) Model of Eq. (1a) Model of Eq. (1b)
Coefficient Coefficient Coefficient Coefficient Coefficient Coefficient
(t-stat.) (t-stat) (t-stat.) (t-stat) (t-stat.) (t-stat)
estimates estimates estimates estimates estimates estimates
a0 : 0,034 (0,870) 0,031 (0,800) 0.039 (0.990) 0,040 (1,020) 0.031 (0.800) 0,029 (0,760)
j
a1 : SUC_DSi,t -0,029c (-4,570) -0,027c (-4,320) -0.030c (-4.710) -0,030c (-4,740) -0.028c (-4.430) -0,026c (-4,140)
j
a2 : L_INT_TASi,t -0,004 (-0,940) -0,004 (-1,000) -0.005 (-1.030) -0,005 (-1,080) -0.004 (-0.930) -0,004 (-1,000)
j
a3 : L_INT_EMPi,t -0,0003 (-0,080) -0,00018 (-0,040) 0.000 (-0.080) 0,000 (-0,080) 0.000 (-0.110) 0,000 (-0,040)
j
a4 : GDPi,t 0,037 (0,740) 0,031 (0,630) 0.042 (0.850) 0,041 (0,810) 0.036 (0.720) 0,028 (0,560)
j
a5 : FCFSHi,t -0,00002 (-0,040) -0,00015 (-0,020) 0.000 (0.070) 0,000 (0,090) 0.000 (-0.110) 0,000 (-0,110)
j
a6 : TARGETi,t 0,020 (3,080) 0,017 (2,601) -0.018 (-0.500) -0,029 (-0,780) 0.021c (3.140) 0,016c (3,256)
j
a7 : TARGETi,t−1 0,021 (3,040) 0,074b (2,460) 0,027c (3,390)
j j
b1 : log(Si,t ⁄Si,t−1 ) 0,919c (4,460) 0,932c (4,520) 0.913c (4.440) 0,912c (4,440) 0.933c (4.540) 0,942c (4,570)
j j j
b2 : SUC_DSi,t log(Si,t ⁄Si,t−1 ) 0,188c (3,310) 0,179c (3,150) 0.187c (3.310) 0,186c (3,280) 0.180c (3.190) 0,168c (2,970)
j j j
b3 : L_INT_TASi,t log(Si,t ⁄Si,t−1 ) 0,110c (3,040) 0,111c (3,050) 0.112c (3.110) 0,113c (3,100) 0.111c (3.070) 0,112c (3,080)
j j j
b4 : L_INT_EMPi,t log(Si,t ⁄Si,t−1 ) -0,004 (-0,090) -0,004 (-0,110) -0.004 (-0.120) -0,005 (-0,130) -0.003 (-0.080) -0,005 (-0,120)
j j j
b5 : GDPi,t log(Si,t ⁄Si,t−1 ) 0,123 (0,470) 0,126 (0,490) 0.105 (0.410) 0,122 (0,470) 0.128 (0.500) 0,139 (0,540)
j j j
b6 : FCFSHi,t log(Si,t ⁄Si,t−1 ) -0,001 (-0,090) -0,001 (-0,070) -0.001 (-0.120) -0,001 (-0,120) -0.001 (-0.080) 0,000 (-0,060)
j j j
b7 : TARGETi,t log(Si,t ⁄Si,t−1 ) -0,122b (-2,132) -0,133b (-2,298) 0.485 (1.140) 0,588 (1,340) -0.089c (-3.606) -0,051b (-2,411)
j j j
b8 : TARGETi,t−1 log(Si,t ⁄Si,t−1 ) -0,140b (-2,370) -0,619 (-1,770) -0,197c (-2,920)
j j j
c1 : DSi,t log(Si,t ⁄Si,t−1 ) -0,121c (-3,356) -0,144c (-3,776) -0.112c (-3.100) -0,118c (-3,016) -0.141c (-3.906) -0,155c (-4,053)
j j j j
c2 : SUC_DSi,t DSi,t log(Si,t ⁄Si,t−1 ) -0,301c (-3,480) -0,284c (-3,260) -0.305c (-3.540) -0,304c (-3,510) -0.292c (-3.380) -0,268c (-3,100)
j j j j
c3 : L_INT_TASi,t DSi,t log(Si,t ⁄Si,t−1 ) -0,152b (-2,540) -0,153c (-2,560) -0.156c (-2.610) -0,157c (-2,620) -0.151 (-2.510) -0,152b (-2,540)
j j j j
c4 : L_INT_EMPi,t DSi,t log(Si,t ⁄Si,t−1 ) -0,025 (-0,440) -0,023 (-0,410) -0.026 (-0.460) -0,026 (-0,460) -0.027 (-0.470) -0,023 (-0,410)

22
 j j j j
c5 : GDPi,t DSi,t log(Si,t ⁄Si,t−1 ) -0,078 (-0,160) -0,099 (-0,210) -0.025 (-0.050) -0,060 (-0,130) -0.090 (-0.190) -0,119 (-0,250)
j j j j
c6 : FCFSHi,t DSi,t log(Si,t ⁄Si,t−1 ) 0,053b (2,290) 0,052b (2,280) 0.056b (2.430) 0,056b (2,430) 0.052b (2.280) 0,051b (2,230)
j j j j
c7 : TARGETi,t DSi,t log(Si,t ⁄Si,t−1 ) 0,339c (2,812) 0,287b (2,587) 0.175b (2.568) 0,162b (2,193) 0.985c (4.570) 0,852c (3,910)
j j j j
c8 : TARGETi,t−1 DSi,t log(Si,t ⁄Si,t−1 ) 0,318c (2,812) 2,249b (2,340 0,540c (3,500)
Number of Obs.: 11,416 11,416 11416 11,416 11416 11,416
Adj. R-Squared: 47.61% 47.65% 47.59% 47.64% 47.61% 47.67%
Notes: This table presents the estimation results of the regression models for Eq. (1a) and Eq. (1b):
Eq. (1a): log(Ci,tj⁄Ci,t−1
j j j j j j j j j j j j
) = a0 + a1 SUC_DSi,t + a2 L_INT_TASi,t + a3 L_INT_EMPi,t + a4 GDPi,t + a5 FCFSHi,t + a6 TARGETi,t + {b1 + b2 SUC_DSi,t + b3 L_INT_TASi,t + b4 L_INT_EMPi,t + b5 GDPi,t + b6 FCFSHi,t +
j j j j j j j j j j j j j
b7 TARGETi,t }log(Si,t ⁄Si,t−1 ) + {c1 + c2 SUC_DSi,t + c3 L_INT_TASi,t + c4 L_INT_EMPi,t + c5 GDPi,t + c6 FCFSHi,t + c7 TARGETi,t }DSi,t log(Si,t ⁄Si,t−1 )+ ei,t

Eq. (1b): log(Ci,tj⁄Ci,t−1

j j j j j j j j j j
) = a0 + a1 SUCDS ji,t + a2 L_INT_TASi,t + a3 L_INT_EMPi,t + a4 GDPi,t + a5 FCFSHi,t + a6 TARGETi,t + a7 TARGETi,t−1 + {b1 + b2 SUC_DSi,t + b3 L_INT_TASi,t + b4 L_INT_EMPi,t +
j j j j j j j j j j j j j j j j j
b5 GDPi,t + b6 FCFSHi,t + b7 TARGETi,t +b8 TARGETi,t−1 }log(Si,t ⁄Si,t−1 ) + {c1 + c2 SUC_DSi,t + c3 L_INT_TASi,t + c4 L_INT_EMPi,t + c5 GDPi,t + c6 FCFSHi,t + c7 TARGETi,t +c8 TARGETi,t−1 }DSi,t log(Si,t ⁄Si,t−1 )+ ei,t

The models are estimated with robust standard errors, clustered by firm, to control for heteroscedasticity and autocorrelation (Petersen, 2009). Country and year dummies are
included. Firm level variables are defined in Appendix A. a, b and c represent significance levels of 10 percent, 5 percent, and 1 percent, respectively (two-tailed).

23
Table 3. Asymmetric cost behaviour and conditional conservatism
j
Dependent variable = the level of earnings (NIi,t ) scaled with the market value of equity at the beginning of the fiscal year
j j j
(MVi,t−1 ) - NIi,t⁄MVi,t−1
Basu model (Eq. 2a) Stick cost model (Eq. 2b) Full model (Eq. 2c)

Coefficient Coefficient Coefficient

(t-stat.) (t-stat.) (t-stat.)
estimates estimates estimates
a0 : 0.021a (1.840) 0.014 (0,840) 0,020 (1,260)
j
a1 : DR i,t -0.021c (-3.470) -0,017c (-3,090)
j
a2 : RETi,t : 0.045c (3.370) 0,039c (3,220)
j j
a3 : DR i,t RETi,t 0.072c (4.300) 0,047c (3,190)
j
b1 : DSi,t -0.032c (-4,800) -0,016c (-2,620)
j j
b2 : ΔSi,t⁄MVi,t−1 0.021c (4,350) 0,016c (3,138)
j j j
b3 : DSi,t (ΔSi,t ⁄MVi,t−1 ) 0.220c (8,850) 0,213c (8,700)
Number of Obs.: 11,416 11,416 11,416
Adj. R-Squared: 12.82% 24.87% 29.13%
Notes: This table presents the estimation results of the regression models of Eq. (2a), Eq. (2b), and Eq. (2c):
Eq. (1a) or Basu model: NIi,tj⁄MVi,t−1
j j j j j j
= a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t + ηi,t

Eq. (1b) or Sticky cost model: NIi,tj⁄MVi,t−1

j j j j j j j j
= a0 + b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1 + b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + εi,t

Eq. (1c) or full model: NIi,tj⁄MVi,t−1

j j j j j j j j
= a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t +b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1 +
j j j j
b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + υi,t

The models are estimated by using firm-clustered standard errors to control for autocorrelation and
heteroscedasticity (Petersen, 2009). Country and year dummies are included. Firm level variables are defined
in Appendix A. a, b and c represent significance levels of 10 percent, 5 percent, and 1 percent, respectively
(two-tailed).

24
Table 4. Variation in asymmetric cost behaviour and conditional conservatism
j
Dependent variable = the level of earnings (NIi,t ) scaled with the market value of equity at the beginning of the fiscal year
j j j
(MVi,t−1 ) - NIi,t⁄MVi,t−1
Coefficient estimates (t-stat.)
a0 : 0.028 (0.810)
j
a1 : DR i,t -0.004 (-0.290)
j
a2 : RETi,t 0.109c (3.800)
j j
a3 : DR i,t RETi,t 0.071c (5.391)
j
b1 : DSi,t 0.008 (0.650)
j j
b2 : ΔSi,t⁄MVi,t−1 0.079c (2.890)
j j j
b3 : DSi,t (ΔSi,t ⁄MVi,t−1 ) 0.127c (3.450)
j j
a4 : DR i,t INT_TASi,t−1 -0.005 (-0.880)
j j
a5 : RETi,t INT_TASi,t−1 -0.055c (-3.410)
j j j
a6 : DR i,t RETi,t INT_TASi,t−1 0.077c (4.320)
j j
b4 : DSi,t INT_TASi,t−1 -0.005 (-0.930)
j j j
b5 : ΔSi,t⁄MVi,t−1 INT_TASi,t−1 -0.045a (-1.840)
j j j j
b6 : DSi,t (ΔSi,t ⁄MVi,t−1 )INT_TASi,t−1 0.310c (8.100)
j j
a7 : DR i,t INT_EMPi,t−1 -2.320 (-1.200)
j j
a8 : RETi,t INT_EMPi,t−1 -3.069 (-0.770)
j j j
a9 : DR i,t RETi,t INT_EMPi,t−1 4.063 (0.830)
j j
b7 : DSi,t INT_EMPi,t−1 -1.682 (-1.010)
j j j
b8 : ΔSi,t ⁄MVi,t−1 INT_EMPi,t−1 -9.816b (-2.140)
j j j j
b9 : DSi,t (ΔSi,t ⁄MVi,t−1 )INT_EMPi,t−1 17.874c (2.810)
j j
a10 : DR i,t FCFSHi,t−1 0.006a (1.710)
j j
a11 : RETi,t FCFSHi,t−1 0.022c (3.450)
j j j
a12 : DR i,t RETi,t FCFSHi,t−1 -0.037c (-3.190)
j j
b10 : DSi,t FCFSHi,t−1 0.002 (0.390)
j j j
b11 : ΔSi,t ⁄MVi,t−1 FCFSHi,t−1 0.029c (3.830)
j j j j
b12 : DSi,t (ΔSi,t ⁄MVi,t−1 )FCFSHi,t−1 -0.113c (-5.300)
j
γ2 : INT_TASi,t−1 0.007 (1.870)
j
γ2 : INT_EMPi,t−1 1.291 (0.790)
j
γ3 : FCFSHi,t−1 -0.005c (-3.110)
Number of Obs.: 11,416
Adj. R-Squared: 39.43%
Notes: This table presents the estimation results of the regression model of Eq. (2d):
Eq. (2d): NIi,tj⁄MVi,t−1
j j j j j j j j j j j
= a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t +b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1 + b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) +
j j j j j j j j j j j j
INT_TASi,t−1 {a4 DR i,t + a5 RETi,t + a6 DR i,t RETi,t } + INT_TASi,t−1 {b4 DSi,t + b5 ΔSi,t ⁄MVi,t−1 + b6 DSi,t (ΔSi,t ⁄MVi,t−1 )} +
j j j j j j j j j j j j
INT_EMPi,t−1 {a7 DR i,t + a8 RETi,t + a9 DR i,t RETi,t } + INT_EMPi,t−1 {b7 DSi,t + b8 ΔSi,t ⁄MVi,t−1 + b9 DSi,t (ΔSi,t ⁄MVi,t−1 )} +
j j j j j j j j j j j j
FCFSHi,t−1 {a10 DR i,t + a11 RETi,t + a12 DR i,t RETi,t } + FCFSHi,t−1 {b10 DSi,t + b11 ΔSi,t ⁄MVi,t−1 + b12 DSi,t (ΔSi,t ⁄MVi,t−1 )} +
j j j j
γ1 INT_TASi,t−1 + γ2 INT_EMPi,t−1 + γ3 FCFSHi,t−1 + μi,t

The model is estimated by using firm-clustered standard errors to control for autocorrelation and
heteroscedasticity (Petersen, 2009). Country and year dummies are included. Firm level variables are defined
in Appendix A. a, b and c represent significance levels of 10 percent, 5 percent, and 1 percent, respectively
(two-tailed).

25
Table 5. Sales changes, asymmetric cost behaviour and conditional conservatism
j
Dependent variable = the level of earnings (NIi,t ) scaled with the market value of equity at the beginning of the fiscal year
j j j
(MVi,t−1 ) - NIi,t⁄MVi,t−1

Coefficient estimates (t-stat.)

a0 : 0.018 (1.060)
j
a1 : DR i,t -0.010 (-1.740)
j
a2 : RETi,t 0.048c (3.980)
j j
a3 : DR i,t RETi,t 0.025b (2.375)
j
b1 : DSi,t 0.009 (1.430)
j j
b2 : ΔSi,t⁄MVi,t−1 0.037c (2.790)
j j j
b3 : DSi,t (ΔSi,t ⁄MVi,t−1 ) 0.129c (4.290)
j
a4 : DR i,t−1 0.013 (1.420)
j
a5 : RETi,t−1 0.040c (3.650)
j j
a6 : DR i,t−1 RETi,t−1 0.065c (3.720)
j
b4 : DSi,t−1 -0.002 (-0.220)
j j
b5 : ΔSi,t−1 ⁄MVi,t−1 0.036c (3.160)
j j j
b6 ∶ DSi,t−1 (ΔSi,t−1 ⁄MVi,t−1 ) 0.036c (2.627)
j j
a7 : DR i,t DR i,t−1 -0.022 (-1.850)
j j
a8 ∶ RETi,t DR i,t−1 0.018 (0.640)
j j j j
a9 ∶ DR i,t RETi,t b1 DSi,t DR i,t−1 -0.018 (-0.580)
j j
b7 : DSi,t DSi,t−1 -0.019 (-1.500)
j j j
b8 ∶ ΔSi,t ⁄MVi,t−1 DSi,t−1 0.020 (0.610)
j j j j
b9 ∶ DSi,t (ΔSi,t ⁄MVi,t−1 )DSi,t−1 -0.025b (-2.535)

Number of Obs.: 11,067

Adj. R-Squared: 34,92%

Notes: This table presents the estimation results of the regression model of Eq. (2e):
Eq. (2e): NIi,tj⁄MVi,t−1
j j j j j j j j j j j j
= a0 + a1 DR i,t + a2 RETi,t + a3 DR i,t RETi,t + b1 DSi,t + b2 ΔSi,t ⁄MVi,t−1 + b3 DSi,t (ΔSi,t ⁄MVi,t−1 ) + a4 DR i,t−1 +
j j j j j j j j j j j j
a5 RETi,t−1 + a6 DR i,t−1 RETi,t−1 + b4 DSi,t−1 + b5 ΔSi,t−1 ⁄MVi,t−1 + b6 DSi,t−1 (ΔSi,t−1 ⁄MVi,t−1 ) + DR i,t−1 {a7 DR i,t + a8 RETi,t +
j j j j j j j j j j j
a9 DR i,t RETi,t b1 DSi,t } + DSi,t−1 {b7 DSi,t + b8 ΔSi,t ⁄MVi,t−1 + b9 DSi,t (ΔSi,t ⁄MVi,t−1 )} + μi,t

The model is estimated by using firm-clustered standard errors to control for autocorrelation and
heteroscedasticity (Petersen, 2009). Country and year dummies are included. Firm level variables are defined
in Appendix A. a, b and c represent significance levels of 10 percent, 5 percent, and 1 percent, respectively
(two-tailed).

26
Table 6. Asymmetric cost behavior and discretionary accruals
j
Dependent variable = the level of operational accruals (OP_ACCR i,t ) scaled with the level of total assets at the beginning
j j j
of the fiscal period (TASi,t−1 ) - OP_ACCR i,t⁄TASi,t−1

Model of Eq. (3c) Model of Eq. (3d)

Coefficient estimates (t-stat.) Coefficient estimates (t-stat.)

𝑎0 : -0.027 (-1.150) -0.021 (-0.860)

j
a1 : (1⁄TASi,t−1 ) -48.909 (-1.360) -44.381 (-1.250)
j
b1 : DSi,t -0.012c (-4.710)
j j
a2 : (ΔSi,t ⁄TASi,t−1 ) 0.034 (4.910) 0.013c (3.105)
j j j
b2 : DSi,t (ΔSi,t ⁄TASi,t−1 ) 0.020c (2.838)
j j
a3 : (PPEi,t ⁄TASi,t−1 ) -0.037c (-6.980) -0.039c (-7.410)
j
a4 : ROAi,t 0.0004c (1.580) 0.0004 (1.560)
j
𝑎5 : AS_B_SCi,t -0.006c (-3.403)

Number of Obs.: 12,121 12,121

Adj. R-Squared: 6.29% 6.64%

Notes: This table presents the estimation results of the regression models of Eq. (3c), and Eq. (3d):
Eq. (3c): OP_ACCRji,t⁄TASi,t−1
j j j j j j j j j
= 𝑎0 + a1 (1⁄TASi,t−1 ) + a2 (ΔSi,t ⁄TASi,t−1 ) + a3 (PPEi,t ⁄TASi,t−1 ) + a4 ROAi,t + 𝑎5 AS_B_SCi,t + ei,t

Eq. (3d): OP_ACCRji,t⁄TASi,t−1

j j j j j j j j
= 𝑎0 + a1 (1⁄TASi,t−1 ) + b1 DSi,t + a2 (ΔSi,t ⁄TASi,t−1 ) + b2 DSi,t (ΔSi,t ⁄TASi,t−1 ) +
j j j j
a3 (PPEi,t ⁄TASi,t−1 ) + a4 ROAi,t +ei,t

The models are estimated by using firm-clustered standard errors to control for autocorrelation and
heteroscedasticity (Petersen, 2009). Country and year dummies are included. Firm level variables are defined
in Appendix A. a, b and c represent significance levels of 10 percent, 5 percent, and 1 percent, respectively
(two-tailed).

27
 Table 7. Asymmetric cost behaviour and earnings smoothing
Dependent variable:
j j j
EARN_S_1i,t := the standard deviation of cash flows from operations (CFOi,t ) over the standard deviation of earnings (NIi,t ), in
three-year rolling window.
j j
EARN_S_2i,t = the negative correlation of a firm’s change in discretionary accruals ( D_OP_ACCR i,t ) and its change in pre-
j
discretionary income ( P_NIi,t ), in three-year rolling window.

Dependent variable = EARN_S_1ji,t Dependent variable = EARN_S_2ji,t

Coefficient estimates (t-stat.) Coefficient estimates (t-stat.)

a0 : 4.535c (5.980) -0.464 (-1.260)

j
α1 : AS_B_SCi,t -0.262c (-2.840) -0.030c (-2.880)
j
α2 : BtMi,t 0.098 (1.580) 0.014 (1.350)
j
α3 : LEVi,t 0.004a (1.780) -0.001c (-2.700)
j
α4 : SIZEi,t -0.142c (-5.810) 0.012c (2.620)
j
α5 : M_ROAi,t 0.052c (10.630) 0.005c (4.440)

Number of Obs.: 11,416 8,010

Adj. R-Squared: 8.13% 6.64%

Notes: This table presents the estimation results of the regression models of Eq. (4a), and Eq. (4b):
Eq. (4a): EARN_S_1ji,t = a0 + α1 AS_B_SCi,tj + α2 BtMi,tj + α3 LEVi,tj + α4 SIZEi,tj + α5 M_ROAji,t + eji,t
Eq. (4b): EARN_S_2ji,t = a0 + α1 AS_B_SCi,tj + α2 BtMi,tj + α3 LEVi,tj + α4 SIZEi,tj + α5 M_ROAji,t + eji,t

The models are estimated by using firm-clustered standard errors to control for autocorrelation and
heteroscedasticity (Petersen, 2009). Country and year dummies are included. Firm level variables are defined
in Appendix A. a, b and c represent significance levels of 10 percent, 5 percent, and 1 percent, respectively
(two-tailed).

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