Price Changes, Resource Adjustments and Rational Expectations

This study investigates the relationship between the accuracy of managerial demand expectations, resource adjustment decisions and selling price changes. In line with rational expectation theory, it is argued that managers adjust resources and selling prices differently in response to expected compared to unexpected demand shocks. The association is tested using the empirical concept of cost stickiness. Cost stickiness arises as a consequence of asymmetric resource or price adjustments. Resource and price adjustments are termed asymmetric if the magnitude of change is different for increases
compared to decreases in activity. Based on a longitudinal dataset of 1,677 private and public companies in Denmark, this paper shows that asymmetric resource adjustments are associated with unforeseen negative demand shocks. Cost stickiness due to asymmetric price adjustments however result from a decrease in prices through managers that anticipated the drop in demand
and proactively lower selling prices and cut resources. Moreover, this study provides evidence for the moderating effect of managerial forecast accuracy on the relationship between demand uncertainty and cost elasticity. Findings show that cost elasticity is higher when a demand decrease is expected among companies with similar exposure to demand uncertainty. Overall, this implies that managerial competences in predicting future demand significantly determines firms’ profitability; especially when demand uncertainty is high or macroeconomic growth is declining.