Unraveling the Black Box of Cost Behavior: An Empirical Investigation of Risk Drivers, Managerial Resource Procurement, and Cost Elasticity

Abstract

ABSTRACT This paper extends prior literature on cost behavior by providing insights into how firms achieve changes to cost structure in response to two important risk drivers, i.e., demand uncertainty and financial risk. Using theory from labor economics, supply-chain management, and finance, we posit that demand uncertainty and financial risk influence cost management activities. Specifically, we argue that firms are likely to alter resource procurement choices to increase cost elasticity in response to these two risk drivers. We use data from California hospitals that allow for the calibration of three distinct resource procurement choices that increase cost elasticity: outsourcing, leasing of equipment, and hiring contract labor. Mediation analysis using 2,202 hospital year observations indicates that both demand uncertainty and financial risk influence cost elasticity. Importantly, these effects are mediated by the three aforementioned resource procurement choices. Overall, our findings support the view that firms make procurement choices to manage the risk associated with cost structures. Data Availability: Data used in this study are publicly available from the Office of Statewide Health Planning and Development (see: http://www.oshpd.ca.gov/). JEL Classifications: I18; M41.