Exploring the Predictive Ability of Cost Asymmetry on Bankruptcy

This study explores whether the intensity of cost asymmetry matters for bankruptcy prediction. An increased level of cost asymmetry implies increased requirements to finance a high level of adjustment costs due to high investments in prior period resource levels, decreased operating efficiency and negative market reactions. In addition, a high level of cost stickiness driven by intense empire building behaviour consumes valuable resources and it signalizes weaker corporate governance mechanisms and auditing efficiency. For these reasons, we speculate that that the intensity of cost asymmetry tends to be positively associated with the likelihood a firm to file delisting for bankruptcy or liquidity issues. Using 54,468 firm-years observations of US publicly listed firms over the period 1990-2020, we provide empirical evidence that the level of cost asymmetry is incrementally useful for bankruptcy prediction. Our findings are more profound in firms experience small and medium current sales changes and in firms with high managerial incentives. Additional robustness tests reveal that our empirical results remain robust against: (i) the effects of financial constraints on the intensity of cost asymmetry, (ii) alternative specifications of cost asymmetry, and (iii) in partitioned samples, propensity-scored for cost asymmetry