Cost Stickiness, Absorbed Slack, and Enterprise Risks: Evidence from China

First Subtopic: Cost Stickiness and Enterprise Risks

Cost stickiness is the situation where costs do not decrease in proportion to a reduction in output levels. This phenomenon creates a protective mechanism that preserves profit margins during economic contractions.

Conversely, enterprise risks represent the latent dangers that can undermine even the best-laid plans. Effective risk management entails the identification and reduction of such risks, as well as the strategic use of these risks to foster innovation and business growth.

Together, cost stickiness, absorbed slack, and enterprise risks interact to shape the trajectory of a business.

Cost stickiness can lead to increased earnings and asset volatility, raising the default and credit risks for the enterprise. It can also exacerbate the agency problem within an enterprise, where managers, influenced by self-interest, may lead business decision-making away from optimal resource allocation, increasing the cost stickiness and consequently the risk faced by the enterprise.

Second Subtopic: Absorbed Slack as a Mediator

Absorbed slack is the buffer that allows for the absorption of shocks without compromising the core operations. It is less liquid and flexible than unabsorbed slack, making it more difficult for managers to recognize and exploit.

When an enterprise fails to cut down on some resources, these resources are gradually absorbed by the enterprise and become absorbed slack with lower recognizability. This can result in the quantification of financial statements and a reduction of accounting information quality, which in turn pushes up the cost of debt and equity financing and heightens the enterprise's financial risk.

Research suggests that absorbed slack mediates the relationship between cost stickiness and enterprise risks. By understanding and addressing the factors that contribute to absorbed slack, enterprises can mitigate the risks associated with cost stickiness and enhance their overall risk management capabilities.