The Information Content of the SG&A Ratio

An increase in the ratio of SG&A costs to sales is associated with contradictory interpretations, namely a negative one due to deficient cost control and a positive one derived primarily from “cost stickiness.” Based on these conflicting explanations, we argue that it is crucial to distinguish between whether an increase in the ratio of SG&A costs to sales is actually intended by management in order to enhance future profitability. We regard an increase as intended if a company’s past SG&A ratio was below its industry average, representing efficiency in SG&A cost management. Indeed, these intended increases significantly enhance future earnings. We attribute this positive impact to lower future cost of goods sold and show that it is particularly strong if there is ample latitude for reduction of these costs. This finding suggests that intended SG&A expenditures partially represent investments in operating efficiency.