Demand downside risk and cost structure

Purpose This study investigates the impact of demand downside risk (DDR) on firms’ cost structure decisions. Drawing on Expected Utility Theory, we hypothesise that heightened DDR is associated with a less rigid cost structure, characterised by relatively lower fixed and higher variable costs. We reason that, when economic and political shocks are notably high, managers seek to avoid committed costs to limit the firm’s exposure to unfavourable demand realisations. Design/methodology/approach We used a fixed-effect model and a sample of 804 firm-year observations for manufacturing firms publicly traded on the Egyptian stock exchange between 2002 and 2019 to examine how DDR affects cost structure. Findings The empirical findings strongly confirm that firms operating in a DDR environment adopt less rigid cost structure to mitigate the high potential unfavourable demand realisations. Our results are robust to alternative model specifications. Originality/value This paper is the first of its kind to examine the cost structure of manufacturing firms in a context characterised by a high and pronounced DDR. The prior literature attempted to capture this relationship in a normal context of demand uncertainty, or a context of economic policy uncertainty (EPU), which does not reflect a high and pronounced DDR.