SFAS No. 151, requiring for reporting idle capacity costs, provides an ideal opportunity to examine how the unused capacity reporting rules affect managers’ behavior regarding capacity investments. This requirement for reporting idle capacity expense may cause managers to actively engage in capacity management in a timely manner by way of changing real economic decisions, such as capacity investment level. Therefore, this study is motivated to examine whether a firm’s over-investment behavior is associated with the mandatory adoption of accounting standard for reporting idle capacity costs. The first purpose of this study is to examine whether the adoption of SFAS 151 leads to a reduction in over-investment in capacity of firms. The second purpose of this study is to examine whether the change in over-investment after adopting SFAS 151 vary with a firm’s prior fixed asset intensity, prior over-investment level, and expected future growth. Using a sample drawn from the U.S. manufacturing firms from 2000 to 2009, this paper provides several findings. First, this study finds that a firm’s over-investment in capacity decreases significantly in the post-periods of implementing SFAS No. 151. Second, we find that the more the firms’ fixed asset intensity, the less the decrease in firms’ over-investment induced by SFAS 151, implying that the effect of cost stickiness for firms with higher fixed asset intensity dominates the pressure imposed by SFAS No. 151 on firms to reveal idle capacity expenses. In addition, we cannot find the effect of adopting SFAS No. 151 on overinvestment to vary with the experience of firms’ prior overinvestment. Finally, the result reveals that managers of high-growth firms will reduce the over-investment level less than low-growth firms in response to SFAS No. 151.

How the Managerial Investment Decision Changes in Response to the Mandatory Accounting Standard for Reporting Unused Capacity? The Case of SFAS No. 151.

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