Magazine article Journal of Services Research

Increased Interest Expense and Management's Expense Preference Behaviour of Publicly-Traded Restaurant Firms

Magazine article Journal of Services Research

Increased Interest Expense and Management's Expense Preference Behaviour of Publicly-Traded Restaurant Firms

Article excerpt

INTRODUCTION AND BACKGROUND

While the ultimate goal of firms should be to maximise profits, there is a conflicting view that some managers will exhibit expense preference behaviour under certain circumstances. This behaviour leads managers to spend money on items that are within their control to better their position monetarily instead of maximising shareholder wealth. For example, defense contractors frequently obtain cost-plus contracts, meaning that they charge the government a fixed percentage above the total cost incurred on a particular project. In this case, it is in the interest of the contractor to inflate expenses to earn higher revenues. The phenomenon of expense preference behaviour has been examined in many contexts; such as firms operating in regulated industries, competition levels due to market structure, and organisational structure. For example, Gropper and Oswald (1996) explain the behaviour of managers with respect to expense preference theory in a situation when deregulation occurs in a previously highly regulated industry.

The purpose of this paper is to evaluate the effect of interest rates changes on publicly traded restaurant firms by assessing whether or not managers adjust other expenses down as interest expense increases. To our knowledge, only one previous study has been done on expense preference theory in the hospitality sector or the restaurant industry.

The examination of the expense preference behaviour has primarily been focused on individual industries and we could not find any papers that consolidate all industries to study this behaviour. Research has found that as firms are deregulated, there is less expense preference behaviour (Gropper and Hudson, 2003; Gropper and Oswald, 1996; Mixon and Upadhyaya, 1996). More expense behaviour is shown when firms have little competition (Rhoades, 1980). Finally, not-for-profit organisations tend to exhibit higher expense preference behaviour (Oswald et al., 1994). However, there has been one study, (Kim et al., 2007), that examines firms in an industry which is not regulated and also has high competition. (Kim et al., 2007) focuses on firm profitability when there is a decrease in the percentage ownership by the managers. They find that for owner-managed firms, profitability declines as the percentage ownership declines to less than 50%. The main difference between Kim et. al. and our study is that we investigate the expense behaviour of managers when there is an exogenous shock to the system. For example, interest expense of firms increases when the Federal Reserve board raises interest rates. Firms with substantial profit margins are able to withstand the increase in interest expenses easily without causing any significant decrease in profits. However, if the firm has a very low profit margin, an increase in any one category of expenses can significantly affect profit margins and managers would need to decrease other expenses to maintain an acceptable profit. We posit that firms in low-margin unregulated industries will decrease other types of expenses if there is an exogenous shock resulting in an increase in one type of expense (in this case, interest expense).

We chose to test this using a sample of restaurant firms for a couple of reasons. The restaurant industry is low profit margin yet highly competitive. In addition, of all the studies on expense behaviour, only one paper targets the hospitality industry. Moreover, expense preference behaviour can be a significant problem in the restaurant industry because restaurants only average approximately a 5 percent net income margin. We calculated this average based on COMPUSTAT data for all public restaurants in SIC code 5812 for 2000-2007. The majority of expenses in the restaurant industry fall into two main categories, cost of goods sold and labour expenses. Cost of goods sold expense comprises food, beverage and paper costs for fast food restaurants, while labour expense includes payroll and benefits. …

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