Cost Behavior Models Analysts and Investors Use

This paper examines cost behavior models implicit in analysts’ and investors’ mind. We reject proportional cost behavior model assumed in prior literature. Analysts seem to recognize variable as well as fixed costs and asymmetric cost behavior, although they marginally incorporate asymmetric cost behavior consistent to recent literature. We find cost-based earnings forecasts have incremental information over analysts’ consensus. Investors primarily rely on cost behavior model implicit in analysts, alluding seemingly inefficient stock valuation. We find abnormal returns by a subset of earnings surprise defined as the difference in cost-based earnings forecast and analysts' consensus. The long-horizon returns are increasing in two types of asymmetric cost behavior, suggesting market pricing of asymmetric cost behavior as a factor rather than under-reaction to earnings surprise.