The Roles of Excess Inventory with Stock Price Interest
Classic inventory theories typically focus on the operational tradeoffs to optimize the inventory<br>decisions. However, managers of public firms might alter their inventory operations to<br>influence their stock price. We develop a stylized model which shows that in the presence of an<br>interest in the stock price, managers overinstall inventory when it can either stimulate the sales<br>or deflate the reported cost of goods sold (COGS) even if the market anticipates such actions<br>in equilibrium. We then conduct an empirical analysis based on the financial data of the U.S.<br>listed public companies. We find that the increase of inventory in the last fiscal quarter has<br>a significantly positive correlation with the top executives’ interest in their firm’s stock price<br>(measured by the weight of their stock and option compensation and the firm’s earnings status).<br>This effect becomes statistically weaker after the implementation of the Sarbanes–Oxley Act in<br>2002. Our empirical results also suggest that for the retailers, the excess inventory likely “pulls”<br>future demand to the current period and thus negatively impacts the sales of the first fiscal<br>quarter of next year, while for the manufacturers, the excess inventory likely “shifts” a part of<br>the costs to the future and thus negatively impacts the gross margin of the first fiscal quarter<br>of next year. On the other hand, the market might have taken such managerial incentives into<br>account. We find that the stock price reacts less to a sales increase or a reduction of COGS but<br>more to an increase of inventory, when the executives’ stock price interest is stronger.