Is Inventory's Fiscal Year End Effect Caused by Sales Timing? A Test Using a Natural Experiment from Germany

Abstract:     
One explanation for firms' inventory cycles is that they are tied to the calendar year, reflecting fundamental demand seasonality. But we find that these cycles are also tied to the fiscal year, an accounting artifact constructed by firms themselves. Specifically, inventory is lower at fiscal year end (FYE), a phenomenon we call inventory's FYE effect. Among U.S. manufacturers, wholesalers, and retailers, we find inventory is 10% lower at FYE than at other times of the fiscal year, controlling for calendar time. In aggregate, this 10% is $47 billion, valued at cost of goods. One possible explanation for the FYE effect is sales timing, in which executives' private benefits lead them to pull some post-FYE sales into the FYE. But the literature suggests three alternative hypotheses that can also explain the FYE effect. To test for sales timing, we employ a novel natural experiment based on Germany's tax code change in 2000, when some firms change their FYEs in a way that is plausibly exogenous to inventory patterns. We find that these German firms also have lower inventory at FYE. This result is robust to corrections for possible treatment selection using the Heckit procedure and propensity scoring. We also examine mediator and moderator effects. For example, the link from FYE to lower inventory is mediated by lower margins and higher sales. Firms whose executive compensations have a higher bonus component have a stronger FYE effect. Taken together, the evidence is consistent with sales timing, but is not explained by the alternative hypotheses. Finally, we estimate that 1 percentage point lower inventory at FYE is associated with an economically significant 1.7% lower Tobin's q, which is due to lower gross profits and higher costs like inventory holdings expenses and capacity investments. We conclude with a discussion of limitations, next steps, and some intriguing implications for research and practice.

Keywords: Inventory, operations, fiscal year end, agency

JEL Classifications: D24, D82, M11, E32

Working Paper Series