Signaling to Partially Informed Investors in the Newsvendor Model
The Johnson School, Cornell University
Cornell University - Samuel Curtis Johnson Graduate School of Management
Richard K. Lai
The Wharton School, Univ. of Pennsylvania
Harvard University - Technology & Operations Management Unit
February 6, 2012
We investigate a phenomenon in which firms may attempt to influence their market valuation by choosing an inventory stocking quantity which does not optimize expected profits. We employ the newsvendor model within a signaling game to examine a relatively common scenario in which the firm's equity holder has incomplete information concerning the demand for the firm's product. We apply a perfect Bayesian equilibrium solution and identify ranges of model parameters where the firm's stocking quantity decision does not maximize expected profits. This includes instances in which a firm facing high demand chooses a lower stocking quantity than that which would optimize expected profits and a firm facing low demand chooses a higher stocking quantity than that which would optimize expected profits. This result contrasts with prior research, which has shown that when equity holders have incomplete information about the quality of the firm's opportunities, high quality firms will consistently overinvest and low quality firms will invest to optimize expected profits. We show an extreme example of this behavior in which a high demand firm chooses that stocking quantity which would have been optimal under complete information for a low demand firm.
Number of Pages in PDF File: 41
Keywords: Capacity investment, inventory, signaling game, newsvendor
Date posted: April 20, 2011 ; Last revised: March 1, 2012
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