Channel Stuffing with Short-Term Interest in Market Value

55 Pages Posted: 30 Apr 2008 Last revised: 2 Oct 2010

See all articles by Guoming Lai

Guoming Lai

University of Texas at Austin - Red McCombs School of Business

Laurens Debo

Dartmouth College - Tuck School of Business

Lin Nan

Purdue University

Abstract

We study an extension of a two-period inventory management problem with positively correlated demands in which the manager's compensation is partially based on an external, market-based assessment of the firm's value. As typically the "real'' demand is only observed internally in the firm, the manager may ship more than the real demand to downstream customers and report higher than real sales revenues to influence the external firm valuation, which is known as "channel stuffing." As it is costly and does not reflect the real demand, channel stuffing destroys the firm's value. We identify three factors that drive the manager's incentives for channel stuffing: the marginal effect, the boundary effect and the carryover effect. The marginal effect, analogous to those earnings management incentives revealed in the literature (e.g., Stein 1989), is independent of the inventory problem, while the boundary and carryover effects arise from the nature of the inventory problem. The boundary effect occurs when the real demand realization is high, but, still less than the available inventory: reporting a "sold out" situation censors the upper tail of the demand distribution, and hence, leads to an increase in market valuation that the manager would like to cash in with channel stuffing. The carryover effect occurs when the real demand realization is low. In this scenario, channel stuffing would make the firm's future performance look more rosy because of positively correlated future demand and high future sales margin as the firm will be able to satisfy the future demand from the large current inventory. When examining the initial inventory decision, we find that under rational market valuation, both over- and under-investment may arise in presence of channel stuffing incentives. Based on our model analysis, we derive empirically testable hypotheses for channel stuffing.

Keywords: Channel Stuffing, Inventory Management, Market-based Compensation

JEL Classification: D82, J33, M41, M43, M46, L23

Suggested Citation

Lai, Guoming and Debo, Laurens and Nan, Lin, Channel Stuffing with Short-Term Interest in Market Value. Available at SSRN: https://ssrn.com/abstract=1126778 or http://dx.doi.org/10.2139/ssrn.1126778

Guoming Lai (Contact Author)

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

Laurens Debo

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

Lin Nan

Purdue University ( email )

100 S Grant St
West Lafayette, IN 47907
United States
7654960551 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
446
Abstract Views
2,766
rank
64,461
PlumX Metrics