Signaling to Partially Informed Investors in the Newsvendor Model

41 Pages Posted: 20 Apr 2011 Last revised: 1 Mar 2012

William Schmidt

Cornell University - Samuel Curtis Johnson Graduate School of Management

Vishal Gaur

Cornell University - Samuel Curtis Johnson Graduate School of Management

Richard K. Lai

The Wharton School, Univ. of Pennsylvania

Ananth Raman

Harvard University - Technology & Operations Management Unit

Date Written: February 6, 2012

Abstract

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.

Keywords: Capacity investment, inventory, signaling game, newsvendor

Suggested Citation

Schmidt, William and Gaur, Vishal and Lai, Richard K. and Raman, Ananth, Signaling to Partially Informed Investors in the Newsvendor Model (February 6, 2012). Available at SSRN: https://ssrn.com/abstract=1815207 or http://dx.doi.org/10.2139/ssrn.1815207

William Schmidt (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

Vishal Gaur

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/faculty/profiles/Gaur/

Richard K. Lai

The Wharton School, Univ. of Pennsylvania ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215 898 1630 (Phone)

Ananth Raman

Harvard University - Technology & Operations Management Unit ( email )

Boston, MA 02163
United States
617-495-6937 (Phone)
617-496-4059 (Fax)

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