Incentives for Efficient Inventory Management: The Role of Historical Cost

42 Pages Posted: 19 Apr 2000

See all articles by Tim Baldenius

Tim Baldenius

Columbia Buiness School

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business; CESifo (Center for Economic Studies and Ifo Institute)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2000

Abstract

This paper examines inventory management from an incentive and control perspective. We demonstrate that the residual income performance measure based on historical cost accounting provides managers with incentives to make optimal production and inventory depletion decisions. The lower-of-cost-or-market rule is shown to be effective in situations where inventory may become obsolete due to unexpected demand shocks. Our analysis also considers settings in which the unit variable cost of production can be lowered by initial investments. Proper incentives require that the depreciation charges for these initial fixed costs are independent of the actual production and sales quantities. Therefore, a variable costing format, rather than an absorption costing format, is essential for the purpose of managerial performance evaluation.

JEL Classification: D82, J33, M41

Suggested Citation

Baldenius, Tim and Reichelstein, Stefan J., Incentives for Efficient Inventory Management: The Role of Historical Cost (July 2000). Available at SSRN: https://ssrn.com/abstract=218328 or http://dx.doi.org/10.2139/ssrn.218328

Tim Baldenius (Contact Author)

Columbia Buiness School ( email )

3022 Broadway
New York, NY 10027
United States

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-736-1129 (Phone)
650-725-7979 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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