Should Inventory Policy Be Lean or Responsive? Evidence for US Public Companies
31 Pages Posted: 4 Sep 2013
Date Written: September 3, 2007
Using financial accounting panel data from the COMPUSTAT database for a universe of all inventory-carrying companies in the period from 1994 to 2003, we develop a statistical methodology that links managerial decisions about inventory with accounting returns. We find that, after we control for industry- and firm-specific effects, superior earnings are associated with appropriately defined responsiveness in inventory management. Specifically, we define responsiveness as the difference between the percentage change in inventory level (over time) and the percentage change in sales (over time), such that a positive (negative) responsiveness measure implies that inventory is growing (declining) relative to sales. We find evidence both across time and in a cross-section that current ROA (return on assets) and forwarded ROA are asymmetrically associated with inventory responsiveness. Namely, faster inventory growth and a faster decline relative to sales are both associated with lower profitability. Our findings are partially consistent with the intuition of investment analysts and managers, who use a similar measure of responsiveness in practice to predict/assess the financial performance of a company, and they are also consistent with the results of classical inventory models.
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