Inventory Signals

Abstract

How does operational competence translate into market value, when firms cannot credibly communicate their competence to the market? I consider the example of inventory and fill rates. When the market sees a high-inventory firm, it cannot tell whether the inventory is due to incompetence or a strategy to enhance fill rate. Firms might decide to signal their competence to the market by carrying less inventory. I show conditions for separating and pooling perfect Bayesian equilibria. I also provide empirical evidence for this theory that inventory has a signaling role. The theory could potentially provide a framework that describes one way in which a range of operational competences such as purchasing and outsourcing, translate to market value. Practically, it has implications for firms, such as how to strategically communicate to the market, reward managers, or even whether to go public and be subject to market pressures.

Keywords: Inventory, signaling, operations management, asymmetric information

JEL Classification: D24, D82, M11