Asymmetric Inventory Management and the Direction of Sales Changes*

Abstract

We study manufacturing firms' asymmetric inventory investment in response to sales changes. Focusing on the costs of resource adjustment and stockout that likely differ in sales‐increasing and sales‐decreasing periods, we predict and find that inventory investment declines less during periods with sales decreases than it rises during periods with sales increases. We validate this claim by showing that managers' expectations of future demand and desire to avoid inventory stockouts are important determinants of this asymmetry. In addition, we find that asymmetric inventory investment provides useful information for predicting future sales growth, and that both managers' and analysts' sales forecasts are positively associated with the asymmetry. Lastly, we document that forecasts of future sales growth that incorporate asymmetric inventory investment are associated with lower absolute forecast errors than benchmark forecasts. Overall, we highlight the importance of inventory information in understanding managers' resource adjustment and utilization decisions that have implications for forecasting future demand. Our findings on asymmetric inventory management provide new insights to fundamental analysis based on inventory signals.

Policy uncertainty and inventory behavior: Evidence from the US manufacturing sector

“…Extant literature documents that financial constraints can restrict a firm's inventory investment ability (Carpenter et al, 1994;Dasgupta et al, 2019;Kashyap et al, 1994). In line with this, Hwang et al (2021) show a negative relationship between financial constraints and asymmetric inventory investment. The higher cost of financing due to an increase in EPU, as reported by Veronesi (2012, 2013), Kaviani et al (2020), andXu (2020), may result in an increased opportunity cost for funding and maintaining capacity.…”

“…Asymmetric inventory investment is related to economic optimization and is dependent on the production and adjustment costs of a firm (Pindyck, 1982). Overall, managers seek to minimize production and potential stockout costs, and adjust inventory investment to reflect their expectations about future demand (Hwang et al, 2021). If production costs have been minimized by keeping unused capacity low, the extent to which inventory investment declines in response to a decrease in sales is lower.…”

Detecting overproduction: Evidence from inventory write‐down

“…To relax this assumption, several papers modify the traditional proxy by incorporating additional variables into the production model. For instance, Gunny (2010) adds firm growth to the model to capture the effect of the investment opportunity set; Cohen et al (2020) add a decline in sales to capture the effect of the asymmetric behaviour of costs (Anderson et al, 2003; Hwang et al, 2021); and Gilliam (2021) adds several firm characteristics, including performance, size, gross margin, past expenditure trends and past inventory growth, to the model. We call these proxies Resid_Growth , Resid_RevDec , and Resid_Chars , respectively.…”

“…Our sample comes from the Compustat annual file covering the period from 2013 to 2015. In line with prior literature on overproduction (Hwang et al, 2021; Jiambalvo et al, 1997), we focus on manufacturing firms, i.e., firms with an SIC between 2000 and 3999. We follow prior literature on how to construct the various overproduction proxies (Cohen et al, 2020; Gilliam, 2021; Gunny, 2010; Jiambalvo et al, 1997; Kothari et al, 2016; Lev & Thiagarajan, 1993; Roychowdhury, 2006; Srivastava, 2019) and exclude firm‐year observations that do not meet the specific data availability requirements for each proxy.…”

“…Second, managers may produce more than usual and stockpile inventory to mitigate future operational risks such as disruption of future production activities due to a strike (Hamm et al, 2022; Neumann & Reder, 1984). In the event of an unexpected decline in current period sales, firms may overproduce due to either their inability to adjust their production level in response to negative economic shocks to demand (Gupta et al, 2010) or a desire to avoid resource adjustment costs (e.g., fixed capacity adjustment costs and employee lay‐off costs; Brüggen et al, 2011; Hwang et al, 2021).…”