Tests of the impact of LIFO adoption on stockholders: A stochastic dominance approach*

Abstract

This study examines the possible economic impact of a firm's decision to switch its inventory costing to LIFO. The contradictory conclusions of previous studies may stem from their use of empirical research methods (e.g., the market model) with overly strong assumptions. The current study applies an alternative approach; it utilizes a research method which relies on two versions of the second degree stochastic dominance critedon: the standard second degree stochastic dominance and stochastic dominance with lending and borrowing. These cdteria examine changes in stockholders' welfare by considedng simultaneously dsk and possible outcomes in a more general manner. They do not require the assumptions of the market model, nor do they necessitate the estimation of specific dsk measures such as stock beta. The stochastic dominance approach is applied to a sample of firms that switched from FIFO to LIFO, and to a control group of firms that did not. The results do not support the hypothesis that stockholders' welfare is affected by corporate LIFO adoption. * Financial support from the Recanati Foundation is gratefully acknowledged. We thank Jeffrey Callen, Haim Falk, Yoram Kroll, Haim Levy, Joshua Livnat and three referees of this joumal for helpful suggestions. Any remaining errors are, of course, ours.

Strategic choice of inventory accounting methods*

“…It is well known that in inflationary periods, the last-in-first-out (LIFO) inventory accounting method yields tax benefits over the first-in-first-out (FIFO) inventory accounting method. Ample research has investigated whether or not the capital market favorably responds to LIFO adoptions due to the tax benefits (e.g.. Sunder 1973;Abdel-Khalik and McKeown 1978;Brown 1980;Ricks 1982Ricks , 1986Biddle and Lindahl 1982;Aharony and Bar-Yosef 1987). The results of these studies, however, were not conclusive.…”