Munich Personal RePEc Archive

Inventory and the Stock Market

Lai, Richard (2006): Inventory and the Stock Market.

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Abstract

How does the stock market affect inventory decisions? The efficient markets view is that low stock price means poor fundamentals, a higher cost of capital, and lower inventory. Normatively, firms should obtain their cost of capital from an efficient markets model of stock prices. My study is motivated by the growing body of evidence that the stock market is not efficient and can temporarily mis-value firms. I report evidence that the market's behavioral component explains firms' inventory as much as its fundamentals component. I further test three possibilities for how the behavioral component works. The first is a financing channel. When the market over-values firms, firms can get cheaper financing and increase inventory. The second is dissipation. When the market mis-values firms, firms are less disciplined and let inventories rise. The third is catering. When the market discounts high-inventory firms, firms decrease inventory, and vice versa. I report evidence that weakly supports financing, rejects dissipation and strongly supports catering. The findings suggest that we need to find new ways of calculating the cost of capital for operations models. They could begin to form the basis of a more empirically accurate account of how inventory decisions are affected by financial markets.

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