Firms' Inventory Choices During the Great Recession
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Citation of Original PublicationGupta, M., M. Pevzner, and C. Seethamraju (2014). Firms’ Inventory choices during the Great Recession of 2007-09. Contemporary Accounting Research.
We study how the interplay between firms’ fixed cost structure and their initial inventory levels influences these firms’ inventory production decisions. We also examine the consequences of those decisions for the firms’ accounting and stock performance during the 2008-09 recession (hereafter “the recession”). In particular, we examine the interaction of firms’ initial inventory levels and fixed production costs structure during the recession and how that interaction: 1) impacts firms’ contemporaneous and subsequent inventory changes; 2) affects contemporaneous and future accounting performance; 3) affects analysts’ expectations of future earnings, and 4) is perceived by the stock market. We find that firms with high fixed production costs and high initial inventories reduce their inventories more substantially than other firms both in 2008 and 2009. These firms take a greater hit to their earnings in 2009 as a result of those cuts. We also find that such firms tend to increase their inventories in 2010 and their earnings improve substantially relative to other firms. This result is consistent with the notion that firms undertake excessive inventory production decreases during recessions, and then take advantage of those production decreases as the recession ends. Financial analysts appear to anticipate this improvement in earnings and incorporate this information in their forecasts. Consistent with this, the stock market reacts favorably to the actions that firms took with respect to their inventories.