Incentives for efficient inventory management: the role of historical cost

Incentives for efficient inventory management: the role of historical cost

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Article ID: iaor20073502
Country: United States
Volume: 51
Issue: 7
Start Page Number: 1032
End Page Number: 1045
Publication Date: Jul 2005
Journal: Management Science
Authors: ,
Abstract:

This paper examines inventory management from an incentive perspective. We show that when a manager has private information about future attainable revenues, the residual income performance measure based on historical cost can achieve optimal (second-best) incentives with regard to managerial effort as well as production and sales decisions. The LIFO (last-in-first-out) inventory flow rule is shown to be preferable to the FIFO (first-in-first-out) rule for the purpose of aligning incentives. Our analysis also finds support for the lower-of-cost-or-market inventory-valuation rule in situations where the manager receives new information after the initial contracting stage.

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