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: | Reichelstein Stefan, Baldenius Tim |
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.