Incentives for Efficient Inventory Management: The Role of Historical Cost

Tim Baldenius () and Stefan Reichelstein ()
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Tim Baldenius: Graduate School of Business, Columbia University, New York, New York 10027
Stefan Reichelstein: Graduate School of Business, Stanford University, Stanford, California 94305

Management Science, 2005, vol. 51, issue 7, 1032-1045

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.

Keywords: inventory management; historical cost accounting; decentralization; agency theory (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (13)

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