Signals to Partially Informed Investors: Inventory Distortion and Realization of Stock-based Payment

Prior literature has shown that managerial short-termism causes only over-investment at the more efficient type firms for the signaling purpose. Two fundamental assumptions are typically made: the manager’s shortterm incentive is exogenous and the setting of information asymmetry guarantees the manager’s possible payoff functions satisfy the single-crossing condition. In an operations context, this study investigates how a manager’s short-term interest in the firm’s market value influences his inventory decision when the aforementioned assumptions do not hold. We consider the case where the firm’s demand uncertainty can be either high or low, ex ante. The true uncertainty is known to the manager while the investors only know the prior distribution. In contrast to prior literature, we show that both overand understocking can arise at either type of firms. We reveal the critical roles of the magnitude of the manager’s short-term incentive and the firm’s newsvendor critical ratio in determining the impacts of the manager’s short-termism on his inventory decision. Furthermore, we find that when the manager’s short-term incentive is endogenous, it is possible that the inefficient inventory distortions can be resolved for both types of firms. Specifically, in our setting, if the manager has the flexibility to decide the timing and the amount of his stocks to sell, then scenarios exist under the characterized condition, where his private demand uncertainty information can be signaled to the investors through his choice of stock selling instead of inventory distortions. These findings can provide useful insights for understanding managers’ short-termist behaviors.