Corporate holding of finished goods inventories

This paper investigates the effects of stock out avoidance and market competition on corporate holding of finished goods inventories. We consider two adverse consequences of stock outs: immediate forgone profit and long-run loss of revenue from the shift of customers to more reliable sources of supply. Firms are more inclined to avoid stock outs with greater inventory if the potential for profit is greater. Therefore, we expect inventories to be increasing in the profit margins of firms. In addition, the likelihood of lost revenue from the loss of disenfranchised customers depends upon the alternative sources of supply that are available. If there are good alternative sources, the prospect of long-term revenue loss is greater. The adverse consequence of stock outs is therefore influenced by market competition and we expect the relation between finished goods inventories and the market-power of firms to be negative. In empirical testing, we find evidence consistent with these predictions.