Accounting-Based Incentives Can Induce Cyclical Inventory Build-Ups

Abstract

It is well established that accounting based incentive schemes can induce managers to adapt their behavior to manipulate accounting metrics even if such behavior is not in the best interest of the firm. Using a parsimonious model, this paper establishes how common accounting based bonus schemes can induce a manager to delay write-off decisions and keep excess inventory. In particular, it suggests a cyclical pattern where excess inventory is gradually built-up and then written off and discarded all at once.