The Effects of Inventory on the Association between Sales Manipulation and Future Profitability
Asian Tax Journal Vol. 19 No. 1 (2018), pp. 213-237
Abstract
The purpose of this paper is to test whether the relation between sales manipulation and future profitability differs across the business environments. Specifically, we focus on the condition where the inventory level is higher than peers and the inventory－to－asset is decreasing. In this circumstance, we predict sales manipulation is not likely to decrease future profitability. Sales manipulation refers to providing customers drastic discounts or extending credit, and increases immediate revenue and profit but impedes economic substance and future performance. However, if firm does not conduct sales promotions in spite of inventory pileup, the firm will experience increased inventory cost and losses from inventory obsolescence. If this is the case, it will be rational for managers to conduct sales manipulation through discount promotion and extending credit to its customers, that is, sales manipulation is rational behavior of managers to avoid additional losses rather than manager’s opportunistic behavior. Therefore, we expect sales manipulations conducted by firms experiencing high－and－decreasing inventory level are not likely to decrease future profitability. We find, consistent with prior studies, sales manipulation tends to decrease future profitability in general. However, sales manipulations of inventory－pileup－firms are not likely to decrease future profitability. In addition, we find the nonnegative relation between sales manipulation and future profitability is stronger in declining and less profitable firms. To sum up, our findings imply that not all the sales manipulations are neither motivated by opportunistic behavior nor hampering future profitability. We suggest that stakeholders of financial statements should consider the circumstances and environments surrounding the firm when they interpret the sales manipulation.
Keywords
- sales manipulation
- real earnings management
- inventory
- future profitability
- rational behavior
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