Retail Inventories, Internal Finance, and Aggregate Fluctuations: Evidence from Firm-Level U.S. Data

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Research Papers

Retail Inventories, Internal Finance, and Aggregate Fluctuations: Evidence from Firm-Level U.S. Data

August 1997 Number 9722

Author: Egon Zakrajsek

We investigate the implications of capital market imperfections for inventory investment in retail trade, using a new source firm-level data—the micro data underlying the published Quarterly Financial Reports. An error-correction model that includes internal funds and forward-looking expectations for the stochastic process of sales is not rejected by the data. Both the cross-sectional and time-series results are consistent with the existence of significant capital market frictions in the retail trade sector: (1) for firms with limited access to capital markets, internal funds are a significant predictor of inventory investment; (2) the predictive power of internal funds is highly asymmetric over a business cycle, rising considerably in recessions. The quantitative significance of financial factors suggests that a large portion of the observed volatility in aggregate retail inventory investment over a business cycle is due to fluctuations in internal funds.

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