Why Do Companies Hold Inventory? Evidence from the COVID-19 Crisis

Abstract

We study the role of inventory in corporate financial management using the exogenous shocks to consumer demand, commodity prices, and global supply chains triggered by the COVID-19 pandemic. The sharp, unexpected drop in consumer demand and commodity prices increases the costs of holding inventory. On the flip side, inventory holdings provide a buffer against supply chain disruptions. Empirically, we find that U.S. firms with higher inventory levels experience a more negative stock market response to COVID-19. We identify the causal effects of inventory by controlling for unobserved firm heterogeneity, various firm characteristics, and endogeneity. The negative impact of inventory is more profound for firms with greater exposure to the slump in consumer demand and commodity prices. For firms that experience supply chain disruptions during COVID-19, inventory holdings have compensating effects. Financially constrained firms suffer higher costs of holding inventory during the crisis. We reconfirm that inventory carries significant costs during demand shocks using two other events – the 9/11 terrorist attacks and the global financial crisis.