INTERIM INVENTORY ESTIMATION ERROR AND THE VOLATILITY OF STOCK PRICES

Many professional accounting groups seek to make interim financial reports more reliable so as to foster more reliable expectations based on these reports. Narrowing the gap between expectations and actual results can dampen the volatility of stock prices, for example. By lessening volatility, economic efficiency is upgraded, internal decision-making is improved, and investors will benefit. A study was done on the relationship between the interim inventory figure and stock price volatility. This interim inventory figure was suspected of containing potential errors because of: 1. use of the 'gross profit method' for making inventory estimations, 2. technical layering problems associated with using LIFO to value interim inventories, and 3. record-keeping errors in inventory systems. A linkage model was developed based upon the idea that a given error in estimated interim inventory figures will have a larger impact on firms whose inventory is large, in relation to net income. A sample of 122 firms was examined with respect to inventory/net income, earnings volatility, and stock price volatility. An observable link was found to exist between interim estimation errors and stock price volatility.