Do analysts’ gross margin forecasts influence manager's decisions to recognize inventory losses?

Abstract

Accounting standards require firms to write down their inventory when its market value (or net realizable value) drops below cost. Recognizing inventory write-downs decreases gross margins and increases scrutiny of managers’ inventory management practices. Further, it is difficult for market participants to assess inventory balances. Therefore, managers often delay recognizing inventory losses. Compared with other analysts, analysts who issue disaggregated gross margin (GM) forecasts evaluate a firm's inventories more closely, which should motivate managers to recognize expected inventory losses. Consistent with this prediction, managers’ likelihood of recognizing an expected inventory loss increases as more analysts provide GM forecasts. However, the number of analysts issuing standalone earnings per share (EPS) or EPS and other disaggregated forecasts is not associated with inventory loss recognition. We address endogeneity concerns by documenting that firms are less likely to recognize an expected inventory loss after exogenous factors cause analysts to stop issuing GM forecasts for the firm. We contribute significantly to the literature by showing that analysts' GM forecasts are closely associated with managers’ timely inventory loss recognition. This insight bridges the gap between anecdotal evidence, which suggests analysts assess inventory carefully, and scholarly research indicating that analysts' forecasts may not fully capture the effects of inventory changes. Our findings suggest that managers act as if inventory management practices are more strictly monitored only when analysts issue GM forecasts.