Intellectual Capital

What can be learned about a company's financial well-being from its inventory practices? Do CEOs' shareholder letters drop hints about pending change? Two Vanderbilt professors want to know.

From the Fall 2014 edition of Vanderbilt Business

As members of one of the nation’s top research universities, Owen faculty always have something interesting on their minds. Here’s a portion of what two faculty members are currently pondering.

Yasin Alan

Yasin AlanWho: Assistant Professor of Operations Management Yasin Alan. He arrived at Vanderbilt in 2012 after receiving his Ph.D. in production and operations management from Cornell University’s Johnson Graduate School of Management. He currently teaches the core operations management course and an elective course in supply chain management in Vanderbilt’s full-time MBA program. Alan holds two patents in inventory and systems management.

What he’s researching: When Alan tells nonacademics that he studies the relationship between a company’s inventory performance and its finances, he quietly braces for the inevitable question: Isn’t that obvious? If a company is selling its goods quickly, the stock should go up; if not, watch out for financial distress. But the relationship is not as straightforward as it sounds—and proving so with real data is even harder.

“Yes, there are lots of correlations, but showing a causal relation is very difficult,” Alan says. In particular, Alan wants to know if there are early signals about a company’s financial performance that investors can glean from inventory metrics.

For example, a recent paper Alan co-authored for the journal Management Science involved ranking retail companies according to their rate of inventory turnover in several different retail segments. The study then tested a portfolio strategy that involved buying stocks in companies in the top 40 percent of the segments—the high performers—and selling the bottom 40 percent in each segment. The result: The portfolio showed a 1 percent average monthly gain over market benchmarks. The results stayed consistent over a 25-year period.

The study also found that there tends to be a 1-to 2-year lag between the time a company makes inventory information public and when it gets reflected in the stock price. For Alan, this helped confirm earlier studies showing that market participants do not fully understand how to incorporate inventory information into their trading strategies and consequently are leaving money on the table.

Alan’s work gets at the interplay of inventory and company performance in other ways as well. One ongoing study examines how inventory indicators may serve as an early warning for bankruptcy. Similar to his work on stock returns, Alan wants to know if there are key operational metrics that could suggest bankruptcy risk long before a negative stock price or earning trend becomes apparent. The study is still in progress, but Alan has seen indications that bolster his hypothesis.

Another avenue of Alan’s research may seem obvious until you dig deeper into the questions being posed and answered. In this case, he’s working with Owen faculty colleagues Michael Lapré and Gary Scudder to understand what operational dimensions have the most impact on airline profitability. “Is it pricing? Is it managing connections? Is it labor? Fuel?” he asks. “We want to know which components have the biggest effects on profitability.” Alan explains that a low-cost airline like Southwest—rising during the same period that many legacy carriers faced bankruptcy—offers an ideal case study to tease out which operational functions play the biggest roles in profitability.

Why it’s important: Alan’s work is part of an emerging field that ties together traditional operations management and finance. At its core, his research topics revolve in many ways around identifying and managing risk. Alan is also exploring how banks value the inventory collateral they use for loans. Currently, banks tend to use rules of thumb to place a value on inventory. Alan wants to develop a more refined, informative approach for banks to value inventory collateral fairly.

Catherine F. Lee

Who: Catherine Lee joined the school’s accounting group in 2013, in what is somewhat of a return home. She grew up in Middle Tennessee and attended Nashville’s Hume-Fogg Academic High School before going to Princeton University to study engineering. From there she worked as an investment banking associate in renewable energies for JPMorgan Chase. She later earned her MBA and Ph.D. from the University of Chicago. “I really enjoyed working on Wall Street,” she says. “But building investment models for clients all day didn’t involve a lot of thinking about the bigger questions.”

Catherine LeeWhat she’s researching: Disclosures. That may seem like a pretty dry topic for someone interested in the “bigger questions” of accounting and finance, but Lee relishes the opportunity to explore seemingly mundane topics in new and different ways. For example, she enjoys guiding her accounting students through CEO shareholder letters.

“It’s kind of like finding the meaning in a novel. It’s amazing what little gems are there,” she says, fully acknowledging that only a true accounting nerd could say something like that. Lee says shareholder letters often drop key hints about the future direction of large public companies. One example she likes to discuss with students is a letter written by Starbucks CEO Howard Schultz just before the company announced a return to its roots and a major retrenchment of its rapid growth strategy. “He starts with this wistful recounting of the company’s original Pike Place location in Seattle,” she says. “Then several months later, they began closing stores. It’s pretty fascinating.” Along the same lines, Lee is starting to look at how material disclosures made in social media—not just by companies themselves, but by clients, partners and suppliers—can affect stock performance.

In another line of research, Lee examines the political influence corporations have on accounting policies and regulation. She says the lobbying money spent by companies to influence the outcome of the 2004 American Jobs Creation Act offers a window into how certain kinds of companies react to changes in accounting regulations. “There aren’t many opportunities to measure how much companies care about certain accounting policies,” she says. “Normally, a company either submits comments to FASB (Financial Accounting Standards Board) or they don’t. With the 2004 Jobs Act, we can see the magnitude—based on how much money is spent on lobbying—to which managers are concerned about how the changes will affect their financial statements.” But asked whether companies or their executives should be required to disclose more of their lobbying activities in financial statements, Lee comes down as a firm “no.” For starters, she says that information is already publicly available through campaign finance laws for any investor who wants to find it. And making political expenditures part of a financial statement, she says, may infect the financial markets with the same caustic elements currently bedeviling the political arena.

Why it’s important: Lee initially decided to pursue a Ph.D. in accounting because it offers the tools and language to understand what’s really happening in a company. That’s still the common thread that underlies her research: Discovering new ways to view a firm’s internal economics. “I’ve always been interested in understanding what motivates managers to make the choices they do. Accounting is a tool that allows me to do that.”