Retail inventories, internal finance, and aggregate fluctuations

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