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Are Inventories A Buffer Against Weak Legal Systems?

  • A.V. Raja

    (University of Hamburg)

  • Hans-Bernd Schäfer

    (University of Hamburg, Germany)

Weak enforcement of contracts leads to inefficient breach of contract and to an overall increase of contract breaches for firms and individuals. Existing literature on contract enforcement has focussed on self-enforcing contracts and contracts within a relationship, family or clan. At the firm level the focus is on ownership structures and vertical integration. Here, we suggest that firms use inventory holdings as a means to counteract weak contract enforcement. We test the hypothesis that firms operating in weak legal environments have a higher ratio of inventories to net sales than firms operating in strong legal environments. We present a conceptual model and empirical evidence in support of the hypothesis using data from over three hundred firms from fourteen product groups across thirty nine countries.

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Paper provided by Berkeley Electronic Press in its series German Working Papers in Law and Economics with number 2004-1-1089.

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Handle: RePEc:bep:dewple:2004-1-1089
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  1. Scheinkman, Jose A & Schechtman, Jack, 1983. "A Simple Competitive Model with Production and Storage," Review of Economic Studies, Wiley Blackwell, vol. 50(3), pages 427-41, July.
  2. George Baker & Robert Gibbons & Kevin J. Murphy, 2002. "Relational Contracts And The Theory Of The Firm," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 39-84, February.
  3. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  4. Bental, Benjamin & Eden, Benjamin, 1993. "Inventories in a Competitive Environment," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 863-86, October.
  5. Martin Brown & Armin Falk & Ernst Fehr, 2004. "Relational Contracts and the Nature of Market Interactions," Econometrica, Econometric Society, vol. 72(3), pages 747-780, 05.
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