Operations management research usually assumes that the interests of firms’ decision makers are perfectly aligned with the interests of the firm. This however may not be the case in practice. For example, public firms are owned by shareholders but are run by their managers (CEOs and senior executives). The managers’ decisions are also motivated by the compensation they receive. The latter is typically tied to the firm’s performance measures, such as stock market prices. According to Morgenson (1998), in 1997, the 200 largest U.S. firms reserved more than 13% of their common stock for compensation awards to managers. If the stock price perfectly reflects the firm’s value, a compensation based on the stock price would perfectly align the manager’s decisions with the firm’s value. Unfortunately, that is not always the case. Managers have better information about the firm’s internal operating environment. In practice, the most common way for investors to retrieve information about a firm’s performance is through financial reports. As these reports indirectly impact the managers’ compensation, it is not surprising that managers may have incentives to intentionally manage the operation to influence the reports. For example, managers may be tempted to sell excess units of inventory and report higher sales in order to obtain a favorable short-term capital market reaction, even if it is costly for the firm in the long run. This is known as “channel stuffing.” In the notorious case of Coca-Cola’s channel stuffing between 1997 and 1999, Coca-Cola offered downstream bottlers extended credit terms to induce them to purchase more than demanded, which turned into inventory at the bottlers’ places. These “padded” sales enhanced the firm’s capital market performance in those years, but, damaged the firm’s value in the long run.

Managers in private firms may have channel stuffing incentives too. Channel stuffing is observed for private firms contemplating IPOs, since firms are tempted to influence the market price upward by boosting their sales revenues. In general, when the compensation of a manager is contingent on the assessment of the firm’s value by external parties, such as potential investors, non-managing shareholders, debt holders, etc., the manager may be tempted to pad the sales to influence the external assessment. For convenience, in the remaining of the paper, we refer to all of those external parties that may potentially value the firm as “investors.” Similarly, we refer to the valuation of the firm by the external parties as the “market price” of the firm, and the manager’s compensation contingent on the external valuation as the “market-based compensation.”