IDEAS home Printed from https://ideas.repec.org/a/eee/corfin/v45y2017icp203-219.html
   My bibliography  Save this article

Cash conversion cycle and value-enhancing operations: Theory and evidence for a free lunch

Author

Listed:
  • Zeidan, Rodrigo
  • Shapir, Offer Moshe

Abstract

The empirical literature shows that firms overinvest in working capital and that these investments are economically inefficient. We decompose working capital investments in the cash conversion cycle and growth effects in the presence of x-inefficiency. We predict that reductions in the cash conversion cycle should increase shareholder value. Direct evidence follows from a case study of a listed company in Brazil, MRV. Changes in operations reduced CCC from 508days in 2012 to 351days in 2015, decreasing working capital requirements by US $1.02 billion. Indirect evidence comes from (1) a synthetic control comparing MRV's free cash flow to equity to its direct and distant competitors; (2) an event study of share prices, and (3) a dynamic cash flow estimation using Tobin's Q as the dependent variable. Outcomes suggest that CCC management, controlling for effects on operating margins, result in higher stock prices and profitability, and increased cash flow. The theoretical framework and results reconcile the literature and provide a rationale for the overinvestment and the inefficiency of working capital investments.

Suggested Citation

  • Zeidan, Rodrigo & Shapir, Offer Moshe, 2017. "Cash conversion cycle and value-enhancing operations: Theory and evidence for a free lunch," Journal of Corporate Finance, Elsevier, vol. 45(C), pages 203-219.
    • Handle: RePEc:eee:corfin:v:45:y:2017:i:c:p:203-219
    DOI: 10.1016/j.jcorpfin.2017.04.014
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0929119916303650
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jcorpfin.2017.04.014?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Ding, Sai & Guariglia, Alessandra & Knight, John, 2013. "Investment and financing constraints in China: Does working capital management make a difference?," Journal of Banking & Finance, Elsevier, vol. 37(5), pages 1490-1507.
    2. Beck, Thorsten & Demirguc-Kunt, Asli, 2006. "Small and medium-size enterprises: Access to finance as a growth constraint," Journal of Banking & Finance, Elsevier, vol. 30(11), pages 2931-2943, November.
    3. Claessens, Stijn & Tong, Hui & Wei, Shang-Jin, 2012. "From the financial crisis to the real economy: Using firm-level data to identify transmission channels," Journal of International Economics, Elsevier, vol. 88(2), pages 375-387.
    4. Bulan, Laarni & Mayer, Christopher & Somerville, C. Tsuriel, 2009. "Irreversible investment, real options, and competition: Evidence from real estate development," Journal of Urban Economics, Elsevier, vol. 65(3), pages 237-251, May.
    5. Rui Albuquerque & Hugo A. Hopenhayn, 2004. "Optimal Lending Contracts and Firm Dynamics," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 71(2), pages 285-315.
    6. Raddatz, Claudio, 2006. "Liquidity needs and vulnerability to financial underdevelopment," Journal of Financial Economics, Elsevier, vol. 80(3), pages 677-722, June.
    7. Murillo Campello & Erasmo Giambona & John R. Graham & Campbell R. Harvey, 2011. "Liquidity Management and Corporate Investment During a Financial Crisis," The Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1944-1979.
    8. Steven M. Fazzari & Bruce C. Petersen, 1993. "Working Capital and Fixed Investment: New Evidence on Financing Constraints," RAND Journal of Economics, The RAND Corporation, vol. 24(3), pages 328-342, Autumn.
    9. Peter Berling & Victor Martínez-de-Albéniz, 2011. "Optimal Inventory Policies when Purchase Price and Demand Are Stochastic," Operations Research, INFORMS, vol. 59(1), pages 109-124, February.
    10. Robert E. Carpenter & Bruce C. Petersen, 2002. "Is The Growth Of Small Firms Constrained By Internal Finance?," The Review of Economics and Statistics, MIT Press, vol. 84(2), pages 298-309, May.
    11. Ben-Nasr, Hamdi, 2016. "State and foreign ownership and the value of working capital management," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 217-240.
    12. Bao, Dichu & Chan, Kam C. & Zhang, Weining, 2012. "Asymmetric cash flow sensitivity of cash holdings," Journal of Corporate Finance, Elsevier, vol. 18(4), pages 690-700.
    13. Karl V. Lins & Paolo Volpin & Hannes F. Wagner, 2013. "Does Family Control Matter? International Evidence from the 2008--2009 Financial Crisis," The Review of Financial Studies, Society for Financial Studies, vol. 26(10), pages 2583-2619.
    14. Hui Tong & Shang-Jin Wei, 2011. "The Composition Matters: Capital Inflows and Liquidity Crunch During a Global Economic Crisis," The Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2023-2052.
    15. Aktas, Nihat & Croci, Ettore & Petmezas, Dimitris, 2015. "Is working capital management value-enhancing? Evidence from firm performance and investments," Journal of Corporate Finance, Elsevier, vol. 30(C), pages 98-113.
    16. Robert Kieschnick & Mark Laplante & Rabih Moussawi, 2013. "Working Capital Management and Shareholders' Wealth," Review of Finance, European Finance Association, vol. 17(5), pages 1827-1852.
    17. Matthew D. Hill & G. Wayne Kelly & Michael J. Highfield, 2010. "Net Operating Working Capital Behavior: A First Look," Financial Management, Financial Management Association International, vol. 39(2), pages 783-805, June.
    18. John Sagan, 1955. "Toward A Theory Of Working Capital Management," Journal of Finance, American Finance Association, vol. 10(2), pages 121-129, May.
    19. Seraina Anagnostopoulou, 2012. "Working Capital Management and Firm Listing Status," Multinational Finance Journal, Multinational Finance Journal, vol. 16(3-4), pages 261-301, September.
    20. Kroes, James R. & Manikas, Andrew S., 2014. "Cash flow management and manufacturing firm financial performance: A longitudinal perspective," International Journal of Production Economics, Elsevier, vol. 148(C), pages 37-50.
    21. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April.
    22. Alberto Abadie & Javier Gardeazabal, 2003. "The Economic Costs of Conflict: A Case Study of the Basque Country," American Economic Review, American Economic Association, vol. 93(1), pages 113-132, March.
    23. Carlos A. Molina & Lorenzo A. Preve, 2009. "Trade Receivables Policy of Distressed Firms and Its Effect on the Costs of Financial Distress," Financial Management, Financial Management Association International, vol. 38(3), pages 663-686, September.
    24. de Almeida, Juliano Ribeiro & Eid, William, 2014. "Access to finance, working capital management and company value: Evidences from Brazilian companies listed on BM&FBOVESPA," Journal of Business Research, Elsevier, vol. 67(5), pages 924-934.
    25. Vikash Ramiah & Yilang Zhao & Imad Moosa & Michael Graham, 2016. "A behavioural finance approach to working capital management," The European Journal of Finance, Taylor & Francis Journals, vol. 22(8-9), pages 662-687, July.
    26. Merville, L. J. & Tavis, L. A., 1973. "Optimal Working Capital Policies: A Chance-Constrained Programming Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 8(1), pages 47-59, January.
    27. Pal, Rudrajeet & Torstensson, Håkan & Mattila, Heikki, 2014. "Antecedents of organizational resilience in economic crises—an empirical study of Swedish textile and clothing SMEs," International Journal of Production Economics, Elsevier, vol. 147(PB), pages 410-428.
    28. A. Craig MacKinlay, 1997. "Event Studies in Economics and Finance," Journal of Economic Literature, American Economic Association, vol. 35(1), pages 13-39, March.
    29. Marc Deloof, 2003. "Does Working Capital Management Affect Profitability of Belgian Firms?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(3‐4), pages 573-588, April.
    30. Marc Deloof, 2003. "Does Working Capital Management Affect Profitability of Belgian Firms?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(3-4), pages 573-588.
    31. Abadie, Alberto & Diamond, Alexis & Hainmueller, Jens, 2010. "Synthetic Control Methods for Comparative Case Studies: Estimating the Effect of California’s Tobacco Control Program," Journal of the American Statistical Association, American Statistical Association, vol. 105(490), pages 493-505.
    32. Darush Yazdanfar & Peter Öhman, 2014. "The impact of cash conversion cycle on firm profitability," International Journal of Managerial Finance, Emerald Group Publishing Limited, vol. 10(4), pages 442-452, August.
    33. Yacine Belghitar & James Khan, 2013. "Governance mechanisms, investment opportunity set and SMEs cash holdings," Small Business Economics, Springer, vol. 40(1), pages 59-72, January.
    34. Hambrick, Donald C. & Crozier, Lynn M., 1985. "Stumblers and stars in the management of rapid growth," Journal of Business Venturing, Elsevier, vol. 1(1), pages 31-45.
    35. repec:eme:arapps:v:19:y:2011:i:2:p:147-156 is not listed on IDEAS
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dhole, Sandip & Mishra, Sagarika & Pal, Ananda Mohan, 2019. "Efficient working capital management, financial constraints and firm value: A text-based analysis," Pacific-Basin Finance Journal, Elsevier, vol. 58(C).
    2. Zhang, Dongyang & Wang, Cao & Wang, Yizhi, 2024. "Unveiling the critical nexus: Volatility of crude oil future prices and trade partner’s cash holding behavior in the face of the Russia–Ukraine conflict," Energy Economics, Elsevier, vol. 132(C).
    3. Karaca Cengizhan, 2023. "A causal and nonlinear relationship between trade credit policy and firm value: Evidence from an emerging market," Economics and Business Review, Sciendo, vol. 9(4), pages 153-178, December.
    4. Paul Lavery & Marian-Eliza Spaliara, 2022. "Private equity buyouts & firm exporting during the global financial crisis," Working Papers 2022_09, Business School - Economics, University of Glasgow.
    5. Hakim Lyngstadaas, 2020. "Packages or systems? Working capital management and financial performance among listed U.S. manufacturing firms," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 31(4), pages 403-450, December.
    6. Chen, Catherine Huirong & Choy, Siu Kai & Tan, Yongxian, 2022. "The cash conversion cycle spread: International evidence," Journal of Banking & Finance, Elsevier, vol. 140(C).
    7. Afrifa, Godfred Adjapong & Tingbani, Ishmael & Adesina, Oluseyi Oluseun, 2022. "Stochastic frontier modelling of working capital efficiency across Europe," Technological Forecasting and Social Change, Elsevier, vol. 184(C).
    8. José Manuel Mansilla-Fernández & Juliette Milgram-Baleix, 2023. "Working capital management, financial constraints and exports: evidence from European and US manufacturers," Empirical Economics, Springer, vol. 64(4), pages 1769-1810, April.
    9. Mélise Jaud & Madina Kukenova & Martin Strieborny, 2009. "Financial dependence and intensive margin of trade," PSE Working Papers halshs-00575005, HAL.
    10. Abdul-Rahman Khokhar, 2019. "Working Capital Investment: A Comparative Study - Canada Versus the United States," Multinational Finance Journal, Multinational Finance Journal, vol. 23(1-2), pages 65-102, March - J.
    11. Tou, Yuji & Watanabe, Chihiro & Neittaanmäki, Pekka, 2020. "Fusion of technology management and financing management - Amazon's transformative endeavor by orchestrating techno-financing systems," Technology in Society, Elsevier, vol. 60(C).
    12. Miemie Struwig & Storm Watson, 2023. "Working Capital Management and Systems Disruption during the COVID-19 Pandemic: Evidence from South Africa," Athens Journal of Business & Economics, Athens Institute for Education and Research (ATINER), vol. 9(1), pages 45-48, January.
    13. Tomáš Heryán, 2018. "What Drives Liquidity of Tourism Companies? Microeconomic Evidence from Bulgaria, Czech Republic and Poland," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 66(6), pages 1477-1484.
    14. Paul Lavery & Marina Spaliara & Holger Görg, 2024. "Private equity buyouts & firm exporting in crisis periods: Exploring a new channel," Working Papers 2024_09, Business School - Economics, University of Glasgow.
    15. Bao-Guang Chang & Kun-Shan Wu, 2021. "The nonlinear relationship between financial flexibility and enterprise risk-taking during the COVID-19 pandemic in Taiwan’s semiconductor industry," Oeconomia Copernicana, Institute of Economic Research, vol. 12(2), pages 307-333, June.
    16. Richard Yeaw Chong Seow, 2023. "Comparative Financial Performance and Firm Valuation Analysis: A Malaysian Logistics Service Provider Case Study," International Journal of Research and Innovation in Social Science, International Journal of Research and Innovation in Social Science (IJRISS), vol. 7(7), pages 594-613, July.
    17. Deari Fitim & Palomba Giulio, 2024. "Does the Cash Conversion Cycle Affect Firm Profitability? Some Empirical Evidence from Listed Firms in North Macedonia," Zagreb International Review of Economics and Business, Sciendo, vol. 27(1), pages 63-77.
    18. Yu, Baojun & Li, Changming & Mirza, Nawazish & Umar, Muhammad, 2022. "Forecasting credit ratings of decarbonized firms: Comparative assessment of machine learning models," Technological Forecasting and Social Change, Elsevier, vol. 174(C).
    19. Bilgehan TEKİN & Yusuf GÖR, 2022. "Cash conversion cycle and its relationship with profitability as a cash management tool in companies: An application on companies trading in Borsa Istanbul," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(3(632), A), pages 113-130, Autumn.
    20. Hassan, M. Kabir & Aysan, Ahmet Faruk & Kayani, Umar Nawaz & Choudhury, Tonmoy, 2023. "Working capital as a firm performance savior? Evidence from Scandinavian countries," Research in International Business and Finance, Elsevier, vol. 65(C).
    21. Kim, Incheol & Lee, Suin & Sharma, Bina, 2023. "Competition law reform and firm performance: Evidence from developing countries," Emerging Markets Review, Elsevier, vol. 56(C).
    22. Muhammad Amin Hasan & Ali Sajid & Aman Abbas Ghouri & Talal Ahmed Khan, 2023. "Re-Examining Working Capital Management and Firm Performance Nexus: Does Investment Policy Matter?," Journal of Economic Impact, Science Impact Publishers, vol. 5(3), pages 269-278.
    23. Zeidan, Rodrigo & Galil, Koresh & Shapir, Offer Moshe, 2018. "Do ultimate owners follow the pecking order theory?," The Quarterly Review of Economics and Finance, Elsevier, vol. 67(C), pages 45-50.
    24. Wetzel, Philipp & Hofmann, Erik, 2019. "Supply chain finance, financial constraints and corporate performance: An explorative network analysis and future research agenda," International Journal of Production Economics, Elsevier, vol. 216(C), pages 364-383.
    25. Xiaodong Teng & Bao-Guang Chang & Kun-Shan Wu, 2021. "The Role of Financial Flexibility on Enterprise Sustainable Development during the COVID-19 Crisis—A Consideration of Tangible Assets," Sustainability, MDPI, vol. 13(3), pages 1-16, January.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Banerjee, Pradip & Dutta, Shantanu & Zhu, Pengcheng, 2021. "Multidimensionality of text based financial constraints and working capital management," International Review of Financial Analysis, Elsevier, vol. 77(C).
    2. Chauhan, Gaurav Singh, 2019. "Are working capital decisions truly short-term in nature?," Journal of Business Research, Elsevier, vol. 99(C), pages 238-253.
    3. Dhole, Sandip & Mishra, Sagarika & Pal, Ananda Mohan, 2019. "Efficient working capital management, financial constraints and firm value: A text-based analysis," Pacific-Basin Finance Journal, Elsevier, vol. 58(C).
    4. Abdul-Rahman Khokhar, 2019. "Working Capital Investment: A Comparative Study - Canada Versus the United States," Multinational Finance Journal, Multinational Finance Journal, vol. 23(1-2), pages 65-102, March - J.
    5. Afrifa, Godfred & Tingbani, Ishmael, 2017. "Working Capital Management, Cash Flow and SMEs’ Performance," MPRA Paper 82894, University Library of Munich, Germany, revised Oct 2017.
    6. Ben-Nasr, Hamdi, 2016. "State and foreign ownership and the value of working capital management," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 217-240.
    7. Sharif N. Ahkam & Khairul Alom, 2019. "Liquidity, Level of Working Capital Investment, and Performance in an Emerging Economy," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 18(3), pages 307-328, December.
    8. Hong, Liu & Jain, Bharat A. & Shao, Yingying, 2024. "Family firm governance and working capital management policy," International Review of Financial Analysis, Elsevier, vol. 95(PB).
    9. Chang, Chong-Chuo, 2018. "Cash conversion cycle and corporate performance: Global evidence," International Review of Economics & Finance, Elsevier, vol. 56(C), pages 568-581.
    10. Vivien Lefebvre, 2020. "Performance, working capital management, and the liability of smallness: A question of opportunity costs?," Post-Print hal-02968569, HAL.
    11. Dbouk, Wassim & Moussawi-Haidar, Lama & Jaber, Mohamad Y., 2020. "The effect of economic uncertainty on inventory and working capital for manufacturing firms," International Journal of Production Economics, Elsevier, vol. 230(C).
    12. Afrifa, Godfred Adjapong & Tingbani, Ishmael & Adesina, Oluseyi Oluseun, 2022. "Stochastic frontier modelling of working capital efficiency across Europe," Technological Forecasting and Social Change, Elsevier, vol. 184(C).
    13. Hari P. Adhikari & Marcin W. Krolikowski & James Malm & Nilesh B. Sah, 2021. "Working capital (mis)management – impact of executive age," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(1), pages 727-761, March.
    14. Randa Mohammed Shams Addin Al-Mawsheki & Norzalina Binti Ahmad & Norhafiza Binti Nordin, 2019. "The Effects of Efficient Working Capital Management and Working Capital Policies on Firm Performance: Evidence from Malaysian Manufacturing Firms," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 9(3), pages 59-69, July.
    15. Burney, Robert B. & James, Hui Liang & Wang, Hongxia, 2021. "Working capital management and CEO age," Journal of Behavioral and Experimental Finance, Elsevier, vol. 30(C).
    16. Alaa Adden A. Abuhommous, 2017. "Net Working Capital and Firm Growth," International Review of Management and Marketing, Econjournals, vol. 7(4), pages 131-137.
    17. Chang, Chong-Chuo & Chen, Hsien-Yi & Mon, Khin Thiri, 2024. "Impact of economic policy uncertainty on the firm's working capital requirements," Pacific-Basin Finance Journal, Elsevier, vol. 86(C).
    18. Sah, Nilesh B. & Banerjee, Anandi & Malm, James & Rahman, Anisur, 2022. "A good name is better than riches: Family firms and working capital management," Journal of Behavioral and Experimental Finance, Elsevier, vol. 33(C).
    19. Nilesh B. Sah & Anandi Banerjee & James Malm & Anisur Rahman, 2021. "A Good Name Is Better Than Riches: Family Firms and Working Capital Management," Discussion Paper Series 2021-02, McColl School of Business, Queens University of Charlotte.
    20. Chen, Catherine Huirong & Choy, Siu Kai & Tan, Yongxian, 2022. "The cash conversion cycle spread: International evidence," Journal of Banking & Finance, Elsevier, vol. 140(C).

    More about this item

    Keywords

    Working capital management; Operating working capital; Synthetic control; Cash conversion cycle; Shareholder value; Dynamic cash flow;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:corfin:v:45:y:2017:i:c:p:203-219. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jcorpfin .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.