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

Rodrigo Zeidan and Offer Moshe Shapir

Journal of Corporate Finance, 2017, vol. 45, issue C, 203-219

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.

Keywords: Working capital management; Operating working capital; Synthetic control; Cash conversion cycle; Shareholder value; Dynamic cash flow (search for similar items in EconPapers)
JEL-codes: G31 G34 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (27)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:45:y:2017:i:c:p:203-219

DOI: 10.1016/j.jcorpfin.2017.04.014

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