Asymmetric Impact of Working Capital Efficiency on Market Performance of Indian Firms

Abstract

This study aims to explore the true nature of the impact of working capital management (WCM) efficiency, measured by cash conversion cycle (CCC), on the stock market performance (proxied by stock’s Alpha) of Indian non-financial firms. The article presents four possible models from literature and argues why the relationship should be non-linear. Generalized method of moments (GMM) estimation is used on firm-level data of 718 Indian firms from 11 industries listed in the Bombay Stock Exchange (BSE) from 2011 to 2017. A negative relationship is confirmed. However, contrary to prior findings, neither a quadratic relationship nor the deviations from industry median CCC can explain the relationship for Indian firms. Therefore, firms are divided into CCC decile-based equally weighted portfolios and estimation of a threshold level of CCC is carried out iteratively. Threshold thus obtained is validated at the firm level, using dynamic panel through GMM estimation. The novelty of this study is that it is the first one to propose the possibility of a universal threshold level of working capital (WC) efficiency and its impact on the market performance of firms in India. The article argues that in India, due to uncertainties in supply chains, firms, as well as the investors, prefer a threshold level of investment in WC. If CCC is above the threshold level, firms’ excess stock returns fall significantly, while there is no impact below the threshold level. The study is relevant for managers so that they can maintain WC below a threshold level, as well as for investors who can use the threshold WC criteria for valuation and selection of stocks.