Cash Conversion Cycle and Value-Enhancing Operations: Theory and Evidence for a Free Lunch

43 Pages Posted: 24 Apr 2017 Last revised: 6 Nov 2017

See all articles by Rodrigo M. Zeidan

Rodrigo M. Zeidan

NYU Shanghai

Offer Shapir

New York University (NYU) - New York University (NYU), Shanghai

Date Written: March 27, 2017

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 508 days in 2012 to 351 days 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

JEL Classification: G31, G34

Suggested Citation

Zeidan, Rodrigo M. and Shapir, Offer, Cash Conversion Cycle and Value-Enhancing Operations: Theory and Evidence for a Free Lunch (March 27, 2017). Journal of Corporate Finance, Vol. 45, 203-219, 2017. Available at SSRN: https://ssrn.com/abstract=2941282

Rodrigo M. Zeidan

NYU Shanghai ( email )

1555 Century Ave
Shanghai, Shanghai 200122
China

HOME PAGE: http://rzeidan.com

Offer Shapir (Contact Author)

New York University (NYU) - New York University (NYU), Shanghai ( email )

1555 Century Ave
Shanghai, Shanghai 200122
China

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