The Effects of Working Capital Balances on Financial Leverage

Abstract

A firm’s working-capital account balances (payables, receivables, and inventory) significantly affect its leverage, credit rating, and security issuances. Payables crowd out debt. Higher receivables and inventories raise leverage, reflecting their relatively low risk and/or their ability to provide financial adaptability. Working capital components also significantly affect firm credit ratings and security issuance decisions. These effects are sizeable: a one standard-deviation increase in payables (receivables) crowds out (raises) leverage by 0.42 (066) standard deviations. Difference-in-difference tests based on two regulatory shocks to working-capital payment policies indicate that these relationships are causal.

Keywords: Working Capital, Inventories, Receivables, Payables, Capital Structure, Leverage

JEL Classification: G18, G21, G28