A Non-Linear relation between Working Capital Management and Stock Liquidity
Abstract
Purpose – Working capital management (WCM) is related to how the firm manages its credits and inventories to achieve a trade-off between its benefits and costs. It shows the manager and the firm’s efficiency, which impacts its profitability and risk. The higher the firm’s efficiency, the better investors’ perception about the firm which can impact stock liquidity. This study aims to analyze if there is an optimal point between WCM and stock liquidity.
Design/Methodology/Approach – For this purpose, a panel of 1,145 firms listed on five Euronext exchanges (Amsterdam, Brussels, Dublin, Lisbon, and Paris), between 2011 and 2019, is analyzed. Stock liquidity is captured using two alternative measures – Amihud (2002) and Fong et al. (2017). Working capital management is measured through the cash conversion cycle (CCC), and its components (days sales outstanding, DSO; days sales inventory, DSI; and days payable outstanding, DPO). Non-linear relations are estimated using fixed effects models.
Findings – Results reveal an inverse U-shaped relation between cash conversion cycle , and its specific component days sales inventory, and stock liquidity, suggesting that there is an optimal value of CCC and DSI that maximize stock’s liquidity.
Originality/Value – Most studies focus on the impact of WCM on operational profitability or stock’s return. The impact on stock’s illiquidity is less explored, so this study contributes to the debate whether being efficient in managing working capital can influence the transaction of stocks. Two alternative measures of liquidity are used since there is no consensus about which is better. This allows us to have different perspectives of liquidity, and to capture not only the breadth and depth of stocks, but also stock rigidity. Finally, instead of analyzing a single market, this work focus on five European stock exchanges. The study insights are important for managers, investors, and shareholders, emphasizing the potential improvement in stock liquidity through effective WCM.
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