Impact of Working Capital Management Policy on Market Value Addition

Transcription

1 Impact of Working Capital Management Policy on Market Value Addition R.M.S. Bandara, Department of Accountancy, University of Kelaniya, Colombo, Sri Lanka. Abstract Working Capital Management (WCM) includes maintaining appropriate levels of current assets and current liabilities required by a firm. Management of short-term assets and liabilities needs a careful investigation since it plays an important role in deciding the firm s profitability, risk as well as its value. This research study investigated the impact of Working Capital Management Policy (WCMP) on firm value in Sri Lankan Companies. Data were gathered from 74 companies listed in the Colombo Stock Exchange (CSE) covering seven business sectors for the sample period of 2009/10 to 2013/14 which comprises 370 firm year observations. Descriptive statistics, correlation and panel regression analysis were employed as measures of analysis. Firms Working Capital Investment Policy (WCIP) and Working Capital Financing Policy (WCFP) were used as independent variables. Firm value was measured in terms of Market Value Addition (MVA) as dependent variable in the study. According to the overall panel regression model, WCIP and WCFP both recorded a negative relationship to MVA proving the individual model results. The results showed significant negative relationship between the firms degree of aggressiveness of WCIP and MVA of the companies in Sri Lanka. It provided evidence that the minimum level of investment in current assets leads to have higher MVA of the firms in Sri Lanka. Further results do not provide statistically significant results to prove the negative relationship between WCFP and MVA. Key words: Working Capital Management Policy, Firm Value, Market Value Added, Sri Lanka 354

2 1. Introduction Corporate financial officers identify Working Capital Management (WCM) as being important to their firms value. Management of short-term assets and liabilities needs a careful investigation since the WCM plays an important role in the determination of the profitability, liquidity and risk as well as the ultimate objective of firm s value (Smith, 1980). The greater the investment in current assets lead for the lower risk due to ability of settling short term obligation, but also the lower the profitability obtained, because of the inability to invest in the profitable long term investments. Efficient management of working capital is a fundamental part of the overall corporate strategy to create shareholders value. Firms try to keep an optimal level of working capital that maximizes the value of the firms (Howorth and Westhead, 2003; Deloof, 2003 and Afza and Nazir, 2007 & 2008). The main objective of WCM is to maintain an optimal balance between each of the working capital components. Business success heavily depends on the ability of financial executives to effectively manage the working capital component of receivables, inventory, and payables (Filbeck and Krueger, 2005). Firms can reduce their financing costs and/or increase the funds available for expansion projects by minimizing the amount of investment tied up in current assets while arising a higher level of liquidity risk. Working Capital Management Policy (WCMP) is the firm s way of making investment in their current assets which is known as working capital investment policy and use short-term liabilities to finance firms assets which is known as working capital financing policy. Theoretically, a firm can adopt different working capital management practices as aggressive working capital management policy, moderate working capital management policy and conservative working capital management policy based on its investment and financing policies. Those different policies and practices are affecting the profitability, liquidity, risk as well as finally the value of the firm in different ways. The Firm Value is the present value of the expected future flows discounted at the rate of return required by investors (Robert, Mark and Rabhi, 2008). Any investment in working capital larger than this optimum would increase the firm s assets without a proportionate increase in its returns and thus lowering the rate of return on investment. Weston and Copeland (1992) suggested that, given the optimum, increasing the cash holding which is one of the working capital components of the company, negatively affects the shareholder value. Peter Drucker (1998) has stated that until a business earns a profit that is greater than its cost of capital, it operates at a loss, means firm is not operating as a value creator, it destroy the value. While most of the studies suggest that firms which minimize their investment in net operating capital leading for an aggressive working capital management policy, will 355

3 maximize their profitability and thereby maximize firm value, this inference does not necessarily follow. In the current research work, a deep attention was given to the financial statements of listed companies in Sri Lanka. Based on the financial figures extracted from the annual reports, researcher observed that organizations are having different levels of current assets and liabilities. Further, some organizations adopt aggressive working capital policy while some are running with conservative and moderate level of policies. Therefore, researcher is interested to carry out a study, to identify the impact of working capital policy on firm value of the listed companies in Sri Lanka. 1.1 Problem statement How does Working Capital Management Policy impact on Firm Value in Sri Lanka? The problem is to identify the relationship between working capital management policy and value of the Sri Lankan companies listed in the Colombo Stock Exchange (CSE). 1.2 Research Question What is the relationship between Working Capital Management Policy (WCMP) and Firm Value? It is argued that the failure of WCM is mainly due to inability of reflecting the characteristics and challenges of contemporary organizational settings that has led to a loss of relevance and give rise to the need for a conceptual framework explaining current WCMP. Having identified working capital management Investment Policy (IP) and Financing Policy (FP) of the firms, backed by the literature and theoretical domain, researcher examined the relationship to value of the firms which is measured by the Market Value Added (MVA). With the answer of this research question, researcher elaborates the behaviour of the WCM in an organization and how it leads to create firm value in Sri Lankan organizations. 1.3 Research objective The researcher expects to achieve following objective at the completion of the study. To determine the relationship between Working Capital Management Policy & Firm Value in Sri Lanka. 1.4 Significance of study In the today s dynamic business environment, survival of the organization is more uncertain even though the companies are earning profit, unless they can t meet the short term obligations. Corporate finance basically deals with three decisions such as capital structure decisions, capital budgeting decisions, and working capital management decisions. Among these, working capital management is a very important component of corporate finance since it affects the profitability and liquidity of a company and finally to its value. Efficient WCM involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet short term obligations on one hand and avoids 356

4 excessive investment (Eljelly, 2004). Therefore, it is deemed that there is a need of studying the role of working capital management policies on firm value in the Sri Lankan context. Further, a profitable company may fail, if it does not have adequate cash flow to meet its liabilities as they fall due. On the other hand, one of the main objectives of a firm is to maximize its value. Therefore, it is important to study how firms should keep the proper investments in current assets and maintain proper level of current liabilities in an enterprise with maximizing its value. Moreover Firm value is more important to have sustainable growth rate for a business leading to attract prospective investors. Because value of the firm is the form that investors motivate to invest in the business and increase of value will benefit the firms prestige by increasing future growth. Further, firm value is also important since it affects to achieve the desired performance and long term survival of the enterprises. Therefore with the current study, researcher attempted to support for the organizations to keep a healthy WCMP in such a way to maximize firm value. If the management of working capital policy is satisfactory, there is high performance in the organization, possibly leading to create its value. Theory explains that the lower degree of aggressiveness is leading for low level of liquidity, high level risk and high level of profitability; it does not explain the ultimate impact to the value creation of an organization. And also it varies according to the Investment policy and the financing policy of the firm. It is evidenced by the inconclusive results generated by the researchers in the literature as mentioned earlier paragraphs. Further, Wadsworth and Bryan (1974) pointed out that sometime managers decisions relating to the working capital management will increase earnings but it destroy value of the firm while some decisions increase the value but no profit is added to the firm. Therefore, researcher expects to study the behavior of working capital management policy adopted by the Sri Lankan organizations and how it leads to create value to the firm. Further, it will contribute to fill the knowledge gap in the existing literature. According to the literature available, very few researches have been carried out in the area of WCM in Sri Lanka and less researches have been carried out relating to the WCMP and the firm value in specific in the Sri Lankan context. Therefore the researcher expected to study the behavior and stability of working capital management in different business sectors and the impact of those on the firm value. While the propose study enhances the WCMP ensuring the maximum utilization of current assets and current liabilities in Sri Lankan enterprises to achieve ultimate objective of value creation, it will lead to fill the empirical gap exists. 2. Literature Review A wide-ranging literature review was conducted to identify the direction of this study and to understand the broader perspectives of Working Capital Management (WCM) and its impact to the value of the firm. 357

5 WCM is important because of its impact on the firm s profitability and risk, and consequently its value (Smith, 1980). Excessive levels of current assets may have a negative effect on the firm s profitability whereas a low level of current assets may lead to lower level of liquidity and stock-outs resulting in difficulties in maintaining smooth operations (Van Horne & Wachowicz, 2004). Accordingly, greater the investment in current assets, the lower the risk, but also the lower the profitability obtained. Filbeck and Krueger (2005) highlighted the importance of efficient WCM by analyzing the WCMP of 32 non-financial industries in USA. According to their findings significant differences exist between industries in working capital practices over time. WCM literature presents a long debate on the risk/return tradeoff among different WCMP (Brigham and Ehrhardt, 2004; Gitman, 2005; Moyer et. al., 2005 & Pinches, 1991). Accordingly, it is worth to notice that more aggressive working capital policies are associated with higher return and higher risk while conservative working capital policies are concerned with the lower risk and return (Carpenter and Johnson, 1983; Gardner et al., 1986 & Weinraub and Visscher, 1998). It further explain, when a company is continuing with the aggressive working capital management policy will lead to have higher level of return, lower level of liquidity and higher level of risk which is not healthy every time. However, effective management of working capital policy has been receiving little attention and yielding more significant results. More aggressive working capital policies are associated with higher return and higher risk while conservative working capital policies are concerned with the lower risk and return (Gardner et al., 1986 & Weinraub & Visscher, 1998). Salawu R.O. (2006) investigated fifteen diverse industrial groups over an extended period to establish the relationship between aggressive and conservative working capital practices. The results strongly explained that the industries had significantly different current asset management policies. Additionally, the relative industry ranking of the aggressive or conservative asset policies exhibited remarkable stability over time. It is evident that there is a significant negative correlation between industry asset and liability policies. Relatively aggressive working capital asset management seems balanced by relatively conservative working capital financial management. Furthermore he explains that a firm in deciding its working capital policies should consider the policies adopted in that particular industry in which it operates and a firm pursing aggressive working capital investment policy should match it with a conservative working capital financing policy. This is important to mitigate the risk being faced under aggressive working capital investment policies by safety involved under conservative working capital financing policy. However, Weinraub and Visscher (1998) have discussed the issue of aggressive and conservative working capital management policies by using quarterly data for a period of 1984 to 1993 of US firms. The researchers have examined ten diverse industry groups to 358

6 study the relative relationship between their aggressive/conservative working capital policies and they have concluded that the industries had distinctive and significantly different working capital management policies over the time. Moreover, the relative nature of the working capital management policies exhibited remarkable stability over the ten-year study period. The study showed a significant negative correlation between industry asset and liability policies. It is important to notice that they also generated similar results and additionally they concluded that relatively aggressive working capital asset policies (working capital investment policy) are followed and balanced by relatively conservative working capital financial policies confirming the Salawu s (2006) similar findings in Nigerian context. Further, Afza and Nazir (2007) investigated the relationship between the aggressive and conservative working capital policies for seventeen industrial groups and a large sample of 263 public limited companies listed at Karachi Stock Exchange for a period of Using ANOVA and LSD test, the study found significant differences among their working capital investment and financing policies across different industries. Moreover, rank order correlation confirmed that these significant differences were remarkably stable over the period of six years of study. Finally, ordinary least regression analysis found a negative relationship between the profitability measures of firms and degree of aggressiveness of working capital investment and financing policies. Another important study which confirms the results of Afza and Nazir (2007), conducted by Mian S. and Talaf (2009) have shown that the negative relationship between the profitability measures of the firm and the degree of aggressiveness of working capital management policies by analyzing the 204 Pakistan firms listed under sixteen industrial groups in the Karachchi Stock Exchange (KSE). The data was analyzed for the period of Theoretically, greater the investment in current assets, the lower the risk, but also the lower the profitability obtained. In contradiction, Carpenter & Johnson (1983) provided empirical evidence that there is no linear relationship between the level of current assets and revenue systematic risk of US firms; however, some indications of a possible non-linear relationship were found which were not highly statistically significant. So, the link between WCM and firm value is not simple as the link between WCM and firm profitability discussed. Turning to the empirical literature on WCM policy and the firm value, researcher could not find any published study of the relationship between WCMP and firm value in specific. Hall, J. (2001); Ruback and Sesia (2000) and Smith (1980) stated that efficient level of WCM is one of the driver for value creation. Deloof (2003); Garcia-Teruel and Martinez- Solano (2007); Soenen (1993) and Shin and Soenen (1998) all showed that the profitability of a firm, measured by either return on assets or return on equity, is improved as the firm improves its management of its working capital. While most of such studies suggest that firms 359

7 that minimize their investment in net operating capital will maximize their profitability and thereby maximize firm value, this inference does not necessarily follow (Robert, Mark & Rabhi, 2008). The study available relating to the Sri Lankan context is the research done by Pandey and Perera (1997), providing an empirical evidence of WCMP and practices of the private sector manufacturing companies in Sri Lanka. The information and data for the study were gathered through questionnaires and interviews with chief financial officers of a sample of manufacturing companies listed on the Colombo Stock Exchange. They found that most companies in Sri Lanka have informal working capital policy and company size has an influence on the overall working capital policy (formal or informal) and approach (conservative, moderate or aggressive). And also, company profitability has an influence on the methods of working capital planning and control. According to the study conducted by S. Morawakage and Lakshan A.M.I (2009) with the companies registered in Colombo Stock Exchange, results suggest that managers can increase corporate profitability by reducing the number of inventory turn over days and increasing the creditor s payable days in order to minimize the length of the working capital cycle. Increase in creditor s payable days would give opportunities to the company for further investments. Turning to the literature on firm value, a well designed and implemented working capital management is expected to contribute positively to the creation of a firm s value. De Wet (2005) has studied companies listed on the JSE Securities Exchange South Africa, using market value added (MVA) as a proxy for shareholder value. The results suggest strong relationship between MVA and cash flow from operations. The study also found very little correlation between MVA and EPS, or between MVA and DPS, concluding that the credibility of share valuations based on earnings or dividends must be questioned. The main objective of a firm is to increase the market value. Working capital management affects profitability of the firm, its risk, thus its value (Smith, 1980). In other words, efficient management of working capital is an important component of the general strategy aiming at increasing the market value (Afza & Nazir, 2007; Deloof, 2003 and Howorth & Westhead, 2003). Even though there are pros and cons of using MVA to measure the firm value, it has been proved by the literature that MVA can be used as the better proxy for measuring the value of the firm. 3. Methodology Research methodology is mainly focused on discussing the hypotheses and relevant variables that are considered in the research design to achieve its above mentioned research problem. 360

8 3.1 Hypotheses The following hypotheses were formulated in the study to examine the impact of WCMP on firm value. H 1: There is a negative relationship between the degree of aggressiveness of working capital management investment policy and MVA of the companies in Sri Lanka. H 2: There is a negative relationship between the degree of aggressiveness of working capital management financing policy and MVA of the companies in Sri Lanka. 3.2 Variables Independent variables For the study, independent variable is the working capital management policy and selected two indicators to measure the degree of aggressiveness of WCMP based on followings two aspects *. Investment Policy (IP) Financing Policy (FP) With the support of available literature and relevant theories of WCM, the degree of aggressiveness or conservativeness is measured by; (Afza, Nazir, 2007; Weinraub Visscher, 1998 and Salawu, 2006) Total Current Assets to Total Assets Ratio (Investment Policy) Total Current Liabilities to Total Assets Ratio (Financing Policy) Investment Policy (IP) It explains the way of firm can invest their funds in the short term or long term assets resulting in minimal level of investment of the firm s funds in current assets comparatively to the fixed assets closes to the more aggressive and if it is vise-versa close to the conservativeness. In order to measure the degree of aggressiveness or conservativeness, following ratio will be used: (Afza, Nazir, 2007; Weinraub and Visscher, 1998 and Salawu, 2006) IP = Total Current Assets (TCA) X 100 Total Assets (TA) Where a lower ratio means a relatively aggressive policy. Where a higher ratio means a relatively conservative policy Financing Policy (FP) It discusses the way that a firm finances their permanent or temporary assets by using short term or long term funds. If a firm utilizes higher levels of current liabilities and less long-term debt to finance its current assets will be close to the aggressiveness and if a firm uses long term funds to finance its permanent assets as well as current assets it closes to conservativeness. The degree of aggressiveness or conservativeness of a financing policy * See Afza, Nazir, 2007; Weinraub and Visscher, 1998 and Salawu, 2006 for further evidence 361

9 adopted by a firm will be measured by: (Afza, Nazir, 2007; Weinraub and Visscher, 1998; Salawu, 2006) FP = Total Current Liabilities (TCL) X 100 Total Assets (TA) Where a higher ratio means a relatively aggressive policy. Where a lower ratio means a relatively conservative policy When the degree of aggressiveness i.e. current assets as a percentage of total asset ratio is close to zero, it is referred as aggressive working capital management policy while that ratio is close to hundred, it is named as conservative working capital management policy. On the other hand degree of aggressiveness i.e. current liabilities as percentage of total asset ratio is close to zero, it is referred as conservative working capital management policy while that ratio is close to hundred it named as aggressive working capital management policy Market Value Addition (MVA) Market value is the difference between market value of the firm s stock and the amounts of equity capital supplied by investors. It measures the effect on value of management s decisions since the firm s inception. Further it says how much management has added to shareholder value over the company s history. The main distinguishing feature of MVA is that, it is largely a cumulative measure and therefore communicates the market s present verdicts on the Net Present Value (NPV) of all the firms past, current and contemplated capital investment projects (O Byrne, 1996). MVA measures the effect on value of management s decisions since the firm s inception. It is calculated as follows. MVA = Market Value of Company Total Operating Capital Invested (O Byrne, 1996) Based on the above mentioned constructs and concepts following expression can be made; Firm Value = f (Aggressive Investment Policy, Aggressive Financing Policy, Conservative Investment Policy, Conservative Financing policy, Moderate Investment Policy and Moderate Financing Policy ) Where the degree of aggressiveness or conservativeness is measured by Total Current Assets to Total Assets Ratio (Investment Policy) Total Current Liabilities to Total Assets Ratio (Financing Policy) FV it = β 0 + β1 (TCA/TA it ) + β 2 (TCL/TA it ) Where: FV it = Firm Value of firm i for time period t TCA/TA it = Total Current Assets to Total Assets Ratio of firm i for time period t TCL/TA it = Total Current Liabilities to Total Assets Ratio of firm i for time period t 362

10 3.3 Sample and sampling procedure A sample of 74 companies is selected representing seven different sectors in the Colombo Stock Exchange (CSE) out of the twenty sectors in the CSE sector categorization. The study did not select bank, financial and insurance sector companies because of the more regularization of the working capital practices in the industry as a result of inherent conditions imposed to the financial sector organizations. Further, diversified holding sector was eliminated from the sample due to the group financial statements are available and it may lead to replication error of data with other sectors. Additionally, since the less number of companies available in the sectors such as Construction and engineering, Foot ware textiles, Health care, Information technology, Investment trust, Motors, Oil palms, Power and energy, Services, Store suppliers and Telecommunication have not been included in to the sample. Accordingly, the sample of 74 companies which covers the fifty percent of the total population is considered for the study. It was drawn by using the stratified random sampling technique from the 142 listed companies which are considered for the study selecting seven different sectors in CSE. Finally researcher possesses the research with 370 firm year observations. Table 1: Distribution of sample companies listed in CSE according to the Industrial Sectors Sector Number of Companies Selected Beverage Food and Tobacco (BFT) 11 Chemicals and Pharmaceutical (C & P) 6 Hotel and Travel (H & T) 16 Land and Property (L & P) 12 Manufacturing (Manu) 15 Plantations (Plant) 9 Trading (Trad) 5 Total Data collection With the evidences supported by the literature, most of the researchers have conducted their researches based on the secondary data from the annual reports published by the companies. This study also based on secondary quantitative data and data collected for the period of 5 years starting from 2009 to 2014 using the annual reports published by the above mentioned companies which have been listed in CSE. Further, the data is obtained from the magnetic data library and the annual handbook published by the CSE. 3.5 Data analysis Data comprises time series nature because it is for five years period and cross sectional nature because it has 74 companies. Therefore, researcher used panel data from the year 2009 to 2014 representing 74 companies covering seven different sectors in the CSE and used 363

11 SPSS for basic statistical analysis and E-views software package for panel data regressions to analyse the data. With the secondary data obtained from the annual reports, following data analysis techniques were used to meet the research objectives. Measures of descriptive statistics such as mean, maximum, minimum, standard deviation is used to analyse the variables. Regression analysis was used to examine the impact of WCMP as IP and FP on Firm Value which is measured and MVA. Pearson s correlation coefficient is used to see the relationship between Firm Value and WCMP of the companies. 4. Results and Discussion 4.1 Results Investment policy, Financing policy and firm value Researcher regressed the firms investment policy and firms financing policy individually with MVA as separate regression models. Relevant regression results are shown in the table no. 2 below. Accordingly, model 1 of investment policy and MVA showed an adjusted R 2 of stating that 55% of variation in MVA was explained by IP of the firm. Its f value recorded as 7.11 and p value was 0.000, revealing that the overall model is statistically significant. According to the coefficient sign, there is a negative relationship of the IP policy of the firm and the MVA (p=0.000). It explained that when CA/TA ratio increases or in the other words, degree of aggressiveness of IP increases MVA of the firm decreases. It further evidenced that a relatively conservative working capital investment policy leads to decrease the MVA of the firm. Model 2 considered FP as independent variable and MVA as the dependent variable and it explained 34% of the variation in MVA (p=0.000) by FP. Further, FP and MVA showed a negative relationship which was not significant at 5% level. Table 2: Investment policy, Financing policy and MVA Investment policy and MVA Financing policy and MVA Overall model IP Overall model FP Adjusted R F value t value Sig. level Sign of the coif. Negative Negative MVA with Investment policy and Financing policy Panel regression model which showed the overall model including MVA as dependent variable with IP and FP as independent variables disclosed and adjusted R 2 of Accordingly 55% of variation in MVA was explained by IP and FP of the firm. Recorded f value was 7.00 with a p value of According to the regression model, IP and FP both showed a negative relationship to MVA as recorded in the individual models while FP (p=.634) was not statistically significant. 364

12 Table 3: MVA with Investment policy and Financing policy Overall model IP FP Adjusted R F value 7.00 t value Sig. level Sign of the coif. Negative Negative According to the correlation analysis taking all the companies together, it recorded a negative relationship between IP and MVA. According to the regression analysis, the relationship between IP and MVA is significant. Also, FP and MVA is not significant. 4.2 Discussion of Findings Investment Policy (IP) and MVA The first hypothesis in the study states that there is a negative relationship between the degree of aggressiveness of working capital management investment policy and MVA of the companies in Sri Lanka. According to the Pearson s correlation coefficients, IP indicated a highly negative correlation to MVA as (p=.000). It explains that the increase in IP which is measured in terms of the ratio of CA/TA resulted in decreasing the MVA of the firm. Complying with the results laid down by the correlation coefficient between IP and MVA, the regression IP and MVA as independent and dependent variables respectively, showed an adjusted R 2 of.550 (p=.000) and.549. It explains that on an average 55% of variation in MVA is explained by IP of the firm. Further, both models record a significant negative relationship between the IP and MVA. This negative relationship between the IP of the firm and MVA explains that, when CA/TA ratio increases or in the other words, degree of aggressiveness of IP increases, MVA of the firm decreases. According to the statistical evidence given by the correlation as well as regression, first hypothesis was failed to reject. It says that any firm invests more in to the current assets compared to the total assets leads to have a lower level of MVA of firms. A firm with high level of CA/TA ratio maintains a relatively conservative working capital management IP which leads to have relatively lower level MVA. On the other way around, it concludes that, if any firm has a low level of CA/TA ratio or a relatively aggressive working capital management IP yields a relatively higher level of MVA. In the empirical research domain, there are few specific evidences to justify the relationship between IP and MVA. On the grounds provided by the literature, profitability has a positive relationship with the value of the firm; this study results in consistent with the findings of Soenen and Solano (1993). Their research was on the effects of working capital management on the profitability of a sample of small and medium-sized Spanish firms with the panel data, covering the period This results demonstrated that managers can create value by reducing their firm s number of day s accounts receivable and inventories, i.e. by reducing the level of CA. Moreover, current finding complied with the study conducted by 365

13 Deloof (2003). He analyzed a sample of large Belgian firms during the sample period and the results indicated that Belgium firms can improve their profitability by reducing the number of accounts receivable days and by reducing inventories. Results of the study can be further validated by examining reasons from the theoretical aspects. Accordingly, one of the reasons for the negative relationship between WC investment policy and the value of the firm is that, minimum level of CA decreases the level of operational capital in the business yielding a high level of operational cash flows in the business and finally it helps to create value to the firm. On the other hand low level of CA as a percentage of TA, leads to have high level of FA which increases the future expansion capacity and revenue generation capacity of the firm as an attractive indicator for the investors. Therefore, it creates a high demand for the shares of the firm leading to increase the market value of the firm. Another reason for the negative relationship is that any firm invests more in the stocks leads to have an unsold stock which tide up money unnecessarily and stock loss cost etc. Similarly, keeping more money in the debtors, having more opportunity cost of cash and possibility for bad debt, and it leads to have cash insufficiency to pay for creditors as a result of financing alternatives with high borrowing cost. Additionally, any investment in working capital more than its optimum, would increase the firm s assets without a proportionate increase in its returns and thus lowering the rate of return on investment. This low level of return causes to have a low market demand for the shares and ultimately decrease the MVA. Weston and Copeland (1992) also suggested that, given the optimum, increasing the cash holding negatively affects the shareholder value. Moreover, excessive exposure to have liquid assets generated higher sales revenues, but at the same time the positive results of increase in the sales volumes have been offset by high level of generated costs of keeping the high level of liquid assets and finally firm generates a lower value. All these cause to have negative value for the firm as a result of high level of investment in CA. Even though the current findings are supported by the literature and theoretical aspects, as decreasing level of CA as a percentage of TA yield to have higher MVA, in the implementation by the firms, they should consider the liquidity as well as risk aspects. When firms try to minimize the investment in CA, it causes to a lower level of liquidity, insufficient stocks to run day today operations and lower level of debtors would result to decrease the revenue. Finally, it leads to have a lower level liquidity and high level of operational risk to the business. Therefore, it is worth to reduce the level of CA investment in such a way to have proper balance between liquidity and risk associated with the business. 366

14 4.2.2 Financing Policy (FP) and MVA The second hypothesis of the study states that there is negative relationship between the degree of aggressiveness of working capital management financing policy and MVA of the companies in Sri Lanka. The regression model indicated a negative relationship between working capital FP and MVA of the firm but relationship was not statistically significant at 5% level. Similar result was given by the Pearson s correlation coefficients as FP has a lower level negative correlation to MVA as (p=.013). According to the hypothesis, it explains that the increase in FP measured by the ratio of CL/TA, leads to decrease the MVA of the firm. On the other hand, the increase in CL/TA ratio means the degree of aggressiveness Increases. Therefore, when degree of aggressiveness of the FP increases, the value of the firm decreases. It further states that the relatively aggressive FP policy yields negative results of MVA providing evidence that if the firms finance their TA more and more CL, leads to have a lower level of MVA. Since the FP to MVA did not demonstrate a statistically significant negative relationship, study rejected the hypothesis no 2 stated as there is a negative relationship between the degree of aggressiveness of working capital management financing policy and MVA of the companies in Sri Lanka. According to the empirical studies, it has been concluded that there is no universally applicable pattern in the FP and value of the firm. The FP is affected by the different environmental conditions prevailed in different countries in different periods. It was further confirmed by the present study findings that there was no linear negative relationship between FP and MVA in Sri Lankan companies. One of the reasons that the negative relationship does not exist in Sri Lankan market may be insufficiency of information to the investors about the FP of the companies because of FP is more internally driven methodology while MVA is more externally driven measurement tool. 5. Conclusion and Recommendation Working capital management (WCM) is vital and an integral part in the financial management which affects the profitability, liquidity, risk as well as the value creation. Empirical research provided evidence that there is negative relationship between the degree of aggressiveness of working capital investment and financing policies with the firm value, stating that more aggressive working capital management is associated with higher profitability leading higher value of the firm. In the study of Working Capital Management Policy (WCMP) and firm value, Investment Policy (IP) and Financing Policy (FP) were considered as independent variables. IP explains the alternative ways in which a firm can invest their funds in assets, either in short term or in long term. The minimal level of investment of the firm s funds in current assets comparatively to the fixed assets leads to the more aggressive IP. FP shows the way in which 367

15 a firm uses temporary funds to finance all of its temporary assets, along with some or even all of its permanent assets. The minimum level of short term funds to finance temporary and permanent assets leads to more conservative FP. Market Value Added (MVA) which, was selected as dependent variable is important tool to measure the Value of the firm. Market value is the difference between market value of the firm s stock and the amounts of equity capital supplied by investors. It measures the effect on value of management s decisions from the firm s inception. The study identified that the WCMP followed by the firms as IP and FP with the ratios of Current Assets (CA) as a percentage of Total Assets (TA) and Current liability (CL) as a percentage of TA respectively, and examined the relationship of those policies with EVA and MVA. Moreover, researcher identified impact on firm size to the WCMP and firm value as moderator variable. In addition to the main objectives of the study, based on the IP and FP of the firms, researcher examined the relationship between the different WCM practices followed by the firms as aggressive, conservative or moderate with value of the firm. The study used the sample of 74 listed companies including 370 firm year observations taken over the last five year period from 2009 to 2014 representing seven different business sectors in the Colombo Stock Exchange (CSE). According to the correlation analysis taking all the sample companies together, recorded a negative relationship between IP and MVA. Similar results were given from the sector-wise correlation analysis. According to the sector-wise correlations, all the sectors IP recorded significant negative relation to MVA, but provided insignificant negative relationship between FP and MVA. Similarly, sector-wise correlation between FP and MVA was negative. Results given by the regression analysis showed that the relationship between IP and MVA was significant and results between FP and MVA were not significant. Regression results derived for the different sectors did not deviate from the overall regression results. According to the examination of sector-wise impact on MVA, study revealed that there is no significant impact of the different sectors on the overall results. According to the statistical evidence supported by the correlation and regression analysis, researcher failed to reject the hypothesis no. 1(H 1) which stated that there is a negative relationship between the degree of aggressiveness of IP with MVA. Accordingly, researcher concluded that the firms can maximize MVA by investing their minimum level of funds in current assets compared to non-current assets. It proves the relatively aggressive WCM IP gives higher MVA. Further, H 2 states that there is a negative relationship between the degree of aggressiveness of IP to MVA. The results do not provided sufficient statistical evidence to accept the hypotheses no. 2 (H 2). Therefore, researcher does not have enough evidence to declare that the firms can improve their MVA by financing their assets with the short term funds. Furthermore, there is no sector-wise impact from the overall sample. Sector-wise 368

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