serie Working papers Working papers How do market imperfections affect working capital management?

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1 serie ec WP-EC How do marke imperfecions affec working capial managemen? Sonia Baños-Caballero, Pedro J. García-Teruel and Pedro Marínez-Solano Working papers g papers Working papers

2 Los documenos de rabajo del Ivie ofrecen un avance de los resulados de las invesigaciones económicas en curso, con objeo de generar un proceso de discusión previo a su remisión a las revisas cieníficas. Al publicar ese documeno de rabajo, el Ivie no asume responsabilidad sobre su conenido. Ivie working papers offer in advance he resuls of economic research under way in order o encourage a discussion process before sending hem o scienific journals for heir final publicaion. Ivie s decision o publish his working paper does no imply any responsibiliy for is conen. La Serie EC, coordinada por Mailde Mas, esá orienada a la aplicación de disinos insrumenos de análisis al esudio de problemas económicos concreos. Coordinaed by Mailde Mas, he EC Series mainly includes applicaions of differen analyical ools o he sudy of specific economic problems. Todos los documenos de rabajo esán disponibles de forma grauia en la web del Ivie hp:// así como las insrucciones para los auores que desean publicar en nuesras series. Working papers can be downloaded free of charge from he Ivie websie hp:// as well as he insrucions for auhors who are ineresed in publishing in our series. Edia / Published by: Insiuo Valenciano de Invesigaciones Económicas, S.A. Depósio Legal / Legal Deposi no.: V Impreso en España (enero 2010) / Prined in Spain (January 2010)

3 WP-EC How do marke imperfecions affec working capial managemen? * Sonia Baños-Caballero, Pedro J. García-Teruel and Pedro Marínez-Solano ** Absrac This paper examines wheher Working Capial Managemen (WCM) is sensiive o marke imperfecions such as asymmeric informaion, agency conflics or financial disress. We find ha firms have a arge invesmen in working capial and ha hey ake decisions in order o achieve his. In addiion, he resuls appear o suppor he hypohesis ha he working capial compees wih invesmen in fixed asses for he funds of he firms when hey have financial consrains. Finally, we also find ha WCM depends on bargaining power and oher financial facors such as he availabiliy of inernal finance, cos of financing and access o capial markes. Keywords: ne rade cycle, working capial managemen, marke imperfecions, panel daa. JEL classificaion: G30, G31, G32. Resumen Ese arículo analiza si la gesión del capial circulane esá afecada por las imperfecciones de mercado ales como la asimería informaiva, los conflicos de agencia o las dificulades financieras. Los resulados muesran que las empresas ienen un nivel de inversión en capial circulane objeivo y oman decisiones con el fin de alcanzarlo. Además, los resulados parecen apoyar la hipóesis de que el capial circulane compie con los acivos fijos por los fondos de las empresas cuando ésas ienen resricciones financieras. Finalmene, la gesión del capial circulane depende del poder de negociación y oros facores financieros ales como la disponibilidad de financiación inerna, el cose de financiación y el acceso a los mercados de capiales. Palabras clave: ciclo de efecivo, gesión del capial circulane, imperfecciones de mercado, daos de panel. * This research is par of he Projec ECO /ECON financed by he Research Agency of he Spanish governmen. Sonia Baños-Caballero was in receip of a FPU gran from he Spanish Governmen. The auhors also acknowledge financial suppor from Fundación Caja Murcia. ** S. Baños-Caballero, P.J. García-Teruel and P. Marínez-Solano: Universiy of Murcia. Conac auhor: pmsolano@um.es. 3

4 1. Inroducion Since he seminal work by Modigliani and Miller (1958) showing ha a firm s financial srucure is irrelevan o invesmen, he lieraure on invesmen decisions has been enlarged by many heoreical and empirical conribuions. I has shown ha in he presence of marke imperfecions, firms may prefer one source of funds over anoher because of a wide cos-wedge beween inernal and exernal funding sources. Myers and Majluf (1984) show ha firms presen a preference for inernal over exernal funds, and in he case of exernal funds, a company prefers deb before equiies. In fac, Fazzar Hubbard and Peersen, (1988) es he financing hierarchy hypohesis and sugges ha he firms invesmen may depend on financial facors such as he availabiliy of inernal finance, access o capial markes or cos of financing. The invesmen ha firms make in curren asses, as well as he curren liabiliies used, represens an imporan share of iems on a firm s balance shee. Decisions abou how much o inves in receivable accouns and invenories, and how much credi o accep from suppliers, are refleced in he managemen of firms working capial. This may have an imporan impac on he profiabiliy and liquidiy of he firm (Shin and Soenen, 1998), so firms have o evaluae he rade-off beween expeced profiabiliy and liquidiy risk before deciding he working capial policy o adop. Despie he imporance of working capial managemen for he profiabiliy of he firms (Smih, 1980; Soenen, 1993; Jose, Lancaser and Sevens, 1996; Shin and Soenen, 1998; Deloof, 2003; and Garcia and Marinez, 2007), here has been lile work on he empirical deerminans of he working capial managemen. Chiou, Cheng and Wu (2006) analyze firm characerisics and macroeconomic facors ha migh affec working capial managemen for companies from Taiwan. Kieschnick, Laplane and Moussawi (2006) also sudy he deerminans of WCM, in his case, for a sample of US companies. However, hese sudies have several limiaions. Firs, hey do no conrol for endogeneiy. Second, none of hese exising empirical sudies has shown he possible exisence of a arge level of he measures of working capial managemen, even hough is exisence appears o be eviden. Several previous sudies (Nadir 1969; Emery, 1984: Blinder, 1986, among ohers) have shown ha firms have arge or opimal levels for heir individual componens such as accouns receivable, invenories and accouns payable. Moreover, under imperfec capial markes, firms have o evaluae he rade-off beween coss and benefis of mainaining a larger invesmen in working capial. 4

5 In his paper we aemp o exend he empirical research on working capial managemen in a number of ways. Firs, in conras o he exising empirical sudies, his paper adops a dynamic framework, which assumes ha firms have a arge invesmen in working capial and ha hey adjus heir curren invesmen gradually over ime because of adjusmen coss. Second, we use panel daa because i allows us o conrol for unobservable heerogeneiy, making i possible o exclude biases deriving from he exisence of individual effecs. Third, we use wo-sep GMM esimaor o avoid he problem of possible endogeneiy. For example, several sudies have shown how he measures of he working capial managemen affec profiabiliy and firms sales. Finally, we presen empirical evidence for a sample of Spanish firms in he conex of he coninenal model, which is characerised by less-developed capial markes (La Pora, Lopez de Silanes, Shleifer and Vishny, 1997, 1998), low invesor proecion and high concenraion of ownership. I allows our resuls o be compared wih ohers obained for companies wih differen financial sysems. Following Shin and Soenen (1998), we use he Ne Trade Cycle (NTC) as a measure of working capial managemen. NTC indicaes he number of days sales he firm has o finance is working capial under ceeris paribus condiions. Our findings indicae ha firms have a arge Ne Trade Cycle and hey adjus heir curren Ne Trade Cycle o heir arge gradually over ime because of adjusmen coss. Moreover, he speed of adjusmen is relaively quick, which may be because being in disequilibrium is cosly for his sample. On he oher hand, he resuls repored in his sudy sugges ha firms ha are capable of generaing more inernal funds have a longer cycle. The resuls also lend suppor for Fazzari and Peersen s (1993) argumen ha working capial compees wih he invesmen in fixed asses for he funds of he firms when hey suffer financial consrains. The hypohesis ha companies wih a greaer bargaining power follow a more aggessive working capial policy is also suppored by he findings of his paper. Finally, our resuls sugges ha Ne Trade Cycle also depends on oher financial facors such as he cos of financing and access o capial markes. Thus, we obain ha growh opporuniies, probabiliy of financial disress and cos of exernal financing negaively affec NTC. However, we do no find suppor for he hypohesis ha leverage influences he measures of working capial managemen. The remainder of his paper is organized as follows. The nex secion develops he hypoheses and reviews he previous sudies on working capial managemen. In secion 3 we describe he empirical model and daa. We presen our resuls in secion 4 and relae hem o earlier findings. Finally, he main conclusions are presened in Secion 5. 5

6 2. Theoreical framework and hypoheses In perfec capial markes, invesmen decisions of a firm are independen of is financial siuaion (Modigliani and Miller, 1958). Since here is no capial raioning, firms can always obain exernal financing wihou problem, so he firms invesmen should be driven only by expeced fuure profiabiliy and, herefore, should no be affeced by he availabiliy of inernal funds. However, in imperfec markes, he firms invesmen may depend on financial facors such as he availabiliy of inernal finance, access o capial markes or cos of financing (Fazzar Hubbard and Peersen, 1988). Under his siuaion, he working capial level held by companies may also be sensiive o hese financial facors. The Ne Trade Cycle (NTC) and Cash Conversion Cycle (CCC) are he mos popular measures of working capial managemen used in previous works, due o he criicism of saic measures (Giman, 1974; Kamah, 1989). Boh of hese measures are a dynamic measure of ongoing liquidiy managemen, and hey are closely correlaed. The CCC is calculaed as (accouns receivables/sales)*365 + (invenories/cos of sales)*365 - (accouns payable/purchases)*365 and shows he ime lag beween expendiure for he purchase of raw maerials and he collecion of sales of finished goods (Deloof, 2003). So, he longer his ime lag, he larger he invesmen in working capial. The Ne Trade Cycle (NTC) is basically equal o he CCC, bu he hree componens (accouns receivable, invenories and accouns payable) are expressed as a percenage of sales, so indicaing he number of days sales he firm has o finance is working capial (Shin and Soenen, 1998). Increasing hese cycles may posiively affec firms profiabiliy for wo reasons. Firs, i may increase firms sales (Blinder and Maccin1991; Smih, 1987; Emery, 1987; Deloof and Jegers, 1996; Peersen and Rajan, 1997; and Ng, Smih and Smih, 1999). These works show ha firms sales increase when hey increase heir invesmen in invenories or rade credi graned. Second, Ng e al., (1999) and Wilner (2000) also demonsrae ha firms may ge imporan discouns for early paymens when hey reduce heir supplier financing. However, his benefi has o offse he coss of a larger invesmen in working capial when firms operae under imperfec capial markes. Firs, firms have a financing cos. Second, he main cos of holding a higher working capial level is he opporuniy cos, because a firm may forgo oher more producive invesmens in order o hold ha level. Finally, and according o Soenen (1993), longer cycles migh also lead companies o bankrupcy. 6

7 Hence, under imperfec capial markes, companies may have an opimal Ne Trade Cycle ha balances he coss and benefis of mainaining i and which maximizes heir value. In addiion, since a longer cycle indicaes a need for addiional capial, i may depend on agency coss, asymmeric informaion and financial disress, because hese lead o a higher cos of financing exernal and credi raioning. Asymmeric Informaion and Agency conflics Asymmeric informaion and agency coss could lead o eiher underinvesmen or overinvesmen. On he one hand, given he limied liabiliy of shareholders, hey migh carry ou riskier invesmen projecs (problem of overinvesmen), because shareholders would benefi from he firm s higher value, while crediors would suffer he possible losses (Jensen and Meckling, 1976). On he oher hand, he conflic beween shareholders and crediors, according o Myers (1977), can also lead o a problem of underinvesmen, because given he prioriy of crediors in case of bankrupcy, shareholders may decide no o carry ou or o abandon invesmen projecs wih a posiive ne presen value when he ne presen value of he invesmen is less han he amoun of deb issued. Consequenly, firms have o pay a risk premium, which resuls in a higher cos for exernal sources of funds. In his sense, he pecking order heory of Myers (1984) saes ha firms give prioriy o resources generaed inernally over deb and new equiy. This idea has been suppored by several earlier sudies ha have demonsraed ha he amoun of corporae invesmen is affeced by is inernal financing (Fazzari e al., 1988; Carpener, 1995; Kadapakkam, Kumar and Riddick, 1998; Hosh Kashyap and Scharfsein., 1991; Hadlock, 1998; Cleary, 1999; Moyen, 2004). Greenwald e al., (1984), on he oher hand, sugges ha asymmeric informaion may also resul in credi raioning in compeiive markes, which migh also affec he level of firms invesmen. Hence, and aking ino accoun hese hypohesis, inernal funds should also posiively influence he firms working capial invesmen, as is demonsraed by Fazzari and Peersen (1993). Growh opporuniies is anoher variable ha migh affec working capial managemen, because firms wih higher growh perspecives have more severe agency conflics beween crediors and shareholders (Myers, 1977) and larger asymmeric informaion due o heir value being largely deermined by hese growh perspecives (Myers and Majluf, 1984). Thus, we would expec hese companies o have a shorer cycle. The resuls obained by he empirical evidence, however, lead o opposie conclusions abou he effecs of his variable. Kieschnick e al., (2006) show ha his 7

8 variable posiively influences Cash Conversion Cycle for US firms, while Chiou e al., (2006) do no find any relaion beween hese variables. These problems, on he oher hand, are also sensiive o leverage, according o he exising lieraure. The resuls obained by Krishnawami e al., (1999) appear o indicae ha agency conflics beween shareholders and crediors decrease also wih privae deb, which predominaes in Spain. In his line, o he exen ha deb raio acs as a proxy for he abiliy of he firms o obain deb i would be expeced ha firms wih higher leverage (greaer abiliy o raise deb) will hold more invesmen in working capial. Firm size is anoher facor influencing hese agency coss. The agency problem beween shareholders and crediors is expeced o be aenuaed by size (Smih and Warner, 1979), since smaller firms suffer more severe asymmeric informaion beween insiders and ousiders (Jordan e al., 1998; and Berger e al., 2001), due o he fac ha less public informaion is available o hem. Thus, his facor would be expeced o posiively influence he lengh of his cycle. However, we should also menion ha his variable has also been associaed in he lieraure wih he firm s bargaining power wih is suppliers and cusomers, showing ha larger firms have a greaer bargaining power, so hey migh have a shorer NTC. According o Long e al. (1993), Lee and Sowe (1993), and Pike, Cheng, Cravens and Lamminmaki (2005), smaller firms have o exend more credi o guaranee heir producs, given heir lower repuaions. In addiion, hey are offered less rade credi (Niskanen and Niskanen, 2006). Wih regard o he resuls obained from he empirical evidence, hey lead o conrary conclusions abou he effec of his variable on he measures of working capial managemen (Moss and Sine (1993); Jose e al., (1996); Kieschnick e al., (2006) and Chiou e al., (2006)). Finally, we also expec invesmen in fixed asses o influence Ne Trade Cycle. The problems of asymmeric informaion and agency conflic beween shareholders and crediors are expeced o be more serious for companies wih lower fixed invesmen and greaer inangible asses, because hese laer asses canno be easily valued by poenial exernal invesors and hese firms would have a lower liquidaion value of heir asses. Thus, shareholders migh decide o carry ou greaer risk projecs in hese firms if he liquidaion value of heir asses is lower han he deb value. We should expec, hence, a posiive relaion beween his variable and he Ne Trade Cycle. However, when firms operae under imperfec capial markes, hey bear financial consrains, so his variable migh compee wih he working capial for firm s capial in 8

9 his siuaion, as is repored by Fazzari and Peersen (1993) and Kieschnick e al. (2006). Financial disress We also inroduce he variable probabiliy of financial disress because he agency conflics commened above are more pronounced for financially disress firms. The coss of financial disress arise when he firm canno mee is paymen obligaions eiher in he shor or he long erm. This can affec he Ne Trade Cycle of firms, since companies wih a greaer probabiliy of financial disress have more difficulies in obaining capial. Given ha a longer cycle indicaes a need for addiional capial, hese firms migh have a shorer NTC. 3. Mehod and Daa 3.1. Mehod Following he heories described in he previous secion and considering he coss and benefis of keeping working capial, we assume ha firms have a arge Ne Trade Cycle. Firms curren Ne Trade Cycle may no always equal heir desired cycle and, hence, firms migh ake ime o adjus from acual o he desired cycle. This can be for several reasons. Nadiri (1969), for insance, suggess ha firms canno always esimae heir sales accuraely and wih cerainy, and hence neiher heir purchases; hey do no accuraely anicipae changes in moneary policy or in he raes of defaul and bad debs on heir rade credi; and he discovery and collecion of delinquen accouns ake ime and involve coss which may be disribued over ime. Like Shin and Soenen (1998), we use he Ne Trade Cycle as dependen variable, which is calculaed by he following expression: NTC= (accouns receivables/ sales)*365 + (invenories/sales)*365 - (accouns payable/sales)*365. Thus, i provides an easy esimae for addiional financing needs wih regard o working capial expressed as a funcion of he projeced sales growh. Wih regard o he independen variables, he capaciy o generae inernal funds is proxied by he variable cash flow (CFLOW), defined as he raio of earnings before ineres and ax plus depreciaion o sales. We use wo proxies o measure he growh opporuniies. GROWTH 1 is calculaed by he raio marke-o-book value of asses ((marke value of equiy + marke 9

10 value of deb) / oal asses), while GROWTH 2 is defined as he raio marke-o-book value of equiy (marke value of equiy / book value of equiy). The raio of oal deb over oal asses (LEV) is used as proxy for he leverage. We use he naural logarihm of asses (SIZE 1 ) and he naural logarihm of sales (SIZE 2 ) o measure he size. The invesmen in fixed asses (FA) of he firm is measured by he raio angible fixed asses over oal asses. The likelihood of financial disress (ZSCORE) is calculaed according o he reesimaion of Alman s (1968) model carried ou by Bergley e al., (1996), given by he following expression: ZSCORE i = 0,104*X 1 + 1,010*X 2 + 0,106*X 3 + 0,003*X 4 + 0,169*X 5 where X 1 = Working capial / Toal asses; X 2 =Reained earnings / Toal asses; X 3 = Ne operaing profis /Toal asses; X 4 = Marke value of capial / Book value of deb; X 5 = Sales / Toal asses. Thus, a higher ZSCORE implies a lower probabiliy of insolvency. Finally, aking ino accoun he previous sudies on he deerminans of working capial managemen and he heories described in secion 2, we also inroduce he variables cos of exernal finance (FCOST) and profiabiliy (PRO) as independen variables. We expec firms wih a higher cos of exernal finance o hold a smaller NTC, since he cos of funds invesed in i is higher. This cos is also measured by wo proxies. The firs (FCOST 1 ) is calculaed by he raio financial coss/(oal deb - accouns payable). In he second one (FCOST 2 ) we do no eliminae accouns payable of he oal deb. On he oher hand, he empirical evidence demonsraes ha reurn also negaively affecs measures of working capial managemen. The raios earnings before ineres and axes over oal asse (PRO 1 ) and earnings before ineres and axes over sales (PRO 2 ) are used in our analysis as proxies for his variable. Thus, Ne Trade Cycle can be explained by he following variables: NTC*= f (inernal resources, growh opions, leverage, size, fixed asses, probabiliy of financial disress, cos of exernal finance, profiabiliy) Firms may be very differen from each oher and here are oher characerisics ha migh influence heir Ne Trade Cycle ha are difficul o measure or hard o obain, and which are no in our model. Therefore, we use panel daa, because i allows us conrol for unobservable heerogeneiy, making i possible o exclude biases deriving 10

11 from he exisence of individual effecs (Hsiao, 1985). Addiionally, we can also include ime effecs o capure he influence of economic facors ha may also affec he lengh of Ne Trade Cycle. Finally, i allows us examine a parial adjusmen model o confirm wheher firms pursue a arge Ne Trade Cycle. If here is a arge Ne Trade Cycle, firms should ake he appropriae seps o achieve i. However, adjusmen is no immediae because firms have o bear coss of adjusmen, so hey will adjus heir curren NTC according o he following expression: NTC NTC = γ ( NTC * NTC ) 0 < γ < (1) where NTC is he Ne Trade Cycle in he period, and NTC* is he arge Ne Trade Cycle, which is esimaed from he following equaion: NTC * = β + β CFLOW 0 + β FA β ZSCORE 6 + β GROWTH 2 + β FCOST 7 + β LEV 3 + β PRO 8 + β SIZE 4 + ε (2) where ε is a random disurbance and β k are he unknown parameers o be esimaed. The expression NTC * NTC ) is he adjusmen required o reach he ( 1 firm s arge NTC, and he coefficien measures he speed of adjusmen, which is inversely relaed o adjusmen coss, and akes values beween 0 and 1. If hen NTC i NTC, = 1 γ γ = 0,, and he curren Ne Trade Cycle remains as in he previous period, indicaing ha companies bear high adjusmen coss. If, in conras, γ = 1, hen NTC, = NTC * i, and firms immediaely adjus heir Ne Trade Cycle o heir arge. If we subsiue equaion (2) ino equaion (1) and we include he unobservable heerogeneiy and he ime dummy variables, he curren NTC is deermined by he following expression: NTC NTC = α + ρ 1 + δ FA 5 + δ CFLOW + δ ZSCORE δ GROWTH + δ FCOST δ LEV + δ PRO 8 3 i + δ SIZE 4 + η + λ + υ (3) where α = γβ0 ; ρ = (1 γ ); δ k = γβ k ; and υ = γε Parameer η i capures oher characerisics of firms which are no observable bu which have a significan impac on he lengh of he Ne Trade Cycle. These change 11

12 across companies bu remain fixed for a given firm hrough ime. The variable λ, on he conrary, is a ime dummy ha changes in ime bu is equal for all firms in each of he ime periods considered. This parameer is designed o capure he influence of economic facors ha also may affec he lengh of his Cycle, bu ha firms canno conrol. Finally, he parameers υ are random disurbances. We use he insrumenal variable esimaion mehod o avoid he problem of endogeneiy, which appears o be eviden in our analysis, as several sudies have shown. For example, he working capial managemen migh affec profiabiliy (Jose e al., 1996; Shin and Soenen, 1998; Deloof, 2003; and Garcia and Marinez, 2007) and firms sales (Blinder and Maccin 1991; Smih, 1987; Emery, 1987; Deloof and Jegers, 1996; Peersen and Rajan, 1997; and Ng e al., 1999). If we do no conrol for endogeneiy, i migh seriously affec he esimaion resuls. Thus, we use he wo-sep GMM esimaor proposed by Blundell and Bond (1998) because, alhough he esimaor of insrumenal variables in one sage is always consisen, if he disurbances show heeroskedasiciy, he esimaion in wo sages increases efficiency Daa The daa for his analysis were obained from hree sources of informaion. Firs, daa from financial saemens have been aken from he SABI (Iberian Balance Shees Analysis Sysem) daabase, which was developed by Bureau Van Dijk. Second, he marke value of equiy was exraced from CNMV (Spanish Securiy Exchange Commission). Finally, Gross Domesic produc daa were colleced from he Bank of Spain. Our daa consiss of non-financial Spanish firms lised on he Spain Sock Exchange for he period We have seleced firms whose informaion is available for a leas five consecuive years beween 1997 and From his, we obained a panel comprising 502 observaions corresponding o 60 firms. Table 1 repors he median values of Ne Trade Cycle by secor and year. We observe ha he Ne Trade Cycle differs beween secors, which suppors he indusry effec on he firms working capial managemen suggesed by earlier sudies (Hawawin Vialle and Vora, 1986; Weinraub and Visscher, 1998; Filbeck and Krueger, 2005; and Kieschnick e al., 2006). So, he larges Ne Trade Cycle during our period of analysis is found in reail rade ( days). In conras, ranspor and public services (37.99 days) has he smalles. On he oher hand, i seems ha some secors 12

13 presen significan changes for he seleced research period. We can see how he NTC has been reduced in all secors from 1997 o 2004, excep in agriculure and mining. This could indicae ha firms have been improving heir working capial managemen and have adoped more aggressive working capial policies in recen years. Table 1 Ne Trade Cycle by year and secor Agriculure and Mining Manufacuring Consrucion Wholesale rade Reail rade Services Transpor and public services Toal The Ne Trade Cycle is calculaed as ((accouns receivable + invenories - accouns payable)/sales)*365 In able 2 we can observe he imporance of curren asses and liabiliies and working capial requiremens by secor of aciviy. In addiion, we also presen he median values of he individual componens of our dependen variable. The high value of curren asses over he oal asses in he majoriy of secors indicaes he imporance of managing hem efficienly. So, he larges invesmen in curren asses over he oal asses is in consrucion (72.7%) and reail rade (67.8%). Wih regard o he average periods by secor, we can see ha he firms dedicaed o he agriculure and mining ake leas ime o collec paymens from heir cusomers and are also he firs o pay heir suppliers. In conras, firms from he consrucion secor gran heir cusomers he longes period in which o pay and ake longes o pay heir suppliers. In relaion o he invenory, i is sored he longes in wholesale rade, while i is sored he leas in ranspor and public services. Table 2 Firms characerisics by secor of aciviy AR INV AP CA/TA CL/TA WKR Agriculure and Mining Manufacuring Consrucion Wholesale rade Reail rade Services Transpor and public services This able shows he median value of firms characerisics by secor of aciviy. AR is he raio (accouns receivable / sales)*365; INV he raio (invenories / sales)*365; AP he raio (accouns payable / sales)*365; CA/TA is he raio curren asses o oal asses; CL/TA he raio curren liabiliies o oal asses; WKR is he raio accouns receivable plus invenories minus accoun payables o oal asses. 13

14 Finally, able 3 summarizes he descripive saisics of our sample. If we observe he mean values, we can see ha he mean Ne Trade Cycle in our sample is days. These firms have had posiive growh perspecives during he seleced research period and an invesmen in fixed asses over he oal asses of 50.6%. They generae a cash flow of 16.9% over sales and presen 58.3% of deb over oal asses. Their profiabiliy over asses and sales are 7% and 10.9%, respecively. Table 3 Summary of Saisics Mean Sd. Dev Min Median Max NTC CFLOW GROWTH GROWTH LEV ASSETS 4,276,179 11,700,000 14, ,551 91,800,000 SALES 2,447,147 6,076,944 3, , ,000,000 AF ZSCORE FCOST FCOST PRO PRO GDP Noes: NTC represens he Ne Trade Cycle; CFLOW he cash flows generaed by he firm; GROWTH 1 and GROWTH 2 he growh opporuniies; LEV he leverage; ASSETS he oal asses in housands of euros; SALES he sales in housands of euros; AF he invesmen in fixed asses; ZSCORE he probabiliy of financial disress; FCOST 1 and FCOST 2 he cos of exernal finance; PRO 1 and PRO 2 he profiabiliy; and GDP he Gross Domesic Produc growh. 4. Resuls Table 4 shows he resuls from regressing Ne Trade Cycle on he differen variables explained above. To confirm he robusness of our resuls we presen he esimaion of equaion (3) using alernaive proxies for some independen variables. In addiion, in column (6) we esimae he model including he Gross Domesic Produc growh and eliminaing he ime dummies o avoid he mulicollineariy problem, since hese dummies should capure ha informaion. The m 2 saisic and Hansen es also are presened. The m 2 saisic indicaes here is no second-order serial correlaion, and Hansen Tes shows he absence of correlaion beween insrumens and error erm. We also presen he Variance Inflaion Facor (VIF) for each independen variable. Our VIF ess are lower han 5, so here is no mulicollinariy problem in our sample (Sudenmund, 1997). In all esimaions we conrol for indusry effecs. 14

15 The resuls show ha he coefficien of he lagged Ne Trade Cycle is posiive and significan a he 1% level in all he esimaions made. Hence, our hypohesis on he dynamic naure of working capial managemen is no rejeced and we conribue o he exising lieraure on working capial managemen, finding ha companies have a arge Ne Trade Cycle and follow an adjusmen process o reach his arge. In addiion, his coefficien is roughly 0.4 in all he esimaions made, indicaing a relaively quick speed of adjusmen ( γ = 0.6) which appears o suppor he idea ha he coss of being away from arge cycles are significan for our sample and ha a good working capial managemen migh be very imporan for hem. The adjusmen process is a rade-off beween he adjusmen coss owards a arge cycle and he coss of being in disequilibrium. Our findings indicae ha he coss of being in disequilibrium are greaer han he adjusmen coss. One possible reason migh be he imporance of bank credi for Spanish companies. The financial sysem of he European Union is classified as a bank-based sysem, excep for he UK where capial markes are well developed (Schmid and Tyrell, 1997). Thus, Spain has a banking oriened financial sysem wih an imporan role played by he banks. Specifically, in Spain, firms have low ransacion coss when borrowing funds from banks, and consequenly, hey could adjus heir acual Ne Trade Cycle o he arge cycle quickly. As we expeced, we find ha firms have a larger Ne Trade Cycle when hey are capable of generaing more inernal funds, so supporing he argumen of Fazzari and Peersen (1993) ha he invesmen in working capial migh be consrained by a shorage of inernal funds. In addiion, we obain ha his variable has he larges economic impac on he dependen variable. Thus, we obain ha an increase of one sandard deviaion in he variable inernal funds increases he NTC by 41.8% (over he mean). Unlike he empirical evidence, and as we also expeced, our resuls show ha he coefficien of growh perspecives is significan and negaive. Hence, we obain ha companies wih larger growh perspecives have a shorer Ne Trade Cycle, supporing he idea ha hese firms end o use more rade credi as a source of finance for heir growh (Peersen and Rajan, 1997; and Cuña, 2007), while companies wih sales declines end o exend more credi o heir cusomers so as o increase heir sales (Emery, 1987; and Peersen and Rajan, 1997). Moreover, he economic significance of he influence of his variable on he Ne Trade Cycle shows ha, all oher hings being 15

16 equal, an increase in he growh opions of one sandard deviaion produces a reducion in he NTC of 13%. Wih regard o he effecs of leverage on Ne rade Cycle, none of he coefficiens esimaed for his variable are significan. Consequenly, we canno provide any empirical suppor for he argumen ha firms ha are capable of obaining more exernal financing have a longer Ne Trade Cycle. Similarly, we canno provide any empirical suppor for he Chiou e al. (2006) argumen ha deb raio negaively affecs he measures of working capial managemen. These auhors sugges ha heir resuls are due o he fac ha according o he pecking order heory firms only raise heir deb raio when heir inernal capial is depleed, so hey end o have a more efficien working capial managemen in his siuaion. The coefficien of he variable size is negaive and significan in all esimaions a he 1% level, which demonsraes ha larger firms have a shorer Ne Trade Cycle, even hough hey should have fewer difficulies in obaining funding and less financial consrains. This resul migh be inerpreed as meaning ha hese firms have a larger bargaining power wih suppliers and cusomers, so hey have a more efficien working capial managemen. Alhough smaller firms have less access o capial markes hey have o exend more credi o guaranee heir producs, given heir lower repuaions (Long e al., 1993; Lee and Sowe, 1993; and Pike e al., 2005), while hey are offered less rade credi (Niskanen and Niskanen, 2006). In addiion, he economic impac of his variable is relevan, since if i decreases by one sandard deviaion he dependen variable increases over is mean by 23.19%. We also observe, as in oher sudies, ha he invesmen in fixed asses has a negaive effec on he Ne Trade Cycle, despie he fac ha firms wih a higher fixed invesmen also have a beer access o capial marke. This resul appears o suppor he argumen developed by Fazzari and Peersen (1993) ha he working capial compees wih he invesmen in fixed asses for he funds of he firms when hey have financial consrains. Wih regard o he economic effec on he dependen variable, an increase of one sandard deviaion in he variable fixed asses reduces he Ne Trade cycle by 30.5%. As we expeced, we find ha firms wih a higher probabiliy of insolvency have a shorer NTC, since he ZSCORE sign is posiive and significan a he 1% level in all he esimaions carried ou. The agency conflics are more pronounced for hese firms, so hey have more difficulies in obaining capial. So, hey end o have larger accouns payable (Niskasen and Niskasen, 2006), because suppliers end o lend o hem when 16

17 banks do no (Cuña, 2007). In addiion, his also could be inerpreed as meaning ha firms wih a large probabiliy of insolvency end o exend less credi o heir cusomers and migh have a lower invesmen in invenories. This variable has he second mos imporan economic impac (around 40%). The coefficien of he variable ha measures he cos of exernal capial is also negaive and significan, which demonsraes ha he Ne Trade Cycle also depends on he cos of financing, as we suggesed above. In fac, our resuls indicae ha an increase of one sandard deviaion in he cos of exernal finance reduces NTC by 19.6%. Our resuls show, as he empirical evidence, ha firms wih a higher profiabiliy have a shorer Ne Trade Cycle. I is known ha hese firms can obain funds more easily, bu ha, like larger firms, hey also have greaer bargaining power wih suppliers and cusomers (Shin and Soenen, 1998). Hence, his resul appears o suppor he idea ha hese firms end o receive significanly more credi from heir suppliers (Peersen and Rajan, 1997) and hold lower finished goods invenories (Blazenco and Vandezande, 2003), while firms facing profiabiliy problems end o increase rade credi receivable prior o enering financial disress (Molina and Preve, 2006). There is also a relevan economic impac since an increase in one sandard deviaion in his variable involves a reducion in he Ne Trade Cycle of 25.5%. Finally, in column 6 we include he Gross Domesic Produc growh, since his variable could affec he individual componens of he Ne Trade Cycle, such as accouns receivable (Smih, 1987; and Walker, 1991), invenories (Blinder and Maccin 1991; Carpener e al., 1994; and Kashyap e al., 1994), and accouns payable (Nilsen, 2002). Our resuls show ha he Gross Domesic Produc growh posiively influences he lengh of he Ne Trade Cycle, which demonsraes ha when economic growh is higher companies have a longer Ne Trade Cycle. However, we should menion ha a only 4.9% his variable has he smalles economic impac. 17

18 Table 4 Deerminans of Ne Trade Cycle (1) (2) (3) (4) (5) (6) VIF *** *** *** *** *** *** NTC i (26.95) (26.33) (29.22) (34.07) (33.40) (42.20) *** *** *** *** *** *** CFLOW 2.86 (4.82) (3.04) (3.29) (3.25) (2.99) (5.03) GROWTH *** (-3.75) *** GROWTH 2 (-2.77) LEV (0.07) (0.80) SIZE *** (-3.00) *** (-2.59) *** (-5.58) *** (-2.83) *** (-5.64) *** (-5.76) (0.25) (1.03) *** (-3.00) (1.30) *** (-3.81) (0.47) *** (-4.96) SIZE *** (-4.83) AF *** (-4.25) *** ZSCORE (6.44) *** FCOST 1 (-5.91) - FCOST *** PRO 1 (-4.15) - PRO 2 GDP *** (-3.34) *** (6.80) *** (-5.31) *** (-2.99) *** (6.01) *** (-6.52) *** (-3.61) ** (-2.53) * (-1.78) *** (4.85) *** (-3.60) ** (-2.59) *** (-3.00) *** (4.25) *** (-5.21) *** (-5.31) *** (8.02) *** (-9.47) ** (-2.30) *** (-3.89) *** (4.58) m Hansen Tes (221) 42 (221) (221) (221) (221) (223) Observaions Noes: NTC represens he Ne Trade Cycle; CFLOW he cash flows generaed by he firm; GROWTH 1 and GROWTH 2 he growh opporuniies; LEV he leverage; SIZE 1 and SIZE 2 he size; AF he invesmen in fixed asses; ZSCORE he probabiliy of financial disress; FCOST 1 and FCOST 2 he cos of exernal finance; PRO 1 and PRO 2 he profiabiliy; and GDP he Gross Domesic Produc growh. Z saisic in brackes. * Indicaes significance a 10% level, ** indicaes significance a 5% level, *** indicaes significance a 1%. level m 2 is a serial correlaion es of second-order using residuals of firs differences, asympoically disribued as N(0,1) under null hypohesis of no serial correlaion. Hansen es is a es of over-idenifying resricions disribued asympoically under null hypohesis of validiy of insrumens as Chi-squared. Degrees of freedom in brackes. VIF represens he Variance Inflaion Facor for each independen variable

19 5. Conclusions This paper exends empirical evidence on he working capial managemen in several imporan dimensions, including he reamen of unobservable heerogeneiy and endogeneiy problems. Unlike previous sudies, we assume ha firms have an opimal working capial level and we examine he deerminans of curren WCM in he presence of adjusmen coss. Ne Trade Cycle is used as a measure of working capial managemen. The proposed model is corroboraed using a sample of non-financial Spanish companies over he period Our findings are consisen wih he view ha firms adjus heir curren Ne Trade Cycle o he arge NTC gradually over ime due o he presence of adjusmen coss. Moreover, he speed of adjusmen is relaively quick, which appears o indicae ha he coss of being in disequilibrium are greaer han he adjusmen coss because of he imporance of bank credi for Spanish companies. The resuls also sugges ha he Ne Trade Cycle depends on he firm s bargaining power wih is suppliers and cusomers as well as on financial facors such as he availabiliy of inernal finance, cos of financing and access o capial markes. Our resuls indicae ha companies ha are capable of generaing more inernal funds have a longer cycle, which is consisen wih he argumen of Fazzari and Peersen (1993) ha he invesmen in working capial migh be consrained by a shorage of inernal funds. On he conrary, our findings also show ha profiabiliy, size, invesmen in fixed asses, growh opporuniies, probabiliy of financial disress, and cos of exernal financing negaively affec Ne Trade Cycle. Unlike earlier sudies, our resuls sugges ha Ne Trade Cycle does no depend on he leverage. Finally, we obain ha when economic growh is higher, companies have a longer Cycle. Furher research focused on similar sudies in counries wih differen insiuional characerisics and financial sysem would seem o be appropriae, since he speed of adjusmen and he effec of explanaory variables on NTC migh be differen. On he oher hand, i would be also informaive o conduc his sudy for small and medium-sized firms, as i would allow us o compare he differences in he cos of adjusmen beween boh SMEs and large firms. An efficien working capial managemen is paricularly imporan for SMEs, according o he empirical evidence, so hey migh have a quicker adjusmen. 19

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