Analysis of the relationship between working capital policy and operating risk: an empirical study on Jordanian industrial companies

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1 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 Fars Nasf Al-Shubr (Jordan) Analyss of the relatonshp between workng capal polcy and operatng rsk: an emprcal study on Jordanan ndustral companes Abstract The study analyzes the workng capal management practces and ther mpact on profably and rsk of ndustral Jordanan frms for the perod of 004 to 007. The total sample of the study conssts of 59 ndustral frms lsted on Amman Stock Exchange. The workng capal management practces examne the mpact of aggressve/conservatve workng capal nvestment and fnancng polcy and analyze through cross-sectonal regresson models the relatonshp between workng capal polces and profably as well as rsk of the frms. Effcent management of workng capal s a fundamental part of the overall corporate strategy amng to create the shareholders value. Frms try to keep an optmal level of workng capal that maxmzes ther value. The optmal level of workng capal s determned to a large extent by the methods adopted for the management of current assets and lables. It requres contnuous monorng to mantan proper level n varous components of workng capal,.e. cash recevables, nventory and payables, etc. The result ndcates a negatve relatonshp between the profably measures of frms and degree of aggressveness of workng capal nvestment and fnancng polcy. The frms yeld negatve returns f they follow an aggressve workng capal polcy. Moreover, the present study valdates the fndngs of Carpenter and Johnson (983) that there s no relatonshp between the level of current assets and lables and rsk of the frms. Keywords: degree of aggressveness/conservatveness, workng capal polces, Tobn s q, operatng rsk and fnancal rsk. JEL Classfcaton: G, G30, G3, G3. Introducton Net operatng workng capal relates to free cash flow and n turn market value of equy. A posve workng capal requrement, or conservatve workng capal polcy, ndcates a need for addonal capal whch frms can fnance nternally, reducng free cash flow, or externally, generally va commercal papers or lnes of cred. Thus, conservatve workng capal polcy mples costs of eher lost opportunes or explc fnancng costs. A negatve workng capal gap means that the frm s net operatng workng capal provdes fnancng for long-term assets, mplyng an aggressve strategy. Workng capal exsts because of market mperfectons occurrng over frms operatng cycles. To mantan day-to-day operatons whle accommodatng these mperfectons, frms choose the pattern and weghts of short-term asset and lably accounts accordng to ther operatng envronments and fnancng ables. Operatng components of workng capal are targeted as vehcles for mprovng cash flow and maxmzng shareholder wealth. Despe the attenton pad to short-term assets and lables typfed by these studes, an examnaton of the motves behnd operatng workng capal strategy, whle accountng for the net nfluence of recevables, nventory, and payables, s absent n the Fars Nasf Al-Shubr, 00. fnance lerature. There are aggregatve studes of workng capal components: Shn and Soenen (998) and Deloof (003) show that profably and rsk-adjusted returns are nversely related to the cash converson cycle suggestng that aggressve workng capal polcy sgnfcantly mproves frm performance. The net nvestment that supports frm operatons s the workng capal requrement, or net operatng workng capal, defned as the sum of accounts recevable and nventores net of accounts payable. Operatng assets and lables ultmately must be managed n concert rather than ndvdually, a condon ths paper attempts to reflect. In general, from the perspectve of Chef Fnancal Offcer (CFO), workng capal management s a smple and a straghtforward concept of ensurng the ably of the organzaton to fund the dfference between the short-term assets and short-term lables (Harrs, 005). However, a Total approach whch covers should be followed all the company s actves relatng to vendor, customer and product (Hall, 00). In practce, workng capal management has become one of the most mportant ssues n the organzatons where many fnancal executves are strugglng to dentfy the basc workng capal drvers and the approprate level of workng capal (Lamberson, 995). Consequently, companes can mnmze rsk and mprove the overall performance by understandng the role and drvers of workng capal. 67

2 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 A frm may adopt an aggressve workng capal management polcy wh a low level of current assets as percentage of total assets or may also be used for the fnancng decsons of the frm n the form of hgh level of current lables as percentage of total lables. Excessve levels of current assets may have a negatve effect on the frm s profably whereas a low level of current assets may lead to lower level of lqudy and stock outs resultng n dffcultes n mantanng smooth operatons (Van Horne and Wachowcz, 004).. Operatonal defnons Degree of aggressveness/conservatveness: the Aggressve Adaptve-Rsk (AAR) approach s an effcent adaptve approach for parallel smulaton whch provdes optmstc logcal processes wh the ably to adjust ther degree of rsk at run tme, based on observed behavor. The AAR approach s mplemented on a network of workstatons. Performance results usng large synthetc loads are reported and compared to those obtaned for the Tme Warp optmstc technque. Ths conservatve stablzaton concept s the result of mposng an addonal condon to a set of necessary and suffcent condons for output statc stablzaton. Workng capal polces: workng capal also known as net workng capal s a measurement of a busness s current assets, after subtractng s shortterm lables, typcally short term. Sometmes referred to as operatng capal, s a valuaton of the assets that a busness or organzaton has avalable to manage and buld the busness. Generally speakng, companes wh hgher amounts of workng capal are better posoned for success because they have the lqud assets that are essental to expand ther busness operatons when requred. Tobn s q: economcs theory of nvestment behavor where q represents the rato of the market value of a frm s exstng shares (share capal) to the replacement cost of the frm s physcal assets (thus, replacement cost of the share capal). It states that f q (representng equlbrum) s greater than one (q > ), addonal nvestment n the frm would make sense because the profs generated would exceed the cost of frm s assets. If (q < ), the frm would be better off sellng s assets nstead of tryng to put them to use. The deal state s where q s approxmately equal to one denotng that the frm s n equlbrum. Also called general equlbrum theory or q theory, was proposed by the US Nobel laureate economst James Tobn n 98. Operatng rsk: ths concept relates to rsk of loss resultng from nadequate or faled nternal processes, people and systems, or from external events. The defnon ncludes legal rsk, whch s the rsk of loss resultng from falure to comply wh laws as well as prudent ethcal standards and contractual oblgatons. It also ncludes the exposure to lgaton from all aspects of an nstuton s actves. The defnon does not nclude strategc or reputaton rsks. Fnancal rsk: probably of loss nherent n the methods used n fnancng a frm, that may mpar s ably to provde adequate return. Problem defnon The corporate fnance lerature has tradonally focused on the study of long-term fnancal decsons, partcularly nvestments, capal structure, dvdends and company valuaton decsons. However, short-term assets and lables are mportant components of total assets and need to be carefully analyzed. Management of these short-term assets and lables warrants a careful nvestgaton snce the workng capal management plays an mportant role for the frm s profably and rsk as well as s value. The optmal level of workng capal s determned to a large extent by the methods adopted for the management of current assets and lables. It requres contnuous monorng to mantan proper level n varous components of workng capal,.e. cash recevables, nventory and payables, etc. The present study nvestgates the relatve relatonshp between the aggressve/conservatve workng capal polces and profably as well as rsk of frms for 59 ndustral companes lsted on Amman Stock Exchange for the perod of Hypotheses Ths study has tested the followng null hypotheses on relaton between the defned varables and workng capal polces of lsted companes: H0: There s no sgnfcant relatonshp between workng capal polces and Return on Assets (ROA) of Jordanan ndustral companes. H0: There s no sgnfcant relatonshp between workng capal polces and Return on Equy (ROE) of Jordanan ndustral companes. H0: There s no sgnfcant relatonshp between workng capal polces and Tobn s (Q) of Jordanan ndustral companes. H0: There s no sgnfcant relatonshp between workng capal polces and rsk of Jordanan ndustral companes. 4. Importance and contrbuton of ths study The man objectve of workng capal management s to mantan an optmal balance between each of the workng capal component. Busness success 68

3 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 heavly depends on the ably of fnancal executves to manage recevables, nventory, and payables n an effectve way (Flbeck and Krueger, 005). Frms can reduce ther fnancng costs and/or ncrease the funds avalable for expanson projects by mnmzng the amount of nvestment ted up n current assets. Most of the fnancal managers tme and effort are allocated n brngng non-optmal levels of current assets and lables back toward optmal levels (Lamberson, 995). An optmal level of workng capal would be the one n whch a balance s acheved between rsk and effcency. It requres contnuous monorng to mantan proper level n varous components of workng capal,.e. cash recevables, nventory and payables, etc. In general, current assets are consdered as one of the mportant components of total assets of a frm. A frm may be able to reduce the nvestment n fxed assets by rentng or leasng plant and machnery, whereas, the same polcy cannot be followed for the components of workng capal. The hgh level of current assets may reduce the rsk of lqudy assocated wh the opportuny cost of funds that may have been nvested n long-term assets. The mpact of workng capal polces on profably s hghly mportant, however, a ltle emprcal research has been carred out to examne ths relatonshp. Ths paper nvestgates the potental relatonshp of aggressve/conservatve polces wh the accountng and market measures of profably as well as the rsk factor of ndustral Jordanan frms. The present study s expected to contrbute to better understandng of these polces and ther mpact on profably especally n the emergng markets lke Jordan. The study analyzes the workng capal management polces and mpact on profably and rsk of ndustral Jordanan frms lsted n Amman Stock Exchange for the perod of 004 to Theoretcal framework 5.. Operatonal rsk conceptual approach. Recently, the changes that took place on the fnancal market, because of the development of new actves and mplementaton of new products, have generated new types of rsks that are more complex and bgger. A recent category s represented by the relatve operatonal rsk, for whch the Basel Commtee elaborated standards and regulatons. In ths way, the mpact of ths rsk on the actvy of a cred nstuton was recognzed. The past experences ndcated that n the case n whch a fnancal nstuton has not an adequate rsk management, s exposed to jeopardy whch can transform nto mportant losses. These losses can generate even the cessaton of the nstuton s actvy. The Basel Commtee consders the operatonal rsk as a dstnct category of the cred rsk or the market rsk. It defnes the operatonal rsks as the rsk of drect or ndrect loss resultng from nadequate or faled nternal processes, people and systems or from external events. It also takes nto consderaton the legal rsk, but excludes categorcal the strategc and reputaton rsks. Accordng to Merrll Lynch, the prevous defnon does not explan clearly how the nature and the measure of the ndrect losses should be nterpreted. Ths determnes the fnancal nstutons to have ther own defnons, but ths wll create nsubstantaly. Because the Basel Commtee wanted to underlne only the mnmum standards for all the fnancal nstutons, and because of the lack a concrete defnon for ths rsk, n practce the lst of rsk categores was adopted and each of them was analyzed. The separaton was made n order to cover all the possble operatonal rsks and to concentrate on the most sgnfcant causes of the severy of loss met day by day. The specalzed lerature presents the opnons of more authors regardng the operatonal rsk area. Therefore, n 00, The PNC Fnancal Servces Group recommended a more concse defnon for the operatonal rsk, a defnon that should be based on more drect losses and whch excluded categorcal the busness rsk, the strategc rsk and the reputaton rsk: the operatonal rsk s the rsk of the ncome drect loss, whch results from nternal events connected to nadequate personal, mportant errors or llegal behavor because of the errors or the systems and processes nadequate, or from external events where the rsks are not covered by the cred, market or nterest rate rsk. Thus, the operatonal rsk can be nterpreted as a vulnerably of the fnancal nstuton that can be reduced or elmnated through an ncreased control. The mportant ncrease n the operatonal rsk s due to organzatonal, nfrastructure, busness envronment or mprovement changes. These changes were materalzed n: the development of the technology, the ncrease n the attenton to the transparency, the ncrease n the electronc commerce, the ncrease n the operatons for the natural person and small economc agents, deregulaton, the ncompatbly of the systems, the ncreased use of the automatc technologes, globalzaton, the ncreased use of the external sources and the complcated technologes to reduce the cred and market rsks. All of ths determned a healthy management of the operatonal rsk and the ncluson n the nternal process of a bank. Thus, the fnancal nstutons consder that ths rsk appears n the departments called Operatons and s concretzed nto potental losses generated by 69

4 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 errors and controls, systems and processes omssons. That s why, s not necessary to have a specal department for the operatonal rsk. Also, the rsk management s made by a global rsk commtee. But there are some nstutons that consder the operatonal rsk as the rsk whch s not harmonzed wh the cred or market rsks and whch ncorporates all the rsks, except the cred rsk and the market rsk, n order to take nto account all the potental nfluences over the prof and losses account. Ths thng brought some problems and, thus, the fnancal nstutons decded to lm themselves to thngs that can be measured easly. For a bankng-fnancal nstuton we can menton a seres of man operatonal rsk factors, such as: nternal fraud, external fraud, employment practces, the job safety, clents, products and busness practces, bank s products and operaton practces, the techncal nfrastructure defcency, actvy dsturbances and system defectons. For a good management of the operatonal rsk there are sx steps that have to be followed: dentfcaton of the rsk type, dentfcaton of the rsk factors, the exposure to the rsk rank evaluaton, the rsks estmaton, the loss and profle estmaton and source explanaton, the comparson of the rsk wh the profably of each rsk type, beng compulsory to know the potental loss or the causes that generated ths type of rsk. 5.. Ably to fnance operatng workng capal. Posve net nvestments n operatng workng capal requre fnancng. Frms wh lmed fnancal resources, more expensve costs of external fnancng, weaker access to capal markets, reduced barganng power, and exhbng fnancal dstress wll fnd fnancng more problematc Operatng cash flow. Posve operatng cash flow enables frms to fnance a posve workng capal requrement, allowng a more conservatve operatng workng capal strategy, thereby faclatng future sales growth. However, frms wh negatve operatng cash flows must fnance a posve workng capal requrement through other sources. Love, Preve, and Sarra-Allende (007) estmate a drect relaton between net trade cred and cash flow for a sample of frms n emergng market countres. Thus, we expect a posve correlaton between workng capal requrements and cash flow. To releve endogenously concerns, cash flow s measured as lagged operatng ncome before deprecaton mnus ncome taxes scaled by net assets Asymmetrc nformaton and costs of external fnancng. Myers and Majluf (984) show that capal markets extract a premum for the external fnancng of frms wh greater nformatonal asymmetres because such frms projects and cash flows are more dffcult to value, whch leads frms to follow a fnancng peckng order, exhaustng the lowest cost sources of capal frst. A posve workng capal requrement must be fnanced. They expect less transparent frms to have a reduced workng capal requrement snce frms wh greater nformatonal asymmetres typcally pay greater rates to borrow. The lagged market-to-book rato s used as a proxy for the degree of asymmetrc nformaton, where market-to-book s defned as the sum of market value of equy and total lables mnus payables scaled by net assets. We expect an nverse relaton between the workng capal requrement and the market-to-book rato Capal market access. Credworthy frms wh superor capal market access are more capable of fnancng the workng capal gap externally. Brennan and Hughes (99) argue that larger frms are covered more ntensely by analysts, whose ncreased monorng reduces nformatonal asymmetres, mplyng that larger frms enjoy ready access to capal relatve to smaller frms. Snce ths study examnes the determnants of net operatng workng capal, we emphasze commercal paper ssues and bank debt. Whle larger frms fnd easer to fnance relaxed cred and nventory polces, smaller frms are less able to ssue commercal papers or negotate lnes of cred. Havng fewer ways to fnance recevables, smaller frms rely on factorng more than large frms. Whed (99) fnds that larger frms face fewer borrowng constrants than smaller frms because the former have better capal market access. Petersen and Rajan (997) show that recevables are drectly related to sze, and they report a weak posve relaton between payables and sze, but Deloof and Jegers (999) report that payables are nsgnfcantly related to sze Market power. The length of trade cred terms s drectly related to market power as more valuable customers can negotate more generous cred terms wh supplers. In addon, frms wh greater market share can stretch the cred terms offered by supplers wh ltle repercusson as contracts wh ndustry leaders are crcal to the vably of smaller supplers. Smlarly, strong relatonshps wh vendors allow frms wh greater market power to hold fewer nventores. Supplers wh more market power relatve to customers can negotate shorter terms wh customers for at least two reasons. Frst, the level of competon from rval frms s reduced for frms wh large market share, whch decreases the lkelhood of losng customers over a 70

5 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 reducton n cred terms. Second, supplers wh large market share are more lkely to have forged longer relatonshps wh clents, mplyng hgh costs of swchng supplers. These swchng costs nclude learnng and transactons costs as documented by Kemmerer (987) and Chevaler and Scharfsten (996). Molna and Preve (008) show that, compared to frms n competve ndustres, frms n concentrated ndustres tghten cred polcy to a greater extent when facng fnancal dstress Fnancal dstress. Dstressed frms have lmed fnancal slack and cash generatng ably, and the stran of fnancal dstress may cause frms to reduce nvestment n operatng workng capal by collectng on recevables, tghtenng cred terms, lqudatng exstng nventory, and by stretchng cred terms granted by supplers. Molna and Preve (008), show that fnancally dstressed frms have sgnfcantly reduced levels of trade cred relatve to ther non-dstressed counterparts. We expect the workng capal requrement to correlate nversely wh fnancal dstress. Followng Molna and Preve (008), a frm must satsfy two crera to be classfed as fnancally dstressed: the frm must have dffculty coverng nterest payments and be over-leveraged. The frst component s havng a coverage rato, calculated as operatng ncome before deprecaton dvded by nterest expense, less than one for two consecutve years, or less than 0.80 n any gven year. Second, a frm s consdered over-leveraged f s leverage rato s n the top two decles of s ndustry s leverage rato n a gven year. 6. Prevous emprcal evdence Fnally, Afza and Nazr (007) nvestgated the relatonshp between the aggressve/conservatve workng capal polces for seventeen ndustral groups and a large sample of 63 publc lmed companes lsted on Karach Stock Exchange for the perod of Usng ANOVA and LSD test, the study found sgnfcant dfferences among ther workng capal nvestment and fnancng polces across dfferent ndustres. Moreover, rank order correlaton confrmed that these sgnfcant dfferences were remarkably stable over the sx-year study perod. Fnally, ordnary least regresson analyss found a negatve relatonshp between the profably measures of frms and degree of aggressveness of workng capal nvestment and fnancng polces. In the Pakstan context, Rehman (006) nvestgated the mpact of workng capal management on the profably of 94 Pakstan frms lsted on Islamabad Stock Exchange (ISE) for the perod of He studed the mpact of the dfferent varables of workng capal management ncludng Average Collecton Perod, Inventory Turnover n Days, Average Payment Perod and Cash Converson Cycle on the Net Operatng Profably of frms. He concluded that there s a strong negatve relatonshp between above workng capal ratos and profably of frms. Furthermore, managers can create a posve value for the shareholders by reducng the cash converson cycle up to an optmal level. Flbeck and Krueger (005) hghlghted the mportance of effcent workng capal management by analyzng the workng capal management polces of 3 non-fnancal ndustres n USA. Accordng to ther fndngs, sgnfcant dfferences exst between ndustres n workng capal practces over tme. Moreover, these workng capal practces, themselves, change sgnfcantly whn ndustres over tme. Sathyamoorth (00) focused on good corporate governance and n turn effectve management of busness assets. He observed that more emphass s gven to nvestment n fxed assets both n management area and research. However, effectve management workng capal has been recevng ltle attenton and yeldng more sgnfcant results. He analyzed selected Co-operatves n Botswana for the perod of and concluded that these frms followed an aggressve approach durng the whole four-year study perod. Pandey and Parera (997) provded an emprcal evdence of workng capal management polces and practces n the prvate sector manufacturng companes n Sr Lanka. The nformaton and data for the study were gathered through questonnares and ntervews wh chef fnancal offcers of a sample of manufacturng companes lsted on the Colombo Stock Exchange. They found that most companes n Sr Lanka have nformal workng capal polcy and company sze has an nfluence on the overall workng capal polcy (formal or nformal) and approach (conservatve, moderate or aggressve). Moreover, company profably has an effect on the methods of workng capal plannng and control. However, Wenraub and Vsscher (998) have dscussed the ssue of aggressve and conservatve workng capal management polces by usng quarterly data of US frms for the perod of Ther study looked at ten dverse ndustry groups to examne the relatve relatonshp between ther aggressve/conservatve workng capal polces. The authors have concluded that the ndustres had dstnctve and sgnfcantly dfferent workng capal management polces. Moreover, the relatve nature 7

6 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 of the workng capal management polces exhbed remarkable stably over the ten-year study perod. The study also showed a hgh and sgnfcant negatve correlaton between ndustry asset and lably polces and found that when relatvely aggressve workng capal asset polces are followed they are balanced by relatvely conservatve workng capal fnancal polces. 7. Populaton and sample selecton Ths study examnes emprcally the workng capal management practces of sampled ndustral frms. All frms that have been lsted on the Amman Stock Exchange (ASE) durng the four-year perod, , were sampled. Ffty nne frms qualfed to be ncluded n the study sample. The data for the emprcal analyss were derved from the fnancal statements of these frms. 8. Research desgn and hypotheses 8.. Specfcaton of the model. The study used aggressve fnancng polcy and aggressve nvestment polcy as measurng varables of workng capal management. Aggressve Investment Polcy (AIP) results n mnmal level of nvestment n current assets versus fxed assets. In contrast, a conservatve nvestment polcy places a greater proporton of capal n lqud assets wh the opportuny cost of lesser profably. In order to measure the degree of aggressveness, followng rato wll be used AIP = Total Current Assets (TCA)/ Total Assets (TA), where a lower rato means a relatvely aggressve polcy. Aggressve Fnancng Polcy (AFP) utlzes hgher levels of current lables and less long-term debt. In contrast, a conservatve fnancng polcy uses more long-term debt and capal. The degree of aggressveness of a fnancng polcy adopted by a frm wll be measured by: AFP = Total Current Lables (TCL)/ Total Assets (TA), where a hgher rato means a relatvely aggressve polcy. The mpact of workng capal polces on the profably wll be analyzed through frequently used profably measures,.e. Return on Assets (ROA) and Return on Equy (ROE) as well as market measure and Tobn s q by runnng cross-sectonal regressons. The regresson models to be estmated are: RO, () ROE, () Tobn s q, (3) where ROA = Return on Assets of Frm for tme perod t; ROE = Return on Equy of Frm for tme perod t; Tobn s q = value of q of frm for tme perod t; TCA/TA = Total Current Assets to Total Assets rato of frm for tme perod t; TCL/TA = Total Current Lables to Total Assets rato of frm for tme perod t; = ntercept; = error term of the model. The mpact of the workng capal assets management and fnancng polces on the relatve rsk wll be measured by applyng regresson models for the rsk of the company and s workng capal management polces over the perod of The regresson equatons are: SDSales, (4) SD ROA, (5) SD ROE, (6) SD q, (7) where SD = Standard Devaton representng rsk of frm. 9. Data and man emprcal results Equaton () has been estmated for 59 ndustral frms for the perod and results are reported n Table. For each year, TCA/TA and TCL/TA ratos have been regressed aganst ROA values and the fve regresson models ndcatng the mpact of workng capal polces on the profably of Jordanan frms. The model of t-test and F- values and the SPSS statstcs ndcate overall best f of the model. The t-statstcs of both TCA/TA and TCL/TA are statstcally sgnfcant at %, 5%, and 0% levels for ROA for all the years except for 006 and 007. The posve coeffcent of TCA/TA shows a negatve relatonshp between the degree of nvestment polcy aggressveness and return on assets. As TCA/TA ncreases, degree of aggressveness decreases, and return on assets goes up. Therefore, there s a negatve relatonshp between the relatve degree of aggressveness of workng capal nvestment polces and return on assets. The negatve value of coeffcent for TCL/TA also ponts at the same negatve relatonshp between the aggressveness of workng capal fnancng polcy and return on assets. The hgher the TCL/TA rato, the more aggressve s the fnancng polcy that yelds negatve return on assets. 7

7 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 Table. Regresson analyss of workng capal polces and return on assets (ROA) Investment polcy + fnancng Investment polcy Fnancng polcy polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.08**) (.04**) *** (.068*) (.967) (33).6.885(.380) (.40) (.769) (.000***) (.46) *** Note: *** Sgnfcant at %. ** Sgnfcant at 5%. * Sgnfcant at 0%. The results of regresson model () have been reported n Table, where the dependent varable s return on equy havng the same ndependent varable of workng capal nvestment polcy and workng capal fnancng polcy. As the degree of aggressveness of workng capal polcy tends to ncrease, the returns are lkely to decrease. Though, the results are statstcally hghly mpressve whch s apparent from the hgh level of sgnfcance of coeffcents and t-values, however, they predct a negatve relatonshp between the degree of aggressveness of workng capal polcy and accountng measures of returns. Table. Regresson analyss of workng capal polces and return on equy (ROE) Investment polcy + fnancng Investment polcy Fnancng polcy polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.039**) (.00**) *** (.0**) (.499) ** (.04**).06.47(.639) (.03**) (.564) (.000***) (.0) *** Note: *** Sgnfcant at %, ** Sgnfcant at 5%. * Sgnfcant at 0%. To further valdate the above-mentoned results, the mpact of workng capal nvestment and workng capal fnancng polcy on the market returns has also been examned. Tobn s q has been used as a measure of market returns, for each year from 004 to 007. q-value greater than ndcates the greater perceved value gven by nvestor to the frm. The results of equaton (3) have been presented n Table 3: the results reported n the frst panel of Table 3 are n accordance wh those of Table and Table hghlghtng that the market returns on Tobn s q are decreasng as the frms are followng the aggressve nvestment polcy by keepng low level of current assets. Ths smlary n the market and accountng returns confrms the noton that nvestors do not beleve n the aggressve approach of workng capal management, hence, they don t gve any addonal value to the frms lsted on Amman Stock Exchange. However, some dssmlares are found n the relatonshp between fnancng polcy and Tobn s q. In the years 005, 006 and 007, the relatonshp between workng capal fnancng polcy and Tobn s q s posve, ndcatng that the hgher the degree of aggressveness of workng capal fnancng polcy, the greater the nvestor s value gven to the frm. Table 3. Regresson analyss of workng capal polces and Tobn s q Investment polcy + fnancng Investment polcy Fnancng polcy polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.050*) (.854) (.473).66.7(.09) (.575).64.5(.6) ** (.390) (.696) (.080*) (.496) *.06 Note: *** Sgnfcant at %. ** Sgnfcant at 5%. * Sgnfcant at 0%. Fnally, to emprcally test the theory of Van- Horne and Wachowcz (004), mpact of workng capal polces on rsk of the frms has been nvestgated by regressng the ordnary least square regressons for equatons (4)-(7). The rsk s measured by the standard devaton of sales and dfferent return measures as operatng and fnancal rsk, respectvely. 73

8 Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 The standard devaton has been estmated over the four years, from 004 to 007, and then fve regressons have been run for workng capal nvestment and workng capal fnancng polcy and results are reported n Tables 4 to 7. The posve coeffcents of SD Sales, SD ROA, SD ROE, and SD Tobn s q ndcate negatve relatonshp between the rsk measurements and the workng capal nvestment polcy. On the other hand, smlar relatonshp has been found for the workng capal fnancng polcy. The ncreased varaton n sales and profably s attrbuted to ncreasng the level of current assets and decreasng the level of current lables n the frm. However, these results are not statstcally sgnfcant except the SD ROA, SD ROE n years 004, 005 and n all years from 004 to 007. In general, there s no statstcally sgnfcant relatonshp between the level of current assets and current lables and operatng and fnancal rsk of Amman ndustral frms. Table 4. Regresson analyss of workng capal polces and rsk (standard devaton of sales (SD Sales )) Investment polcy + fnancng Investment polcy Fnancng polcy polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.746) (.54) (.90) (.367) (.889).05.87(.85) (.959) (.98) (.783) (.54) Note: *** Sgnfcant at %. ** Sgnfcant at 5%. * Sgnfcant at 0%. Table 5. Regresson analyss of workng capal polces and rsk (standard devaton of return on assets (SD ROA )) Investment polcy + fnancng Investment polcy Fnancng polcy polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.377) (.000***) * (.67) (.87) * (.365) (.96) (.74) (.734) (.5) (.40) * Note: *** Sgnfcant at %. ** Sgnfcant at 5%. * Sgnfcant at 0%. Table 6. Regresson analyss of workng capal polces and rsk (standard devaton of return on equy (SD ROE )) Investment polcy + Investment polcy Fnancng polcy fnancng polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.45) (.00***) *** (.500).74.50(.036**) (.).60.(.7) (.57) (.66) (.034**) (.00***).399 ***.000 Note: *** Sgnfcant at %. ** Sgnfcant at 5%. * Sgnfcant at 0%. Table 7. Regresson analyss of workng capal polces and rsk (standard devaton of Tobn s q (SD q )) Investment polcy + Investment polcy Fnancng polcy fnancng polcy -coeffcent t-value (sg) -coeffcent t-value (sg) F-value sg (.664) (.957) (.743) (679) (.369) (.0) (.587) (.798) (.894) (.54) Note: *** Sgnfcant at %. ** Sgnfcant at 5%. * Sgnfcant at 0%. 74

9 The results above are n conflct wh those of Gardner et al. (986), and Wenraub & Vsscher (998), but they are n accordance wh the fndngs of Afza and Nazr (007) and produced negatve relatonshp between the aggressveness of workng capal polces and accountng measures of profably. Although the results of all return varables are sgnfcant, model () produces more broader and consstent results as compared to models () and (3) where F-value and coeffcents are hghly sgnfcant. Market returns (Tobn s q) are slghtly less sgnfcant n our study whch s attrbuted to the more volatle stock market of Jordan. The Amman Stock Market s sad to be heavly overvalued stock market, and hence, the results based on market share prce data are more nconsstent. Moreover, results of Tables 4-7 confrm the results of Carpenter and Johnson (983) n that there s no statstcally sgnfcant relatonshp between the workng capal levels and the operatng and fnancal rsk of the frms. Concluson and recommendatons Short-term assets and lables are mportant components of total assets and needs to be carefully analyzed. Management of these short-term assets and lables warrants a careful nvestgaton snce the workng capal management plays an mportant role n a frm s profably and rsk as well as s value. Effcent management of workng capal s a fundamental part of the overall corporate strategy to create the shareholders value. Frms try to keep an optmal level of workng capal that maxmzes ther value. In practce, workng capal management has become one of the most mportant ssues n the organzatons where many fnancal executves are strugglng to dentfy the basc workng capal drvers and the approprate level of workng capal. Consequently, companes can mnmze rsk and mprove the overall performance by understandng the role and drvers of workng capal The study nvestgated the relatve relatonshp between the aggressve/conservatve workng capal polces for 59 ndustral companes lsted on Amman Stock Exchange for the perod of References Investment Management and Fnancal Innovatons, Volume 7, Issue, 00 The mpact of aggressve/conservatve workng capal nvestment and fnancng polces has been examned through cross-sectonal regresson models between workng capal polces and profably as well as rsk of the frms. The result ndcates a negatve relatonshp between the profably measures of frms and degree of aggressveness of workng capal nvestment and fnancng polces. The frms yeld negatve returns f they follow an aggressve workng capal polcy. These results are further valdated by examnng the mpact of aggressve workng capal polces on market measures of profably whch was not tested before. The results of Tobn s q were n lne wh the accountng measures of profably and produced almost the same results. Moreover, the fndngs of Carpenter and Johnson (983) are also confrmed that there s no sgnfcant relatonshp between the aggressveness/conservatveness of workng capal polces of frms and ther operatng and fnancal rsk. Usng a new measure of profably,.e. Tobn s q to estmate the relatonshp of workng capal management and frm returns n Amman, the current study s expected to be a sgnfcant contrbuton to fnance lerature. Moreover, theoretcal dscusson on rsk and workng capal management has also been tested on the emprcal bass n an emergng market of Jordan. Although the results of current study are n contrast to some earler studes on the ssue, yet, ths phenomenon may be attrbuted to the nconsstent and volatle economc condons of Jordan. The reasons for ths contradcton may further be explored n upcomng researches and ths topc s left for future. Fnally, the study recommends to address vagares of generally accepted accountng practces related to unexpected and uncontrollable events or changes n the suaton. The success of the event wll depend on whether the careful analyss of accountng data of fnancal statements wll be done to gan access to the fnancal status of frms to try to make a proper assessment and mprove the overall performance and rsk of the frms.. Afza T. and M.S. Nazr (007). Workng Capal Management Polces of Frms: Emprcal Evdence from Pakstan. Presented at 9th South Asan Management Forum (SAMF) on February 4-5, North South Unversy, Dhaka, Bangladesh.. Brennan, M., and P. Hughes (99). Stock Prces and the Supply of Informaton, Journal of Fnance 46, Carpenter M.D. and K.H. Johnson (983). The Assocaton between Workng Capal Polcy and Operatng Rsk, The Fnancal Revew 8(3): Chevaler, J. and D. Scharfsten (996). Capal Market Imperfectons and Countercyclcal Markups: Theory and Evdence, Amercan Economc Revew 86,

10 Investment Management and Fnancal Innovatons, Volume 7, Issue, Deloof M. (003). Does Workng Capal Management Affect Profably of Belgan Frms? Journal of Busness, Fnance and Accountng 30(3&4): Deloof, M., and M. Jegers. (996). Trade Cred, Product Qualy, and Intragroup Trade: Some European Evdence, Fnancal Management 5, Flbeck G. and T. Krueger (005). Industry Related Dfferences n Workng Capal Management, Md- Amercan Journal of Busness 0(): Gardner M.J., D.L. Mlls, and RA Pope (986). Workng Capal Polcy and Operatng Rsk: An Emprcal Analyss, The Fnancal Revew (3): Hall C. (00). Total Workng Capal Management. AFP Exchange (6): Harrs A. (005). Workng Capal Management: Dffcult but Rewardng. Fnancal Executve (4): Klemperer, P. (987). Markets wh Consumer Swchng Costs, The Quarterly Journal of Economcs 0, Lamberson M. (995). Changes n Workng Capal of Small Frms n Relaton to Changes n Economc Actvy, Md-Amercan Journal of Busness 0(): Love, I., L. Preve, and V. Sarra-Allende (007). Trade Cred and Bank Cred: Evdence from Recent Fnancal Crses, Journal of Fnancal Economcs 83, Molna, C. and L. Preve (008). Trade Recevables Polcy of Dstressed Frms and s Effect on the Cost of Fnancal Dstress, Fnancal Management, forthcomng. 5. Myers, S., Majluf, N. (984) Corporate Fnancng and Investment Decsons When Frms Have Informaton That Investors Do Not Have, Journal of Fnancal Economcs 3, Pandey I.M. and K.L.W. Parera (997). Determnants of Effectve Workng Capal Management A Dscrmnate Analyss Approach. IIMA Workng Paper # 349. Research and Publcaton Department Indan Instute of Management Ahmedabad Inda. 7. Petersen, M., and R. Rajan (997). Trade Cred: Theores and Evdence, Revew of Fnancal Studes 0, Rehman A. (006). Workng Capal Management and Profably: Case of Pakstan Frms (Unpublshed Dssertaton). Pakstan: COMSATS Instute of Informaton Technology Islamabad. 9. Shn H.H. and L. Soenen (998). Effcency of Workng Capal and Corporate Profably, Fnancal Practce and Educaton 8: Sathamoorth C.R. (00). The Management of Workng Capal n selected co-operatves n Botswana. Fnance Inda Dehl 6(3): Van-Horne JC and JM Wachowcz (004). Fundamentals of Fnancal Management ( th Edon). New York: Prentce Hall Publshers.. Wenraub H.J. and S. Vsscher (998). Industry Practce Relatng To Aggressve Conservatve Workng Capal Polces, Journal of Fnancal and Strategc Decson (): Whed, T.M. (99). Debt, Lqudy Constrants, and Corporate Investment: Evdence from Panel Data, Journal of Fnance 47,

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