Abstract
High-performance management drives outstanding corporate operating performances, excels against competitions, and results in superior stock returns. Although every investor pursues to invest in companies with such higher-performance management teams, identifying these management talents, though makes common sense, is indeed a challenging and elusive endeavor. The research paper explores the hypotheses of using working capital metrics as a sign or symptom for projecting future performances of management teams. In other words, companies with superior working capital metrics can potentially suggest high-performance management teams present. Some literatures in the past studied working capital management and its relationship with company’s profitability. However, these past literatures were not in large number, and they often studied companies outside of the United States. Our research paper proposes two hypotheses: (i) evaluate how much time companies with top performing working capital management metrics can sustain over their low performing peers and (ii) determine if the companies with top performing working capital management metrics can indeed achieve superior operating performances over time. Our dataset is very limited to contain only one year of fundamental data from 2,388 public companies. We expect our research to show that companies with top performing working capital metrics can sustain their superior working capital performances. We also expect to observe that these top performing companies achieve superior operating performances, equity returns, and equity valuation multiples. Our preliminary result reveals that top performing companies have statistically significant outperformance of working capital metrics over low performing companies. Preliminary result also illuminates that top performing companies have statistically significant higher equity valuation multiples over low performing companies. However, it is inconclusive to suggest if top performing companies have statistically significant higher equity returns over low performing companies.
I. Introduction
High-performance management drives outstanding corporate operating performances, excels against competitions, and results in superior stock returns. These selected groups of managers invest in high-return projects, leverage limited capital, optimize available resources, and eliminate operating inefficiencies. While executives involved in mergers and acquisitions are often featured in the presses, high-performance executives who focus on business objectives, operational details, and process efficiencies are the ones who actually add superior values.
Legendary money managers are known for their unique skills in identifying these high-performance management talents. For example, Peter Lynch of Fidelity Magellan Fund was known to relentlessly visit company after company to seek out effective managers. Warren Buffett, considered by some to be one of the most successful investors in the world, routinely identifies business managers who can increase cash flows by leveraging existing assets and optimizing resources. Identifying high-performance management, though makes common sense, is indeed a challenging and elusive endeavor. As a result, there is no guaranteed method to identify these managers.
This research paper explores an approach using working capital management metrics to identify the companies which are likely managed by high-performance managers. The hypothesis is that excellent working capital management is potentially a sign or symptom of highly effective managers who focus on operational details of optimizing resources utilization, make effective uses of key performance indicators, benchmark against other peers and competitors, adopt best practices, and go beyond merely pursuing revenue growth or improving profit margins.
We develop two hypotheses in the research paper. The first hypothesis is to evaluate how much time companies with top performing working capital management metrics can sustain over their low performing peers. The second hypothesis is to determine if the companies with top performing working capital management metrics can indeed achieve superior operating performances including equity returns over time.
After we perform the hypothesis testing procedures in this research paper, we expect to observe that companies demonstrating top performing working capital metrics within their respective industry sectors in year 0 will be able to sustain or continue their top performances of working capital metrics over the next 1 to 3 years. We expect the statistical significance of the superior performances to be strong in year 1; however, we also expect the statistical significance to diminish over time in year 2 and 3.
We expect the means of operating performance metrics including equity returns of the top performing companies with superior working capital metrics to demonstrate statistical significant differences from the low performing companies when we perform two-sample t-tests and we expect the statistical significance to be strong in year 3; however, we also expect the statistical significance to diminish over time in year 4 and 5.
Our empirical study shows that the top performing companies with superior working capital metrics show statistically significant results from two-sample t-tests on working capital metrics over low performing companies with inferior working capital metrics. (Please note that our limited dataset only has one year of data available.)
Our empirical study also shows that companies with top performing working capital metrics have much higher equity valuation multiples than companies with low performing working capital metrics and results are statistically significant.
However, there are some signals that companies with top performing working capital metrics have slightly higher equity returns than companies with low performing working capital metrics but results’ statistically significance can’t be evaluated with our limited dataset.
(Please note that our limited dataset only has one year of data available; therefore, our preliminary conclusions are non-comprehensive.)
Finally, the results of this research paper can help to identify effective management teams, learn their effective business practices, case study their strategies, and construct investment portfolio of their stocks with a potential yielding market-beating returns.
II. Literature Review
“Working Capital Management And Profitability – Case Of Pakistani Firms”, by Abdul Raheman* and Mohamed Nasr, March 2007. They find that there is a significant negative relationship between liquidity and profitability.
“Effect of Working Capital Management on Firm Profitability: Empirical Evidence from India”, by A.K. Sharma and Satish Kumar, 2011. The study reveals that inventory in number of days and number of days accounts payable are negatively correlated with a firm’s profitability, whereas number of days accounts receivables and cash conversion period exhibit a positive relationship with corporate profitability.
“Working Capital Management and Shareholder Wealth”, by Robert Kieschnick, Mark LaPlante, and Rabih Moussawi, 2013. We provide the first empirical study of the relationship between corporate working capital management and shareholder wealth. Examining U.S. corporations from 1990 through 2006, they find evidence that: the incremental dollar invested in net operating working capital is worth less than the incremental dollar held in cash for the average firm and the value of the incremental dollar extended in credit to one’s customers has a greater effect on shareholder wealth than the incremental dollar invested in inventories for the average firm.
“Working capital management and corporate performance: Case of Malaysia”, by M. A. Zariyawati, M. N. Annuar, H. Taufiq, and A.S. Abdul Rahim, 2009. This study is used panel data of 1628 firm-year for the period of 1996-2006 that consist of six different economic sectors which are listed in Bursa Malaysia. The coefficient results of Pooled OLS regression analysis provide a strong negative significant relationship between cash conversion cycle and firm profitability. This reveals that reducing cash conversion period results to profitability increase. Thus, in purpose to create shareholder value, firm manager should concern on shorten of cash conversion cycle till optimal level is achieved.
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