Document Type : Research Paper

Authors

1 Associate Professor, Department of Accounting, Faculty of Economics and Social Sciences, Bu-Ali Sina University, Hamedan, Iran

2 MSc Student in Accounting, Faculty of Economics and Social Sciences, Bu-Ali Sina University, Hamedan, Iran

Abstract

Working capital management increases performance and reduces risk, thereby lowering the cost of capital. Many studies have been conducted in the field of working capital, including the adjustment of working capital toward targets and the effects of various variables on it. However, the influence of the prevailing economic environment, including booms and recessions, on the speed of adjustment has received less attention. The purpose of this research is to investigate the effect of economic booms and recessions on the speed of working capital adjustment in firms listed on the Tehran Stock Exchange. For this purpose, data from 153 firms listed on the Tehran Stock Exchange during the period of 2011 to 2022 were used. This research is practical in terms of purpose. The research method is based on the use of panel data and is quantitative and correlational. To analyze the data and test the research hypotheses, the dynamic panel method with the System Generalized Method of Moments (GMM) was used. The research results showed that managers adjust the firm's working capital ratio toward the target working capital. Other findings indicated that the rate of working capital adjustments during economic booms is greater than during recessions in both the financial and real sectors of the economy.
 

Introduction

Periods of prosperity increase a company's sales and growth, leading to more financing through internal financial resources and working capital. On the other hand, maintaining a larger amount of current assets may negatively affect the company's liquidity management and profitability, potentially reducing the return on assets. Additionaly, during economic recessions, financing through internal financial sources becomes limited, and financing through other sources increases the cost of capital. Accordingly, investing more or less than the optimal amount in working capital may negatively impact the company's performance. Therefore, based on the balance theory, firms may have a target working capital level that balances its benefits and risks (Ahangar, 2020). Nevertheless, firms adjust their working capital levels only when the benefits of the adjustment outweigh its costs (Ahangar, 2020).
Greater attention to working capital management is valuable for firms, as it increases performance and reduces risk, which in turn will reduce the cost of capital (Aktas et al., 2015). Business units may deviate from the optimal level of capital turnover due to advances in technology, changes in production costs, or random shocks. However, because optimal working capital offers advantages for business units, they continually strive to bring the actual level of working capital closer to the optimal level. The speed at which firms correct the deviation between the actual level and the optimal level of working capital is called the speed of working capital adjustment (Ahangar, 2020).
In domestic research, working capital has not been adequately explored as a dynamic concept, and many questions in this area remain unanswered for Iranian firms. For this reason, this research intends to investigate the existence of optimal working capital in Iranian firms using dynamic models and to measure their speed in achieving optimal working capital. Additionally, given the impact of economic booms and recessions on the provision of financial resources, especially working capital, and the need to adjust working capital toward optimal levels to increase firm value, this research examines the effect of economic booms and recessions on the speed of working capital adjustment in Iranian firms.

Literature Review

Firms that do not face restrictions on financing through external financial sources can more easily change the cash conversion cycle and, in fact, their working capital ratio. They can adjust working capital more quickly and reach the target working capital ratio faster. This means that during periods of economic prosperity, financing company expenses becomes easier, reducing adjustment costs such as financing costs. According to the balance theory, the speed of working capital adjustment increases or decreases depending on these factors (Ahangar, 2020).
In the literature related to capital turnover, several theories of capital structure, including balance theory (Miller, 1977) and hierarchical theory (Myers, 1984; Myers & Majluf, 1984) have been used to study the behavior of capital turnover. The equilibrium theory states that there is a balance point between the benefits and risks of investment, at which maximum value is obtained for firms. According to this theory, any deviation from the target turnover level is quickly adjusted (Ahangar, 2020). In the static balance theory, movement toward the target ratio is assumed to be instantaneous, while in dynamic balance theory, the path to the target ratio is a gradual process (Orlova & Rao, 2018). According to the hierarchical theory, firms, regardless of their target working capital, provide financial support according to a predetermined hierarchy. This financing can come from internal or external funds. Furthermore, in this theory, firms prefer internal funds to external financial sources to reduce the costs associated with information asymmetry when financing investment projects (Myers, 1984). In research related to working capital, the balance theory has attracted more attention (Aflatooni et al., 1401). The research hypotheses are presented as follows:
H1: Managers adjust the company's turnover ratio toward the target turnover.
H 2: During periods of prosperity, the speed of working capital adjustment in firms is higher than during recessions in the financial sector of the economy.
H 3: During periods of prosperity, the speed of working capital adjustment in firms is higher than during recessions in the real sector of the economy.

Methodology

This research is practical, analytical, quasi-experimental, correlational in terms of research purpose, and retrospective and post-event in terms of the time dimension of the data. To collect financial and accounting data, the Rahvard Novin database and reports published on the Codal website were used, and Eviews software was employed to analyze the data. To estimate the research models, the Blundell & Bond (1998) system generalized method of moments estimator was used. The statistical population of this research consists of firms listed on the Tehran Stock Exchange.

Results

The results of the research show that managers adjust the company's working capital ratio to align with the target working capital. Additionally, the research findings indicate that the speed of working capital adjustment during periods of prosperity is higher than during periods of recession in both the financial sector and the real sector of the economy.

Discussion

The results of the first hypothesis test showed that company managers tend to adjust the company's capital turnover according to their goals, whether they are in a period of prosperity or recession. This finding is consistent with the results of Banos et al. (2020), Ahangar (2020), and Aflatooni et al. (1400). This suggests that Iranian firms, by moving toward the goal of capital turnover, attempt to manage the impact of prevailing economic conditions to avoid the risk of bankruptcy during recessions and the decrease in profitability caused by the uncontrolled and unmanaged increase in current assets during boom periods. The results of the second and third hypothesis tests indicate that the speed of capital turnover adjustment during economic prosperity is higher than during economic recession in both the financial sector and the real sector of the economy. These findings are consistent with the results of Helfin et al. (2018) and Aflatooni et al. (1401). According to the results of this research, it can be concluded that firms have a greater ability to adjust their working capital during economic booms in both the financial and the real sectors. This plays an important role in the financial management of firms under different economic conditions. These results can assist financial managers in determining appropriate strategies for managing capital turnover in any economic period. Additionally, these findings can help financial and economic researchers gain a better understanding of how different economic conditions affect the financial behavior of firms.

Conclusion

These results can help financial managers determine appropriate strategies for managing capital turnover in any economic period. Additionally, these findings can help financial and economic researchers gain a better understanding of how different economic conditions affect the financial behavior of firms. Based on the findings of this research, the following practical suggestions are provided: Investors and company managers should always keep in mind that economic prosperity cannot be sustained without optimal capital management. It is merely a factor that increases the value of firms, or, in the case of economic recession, it may lead firms toward bankruptcy. Therefore, they should consider the effects of deviations in working capital when making decisions. Investors and managers should pay particular attention to the speed of working capital adjustment during economic booms (both in the financial and real sectors) due to the growth in the company and the simultaneous increase in current assets. The necessity of optimal liquidity and working capital management is crucial, as creating a balance in these areas will lead to improved performance and increased value for firms.
 

Keywords

Main Subjects

  1. Ahangar, N. (2020). Financial constraints and speed of working capital adjustment. Asia-Pacific Journal of Business Administration, 12(3/4), 371-385. https://doi.org/10.1108/APJBA-05-2020-0145
  2. Aktas, N., Croci, E., & Petmezas, D. (2015). Is working capital management value-enhancing? Evidence from firm performance and investments. Journal of Corporate Finance, 30, 98-113.‏ https://doi.org/10.1016/‌j.jcorpfin.2014.12.008
  3. Altman, E.I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The Journal of Finance, 23(4), 589-609. https://doi.org/10.2307/2978933  
  4.  Banos, S., P.J. Garcia., & P. Martinez. (2021). the speed of adjustment in net operating working capital: an international study. Journal of Finance and Accounting, 50, 423–440. https://doi.org/10.1080‌/02102412.2020.1864176
  5. Banos-Caballero, S., García-Teruel, P. J., & Martínez-Solano, P. (2013). The speed of adjustment in working capital requirement. The European Journal of Finance, 19(10), 978-992.‏ https://doi.org/10.1080/‌1351847X.2012.691889
  6. Baños‐Caballero, S., García‐Teruel, P. J., & Martínez‐Solano, P. (2010). Working capital management in SMEs. Accounting & Finance, 50(3), 511-527.‏ https://doi.org/10.1111/j.1467-629X.2009.00331.x
  7. Blinder, A. S., & Maccini, L. J. (1991). The resurgence of inventory research: what have we learned?. Journal of Economic Surveys, 5(4), 291-328.‏ https://doi.org/10.1111/j.1467-6419.1991.tb00138.x
  8. Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of econometrics, 87(1), 115-143.‏ https://doi.org/10.1016/S0304-4076(98)00009-8
  9. Chauhan, G.S., & Banerjee, P. (2017). Financial constraints and optimal working capital–evidence from an emerging market. International Journal of Managerial Finance, 14(1), 37-53. https://doi.org/10.1108/IJMF-07-2016-0131
  10. Cook, D. O., & Tang, T. (2010). Macroeconomic conditions and capital structure adjustment speed. Journal of corporate finance16(1), 73-87. https://doi.org/10.1016/j.jcorpfin.2009.02.003
  11. Deloof, M., & Jegers, M. (1996). Trade credit, product quality, and intragroup trade: some European evidence. Financial management, 3(14), 33-43.‏ https://doi.org/10.2307/3665806
  12. Emery, G. W. (1987). An optimal financial response to variable demand. Journal of financial and quantitative analysis, 22(2), 209-225.‏ https://doi.org/10.2307/2330713
  13. Hill, M. D., Kelly, G. W., & Highfield, M. J. (2010). Net operating working capital behavior: a first look. Financial management, 39(2), 783-805. https://doi.org/10.1111/j.1755-053X.2010.01092.x
  14. Kim, Y. H., & Chung, K. H. (1990). An integrated evaluation of investment in inventory and credit: A cash flow approach. Journal of Business Finance & Accounting, 17(3), 381-389.‏ https://doi.org/10.1111/j.‌1468-5957.1990.tb01192.x
  15. Liu, L., Zhou, X., & Xu, J. (2024). Does working capital management improve financial performance in China’s agri-food sector during COVID-19? A comparison with the 2008 financial crisis. Plos one19(4), 1-18.‏ https://doi.org/10.1371/journal.pone.0300217
  16. Miller, E. M. (1977). Risk, uncertainty, and divergence of opinion. The Journal of Finance, 32(4), 1151-1168. https://doi.org/10.1111/j.1540-6261.1977.tb03317.x
  17. Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of financial economics, 13(2), 187-221.‏ https://doi.org/10.1016/0304-405X(84)90023-0
  18. Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 574- 592. https://doi.org/10.1111/j.1540-6261.1984.tb03646.x
  19. Nadiri, M. I. (1969). The determinants of trade credit in the US total manufacturing sector. Econometrica: Journal of the Econometric Society, 14(3), 408-423.‏ https://doi.org/10.2307/1912790
  20. Ng, C. K., Smith, J. K., & Smith, R. L. (1999). Evidence on the determinants of credit terms used in interfirm trade. The journal of finance, 54(3), 1109-1129.‏ https://doi.org/10.1111/0022-1082.00138
  21. Nyeadi, J. D., Sare, Y. A., & Aawaar, G. (2018). Determinants of working capital requirement in listed firms: Empirical evidence using a dynamic system GMM. Cogent Economics & Finance, 6(1), 1558713.‏ https://doi.org/10.1080/23322039.2018.1558713
  22. Orlova, S. V., & Rao, R. P. (2018). Cash holdings speed of adjustment. International Review of Economics & Finance, 54(2), 1-14. https://doi.org/10.1016/j.iref.2017.12.011
  23. Peles, Y. C., & Schneller, M. I. (1989). The duration of the adjustment process of financial ratios. The Review of Economics and Statistics, 17(3), 527-532. ‏ https://doi.org/10.2307/1926912
  24. Petersen, M. A., & Rajan, R. G. (1997). Trade credit: theories and evidence. The review of financial studies, 10(3), 661-691.‏ ‌https://doi.org/‌10.1093‌/rfs/10.3.661
  25. Smith, J.K. (1987). Trade credit and informational asymmetry. Journal of Finance, 42(4), 863–72. https://doi.org/10.1111/j.1540-6261.1987.tb03916.x
  26. Smith, K. (1980). Profitability versus liquidity tradeoffs in working capital management. Readings on the Management of Working Capital, 42(1), 549-562.
  27. Soenen, L. (1993). Cash conversion cycle and corporate profitability. Journal of Cash Management, 13(4), 53–7.
  28. Wilner, B.S. (2000). The exploitation of relationships in financial distress: The case of trade credit. The Journal of Finance, 55(1), 153-178. https://doi.org/10.1111/0022-1082.00203
  29. Aflatooni, A. (2023). Econometrics in Accounting and Finance Using EViews. Tehran: Termeh. https://www.termehbook.com /product/9786223270949 [In Persian]
  30. Aflatooni, A., Karimi, J., & Khatiri, M. (2022). Access to external financial resources, bargaining power, and speed of working capital adjustment. Journal of Accounting Knowledge, 13(3), 45-63. 10.22103/JAK.2021.17897.3577 [In Persian]
  31. Aflatooni, A., Kazemi, P., & Khatiri, M. (2022). Comparing the Cash Holdings Speed of Adjustment during Economic Prosperities and Recessions. Journal of Financial Management Strategy, 10(38), 141-160. 10.22051/JFM.2022.37631.2596 [In Persian]
  32. Badpa, B., Osta, S., & Darvish-Hoseini, F. (2024). Role of Management of Working Capital Items in Explaining the Operational Efficiency of Companies Listed on the Tehran Stock Exchange. Empirical Studies in Financial Accounting20(80), 255-287. doi: 10.22054/‌qjma.2024.74109.2468 [In Persian]
  33. Dadashzadeh, G., & Hejazi, R. (2020). The Relationship between of the Value of Financial Flexibility, Investment Efficiency and Adjustment Speed of Working Capital. Journal of Financial Management Strategy, 8(28), 177-196. 10.22051/JFM.2018.19359.1615 [In Persian]
  34. Iskandarnejad, S., Hassanzadeh Baradaran, R., & Taheri, H. (2020). The impact of working capital management on Listed companies profitability in business cycles based on the output gap. Asset Management and Financing, 8(2), 31-48. 10.22108/AMF.2017.21421 [In Persian]
  35. Khedri, N., Dastgir, M., & Soroushyar, A. (2020). The Effect of Stock Returns Volatilities on Working Capital Accruals: Considering the Moderating Effect of Financial Distress. Asset Management and Financing, 8(3), 85-102 10.22108/AMF.2019.115832.1391 [In Persian]
  36. Koochaki, M., & Seyed nezhad fahim, R. (2015). The impact of working capital management on firm profitability (return on assets) in different business cycles. Modern Theories of Accounting, 5(1), 55-78.‏ http://mta.raja.ac.ir/article-1-133-fa.html [In Persian]
  37. Rezaei, N., & Gharkaz, M. (2013). The effect of changes working capital on investment opportunities. Asset Management and Financing, 1(3), 99-118.‏ 20.1001.1.23831170.1392.1.3.8.8 [In Persian]
  38. Sepasi, S., & Hasani, H. (2016). The impact of working capital management on firm profitability in different business cycles. Financial management perspective, 6(1(13)), 93-116.‏ https://jfmp.sbu.ac.ir/‌article_94805.html [In Persian]
  39. Setayesh, M., Kazemnejad, M., & Zolfaghari, M. (2008). The effects of working capital management on the profitability of the firms listed in Tehran Stock Exchange. Empirical Studies in Financial Accounting6(23), 43-65. ‌‌‌https://dorl.net/dor/20.1001.1.‌28210‌166.‌1387.‌6.23.3.8 [In Persian]
  40. Zamani Sabzi, M., Saeedi, A., & Hasani, M. (2020). Capital Structure Adjustment Speed and the Effect of Boom and Recession on that: Evidence from Tehran Stock Exchange Listed Companies. Financial Research Journal, 22(2), 160-181. 10.22059/FRJ.‌2019.‌288995‌.1006925 [In Persian]