Does Working Capital Management Influence Operating and Market Risk of Firms?

TLDR

Previous research has mainly focused on the link between working‑capital management and corporate profitability. The study examines Pakistani‑listed firms across 12 industries over 2005–2014 to investigate the relationship between working‑capital management and firm risk. The authors used a System Generalized Method of Moments regression to assess how working‑capital management influences operational and market risk. The study found that higher working‑capital levels and better cash positions reduce stock‑price volatility, while excess working capital and a larger net trade cycle increase operating‑income volatility; firms with lower working‑capital relative to their industry experienced more stable operating profits, underscoring the importance of short‑term financial management for both operating and market fundamentals.

Abstract

Extant empirical studies have predominantly focused on the nexus between working capital management (WCM) and corporate profitability. While there is a dearth of literature on the nexus between WCM and a firm’s risk, the present study examines Pakistani-listed firms coming from 12 diverse industrial segments to observe this association for a time span of ten years (2005–2014). To ensure robustness, we employed a System Generalized Method of Moments (SGMM) regression estimation to investigate the influence of WCM on the operational and market risk for firms. Empirical testing revealed that higher working capital levels were associated with lower volatility in firms’ stock price, which shows that shareholders prefer a conservative working capital policy. Moreover, firms with better cash positions were subject to lesser stock market volatility. In contrast, excess working capital and a larger net trade cycle were associated with increased volatility in the operating income. Besides, firms with lower working capital levels relative to their respective industry experienced fewer fluctuations in their operating profits. Our findings assert that short-term financial management has important ramifications for firms’ operating and market fundamentals. Practical implications are discussed for corporate managers and relevant stakeholders.