There’s Gold in The Hills

I recently ran across an excellent research paper by Robert Kieschnick of the University of Dallas, Mark LaPlante of the University of Georgia and Rabih Moussawi of the University of Pennsylvania titled Working Capital Management and Shareholder Wealth. They performed an empirical study which shows the strong impact that effective working capital management has on shareholder value. One of their findings was that for a firm with average characteristics, an additional $1 invested in net operating working capital is valued by shareholders at about $0.52, which is less than the dollar so invested and substantially less than the $1.49 valuation being put on an incremental dollar in cash and marketable securities during this period. Interestingly, this evidence is consistent with the evidence in Autukaite and Molay (2011) for French companies. Both of our results make clear why firms worry so much about their working capital management–our evidence makes clear the importance to shareholders of a firm managing its net operating working capital as efficiently as possible. Put another way, in terms of shareholder value, you earn a return of 3x on every dollar of working capital reduction. That’s a pretty big opportunity considering that according to this research paper, a median of 27.7% of a firm’s assets are tied up in working capital. I’m often puzzled when I hear companies say they have so much cash they don’t need to worry about working capital efficiency. Would you really rather generate $0.52 in shareholder value on a dollar tied up in working capital or $1.49 on a dollar of working capital reduction? If current management isn’t focused on generating that kind of shareholder value, I’m sure new management will be happy to.