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We assess short-run variations in firms’ working capital allocations in light of finding persistence in these allocations in the recent literature. Specifically, we study the extent and speed of mean reversion in firms’ working capital allocations to evaluate if firms tend to follow firm-specific value-maximizing optimal allocations. Furthermore, we assess whether and to what extent firms trade off their working capital to accommodate capital expenditure shocks. While we find frequent inter-temporal offsetting movements in working capital allocations in the short run, we do not find evidence of a systematic trade-off between working capital and fixed asset investments.

Finance and Accounting

Fulltext

Australian Journal of Management

Working capital dynamics

Purpose Recent papers on target capital structure show that debt ratio seems to vary widely in space and time, implying that the functional specifications of target debt ratios are of little empirical use. Further, target behavior cannot be adjudged correctly using debt ratios, as they could revert due to mechanical reasons. The purpose of this paper is to develop an alternative testing strategy to test the target capital structure.Design/methodology/approach The authors make use of a major “shock” to the debt ratios as an event and think of a subsequent reversion as a movement toward a mean or target debt ratio. By doing this, the authors no longer need to identify target debt ratios as a function of firm-specific variables or any other rigid functional form.Findings Similar to the broad empirical evidence in developed economies, there is no perceptible and systematic mean reversion by Indian firms. However, unlike developed countries, proportionate usage of debt to finance firms’ marginal financing deficits is extensive; equity is used rather sparingly.Research limitations/implications The trade-off theory could be convincingly refuted at least for the emerging market of India. The paper here stimulated further research on finding reasons for specific financing behavior of emerging market firms.Practical implications The results show that the firms’ financing choices are not only depending on their own firm’s specific variables but also on the financial markets in which they operate.Originality/value This study attempts to assess mean reversion in debt ratios in a unique but reassuring manner. The results are confirmed by extensive calibration of the testing strategy using simulated data sets.

Managerial Finance

Mean reversion in corporate leverage: evidence from India

We investigate the extent of short-term flexibility in firms' working capital management decisions. Contrary to the firms' perceived ability to frequently modulate their working capital allocations, we find systematic and persistence differences in working capital allocations across and within industries. Specifically, industries and firms within industries with relatively higher or lower working capital allocations remain so for a sustained period of time, often exceeding 15 years. Contrary to the past literature suggesting that such allocations are driven by firms' concerns over improving inter-temporal cash flows and sales or absorbing shocks to their capital expenditure schedules, we find that firm-specific time-invariant factors rather primarily drive them.

Journal of Business Research

Are working capital decisions truly short-term in nature?

We conduct a novel holdings‐based performance attribution, particularly suited to emerging markets, for equity‐oriented active mutual funds in India. Although, we find significantly positive alphas for an average fund, the stated benchmarks are grossly mis‐specified. A style‐adjusted benchmark could beat the stated benchmarks by greater margins than the funds themselves. While funds’ trading activity consistently adds value, cash drag and market timing usually diminish value. Although, the best‐performing funds exhibit superior security selection abilities, their outperformance does not persist. However, despite the lack of persistence winner funds continue to generate significantly higher alphas than loser funds for quite some time.

Accounting and Finance

Performance attribution of mutual funds in India: outperformance or mis-representation?

In early 2013, Plethico Pharmaceuticals Ltd had to contemplate very carefully the overdue redemption of its Foreign Currency Convertible Bonds (FCCBs) amounting to INR5.96 billion. Plethico was a strong multinational pharmaceutical company headquartered in India, with an annual turnover of more than INR16 billion, and a product portfolio of more than 400 formulations in 20 different therapeutic segments marketed through 200 brands in more than 60 countries. In October 2007, Plethico had raised USD75 million (INR2.97 billion) through FCCBs for the acquisition of Natrol Inc, in order to make strategic entry into the regulated markets of the USA and Europe. The FCCBs were listed on SGX-ST Singapore and due to mature on 23 October 2012. Due to being in a difficult cash flow position, Plethico could not redeem the bonds on time and sought from the Reserve Bank of India (RBI) an extension of the maturity date till 23 April 2013.

World University root node

Journal of International Business Education

The Flip Side of Convertible Financing: The Case of Plethico Pharmaceuticals Ltd

This study addresses the recent concerns in the capital structure literature about the reliability of tests of the target-following behavior. Using a novel testing strategy, we examine whether and to what extent firms' financing choices–rather than the movement of their debt ratios per se – concur with the target-following behavior. We find that firms' financing decisions are not generally consistent with systematic target-following. Our results remain similar when we examine an extended period of time and also when we consider that firms may have a range of target debt ratios rather than a unique target or varying financial constraints. Our results are also robust to different target specifications and our methodology can reliably distinguish the target behavior from random financing. Further tests also confirm our results by suggesting that the firms' financing decisions are not primarily driven by deviations from the firms' target debt ratios.

Journal of Corporate Finance

Corporate financing and target behavior: New tests and evidence

The paper highlights systematic deleveraging of firms in India and explores the factors contributing to such deleveraging. The paper further highlights that deleveraging is pervasive in manufacturing and non-manufacturing firms almost equally. The empirical findings of the paper suggest that most consistent theoretical determinants of corporate leverage fail to explain the decline in debt ratios of the firms. However, institutional deficiencies in the form of underdeveloped bond markets and decline in corporate investments were found to be significant in explaining the decline. The results suggest that firms could be credit rationed and hence losing value on account of such deficiencies.

IIMB Management Review

Corporate financing and deleveraging of firms in India

PurposeThe purpose of this paper is to investigate the existence of an optimal or target level of working capital for the Indian manufacturing firms, and whether firms intensely follow the target or not.Design/methodology/approachThe paper uses cash conversion cycle as a measure of net working capital and employs partial-adjustment dynamic panel models to test its target-following behavior.FindingsThe empirical results show that there is no evidence of systematic target-following behavior of working capital for the Indian manufacturing firms. The results hold true even after dividing the sample into four groups depending on the sign and magnitude of deviation. The results further show that lack of target-following tendency is not quite influenced by varying firm-specific characteristics and, therefore, seems to be a systematic feature across firms in India.Research limitations/implicationsScarcity of such working capital management studies across emerging economies, facing several financial constraints, limits the comparison of findings. Future studies should be conducted to confirm the results.Practical implicationsThe findings imply that even though an optimal working capital might exist, emerging market firms may not be able to actively pursue it on account of several financial constraints and managerial considerations.Originality/valueThe study contributes to the scant existing literature on the target-following behavior of working capital management in the Indian manufacturing firms, representing a typical emerging market facing several financial constraints.

International Journal of Managerial Finance

Financial constraints and optimal working capital – evidence from an emerging market

The case presents an evaluation by the management of the National Thermal Power Corporation (NTPC) in the year 2001 for a joint venture with the Steel Authority of India Ltd (SAIL) in captive power generation. The joint venture is triggered by the financial and business restructuring plans proposed for the financial recovery of ailing SAIL in the late 1990s. The venture would primarily function to provide the much needed critical power supply to the manufacturing units of SAIL. Although the possibility of selling excess power to the outside markets remains feasible, the escalation of the capacity could be a bone of contention with NTPC and SAIL. Among several other considerations, NTPC needs to review the proposed valuations of ₹3,910 million for the proposed venture. Amidst the inward pressure from the Government of India, given the state of the affairs, while NTPC inner circles might be concerned about buying some ‘junk assets’, the stakeholders at SAIL would have been curious about a possible fire sale of its assets.

Asian Journal of Management Cases

NTPC-SAIL power company limited (NSPCL): Born or bound to succeed?

https://efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2017-Athens/papers/EFMA2017_0300_fullpaper.pdf

Working Capital Management and Target Following: Evidence from India

The article tries to reconcile theoretical predictions of the two most important capital structure theories with evidences for corporate financing in India. We identify that while the pattern of leverage supports the prediction of pecking order hypotheses strongly, the key arguments of the theory are missing. We also found a significant explanation for incremental changes in debt ratios caused by mechanical stock price movement as compared to the changes caused by the overall issuance activities of firms. Firms do not seem to readjust their debt ratios to counter the drift caused by these stock-related movements in debt ratios.

Journal of Emerging Market Finance

Reconciling Theory and Evidences for Corporate Financing in India

We present a model of a bank with endogenous risk choices, where delegated monitoring by an active market in subordinate debt helps in containing the bank's risk shifting in the presence of deposit insurance. In comparison to static ex ante contracting, an active market enables continuous monitoring by subordinate debt to penalise the bank's risk shifting. The model is instrumental in deriving optimal level of subordinate debt required to achieve equilibrium where banks choose risk levels consistent with the first best as envisaged by a social planner. The optimal quantity of subordinate debt further eliminates any risk shifting associated even with risk insensitive premiums.

Subordinate debt, deposit insurance and market oriented monitoring of banks

PurposeThe paper explores the importance of mobile technology to enable diffusion of agriculture-related knowledge among farmers in India. The purpose of the paper is to evaluate the current socio-economic factors and challenges that impact the feasibility of m-governance project. The authors intend to explore different behavioral aspects of farmers, specifically their information seeking behavior to understand their communication ecosystem.Design/methodology/approachThe authors have used multiple methods to analyze the significance of m-governance in current social dynamics. To achieve in depth understanding of farmer’s attitudes and opinion, the authors have conducted semi-structured interviews with farmers. The authors have also applied experimental observations to evaluate the actual effectiveness of information dissemination and the social dynamics behind the process. The secondary/archival data was also collected from the government offices and non-governmental organizations.FindingsFindings explore the pattern of mobile usage among the farmers which could lead to interesting implications for the design and implementation of future m-governance projects. The research has also drawn some interesting implication on the feasibility of m-governance project.Research limitations/implicationsBecause the findings are co-related with the prevalent socio-cultural dynamics, testing the findings in different context might add value to the proposed theory and its implications.Originality/valueConsidering the need and significance of agriculture-based reforms in rural India, present study offers guidance in devising an efficient communication medium among farmers and government. The authors infer from our field observations that the communication platform is vital for successfully reaching farmers for their overall welfare. The present work is based on findings which are drawn from the ground reality which helps in explicating inferences which are useful for implementation purpose.

Information Systems

Transforming Government: People, Process and Policy

Feasibility of m-governance in agriculture: insights from a multimodal study in rural India

One of the important lessons from the crisis in the last decade relates to the realignment of the policies in explicit pursuit of macroeconomic and financial stability. Macro-prudential regulation with the larger objective of enhancing the resilience of financial system, calls for a comprehensive understanding of the interplay between macroeconomic factors to counter the buildup of imbalances within the financial system. This paper is an attempt to investigate into the relationship between financial stability and a set of macroeconomic determinants pertaining to a full business cycle in India. We have analyzed the macroeconomic determinants of financial stability from two perspectives, i.e., banking stability in terms of NPA ratio and financial stability in terms of credit extension. Our results show that the key determinants of banking and financial stability are rate of growth in credit, rate of growth in stock-market index and short-term interest rates apart from select sectoral GDP growth rates.

The Indian Economic Journal

Macroeconomic Determinants of Financial Stability in a Business Cycle: Evidence from India

Unlike many other emerging markets, debt ratios in India remain low and fallingover the years. While low debt ratios can be a conscious choice of firms in growthphase, firms in India seems to be deprived of the availability of credit through poorcredit market infrastructure and its development. Low debt ratios coupled with highertax rates entail higher tax payments by the firms in India. More importantly,government seems to rely heavily on these tax receipts to finance its fiscal expenditure.While development of debt markets would benefit the firms, it would seriously distortthe magnitude of fiscal deficit in India. The article here highlights this moral hazardwith government of India to develop debt markets in India

Indian Journal of Economics and Business

Capital structure in India: Implications for the development of bond markets

Firms in India face varying degree of macroeconomic constraints. Most important of these constraints relate to the availability of capital and cost of funds. The paper here highlights the implicit value losses incurred by the firms in India owing to such constraints. The paper identifies systematic deleveraging for firms in India overtime, which might be responsible for the increasing tax burden on these firms. While forgoing the tax benefits of the debt tax shields, these firms do not seem to be facing distress of similar magnitude. Moreover, upon closely observing their financing patterns, one can see the reduction in external financing, both in the form of equity and debt, by these firms overtime. While the average profitability remains robust and stable, this points towards a possible underinvestment problem on account of systemic capital constraints faced by the firms. The evidence suggests that these constraints, at times, can be so severe so as to prevent firms to even restructure their capital structure in order to avoid the tax drain. Further, the underinvestment remains robust even to firms with easier access to credit i.e. larger firms. The paper also highlights the consequences of such distortions arising out of capital constraints to the growth of the firms and also to the broad economy.

Indian Development Review

Corporate Financing and Investments under Capital Constraints: Evidences from India

We present a model of multiple banks with endogenous risk choices in an economy, where delegated monitoring by an active market in subordinate debt helps in containing systemic risk shifting by banks. Ex ante anticipation of greater regulatory forbearance, in case of joint failures, incentivize banks to keep their portfolios highly concentrated so as to succeed and fail simultaneously. However, when depositors are insured, regulatory forbearance is minimal and banks do not have incentives for failing together. Also, subordinate debt can penalize banks for increasing asset correlations since the payoffs to the subordinate debt are negatively influenced by higher correlations. The featuring of deposit insurance along with subordinate debt incentivizes banks to choose lower asset correlations among themselves as their respective optimal strategies. Therefore, the choice of lower asset correlations by the banks mutually represents a Nash equilibrium with reduced systemic risk endogenously.

Economics

International Journal of Economic Perspectives

Can systemic risk shifting of banks be checked by subordinate debt and deposit insurance? A game theoretic approach

The paper presents an empirical application of Extreme Value Theory (EVT) in modeling extreme behavior of financial asset prices. EVT is a branch of statistics dealing with the extreme deviations from the mean of probability distributions. It is the theory behind modeling the maxima of a random variable. Market risk takes extreme form when certain events, which are assumed to be rare in the distribution of assets, cause severe changes in the valuation of the portfolio. These rare events usually lie in the tails of the return distribution of the assets. We model two different risk measures with three different return distributions and analyze the importance of extreme value distributions in underscoring the behavior of extreme market moves. The paper highlights that the high volatility of Indian stock market associated with higher returns is better captured through extreme value distributions rather than conventional distributions. Also, for all the stock indices, EVT help in modeling the market risk better than conventional distributions.