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.

Introduction

Corporate working capital decisions are often cited as short-term financial decisions. Textbook treatment of working capital management concurs with this idea (see, e.g., Brealey, Myers, & Allen, 2016, and Brigham & Ehrhardt, 2015). Such perceptions often stem from the short-term turnover cycles associated with working capital components viz: credit receivables, inventories and trade payables. For many firms, these components turn over several times in a typical year of operation. Past literature seems to evaluate the efficiency of firms’ working capital management by comparing the relative working capital allocations across firms (see, e.g., Frankel, Levy, & Shalev, 2017 and Ek & Guerin, 2011). Presumably, firms can swiftly modulate their working capital to conform to the optimal allocations in their respective industry (see, e.g., Aktas, Croci, & Petmezas, 2015 and Baños-Caballero, GarcíaTeruel, & Martínez-Solano, 2010). As per this literature, such modulations may provide the required tactical asset allocation to enhance firm value. Accordingly, we should expect frequent modulations in firms’ working capital allocations within the industry over time. For example, we expect firms with relatively higher (lower) working capital allocation within an industry to decrease (increase) their allocations over time. Similarly, firms within an industry are likely to operate with a similar working capital allocation that is presumably optimal for the industry. However, interestingly, such modulations in working capital allocations and industry-wide optimal allocations are not empirically observed in the data.