The IUP Journal of Applied Finance 

About: The IUP Journal of Applied Finance is an academic journal. The journal publishes majorly in the area(s): Stock market & Stock exchange. Over the lifetime, 178 publications have been published receiving 1142 citations.

Impact of Aggressive Working Capital Management Policy on Firms' Profitability

Abstract: (ProQuest: ... denotes formulae omitted.)IntroductionThe corporate finance literature has traditionally focused on the study of long-term financial decisions, particularly investments, capital structure, dividends or company valuation decisions. However, short-term assets and liabilities are important components of total assets and need to be carefully analyzed. Management of these short-term assets and liabilities warrants a careful investigation since the working capital management plays an important role in a firm's profitability and risk as well as its value (Smith, 1980). Efficient management of working capital is a fundamental part of the overall corporate strategy in creating the shareholders' value. Firms try to keep an optimal level of working capital that maximizes their value (Deloof, 2003; Howorth and Westhead, 2003 and Afza and Nazir, 2007).In general, from the perspective of Chief Financial Officer (CFO), working capital management is a simple and straightforward concept of ensuring the ability of the organization to fund the difference between the short-term assets and short-term liabilities (Harris, 2005). However, a 'Total' approach is desired as it can cover all the company's activities relating to vendor, customer and product (Hall, 2002). In practice, working capital management has become one of the most important issues in the organizations where many financial executives are struggling to identify the basic working capital drivers and an appropriate level of working capital (Lamberson, 1995). Consequently, companies can minimize risk and improve the overall performance by understanding the role and drivers of working capital management.A firm may adopt an aggressive working capital management policy with a low level of current assets as a percentage of total assets, or it may also be used for the financing decisions of the firm in the form of high level of current liabilities as a percentage of total liabilities. Excessive levels of current assets may have a negative effect on the firm's profitability, whereas a low level of current assets may lead to a lower level of liquidity and stockouts, resulting in difficulties in maintaining smooth operations (Van Horne and Wachowicz, 2004).The main objective of working capital management is to maintain an optimal balance between each of the working capital components. Business success heavily depends on the financial executives' ability to effectively manage receivables, inventory, and payables (Filbeck and Krueger, 2005). Firms can reduce their financing costs and/or increase the funds available for expansion projects by minimizing the amount of investment tied up in current assets. Most of the financial managers' time and efforts are allocated towards bringing non-optimal levels of current assets and liabilities back to optimal levels (Lamberson, 1995). An optimal level of working capital would be the one in which a balance is achieved between risk and efficiency. It requires continuous monitoring to maintain proper level in various components of working capital, i.e., cash receivables, inventory and payables, etc.In general, current assets are considered as one of the important components of total assets of a firm. A firm may be able to reduce the investment in fixed assets by renting or leasing plant and machinery, whereas the same policy cannot be followed for the components of working capital. The high level of current assets may reduce the risk of liquidity associated with the opportunity cost of funds that may have been invested in long-term assets. Though the impact of working capital policies on profitability is highly important, only a few empirical studies have been carried out to examine this relationship. This study investigates the potential relationship of aggressive/conservative policies with the accounting and market measures of profitability of Pakistani firms using a panel data set for the period 1998-2005. …

Working Capital Requirements and the Determining Factors in Pakistan

Abstract: Literature on corporate finance has traditionally focused on the study of long-term financial decisions. Researchers have examined, in particular, the investment decisions, capital structure, dividends or company valuation decisions, among other topics. However, short-term assets and liabilities are important components of total assets and need to be carefully analyzed. Management of these short-term assets and liabilities warrants a careful investigation because working capital management plays an important role in a firm’s profitability as well as its value (Smith, 1980). The optimum level of working capital is determined, to a large extent, by the methods adopted by the management. Continuous monitoring is required to maintain optimum levels of various components of working capital, such as cash receivables, inventory and payables. In line with the studies of Afza and Nazir (2007 and 2008), the present study examines the factors that determine the working capital requirements of the firms. For this purpose, a study of 132 manufacturing firms from 14 industrial groups that were listed on Karachi Stock Exchange (KSE) between the period 2004-2007 was undertaken. While the working capital requirement was used as the dependent variable, various financial and economical factors, such as operating cycle of the firm, level of economic activity, leverage, growth of the firm, operating cash flows, firm size, industry, return on assets and Tobin’s q, were used as the determining factors of working capital management. Regression analysis was carried out on the panel data for 132 non-financial firms over a period of nine years. Finally, the study suggests some policy implications for the managers and investors of Pakistani markets.

Semi-Strong Form Efficiency: Market Reaction to Dividend and Earnings Announcements in Malaysian Stock Exchange

Abstract: This study focuses on the announcement effect of both dividend and corporate earnings on stock prices to examine evidence of semi-strong form efficiency in Malaysian Stock Exchange. A sample of 120 companies listed on the Main Board of Bursa Malaysia that announced the final dividends in their fourth financial quarter was selected covering a time period from January 1, 2006 to November 30, 2006. The study results support the information content of dividend theory that increasing dividend announcements, on an average, earn positive abnormal return, while decreasing dividend announcements are associated with negative abnormal return. Based on the market reaction to both dividend and earnings announcements, this study concludes that both dividends and earnings play a significant role as signaling effects of the future prospects of the firm, with the dividends effect proving to be significantly stronger than the earnings effect. The results provide some evidence of semi-strong form efficiency in the Malaysian stock market, where stock prices adjust in an efficient manner to dividend and earnings announcements.

Measuring Value Enhancement through Economic Value Added: Evidence from Literature

Abstract: IntroductionThe success of a business depends on how well the management of the company is able to plan, direct resources from less productive to more productive investments, enhance productivity, take informed decisions, innovate and lead the company towards achievement of its goals. During the last few decades, globalization and intense competition, combined with the growth of capital markets and shareholder activism, forced several corporations to adopt shareholder value maximization as their goal and work continuously towards shareholder value enhancement. Traditional accounting based measures of value, such as profit margin and earnings per share, cease to be relevant under the changing conditions as they fail to take into account the factors that drive shareholder value. Contributors of capital to a given risky venture expect returns which are equal to the opportunity cost of such capital. Capital markets measure value by discounting the expected future cash flows at a rate that the investors expect to get if they invest in companies with similar risks. Hence, a company that reports accounting profits need not necessarily be a value creator from the perspective of a shareholder (Drucker, 1998). Further, the traditional bonus system also failed to link up with value correctly. This resulted in too small incentives for good performers and too big compensation for mediocre performers (Jensen and Murphy, 1990). Thus, the need to measure and manage value in a manner consistent with the way owners and other stakeholders measure value was felt by the top management. It became essential for managements not only to understand the process of value creation but also to create tangible links between their strategies and value creation to facilitate both decision making and performance measurement. To meet this need, a novel approach to management known as the Value Based Management (VBM) was innovated. Taggart et al. (1994) first coined the term VBM. They suggested a framework that links the company's strategy to its value in capital markets. They have identified five key institutional value drivers that are essential for sustainable value creation. They are: governance, strategic planning, resource allocation, performance management and top management compensation. The VBM approach uses metrics at different levels that are aligned to the institutional drivers, key functions and processes.Measures of PerformanceSensing the need for a comprehensive metric for measurement and management of value, a few metrics were devised, such as Economic Value Added (EVA) by Stern Stewart & Co., Cash Flow Return on Investment (CFROI) by HOLT Value Associates, Shareholder Value Added (SVA) by LEK-Alcar Consulting Group, Economic Profit approach by McKinsey, Economic Earnings by AT Kearney. All the above-mentioned metrics are rooted in the concept that reported earnings are subject to accounting distortions and do not take into account the total cost of capital. Hence, a financial performance measure must look at the returns that exceed the total cost of capital. Each metric also uses the principles of discounted cash flow (Myers, 1996). While the economic profits and economic earnings are variants of EVA, the other two metrics differ in their calculations. The calculation and relative merits and demerits are reported in Table 1.As stated earlier, of the above-discussed metrics, EVA is the most popular measure used by corporations across the globe. EVATM, the trademark metric of Stern Stewart & Co., is claimed by Stewart (1991) as, "The financial performance measure that comes closer than any other measure in capturing the true economic profit of an enterprise. It is the performance measure most directly linked to the creation of shareholder wealth overtime."Stewart (1994) further adds, "EVA is the single measure of corporate performance, enabling investors to identify investment opportunities and motivate managers to make value added business decisions. …

Ownership Structure and Firm Performance: An Empirical Study on Listed Mid-Cap Indian Companies

Abstract: IntroductionIn the finance literature, the relationship between ownership structure and firm performance has received considerable attention. Berle and Means (1932) are the pioneers to draw attention to the notion that with the enhanced diffuseness of the ownership structure the firm performance deteriorates. In other words, there exists an inverse correlation between the diffuseness of ownership and firm performance. The argument is-professional managers, acting on behalf of scattered ownership, do not act in the best interests of the shareholders by optimally utilizing the corporate resources to enhance profit and, thereby, shareholders' wealth. The observations of the study have triggered a debate.Demsetz (1983) puts a counter argument by observing that it is unreasonable to suppose that the diffused ownership structure dilutes profit maximization objective as a guide for resource allocation and utilization. He argues that the ownership structure is an 'endogenous' element for maximizing the profit and value of a corporate entity. When the requirement of capital is large for achieving scale rapidly, there is a need to meet the requirement (of capital) by making offer to the public at large to contribute to the equity share capital of a firm. Subscription by the members of public to the equity share capital of a firm leads to diffusion of ownership structure. Thus, the value enhancement of a corporate entity by achieving scale requires a diffused ownership structure, as single ownership is not enough to maximize the value of a firm.Based on the above-stated arguments and counter arguments, a number of empirical studies have been undertaken in different countries; but no consensus has been arrived at. The findings of some of the significant studies are incorporated under the subhead 'Literature Review'.Literature ReviewMorck et al. (1988), taking percentage of shares held by the board of directors of the company as a measure of ownership concentration and holding both Tobin's Q and accounting profit as performance measure of 500 Fortune companies and using piece-wise linear regression, found a positive relation between Tobin's Q and board ownership ranging from 0% to 5%, a negative relation for board ownership ranging from 5% to 25%, and again a positive relation for the said ownership above 25%. The interpretation of such a non-monotonic relationship is-firms having a lower level of ownership concentration are easier targets of takeover and hence managers of such firms act and take decisions to maximize the shareholders' value as anti-takeover measure, because takeover may result in loss of jobs for them. At moderate level of concentration of holding, they are less concerned about takeovers, as they believe that takeover attempts would be less likely to succeed, but again at a higher level, incentive effect of better performance leads to positive relation.Loderer and Martin (1997) took shareholding by the insiders (i.e., director's ownership) as a measure of ownership. Taking the said measure as endogenous variable and Tobin's Q as performance measure, they found (through simultaneous equation model) that ownership does not predict performance, but performance is a negative predictor of ownership. Cho (1998) found that firm performance affects ownership structure (signifying percentage of shares held by directors), but not vice versa.Demsetz and Villalonga (2001) investigated the relation between the ownership structure and the performance (average Tobin's Q for five years-1976-80) of the corporations if ownership is made multidimensional and also treated it as an endogenous variable. By using Ordinary Least Squares (OLS) and Two-stage Least Squares (2 SLS) regression model, they found no significant systematic relation between the ownership structure and firm performance. According to them, "[T]he market responds to forces that create suitable ownership structures for firms, and this removes any predictable relation between empirically observed ownership structures and firm rates of return. …