Does halo effect of innovative firms moderate the impact of working capital efficiency on firm value? Evidence from India

Abstract

The purpose of this study is to examine whether perceived innovativeness moderates the relationship between working capital management (WCM) and firm value. The study uses a sample of 200 listed Indian firms for 2015–2019. The firms are classified into innovative and non-innovative categories using the OECD and the EU Industrial R&D Investment Scoreboard 2018. Using OLS and GMM-DPD estimations, the study finds in accordance with the prior literature that a sample of firms exhibits a positive relationship between WCM efficiency and firm value. The original contribution of the paper is finding that low R&D and high R&D firms are treated differently when investors factor WCM into prices. The firms belonging to industries that are perceived to be innovative are not penalised in terms of valuation even if they follow inefficient WCM. However, firms that belong to industry sectors that are perceived to be non-innovative experience a drop in their valuation if their WCM is inefficient. The authors argue that this difference is due to the halo effect of innovative firms. The results imply that the halo effect obscures the true valuation. Hence, investors should learn to avoid valuing innovative firms’ WCM based merely on their classification into an innovative industry sector.

Keywords:

• Halo effect
• innovative
• R&D
• working capital
• CCC
• firm value

Public interest statement

The paper studies how innovativeness, perceived either through industry affiliation or by higher Research and Development expenditure, changes the way investors value the efficiency of firms’ working capital management (WCM). Data for 200 Indian firms over 2005–2009 were analysed using robust regression models. The study finds that as WCM becomes more efficient, it increases the firm value. However, when firms are classified into innovative and non-innovative industry categories or low R&D and high R&D categories, it is found that investors value the WCM efficiency differently based on perceived innovativeness. The firms that belong to the innovative industry sector do not exhibit a drop in firm valuation even if they follow inefficient WCM. On the contrary, firms that belong to non-innovative industry sectors experience a decline in their valuation if their WCM is inefficient. The study implies that the halo effect around innovativeness obscures the actual valuation. Hence, investors should be conscious of the bias while valuing innovative firms based on WCM efficiency.

Disclosure statement

No potential conflict of interest was reported by the author(s)

Notes

1. Please refer to the PwC report titled “Navigating uncertainty: PwC’s annual global Working Capital Study” 2018–19

2. Capitaline Database for Indian companies by Capital Market Publishers India. See https://www.capitaline.com/

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Sayantan Kundu

Sayantan Kundu, a Fellow of IIM Calcutta, is an Assistant Professor of Finance at Praxis Business School, Kolkata. His research and teaching interests lie in Capital Markets, Asset Pricing, Corporate Finance, and Financial Institutions. He has published papers in reputed indexed journals and is a reviewer of a few reputed journals.

Kamran Quddus

Kamran Quddus is currently engaged as an Assistant Professor in Accounting & Finance area at IIM Ranchi. He graduated from IIM Calcutta with a specialization in Finance and Control. His research areas include Asset Pricing, Behavioural Finance, and Investments.

Nistala Jagannath Sharma

Nistala Jagannath Sharma is an Executive PhD scholar in the area of Accounting and Finance at the Indian Institute of Management Ranchi. He is a Fellow of the Institute of Chartered Accountants of India, CPA(USA), LLB. His research interests are in Working Capital Management, Forensic Accounting, Sustainability Reporting, and Corporate Finance.