Performance, working capital management, and the liability of smallness: A question of opportunity costs?

ABSTRACT

This article studies the relationship between working capital management and firm operating performance and focuses on the moderating effect of size. We use a large sample of 56,221 small, medium, and large firms from France, Germany, and Italy, and our results indicate that the impact of working capital management on performance strongly depends on size. We identify a higher sensitivity of performance to underinvestment in net operating working capital for small firms, but no higher sensitivity to overinvestment. These findings suggest that small firms experience high opportunity costs from lost sales when their net operating working capital is low. Financial constraints and lack of financial management are discussed as potential explanations because both are expressions of the liability of smallness.

KEYWORDS:

• Working capital management
• performance
• small business/small and medium enterprises

Acknowledgments

The author thanks Anaïs Hamelin, Laurent Weill, Christophe Godlewski, Maxime Merli, Marie-Hélène Broihanne, and seminar participants at LaRGE research center in EM Strasbourg Business School for their suggestions on early versions of this article. The constructive comments of two anonymous reviewers are gratefully acknowledged.

Notes

¹ As noted by Aktas et al. (2015), longitudinal observations of WCM shows that the adoption of just-in-time practices in the last twenty years reduced the amount firms invest in inventories and, thus, in NOWC.

² We acknowledge that small firms’ managers sometimes have external financing aversion and that they prefer internal financing, even if this constrains their firm’s growth as suggested by Howorth (2001). This, however, does not impact our reasoning, as the consequence of external financing aversion is that investment in NOWC is low as the need for internally generated cash is high. The impact of NOWC on firm performance is therefore the same whether a small firm is constrained by external factors or by internal preferences.

³ Arend and Wisner (2005) show that small firms’ performance is negatively related with supply-chain management.

⁴ The calculation of one of our control variables, sales volatility, motivates this choice. We acknowledge that this choice reduces the generalizability of our findings because many small firms, especially newly founded ones, are excluded from the analysis.

⁵ Germany is the country in Continental Europe with the shortest payment delays, while Italy is the one with the longest payment delays and France stands at the median (Source: ECCBSO, Financial Statement Analysis Working Group).

⁶ We provide a sample breakdown by country, years, and industries as Appendix A and B.

⁷ To estimate the existence of statistically significant differences between samples, we calculate the difference between the two samples’ coefficients divided by the square root of the sum of their squared errors. Then, we use a standard t-test to estimate whether or not the differences are statistically significant.

⁸ We thank an anonymous referee for this remark.

⁹ We also reestimate the regressions for the country clusters and the business group affiliation clusters with this alternative approach and observe comparable results.