Evidence of Manager Intervention to Avoid Working Capital Deficits
54 Pages Posted: 24 May 2012 Last revised: 13 Aug 2015
Date Written: April 20, 2015
Abstract
We study the managerial propensity to intervene in financial reporting by examining working capital deficits, measured as current ratios less than 1.0. Current ratios represent important balance sheet liquidity indicators to lenders and creditors, and have an identifiable and naturally occurring reference point at 1.0, analogous to the profit/loss income statement reference point. We find that distributions of reported current ratios exhibit a severe discontinuity at 1.0, that the discontinuity increases with exogenous increases in the cost of credit in the economy, and that determinants of a firm’s likelihood to achieve a given current ratio are diagnostic precisely at the 1.0 discontinuity location but not at other nearby locations in the current ratio distribution. Firms that avoid working capital deficits report lower proportions of inventory and higher proportions of accounts receivable and, when credit is tight, higher proportions of cash, consistent with managers increasing sales volume so as to capitalize profit margins and thereby increase current assets.
Keywords: reference points, financial reporting, working capital
JEL Classification: M41
Suggested Citation: Suggested Citation
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