Cash Conversion Cycle and Credit Constraint: A Theoretical/Empirical Synthesis

We investigate the effect of cash conversion cycle (CCC) on firm's financial constraint and its investment. In a partial equilibrium model, we show that the time mismatch between cash inflows and outflows increases firm's financial constraint. This hypothesis is tested via GMM estimation of Euler’s Investment Equation, using Iranian listed companies from 1996 to 2012. Our estimation shows that CCC affects investment through financial constraints. Besides, including CCC improves the quality of financial constraint index. The improvements are sizable in predicting the micro aspects of the firm’s financial constraints.
We demonstrate that in the Iranian listed companies: 1- Financial frictions significantly affect investments; 2- Dominant form of financial friction is credit ceiling; 3- long-term debt ratio and CCC positively correlate with financial constraints; though, funds from working capital, size and operating in industries with lower growth opportunities negatively correlate with financial constraints; and finally 4- Duration of the time-lapse for production and sale is the most effective channel for transmission of CCC on financial constraints.