Cash conversion cycles and financial flexibility under economic shocks: evidence from emerging markets

Abstract

This study examines whether the cash conversion cycle (CCC) supports financial flexibility or instead increases firm vulnerability under economic policy uncertainty (EPU), and tests whether the COVID-19 pandemic altered this relationship for firms with different pre-existing working-capital structures. The study uses a balanced panel of 391 non-financial Indian listed firms over 2014–2024 (4,301 firm-year observations), drawn from the CMIE Prowess database. Firm fixed-effects and random-effects models are estimated with default, firm-clustered, and Driscoll-Kraay standard errors; a difference-in-differences design with firm and year fixed effects is used to exploit the COVID-19 pandemic as an exogenous shock, with firms classified into treatment (above-median pre-pandemic CCC) and control (below-median) groups. The analysis is supplemented with an event-study test of the parallel-trends assumption, a placebo test, a lagged-CCC specification, and a dynamic-panel system GMM model. CCC is not robustly significant for return on assets (ROA) once firm-clustered standard errors are applied (p = 0.264), though a one-year-lagged CCC is significantly positive for both ROA and ROE (p < 0.05); CCC is not significant for return on equity (ROE) in the static specification. EPU is positively associated with ROA at conventional or near-conventional levels across specifications. The CCC × EPU interaction is consistently negative but reaches significance only in the dynamic system-GMM specification for ROA (p = 0.025). An event-study test does not reject parallel pre-trends, and the difference-in-differences and placebo estimates show no significant differential effect for high-CCC firms at the onset of the pandemic, though a significant gap emerges by 2024. Working-capital efficiency appears to operate as a gradual, lagged operational channel rather than an immediate source of profitability or crisis vulnerability. Managers should treat CCC as a medium-term operational lever rather than a short-term crisis response tool, and should prioritise short-term liquidity buffers - proxied here by the current ratio, the most consistently significant predictor of ROA throughout this study. Policymakers should prioritise macroeconomic stability, since EPU itself shows a positive association with ROA, consistent with well-managed firms being better placed to absorb policy uncertainty. The study combines a continuous, time-varying uncertainty measure (EPU) with a discrete exogenous shock (COVID-19) within a single firm-level identification strategy, and is, to our knowledge, among the first studies of Indian working-capital management to combine static fixed-effects estimation with an event-study test of parallel trends, a placebo test, and a system-GMM dynamic-panel specification within one design.