U-shaped Relationship between Cash Conversion Cycle and Financial Distress: Evidence from Unlisted Companies in Korea

The cash conversion cycle (CCC) is a value that indicates how much of a firm’s cash is tied up in working capital during the business process, which creates value, and how much time it takes from when sales are generated until those sales are converted to cash. Given that prior studies mostly target listed - rather than unlisted - companies when investigating the relationship between the cash conversion cycle and profitability, this study investigates whether the CCC has a non-linear U-shaped relationship with the financial distress of unlisted companies by adding variables that squared the CCC. It employs unlisted company data from the Korea Credit Guarantee Fund from 2003 to 2015 to estimate the CCC’s critical value where the credit risk of unlisted companies decreases and then increases, given the longer CCC by industry. Moreover, it probes thresholds of CCC components with the changes in financial distress. The results show a U-shaped relationship between the CCC and financial distress. Furthermore, this concave relationship applies to all types of companies, suggesting that unlisted firms can reduce liquidity risk using the variation in the threshold of each component in the CCC. Finally, industry type affects the U-shaped relationship between the CCC and financial distress; thus, the CCC threshold varies by industry type. Notably, the findings empirically demonstrate the U-shaped relationship between the CCC and the default risk of unlisted companies. Moreover, the industry-specific CCC threshold provides a useful indicator for the working capital management of unlisted companies and credit analysis of borrowers in financial institutions.