Abstract
In previous works, the importance of risk management implementation was addressed with regard to the problem of bankruptcy threat, with the explanation of risk impact on higher bankruptcy costs or the underinvestment problem. However, the evaluation of the impact of risk outcomes is technically linked to risk frequency and risk severity as the two dimensions of the risk map. The purpose of our study is to advocate two additional dimensions that incorporate liquidity and/or debt capacity constraint in the aftermath of risk occurrence. In the conceptual dimension, we propose a model that may support the appropriate design of risk management methods, by scaling a company’s ability to self-resist the risk outcomes. The study provides the empirical illustration of the frequency of the distinguished patterns of risk self-resistance. It was found that most frequently companies face the limited ability to self-resist risk outcomes, due to high debt capacity and high liquidity constraints. We also found statistically significant interdependencies between the company’s sector and the risk self-resistance. It supports the conclusion that the level of liquidity and debt capacity constraints and thus the ability to retain risk outcomes is sector-specific. It has important implications for the effective design of risk management methods.
Highlights
The problems related to bankruptcy threat and bankruptcy costs remain in focus in numerous corporate finance-related works since the seminal work of Miller and Modigliani (1958)
The models focus on the identification of variables that allow the detection of symptoms but not the causes of the arising bankruptcy threat—this paper contributes to this debate, as it considers one of the possible reasons behind the emergence of bankruptcy threat; the impact of risk outcomes
With reference to previous studies on the importance of risk management, this study aims at providing a conceptual framework that may potentially expand the traditional view on risk assessment and the selection of appropriate risk management methods
Summary
The problems related to bankruptcy threat and bankruptcy costs remain in focus in numerous corporate finance-related works since the seminal work of Miller and Modigliani (1958). Bankruptcy costs are imposed by the implementation of debt to capital structure, which may in turn increase a company’s value if the effects of financial leverage are positive. Higher levels of debt in the capital structure may lead to bankruptcy, as the debt capacity constraint emerges. The models focus on the identification of variables (ratios) that allow the detection of symptoms but not the causes of the arising bankruptcy threat—this paper contributes to this debate, as it considers one of the possible reasons behind the emergence of bankruptcy threat; the impact of risk outcomes
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