Financial Distress, Governance and Diversification Strategy: Evidence from Turkey

Abstract

This paper documents determinants of financial distress employing firm performance and governance indicators. It also aims to investigate if diversification strategy is affected by the likelihood of distress.The analysis is based on probit regressions employing panel data for the 2006-2010 period. Evidence reveals that operating profitability is negatively related with distress and has the highest impact on the likelihood of distress. Liquidity decrease is the second most important determinant of distress for cash- constrained firms , while high leverage is the second most important determinant of distress for the equity-constrained firms.Governance variables have weaker impact on distress. Group-affiliated firms have lower likelihood of distress.Globalization reduces distress in all models.Reducing investments and increasing diversification raises the likelihood of failure in equity constrained firms.Evidence documents that the likelihood of distress is the most important determinant of diversification. Financial distress acts as a disciplining device and induces higher relatedness in cash-constrained firms while it encourages diversification in equity-constrained firms.The paper contributes to existing literature by revealing that the type of distress affects the ranking and sign of the coefficients of its determinants, documents that corporate ownership and diversification affects the likelihood of distress , and distress is the main determinant of diversification strategy.Results indicate that corporations prevailing in countries with weak protection of investor rights and small financial markets ,which increase vulnerability to shocks , should focus on pre-distress restructuring of diversification strategy and ownership structure in addition to financial policies.