Abstract
The objective of the study is to examine the impact of both the number and types of causes of business failure onthe failure risk as indicated by values of bankruptcy scores during the process of business decline. Causes ofbankruptcy were obtained from court judgments for 70 Estonian manufacturing firms and classified into twotaxonomies–the number of causes and the different types of causes of failure such as internal (differentmanagement deficiencies) or from factors external to the firm. Bankruptcy scores for the first and secondpre-bankruptcy years were calculated using both Ohlson’s model and a local (Grünberg’s) bankruptcy predictionmodel. Independent samples median tests were applied to examine, whether different causes are associated withdifferent failure risk. Findings indicate that multiple causes lead to a significantly higher bankruptcy risk than asingle cause for the year prior to the declaration of bankruptcy. On the contrary, no significant effect of differenttypes of failure causes was found on the risk of failure. Implications of the results for research and practice arediscussed.
Highlights
Much of the extensive research on firm failure has focused on failure prediction, with other domains such as failure causes and processes remaining relatively under investigated
Using Ohlson’s score, it can be seen in Table 2 Panel 1, that median pre-bankruptcy score for Group 1.1 firms experiencing one failure cause indicates a very healthy firm at period t-1 while the pre-bankruptcy score for Group 1.2 firms facing multiple causes of failure is remarkably larger, indicating a very unhealthy firm
Despite the Independent Samples Median Test (ISMT) shows that t-1 median scores for the two groups differ markedly more than in case of Ohlson’s model, the median value for period t-1 is very near to the cut-off point of 0.5 for Group 1.1, but for Group 1.2 it is quite similar to that obtained with Ohlson’s model
Summary
Much of the extensive research on firm failure has focused on failure prediction (e.g., reviews by Dimitras, Zanakis, & Zopounidis, 1996; Altman & Narayanan, 1997), with other domains such as failure causes and processes remaining relatively under investigated. In an extensive review of the literature Trahms, Ndofor, & Sirmon (2013) have called for studies integrating firms’ resource use and decline These authors call for using more complex indicators than merely changes in profitability for measuring decline. Hambrick & D’Aveni, 1988; Moulton, Thomas, & Pruett, 1996) do not apply complex indicators of decline or the whole spectrum of possible causes of failure. This current study aims to be the first to relate the actual causes of failure to a firm’s failure risk and its actual onset as reflected through its bankruptcy scores prior to failure. The findings with discussion are presented along with implications for future research and practice
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