Liquidity Holding of Highly-Distressed Firms: Recent Financial Crisis and Changes in Default-Risk Factors

Abstract

After the financial crisis in 2008, the negative abnormal stock price returns on the downgrade announcements with respect to the firms that eventually filed for Chapter 11 are no longer significant. Because the negative CARs for the firms that were within the same rating categories but did not file for bankruptcy during the same period remained significant, the result cannot simply be attributed to the change in the general perception of investors. Instead, the disappearing negative CARs for these “defaulting” firms may be explained by the shifts in relevant risk factors for those firms. Such shift is supported by the empirical test in this study showing that, after the crisis, the financial ratios used in Altman’s (1968) Z-model may no longer represent the characteristics unique to the firms filing bankruptcy. In particular, highly distressed firms in the post-recession era seem to have stronger propensity to maintain working capital.