Predicting Firms’ Financial Distress: An Empirical Analysis Using the F-Score Model

Mahfuzur Rahman,Cheong Li Sa,Md Abdul Kaium Masud

doi:10.3390/jrfm14050199

Abstract

Financial performance of firms is very important to bankers, shareholders, potential investors, and creditors. The inability of firms to meet their liabilities will affect all its stakeholders and will result in negative consequences in the wider economy. The objective of the study is to explore the applicability of a distress prediction model which uses the F-Score and its components to identify firms which are at high risk of going into default. The study incorporates a prediction model and vast literature to address the research questions. The sample of the study is collected from publicly listed firms of the United States. In total, 81 financially distressed firms wereextracted from the UCLA-LoPucki Bankruptcy Research Database during 2009–2017. This study found that the relationship of the F-Score and probability of firms going into financial distress is significant. This study also demonstrated that firms which are at risk of distress tend to record a negative cash flow from operations (CFO) and showed a greater decline in return on assets (ROA) in the year prior to default. This study extends the existing literature by supporting a model which has not been widely used in the area of financial distress predictions.

Highlights

When a firm goes into bankruptcy or when it defaults on its financial obligations, it will have negative impacts on its stakeholders such as lenders, creditors, customers, employees, and shareholders
This study demonstrates that firms which are at risk of distress tend to record a negative cash flow from operations (CFO) and show a greater decline in return on assets (ROA)
Independent t-tests were run for Model 1 and Model 2 and the results together with their respective descriptive statistics arepresented in Tables 4 and 5, respectively

Summary

Introduction

When a firm goes into bankruptcy or when it defaults on its financial obligations, it will have negative impacts on its stakeholders such as lenders, creditors, customers, employees, and shareholders. Lenders and creditors will lose their capital loaned. Whereas shareholders might suffer losses from capital invested. These stakeholders are often debtors themselves and this affects their ability to meet financial obligations. The bankruptcy of one firm affects its direct stakeholders, it will have spillover effects on the economy as a whole, and its severity is dependent on the size of the company. In the United States (US), businesses can declare bankruptcy by filing for Chapter 7 or Chapter 11 with the United States Courts.

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Discussion

Conclusion