STOCK MARKET PERCEPTION OF INDUSTRIAL FIRM BANKRUPTCY

Abstract

ABSTRACTThe objectives of this study are to determine (1) when the stock market first perceives the impending bankruptcy of a potentially bankrupt firm and (2) what firm‐specific factors explain the interval between the perception time and the eventual date of bankruptcy (i.e., market lead time). A computational methodology based on the Hillmer‐Yu technique is used to determine the month in which a structural change in the mean and variance of monthly stock return occurs for a potentially bankrupt firm. This parametric change month or the “market perception time” is computed for a sample of 47 industrial firms. The range of market lead times cautions against the common assumption of a uniform event period in event studies. The lead time interval (for both the mean and variance of monthly market return) of poteintially bankrupt firms is found to be positively related to the firm's earnings per share at the time of stock market perception of eventual bankruptcy. Neither the firm's asset size nor systematic risk appear to be significant indicators of lead time interval. Also, change in investment at market perception time is positively related to percentage change in the market lead times. This suggests that innovations in the investment variable are a source of new information to the security market in assesing the probability of future bankruptcy of a firm.