The Interaction of Solvency with Liquidity and its Association with Bankruptcy Emergence

Abstract

Prior research has shown that accounting information available prior to a bankruptcy is associated with the likelihood of bankruptcy. We show that additionally, the accounting information available prior to bankruptcy is associated with whether or not a firm will emerge from bankruptcy. We predict that firms that exhibit low solvency risk and high liquidity risk are most likely to emerge from bankruptcy. Firms that exhibit high solvency risk and high liquidity risk are predicted to be least likely to emerge from bankruptcy. Cross–sectionally, our results support these predictions, but our findings differ across large and small firms.