The Relationship between Non-Financial Information and Financial Distress

Abstract

There has been a prevalence of firms facing financial distress in the past few years, causing losses to many investors. Past research has shown that there are financial variables that are correlated with financial distress and these have been used in ratios and scores that are used to predict bankruptcy e.g Atman's Z-score (Altman, 1968) and Ohlson's O-Score (Ohlson, 1980). However, no research has studied the relationship between non-financial indicators and financial distress. Non-financial information, specifically customer satisfaction, was shown in prior research to be a leading indicator of financial performance (Ittner and Larcker, 1998) but it has never been established as an explanatory variable of financial distress. This paper seeks to explain the relationship between current financial distress of firms, proxied by the Z-score, and customer satisfaction indices in the current and past years. The results indicate that there is a significant relationship between these variables. Specifically, firms that have lower customer satisfaction indices in the current and prior two years are more likely to face financial distress in the short term. There are also significant differences in terms of customer satisfaction between firms that are expected to face bankruptcy in the short term (Z-scores below 1.81) and those that are financially healthy (Z-scores above 3.0). These findings pave the way for future research on models that estimate financial distress. In addition, results using returns indicate that market participants do not value this type of information. Long-term returns are not significantly related to current or past year customer satisfaction indices.