Distressed Firms Research Articles

The labor market channel of systemic risk

In this paper, we explore the labor market channel of systemic risk. We consider that distressed firms, besides defaulting on part of their debt commitments, also react to negative shocks by laying off part of their employees. This constitutes another source of systemic risk, as we assume that laid-off employees will default on their debt commitments. Using Brazilian data, we compute the systemic risk considering three possible strategies distressed firms can adopt: layoff of employees, default on debt commitments, or both strategies. Our findings highlight the importance of the labor market channel. It has contributed noticeably more to overall systemic risk during the study's assessment period (2015–2020). Moreover, the shock multiplier of the employees' layer is higher than that of the firms' layer. We also assess, through machine learning techniques, the determinants of firms' systemic impact under different layer configurations–that is, when the bank-firm layer is composed of the corporate loans extended to the firms, and when this is composed of the loans extended to the firms' employees. This study emphasizes the crucial role that the labor market plays in determining systemic risk dynamics and calls for improved risk management practices to address these issues effectively.

Impact of Debt Composition and Accounting Conservatism on Financial Distress in Emerging Markets

Aims: This study investigates the impact of debt composition, specifically short-term and long-term debt, on corporate financial distress, focusing on the moderating role of accounting conservatism. It aims to understand how firms in emerging markets, particularly Kenya, can achieve financial stability through prudent debt structuring and conservative accounting practices. Study Design: The research adopted an explanatory research design. Place and Duration of Study: The study utilized financial data from firms listed on the Kenyan Securities Exchange between 2008 and 2021. Methodology: The study analyzed a sample of 45 firms trading at the Nairobi Stock Exchange over 14 years from 2008 to 2021. The study used panel logistic regression, a statistical method for analyzing data with multiple observations over time, to test its hypotheses. Results: The results show that both short-term and long-term debt increase the likelihood of financial distress, with accounting conservatism further intensifying the risk for firms heavily reliant on short-term debt while mitigating it for those with long-term debt. This suggests that conservative accounting practices, which promote early recognition of losses, may exacerbate financial distress for firms heavily reliant on short-term debt. In contrast, for long-term debt, accounting conservatism has a mitigating effect helping firms manage their debt obligations more effectively over time. This highlights a nuanced role of accounting conservatism, where it increases the pressure on firms with short-term debt while providing stability for those with long-term obligations. Conclusion: The findings suggest that corporate managers in emerging markets should carefully balance short- and long-term debt to minimize financial distress risks. Additionally, adopting conservative accounting practices can serve as a safeguard, providing early warning signals for financial trouble and enhancing corporate stability. Managers should therefore carefully balance short-term and long-term debt to reduce financial distress while adopting conservative accounting practices to enhance financial transparency and risk management. Policymakers can support firms by promoting responsible debt management and offering incentives for conservative financial reporting to strengthen overall financial stability.

Dividend policy adjustments under bankruptcy law: Insights from distressed firms

This paper investigates the impact of the Insolvency and Bankruptcy Code (IBC) on the dividend policy of financially distressed Indian firms. Utilizing a dataset of 33,820 firm-year observations from 2003 to 2023, we employ a difference-in-difference framework to examine how the introduction of IBC influences dividend payouts. Our findings reveal that distressed firms pay more dividends post IBC than non distressed firms, primarily benefiting underlevered distressed firms by enhancing their access to credit. Conversely, overlevered distressed firms experience a reduction in dividend payouts post-IBC. Additionally, the study highlights that standalone distressed firms are more likely to increase dividend payouts post-IBC compared to their business group-affiliated counterparts, due to the latter's access to internal capital markets. These insights contribute to the understanding of how bankruptcy reforms impact the financial strategies of distressed firms and provide valuable implications for policymakers and stakeholders in emerging economies.

Unpacking Capital Structure Decisions: Analyzing Short-Term Debt to Equity Dynamics in Shariah Compliant Financially Distressed Firms

Unpacking Capital Structure Decisions: Analyzing Short-Term Debt to Equity Dynamics in Shariah Compliant Financially Distressed Firms

Exposure to superstar firms and financial distress

AbstractA few highly successful firms (“superstar firms”) have captured large market shares and earned massive profits in recent decades. We examine whether superstar firms are associated with a greater likelihood of financial distress for firms exposed to them in product markets. Building on recent research, we identify superstars as firms with the highest markups in the industry and whose industry markup share increases over time. We then measure, with product similarity scores, a firm’s overall product market exposure to superstars. We document that firms with greater exposure are more likely to file for bankruptcy. We examine why superstar exposure is associated with bankruptcy and show that firms with the greater superstar exposure exhibit weaker financial performance and greater riskiness. Furthermore, we show that the association between superstar exposure and the likelihood of bankruptcy strengthens when superstars have greater market power.

Do oil market shocks affect financial distress? Evidence from firm-level global data

This study investigates the impact of three oil price shocks on financial distress of global firms using a dataset of 8130 firms across 48 countries from 2002 to 2022. It also analyses the role of energy diversification in the relationship between oil shocks and firm distress. The findings reveal that aggregate demand and specific demand shocks increase firm distress risk, while supply shocks reduce it. Furthermore, the results suggest that energy diversification mitigates the impact of specific demand shocks on firm distress. The study also implements several robustness checks, and the results remain consistent. Potential policy implications are also discussed.

Earnings management among distressed firms: evidence from India

ABSTRACT The rise in insolvency filings in India has drawn significant academic attention due to the high costs associated with financial distress. This study investigates the extent of earnings management by distressed firms in India, exploring factors like capital infusion, institutional ownership, regulation, and accounting flexibility. Earnings management is captured through three different proxies: accrual, real, and total earnings management. Financial distress is measured through three comprehensive definitions. Data spanning from 2008 to 2022 is collected, and panel fixed-effects regression is used for data analysis. The findings suggest that distressed firms tend to engage in earnings management through real earnings management, primarily via sales manipulations and overproduction. Earnings management is prevalent prior to new debt issuance but not before new equity issuance, and the presence of institutional investors effectively limits earnings management. Furthermore, companies resort to real earnings management when accrual earnings management is constrained by regulation and accounting flexibility.

The performance of private equity portfolio companies during the COVID-19 pandemic

We study the performance of PE-backed companies during the COVID-19 pandemic. Our findings suggest that, on average, PE-backed firms were more resilient compared to closely matched industry peers during the pandemic. However, this outperformance is of a smaller magnitude than during the pre-pandemic non-crisis period, suggesting that the outperformance is driven by investor selection of target firms ex ante, rather than active support mechanisms. The outperformance during the pandemic is found to be insignificant among firms which were the most vulnerable at the onset of the pandemic, and firms in the most exposed industries. These more vulnerable firms appear to have been less active in obtaining additional financing during the pandemic, and consequently, suffered a significantly higher incidence of distress. However, non-PE-backed firms in distress had a higher incidence of liquidation, while PE-owned firms more often negotiated formally with creditors to continue trading. Our analysis shines light on the role of PE investors during a large, exogenous shock, and suggests that, in the case of the pandemic, their adept target selection may help to explain the outperformance more so than their actions to protect vulnerable firms in a crisis.

Heterogeneity in the competition-cost of equity relation

We explore the effect of firm heterogeneity on the implied cost of equity. To this end, we exploit two opposing effects of competition on the cost of equity: its negative effect on a firm's exposure to systematic risk and its positive effect on a firm's agency costs when it acts as a managerial disciplining device. Using a U.S. sample comprising 4764 firms from 1986 to 2017, we find that, on average, competition reduces equity costs by diminishing managerial expropriation, but increases these costs for small and distressed firms as they are more exposed to systematic risk. This agency costs link holds in developed countries only.

Ownership structure and financial distress: is the tale from Sub-Saharan Africa different?

PurposeThe paper investigates the effect of ownership structure on the financial distress of firms listed in sub-Saharan Africa.Design/methodology/approachUsing secondary data from 106 non-financial firms listed in 9 selected SSA countries from 2016 to 2021, the research using paired t-tests and conditional logistic regression model analysed a sample of 174 distressed observations matched with 174 non-distressed observations.FindingsT-tests determined significant differences between distressed and non-distressed groups concerning institutional, foreign, and local ownership. Conditional logistic results established that institutional, foreign, and state ownership significantly reduce distress. However, managerial ownership does not influence financial distress while a significant positive relationship is observed between local ownership and financial distress.Originality/valueThis is the first study to investigate the influence of ownership structure, including local ownership, on financial distress in SSA, employing a unique methodology of matched design and conditional logistic regression analysis. Furthermore, the paper presents cross-country evidence from emerging frontier markets, highlighting the importance of governance frameworks in firms’ stability.

Temporary employment and financial distress in times of crisis

PurposeThis study investigates the impact of temporary employment on various forms of financial distress for firms during the COVID-19 pandemic.Design/methodology/approachThe authors apply a logit model to evaluate the differences in the probabilities of experiencing financial distress for firms with or without temporary reemployment and for firms with different intensities of temporary workers. As an additional test, an ordinal logistic model is applied to reflect different degrees of financial distress.FindingsOur main results indicate that firms with temporary employment are more likely to experience financial distress than firms without temporary employment, regardless of the severity of financial distress. Among firms with temporary employment, our analysis suggests that a firm’s likelihood of experiencing financial distress depends on its relative share (quantile) of temporary workers.Practical implicationsOur findings provide valuable insights for evaluating the impact of temporary employment on firms’ vulnerability during the COVID-19 crisis and suggest strategies for firms to enhance resilience to similar future crises.Originality/valueOur study is the first one that explores the relationship between temporary employment and financial distress. Firms around the world have been pursuing flexible labor to improve resilience and firm performance. The pandemic may further ramify this trend, creating a future “new normal” regarding employment relationships, job segmentation and gender equality in the job market. This article adds a new dimension to the evaluation of the new normal, which may help firms evaluate the consequences of temporary employment, especially in times of crisis.

Publicly Traded Debt Restructuring Methods, Corporate Investment, and Debt Contracting

I use an important ruling, Marblegate Asset Management v. Education Management Corporation (EMC), to study the economic role of two publicly traded debt restructuring methods: coercive bond exchange offers and Chapter 11. This ruling restricted firms from employing coercive bond exchange offers to facilitate out-of-court restructurings, thereby increasing the likelihood of restructuring publicly traded debt under Chapter 11. Following the ruling, investment in affected distressed firms decreased substantially, but investment efficiency improved. The changes in covenant, maturity, and offering yield of newly issued bonds suggested that existing bondholders with covenants gained more bargaining power than shareholders and new bondholders. The paper provides causal evidence from a large sample analysis, demonstrating the divergent effects of these two publicly traded debt restructuring methods on investment policies. This paper was accepted by Victoria Ivashina, finance. Funding: Funding for this research was provided by University of Pittsburgh (Doctoral Fellowship) and Vanderbilt University (standard research funds). Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.01831 .

Supply chain risks and the cost of debt: Evidence from the COVID-19 pandemic

This study aims to examine the impact of supply chain risks on the cost of debt. Our analysis is based on a comprehensive dataset of corporate bond offerings of listed firms. We utilize input−output tables to construct the proxies for supply chain risks that capture trade credit financing risks. The results demonstrate that supply chain risks substantially raise the corporate cost of debt and that the effects are magnified during COVID-19. The effects are more pronounced for firms in industries that were hit by COVID-19 more severely, those with high supply chain concentration, state-owned enterprises, and firms in financial distress. Our results are robust to alternative measures of the cost of debt, supply chain risk, and alternative samples. Our study suggests that supply chain security and stability are crucial for ensuring the smooth operation of businesses and maintaining a stable economy.

Does financial distress suppress CSR gap? The moderating effect of state ownership and market competition

AbstractCompanies will prioritize external corporate social responsibility (CSR) practices over internal ones, a phenomenon known as the corporate social responsibility gap (CSR gap). Previous studies have mostly focused on its consequences, little is known about its antecedents. We argue that such practice is illegitimate because it goes against stakeholder expectation that primary stakeholders' interests should be prioritized, but it also has potential to gain differentiation benefit for intense investment on external CSR. Drawing on compensatory orchestration logic and the three types of firm legitimacy, we argue that firms that have gained high pragmatic legitimacy are more likely to engage in morally illegitimate but differentiation gaining activities such as CSR gap. Using financial distress to indicate low pragmatic legitimacy, we predict that distressed firms are inclined to practice low CSR gap. Considering the competing logics in China, we further argue that this negative relationship will be less pronounced if firms are state‐owned or operating in a competitive industry. Using Chinese listed firms from 2010 to 2019 as an empirical sample, the results provide support for our arguments.

Cognitive load, social values and financial distress: drivers of restructuring decisions

PurposeThis study aims to analyze the effect of cognitive load and social value orientation on managers’ preferences when they face with two types of restructuring choices in financially distressed firms: the first belonging to the family of organizational restructuring (massive layoffs) and the second to the family of financial restructuring (debt increases).Design/methodology/approachThe authors investigate experimentally the impact of managers’ cognitive load and social value orientation on the decision to restructure leveraged buyout (LBO) firms in financial distress by using either massive layoffs or debt increases.FindingsBy investigating the impact of managers’ cognitive load and social value orientation on the restructuring decision of an LBO firm in financial distress, the research reveals that, on average, cognitively loaded managers prefer massive layoffs over increased debt levels. The massive layoffs seemingly provide a relatively easier way to avoid conflict with influential, residual claimants. In contrast, social value–oriented managers actively avoid massive layoffs and prefer to increase debt.Research limitations/implicationsThese results imply that the performance mechanisms emphasized to improve agency relations, for example, in LBOs, have their own limitations during periods of financial distress. This study shows that one of these limits is related to cognitive distortions and personality traits.Originality/valueIn this research, the originality lies in understanding how managers’ internal factors affect their restructuring decision-making, in the case of LBO firms in financial distress.

Annual report readability and earnings management of financial distressed firms: the moderating role of ownership concentration in India

Annual report readability and earnings management of financial distressed firms: the moderating role of ownership concentration in India

Predicting Construction Company Insolvent Failure: A Scientometric Analysis and Qualitative Review of Research Trends

The construction industry is infamous for its high insolvent failure rate because construction projects require complex processes, heavy investment, and long durations. However, there is a lack of a comprehensive framework and a requirement for such a framework in predicting the financial distress of construction firms. This paper reviews relevant literature to summarize the existing knowledge, identify current problems, and point out future research directions needed in this area using a scientometric analysis approach. Based on a total of 93 journal articles relating to predicting construction company failure extracted from multiple databases, this study conducts a holistic review in terms of chronological trends, journal sources, active researchers, frequent keywords, and most cited documents. Qualitative analysis is also provided to explore the data collection and processing procedures, model selection and development process, and detailed performance evaluation metrics. Four research gaps and future directions for predicting construction company failure are presented: selecting a broader data sample, incorporating more heterogeneous variables, balancing model predictability and interpretability, and quantifying the causality and intercorrelation of variables. This study provides a big picture of existing research on predicting construction company insolvent failure and presents outcomes that can help researchers to comprehend relevant literature, directing research policy-makers and editorial boards to adopt the promising themes for further research and development.

Predicting likelihood of fraud among financial distressed firms in Malaysia using textual analysis

This research paper aims to analyze and predict fraud patterns among failed companies in Malaysia. The approach involves utilizing textual analysis on the management discussion and analysis (MD&A) section within the annual reports. The dataset is subjected to text clustering to group companies based on similar financial characteristics. This clustering process entails several steps, including data conversion, collation, and summarization into a structured format, followed by text pre-processing to cleanse the dataset. Notably, RapidMiner Studio software was utilized to extract data for the study. Subsequently, the documents are clustered using both the K-means and latent dirichlet allocation (LDA) methods. Upon examining a sample of 22 failed companies in the year 2020, the study reveals that financially distressed companies exhibit prominent financial negativity and utilize litigious financial terms within their MD&A sections. These linguistic traits are found to be closely associated with seven distinct characteristics of fraudulent firms. This preliminary findings provide compelling evidence that financial pressure may serve as a triggering factor for fraudulent activities within companies.

The Effect of The COVID-19 Pandemic on The Tax Compliance of Digital Economy Business

Purpose: Tax authority have faced one of the challenges collecting tax revenue during the Covid-19 pandemic in decreasing of the economy will potentially leads firms in financial distress. Financial distress motivated firms to engage tax avoidance. Moreover, activities in the digital economy that are growing rapidly could be a challenge to prevent tax avoidance. Thus, this research intends to investigate how the Covid-19 pandemic affects associations between businesses that engage in digital economy activities and tax avoidance on Indonesian public enterprises. Method: The study used sample of 250 firms which are listed on Indonesia Stock Exchange (BEI) in 2018-2021 and conducted using difference-in-difference method. Findings: The study finds empirical evidence that digital economy activities positively associated with effective tax rate. Nevertheless, the Covid-19 pandemic weakened this association. Novelty: Previous studies partially examined the relationship between the COVID-19 pandemic on tax avoidance and the digital economy on tax avoidance. Quantitative researches about digital business are also mainly carried out in developed countries considering that digital economic activities have been massively carried out in developed countries. This study will complement previous studies where the Covid-19 pandemic and economic activity will be interacted with and linked to corporate tax avoidance behaviour, especially in Indonesia. Keywords: Covid-19; Tax Avoidance; Digital Economy

INVESTIGATING THE ROLE OF FIRM LIFE CYCLE ON FINANCIAL DISTRESS: EVIDENCE FROM BORSA ISTANBUL

This paper aims to examine whether acting non-compatible with life cycle has impact on firm’s financial distress. Considering every life stage requires unique priorities, firms should consider their life phases when determining their strategical decisions. We handle the causes of financial distress from a broad and strategical perspective on corporate finance ground. In this regard, we seek the relationships of investment, finance, and dividend policies with financial distress, considering firm life cycles. We applied panel data analysis examining 154 Borsa Istanbul (BIST) firms in manufacturing sector using their last seven-year data. We find that the ratio of investment to equity is positively correlated with financial distress for growth and decline firms at different levels. Additionally, we find that leverage increases financial vulnerability in all life cycles, however, the impact of leverage is larger for growth firms and decline firms. These findings are significant to navigate managers in the right direction.