Distressed Firms Research Articles

Bankruptcy reform and corporate risk-taking: Evidence from a quasi-natural experiment

Using the initiation of bankruptcy reforms in India, we assess the causal effect of the bankruptcy reform on corporate risk-taking. We observe that the reform that balances the rights of creditors and debtors enables distressed firms to increase their corporate risk-taking than non-distressed firms. We next show that an increase in corporate risk-taking increases the operating performance of distressed firms, compared with non-distressed firms. These results indicate that the bankruptcy reform that favors safe viable businesses instead of forcing distressed firms to inefficient liquidation alters firms’ incentives to take the risk.

OWNERSHIP STRUCTURE AND CORPORATE RESTRUCTURING: DOES IT HAVE AN IMPACT?

Ownership structure has a role in decision making by the company. This study wants to examine the effect of ownership structure on the choice of corporate restructuring: asset divestment and dividend cut. This study focuses on the restructuring strategy on manufacturing firms that experience declining performance, using the proxy of decreasing Earnings Before Interest and Tax for two or more consecutive years, in the period of 2010 until 2020. Data analysis techniques using OLS Regression through Stata Program. The result shows: 1. Managerial ownership has positive impact on asset divestment, but family ownership, liquidity and inflation (as control variable) have negative impact on asset restructuring, namely, assets divestment, and 2. Family ownership have positive significant impact on financial restructuring through dividend cut, but institutional ownership have negative impact on dividend cut restructuring.. Applications/Originality/Value: This study provides strengthening empirical evidence about the impact of ownership structure on corporate restructuring (divestment and dividend cut) choices in distress firms. This study is appropriate to carried out in Indonesia, which has a high leveraged firm on average 43% and emerging market. 
 
 Keyword: Managerial ownership, institutional ownership, family ownership, assets divestment, restructuring

Do Shadow Loans Create Firm Distress and Harm Investment? Evidence from China

Do Shadow Loans Create Firm Distress and Harm Investment? Evidence from China

The Different Impact of Top Executives’ Turnover on Healthy and Restructured Companies

The aim of this paper is to investigate if top executives’ turnover affects the performance of a company and if it differently impacts the performances of a healthy and a restructured company. In order to investigate the impact of the renewal of both members of the board of directors and CEO impacts on company profitability, we performed a quantitative analysis based on a sample of 144 Italian companies using a logit model. The findings show that management changes influence the performance of a company. However, the results show a different impact for healthy and restructured companies. The renewal of the board of directors negatively affects the performances of a healthy company while influences positively the probability of a future increase in performances for restructured companies, suggesting useful implications for scholars and practitioners. This analysis confirms that the renewal of top executives can affect the probability of an increase of company performances, especially for distressed firms, contributing to existing literature which is still limited and focused only on few countries.

Dynamics of managerial power and CEO compensation in the course of corporate distress: Evidence from 1992 to 2019

AbstractWe study the dynamics of two governance constructs, managerial influence over the board of directors and chief executive officer (CEO) compensation, in firms undergoing distress during 1992–2019. Data show a clear trend that governance improves over time, which confounds the inference about the effects of distress on governance. Controlling for the secular changes with a bias‐corrected matching estimator, we find that distressed firms reduce managerial board appointments and CEO pay, intensify managerial incentive alignment, and increase CEO turnover. The bulk of CEO compensation changes in distressed firms derives from the performance‐related part of compensation, consistent with the “shareholder value” view of CEO compensation.

Dynamic optimal restructuring policies under debt renegotiation with positive externalities

AbstractThis paper develops a debt renegotiation model with positive externalities using the Nash bargaining game and explores dynamic optimal downward debt restructuring policies in times of financial distress. We derive closed‐form expressions for the optimal restructuring policies. Moreover, we provide theoretical support for the advantages of debt renegotiation with positive externalities. In addition, our model could explain the violation of the absolute priority rule for firms in financial distress. Finally, we find that debt renegotiation is facilitated among firms with relatively low risk and a high leverage ratio, as documented by empirical evidence.

The Effect of Board and Ownership Structure on the Possibility of Financial Distress

Research aims: This study aims to examine the effect of corporate governance, specifically relating to the ownership structure and board structure, on the possibility of financial distress.Design/Methodology/Approach: The sample used in this study are companies listed on the Indonesia Stock Exchange (IDX) from 2015 to 2019, excluding the financial industry. Conditional logistic regression is used as the study uses paired data based on the total assets of the company.Research findings: The results of this study indicate that board ownership, independent commissioners, and the board of directors can increase the likelihood of financial distress. On the other hand, institutional ownership and concentrated ownership are proven to have no effect on the likelihood of financial distress. The results of sensitivity testing using logistic regression showed different results on the variable institutional ownership, which is that institutional ownership can increase the likelihood of financial distress. Meanwhile, the other variables showed the same outcome as the main regression used in this study.Theoretical contribution/Originality: This study contributes to the knowledge on the relationship of board ownership, institutional ownership, concentrated ownership, independent commissioners and board size and the possibility of financial distress. Also, this research found that the provision of incentives in the form of shares to the board may not be an effective way to overcome financial distress in Indonesian firms.

Financial Distress, the Severity of Financial Distress and Direction of Earnings Management: Evidences from Indian Economy

This paper investigates the relationship between earnings management and financial distress and considers whether this relationship varies based on the severity of financial distress and signs of discretionary accruals (a proxy for earnings management). For this purpose, multiple regression analysis has been employed on a sample of 192 financially distressed Indian firms during the period 2011–2018, counting to 1,272 firm-year observations. Discretionary accruals are estimated by the Modified Jones model and Raman and Shahrur (2008) model, while Altman’s Z-score and distance-to-default model are used to detect the degree of financial distress. The findings disclose that the low distressed firms are indulged in higher earnings management than high distressed firms. Also, the low distressed firms are engaged more in income-decreasing earnings management. However, the results are not consistent across both earnings management and distress measures. The findings have significant implications for investors and creditors. They need to be aware of this fact while evaluating creditworthiness of a firm since firms with even a low degree of financial distress can indulge in earnings management to camouflage their true financial condition.

“Tiga Wajah” Financial Distress: Determinan, Pemediasi, dan Pemoderasi dari Praktik Manajemen Laba di Indonesia

This study explicates the dynamic relationship between financial distress and earnings management using property and real estate companies listed in the Indonesia Stock Exchange from 2018 to 2020 as the unit analysis. The paper also aims to test whether financial distress can be positioned as a determinant, mediator, and moderator towards earnings management simultaneously. Structural Equation Modelling with Partially Least Square technique was used to analyzed data gathered from 90 financial reports of property companies. This research sheds a light on the use of silver-bullet analytical tools in form of the Partially Least Square method to produce robust results stronger than ordinary least squares. Researches on this issue were still scant. This study found that financial distress has a significant positive influence on earnings management practice and can mediate the negative relationship between earnings management practice and its determinants. The financial distress can also play a partial role as a moderator on the negative relationship between earnings management and its determinant. This research implicates that investors should pay more attention to the financial distressed property companies during the pandemic period because this research has proved the manager’s misbehaviour in increasing the earnings management practice of the financial distressed firms. Future research can adapt the proposed research model and test it with panel data regression procedures.

CSR assurance practice and financial distress likelihood: evidence from India

Purpose The purpose of this study is to examine the effect of corporate social responsibility assurance practice (CSRAP) on the financial distress likelihood of listed firms in India. It uses the signalling theory to interpret the relationship among the variables of the study. Design/methodology/approach The study used the Indian stock market as the testing grounds and applied probit and panel probit regression to examine the data set with 800 firm-year observations from 2010 to 2019. Findings The study’s first findings show that firms with an assurance service have a negative correlation and are less likely to stay in financial distress situations for an extended period. However, corporate social responsibility (CSR) assurance has a positive but weak correlation with insignificance with financial distress likelihood of firms in India. The authors also find that the engagement of CSR assurance and level of assurance (limited assurance) does not cause a change in a firm financially distress likelihood of firms in India. However, as assurance service providers, auditing firms are more likely to reduce a firm’s likelihood of financial distress. Finally, the study shows that CSRAP (CSR assurance, assurance service providers and level of assurance) does not moderate the association between CSR expenditure and financial distress likelihood of listed firms in India. Originality/value The study findings are the first to examine the level of assurance and financial distress of firms according to the authors’ knowledge. This study also adds new knowledge to the factors that cause or reduces the financial distress of listed firms, including CSRAPs.

Does economic policy uncertainty matter for financial reporting quality? Evidence from the United States

We examine the effect of economic policy uncertainty (EPU) on the financial reporting quality of US firms over 1999–2015. We use accruals-based earnings management as a proxy for financial reporting quality and the index of Baker et al. (Quart J Econ 131:1539–1636, 2016) as an EPU measure to show that they exhibit a positive and significant association. We also find a causal effect by employing three political polarization instruments for EPU. In a cross-sectional analysis, we further show that the positive relationship between EPU and earnings management strengthens for firms operating in politically sensitive industries, for firms in more financial distress, and during recessionary periods. We also provide evidence that increased financial constraints facilitate the positive relationship between EPU and earnings management. These findings are robust to the use of alternative measures of economic policy uncertainty and when we employ real earnings management as a dependent variable. These results indicate that managers aim to provide outsiders with an improved financial position of the company when EPU is high. Our findings suggest that investors, analysts, creditors, and regulators should be wary of firms’ financial reporting quality in periods of high economic policy uncertainty.

WORKING CAPITAL MANAGEMENT AND FINANCIAL DISTRESS OF NON-FINANCIAL COMPANIES LISTED AT THE NAIROBI SECURITIES EXCHANGE

Financial distress is a common global phenomenon among the corporate entities. Locally, there is overwhelming evidence of firms that have undertaken financial restructuring, delisted from the exchange market, gone into receivership and subsequently liquidated on account of financial distress. This study therefore set out to examine the way in which management of working capital affects financial distress of non-financial firms listed at the Nairobi Securities exchange. In fulfilling this objective, the study sought to establish how cash management, inventory management and accounts receivables management effects financial distress of non-financial firms listed at Nairobi Securities Exchange. The free cash flows theory, Precautionary motive theory, financing advantage theory and liquidity theory formed the theoretical basis of the study. The study adopted longitudinal research design and collected secondary data over ten years period (2009-2018) from a census of the 40 non-financial firms listed in Nairobi Securities exchange. Descriptive statistical analysis was used to obtain the initial overview of the data collected. Inferential statistical analysis was undertaken using the F and t-tests at 95% confidence level. The study found that cash management had a positive and significant effect on the firms’ distress index. Further, the study revealed that inventory holding period was negatively and significantly related to the firms’ financial distress index. The study also showed that suppliers’ payment period had a positive and significant effect on financial distress indicator. The study however depicted a negative but insignificant relationship between receivables period and financial distress. The study recommended that the management of non-financial listed firms should ensure appropriate management of working capital components in order to guard against instances of corporate financial distress 
 
 JEL: O15; J24; L20
 
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Do different political connections affect firms' distress risk differently?

PurposeThis paper investigates how different types of corporate political connection, including government-linked investment (GLI), former officials as politically-connected directors (PCD), cronyism (CRO) and government leaders' family ties (FAM), influence financial distress risk in Malaysian firms.Design/methodology/approachWe separate political connections into four distinct categories and investigate their relationship with firm distress risk and compare the results with the one-size-fits-all treatment which is popular in the literature. We apply a battery of sensitivity test to ensure that our inferences are robust to a wide range of test specifications, endogeneity concern and sample selection methods.FindingsThe empirical results show that the effect of political connections on distress risk is strongly heterogeneous. GLI and PCD firms tend to have higher distress risk via increased risk-taking behaviors because of the different incentives of the connections, while this nexus does not directly exhibit in CRO and FAM firms. Further analyses reveal that CRO and FAM firms are more likely to venture into risky international diversification, thus indirectly amplifying their distress risk.Originality/valueOur findings are novel and provide practical implications for financial analysts, investors and portfolio managers operating in the capital markets.

Turnaround Prediction Model with Content Dimension on Financial Distressed Firms

Objectives - This article aims to examine the influence of content dimensions of Organization Change Theory, such as CEO Expertise, Free Assets, Debt to Equity Ratio and Growth of Sales, on a company’s turnaround ability when it is experiencing financial distress. The companies examined are listed on the Indonesian Stock Exchange (IDX). Methodology/Technique - The population used in this study is companies from sectors excluding the finance sector that were listed on the Indonesian Stock Exchange between 2013 and 2018. The sample size was determined using purposive sampling method. From the 109 companies that experienced financial distress, 57 have successfully turned their business around. The research data was collected from the ICMD (Indonesian Capital Market Directory), which was then analysed using multi regression technique analysis, using SPSS software to examine the determinants of company turnaround ability. Finding - The results indicate that CEO Expertise, Debt to Equity Ratio and Growth of Sales have a negative relationship on a company’s turnaround ability. Meanwhile, Free Assets has a positive and significant relationship on a company’s turnaround ability. Novelty - Previous studies have been conducted in many western countries, giving rise to researchers' doubts about the generalizability of research based on previous research findings when applied in developing countries such as Indonesia, particularly due to differences in regulations, conditions of distress, culture, financial systems and strategies used in overcoming distress. Type of Paper: Empirical. JEL Classification: B26, G15, P34. Keywords: Financial Distress; Turnaround Model; CEO Expertise; Free Assets; Debt to Equity Ratio; Growth of Sales Reference to this paper should be made as follows: Giriati, S.E, M.E. (2021). Turnaround Prediction Model with Content Dimension on Financial Distressed Firms, Journal of Finance and Banking Review, 5 (4): 36 – 42. https://doi.org/10.35609/jfbr.2021.5.4(4)

Analyzing the impact of board vigilance on financial distress through the intervention of leverage structure and interaction of asset tangibility in the non-financial sector of Pakistan

This study focuses on the relationship between board vigilance and financial distress in non-financial firms listed on the Pakistan Stock Exchange (PSX). The mediating role of leverage structure and moderating role of asset tangibility is also studied following Baron and Kenney’s approach. The study analyzed the data of 284 firms ranging from 2013 to 2017 by using ordinary least squares (OLS) and panel corrected standard errors (PCSE) regressions. The study revealed that the debt maturity structure mediates the relationship between board independence and financial distress and between CEO non-duality and financial distress but the capital structure did not mediate any of the stated relationships. Similarly, asset tangibility negatively moderated the relationship between debt maturity and financial distress. However, there was no such moderation detected between the relationship of capital structure and financial distress. The results remained consistent throughout the analysis with both regression techniques. These results suggest using more long-term debt in debt maturity structure to have control over financial distress and also to reduce the reliance on non-productive tangible assets in the asset structure of non-financial firms of Pakistan.

Financial distress and commodity hedging: Evidence from Canadian oil firms

Properly implemented risk management practices can help maximize shareholder value by reducing the expected cost of financial distress, and as such firms in deeper financial distress are expected to hedge more. However, empirical studies on such relationship have yielded mixed results. This paper documents the main determinant of hedging decisions using a newly assembled dataset for 92 Canadian-based, publicly traded oil extraction companies between 2005 and 2015. We adopt empirical techniques - Honoré's semiparametric model and simultaneous equations with the minimum distance estimator - that explicitly deal with issues that frequently arise when studying hedging decisions, namely a clustering of firms that choose to not hedge at all and the endogeneity associated with concurrent determination of hedging and borrowing decisions. Even after controlling for endogeneity and other possible drivers of hedging, we still detect a positive and statistically significant relationship between a firm's perceived financial distress and the degree to which it hedges.

Financial distress in the hospitality industry during the Covid-19 disaster

We implement the stress test methodology of the banking industry in conjunction with a Logit model of bankruptcy with parameters estimated with data from the Great Recession (2008–2013) to predict which firms would face financial distress among Spanish hospitality firms during 2020 due to the Covid-19 disaster. The predictions from both methods rely on the last accounting data available and on the expected revenue drop for 2020. Both methods coincide to predict that 25% of these firms will face a financial distress situation if revenues drop 60%. This forecast raises up to 32% of firms if revenues drop 80%. Financial distress will affect mainly small firms. Most of the firms in financial distress will face solvency problems, with total assets being insufficient to pay all debts.

Fixed asset revaluation and external financing during the financial crisis: Evidence from Korea

During the 2008–2010 global financial crisis, the Korean government allowed firms to revalue fixed assets to strengthen their balance sheets, helping distressed firms to obtain external financing. Using firms listed on the Korea Exchange from 2008 to 2010, this study finds that subsequent to fixed asset revaluation, firms in need of financing use long-term debt financing more than short-term debt and equity financing. The increased long-term debt financing is in the form of private debt rather than public debt. The increase in private long-term debt financing is driven by financially constrained firms rather than by financially healthy firms. Our findings imply that fixed asset revaluation was an effective policy tool in Korea for helping firms with financial constraints obtain long-term debt financing.

Relationship finance, informed liquidity, and monetary policy

We study the aggregate effects of credit relationships in an economy where lenders provide liquidity and expertise to firms in distress. Lenders' effort in the restructuring of firms' investments endogenously depends on their financial involvement in investments. Firms trade off the benefits of precautionary internal liquidity with the need to incentivize lenders' restructuring effort through their financial involvement. We find that, through these intensive margin effects, credit relationships can induce overinvestment, calling for a positive interest rate policy that departs from the Friedman rule. Credit relationships, however, can enhance the resilience of investment to economic conditions. Unconventional monetary policies that inject liquidity into the lending sector enhance the stabilizing effects of credit relationships but have ambiguous welfare consequences.

Shareholder Value Implications of the Internal Audit Function

SYNOPSIS In 2013, NASDAQ Stock Market LLC (NASDAQ) issued a proposal to mandate the internal audit functions (IAFs) for all listed companies but later withdrew the proposal. In this study, I investigate whether the mandatory IAF adds shareholder value and how the value implications vary across companies. For companies without IAFs before the proposal, I document a positive (negative) price response to the NASDAQ IAF proposal filing (withdrawal). This evidence suggests that, on average, investors perceive mandatory IAF as value enhancing. I find that the positive market reaction is concentrated among firms with lower external audit quality and institutional ownership. Additionally, I document that the return responses are higher for companies with smaller book-to-market ratios, multiple business segments, and lower Altman z-scores. Those results suggest that investors' perceptions of the mandatory IAF are more positive for weakly monitored firms, firms with high-growth prospects and complex business, and firms in financial distress.