Healthy Firms Research Articles

The anatomy of business failure

Purpose The purpose of this paper is to analyze the aftermath of business failure (BF) by addressing: how the individual progressed and developed new ventures, how individuals changed business behaviors and practices in light of a failure, and what was the effect of previous failure on the individual’s decisions to embark on subsequent ventures. Design/methodology/approach The authors resort to qualitative methods to understand the aftermath of BF from a retrospective point of a successful entrepreneur. Specifically, the authors undertook semi-structured interviews to six entrepreneurs, three from the north of Europe and three from the south and use interpretative phenomenological analysis. Findings The authors found that previous failure impacted individuals strongly, being shaped by the individual’s experience and age, and their perception of blame for the failure. An array of moderator costs was identified, ranging from antecedents to institutions that were present in the individual’s lives. The outcomes are directly relatable to the failed experience by the individual. The authors also found that the failure had a significant effect on the individual’s career path. Originality/value While predicting the failure of healthy firms or the discovery of the main determinants that lead to such an event have received increasingly more attention in the last two decades, the focus on the consequences of BF is still lagging behind. The present study fills this gap by analyzing the aftermath of BF.

Do financially distressed firms misclassify core expenses?

PurposeThis paper aims to examine whether financially distressed firms manipulate core or operating income through the misclassification of operating expenses as income-decreasing special items.Design/methodology/approachThis sample comprises firms in the USA with data from 1989 to 2010. The authors used the methodology given in McVay (2006) and multiple regressions.FindingsManagers of financially distressed firms are more likely to inflate core or operating income as compared to the healthy firms to meet or beat earnings benchmarks. They do so by misclassifying core or operating expenses as income-decreasing special items. Specifically, core expenses are shifted to income-decreasing special items like goodwill impairments, settlement costs, restructuring costs and write downs.Practical implicationsThe paper sheds light on an important firm characteristic, financial distress that intensifies classification shifting – an earnings management tool which auditors, investors and regulators find tough to detect. The findings have implications for investors, as they fail to comprehend such shifting (McVay, 2006); analysts, who issue forecasts based on street earnings; lenders, as distressed firms may be concealing their true performance; and regulators, as the misclassification of income statement items is a violation of accounting principles.Originality/valueThe authors extend the literature on accruals and real earnings management by the financially troubled firms and present first evidence that the managers of such firms also manipulate core or operating income through classification shifting.

The Impact of Earnings Management on Bankruptcy Prediction Models: An Empirical Research

We examine the impact of two types of earnings management, accruals and real activities manipulation, on bankruptcy prediction models. Consider that the form of engaging on earnings management might characterize firms’ financial condition, we hypothesize and find that the special information extracted from earnings management models, which encompass potential manipulations, serves to improve the accuracy of bankruptcy prediction models. We further provide evidences that when potential accruals manipulation is measured, it allows an improvement of bankrupt firms, while real activities measures, especially sales manipulation, enhance the prediction improvement of non-bankrupt firms. Our finding suggests that failed firms are more likely to engage on accruals manipulation, while healthy firms do it on real activities manipulation. As a result, this study contributes to the literature by analyzing a novel explanatory variable, earnings management variable, to predict bankruptcy that can overcome financial alteration and can be applied to any type of firms.

Zombie firms and over-capacity in Chinese manufacturing

The problems of over-capacity and zombie firms in China's manufacturing attract all aspects of attention, but academic analysis is still absent. Using firm-level data of Chinese manufacturing, this study first documents the problems of over-capacity and zombie firms during 2011–2013. We find that the over-capacity problem is much more severe in the northeastern and western regions of China, in heavy chemical industries, and in state-owned sector. The distribution of zombie firms is in a similar manner across region, industry and ownership. We also empirically test the relationship between zombie firms and over-capacity, finding that zombie firms cause and worsen over-capacity by crowding out healthy firms.

The impact of liquidity crises on cash flow sensitivities

Abstract We examine the relationship between liquidity crises and frictions in raising funds, and find that both the gap between the cash flow sensitivities of financially healthy and weak firms and the cash flow sensitivities of healthy and weak firms themselves are positively correlated with the severity of liquidity crises. Using a multi-equation model of cash flow sensitivities, we find that moderate liquidity crises mostly affect firms’ financing activities. The recent financial crisis was especially severe for financially weak firms and curtailed both their investment and financing decisions. Financially healthy firms were able to protect their investments by maintaining financial flexibility.

Credit Misallocation During the European Financial Crisis

Do banks with low capital extend excessive credit to weak firms, and does this matter for aggregate efficiency? Using a unique data set that covers almost all bank-firm relationships in Italy in the period 2004-2013, we find that, during the Eurozone financial crisis: (i) Under-capitalized banks were less likely to cut credit to non-viable firms. (ii) Credit misallocation increased the failure rate of healthy firms and reduced the failure rate of non viable firms. (iii) Nevertheless, the adverse effects of credit misallocation on the growth rate of healthier firms were negligible, and so were the effects on TFP dispersion. This goes against previous influential findings that, we argue, face serious identification problems. Thus, while banks with low capital can be an important source of aggregate inefficiency in the long run, their contribution to the severity of the great recession via capital misallocation was modest.

PENGARUH POTENSI KEBANGKRUTAN PERUSAHAAN PUBLIK TERHADAP PERGANTIAN AUDITOR

The main objective of this paper is to examine the effect of failing firms (firms which arepotential to be bankrupt) on auditor switching. Hypothesis was derived from Schwartz and Menon (1985) which implies that failing firms have a greater tendency to switch auditors than healthier firms do. The Z score (Altman model) was used as a proxy to measure the potential of bankruptcy. This method was applied since it has been developed in several countries such as US, Germany, Brazil, Australia, England, Ireland, Canada, the Netherlands, and France. Annual report and Indonesian Capital Market Directory were used to collect the data for a sample of 7 firms that changed their auditors and 7 firms that did not. Those four-teen (14) firms have been selected as sample among firms in consumer goods industries to answer the question about the impact of firns with potential to go bankrupt on auditor switching. Chi-Square result shows that firms with potential to go bankrupt could not influence auditor switching.Keywords: auditor switching, bankruptcy, Altman Z-Score, failing firm

Credit Misallocation During the European Financial Crisis

Do banks with low capital extend excessive credit to weak firms, and does this matter for aggregate efficiency? Using a unique data set that covers almost all bank-firm relationships in Italy in the period 2004-2013, we find that, during the Eurozone financial crisis: (i) Under-capitalized banks were less likely to cut credit to non-viable firms. (ii) Credit misallocation increased the failure rate of healthy firms and reduced the failure rate of non viable firms. (iii) Nevertheless, the adverse effects of credit misallocation on the growth rate of healthier firms were negligible, and so were the effects on TFP dispersion. This goes against previous influential findings that, we argue, face serious identification problems. Thus, while banks with low capital can be an important source of aggregate inefficiency in the long run, their contribution to the severity of the great recession via capital misallocation was modest.

KEBANGKRUTAN VERSUS RESTRUKTURISASI: EVALUASI DAN PREDIKSI KELANGSUNGAN HIDUP PERUSAHAAN PASCA KRISIS KEUANGAN 1997

The purposes of this study are to evaluate the persistence in healthy firms during financial crisis periods, to predict healthy firms based on some relevant variables, and to evaluate the effectiveness of the change of company strategic attributes to cope with the financial distress, and to avoid firms bankruptcy in the future. This study provides a methodology that useful to evaluate and predict firm performance. This study uses statistical and qualitative approaches in order to get comprehensive conclusion whether non-healthy firms can increase their performance or not.Twelve selected variables are employed to predict the healthy firms from one through four periods (from 1994 through 1999) before the events (from 1998 through 2000). Seven strategic attributes are identified during the crisis periods to evaluate the change of firm performance. Four major research findings can be summarized as follows. First, there is persistence in the firm performance. The non-healthy firms underperform healthy firms and they also persistently have the worst performance in one and two next years. Second, two business risk proxies, sales stability and standard deviation of return on investment, are consistently significant in predictingthe healthy firms. The effect of investment opportunity, leverage (financial risk), and liquidity in predicting the healthy firms is relatively moderate from one through four years before the event years. While other variables including dividend policy, earning stability, and assets structure are less consistent to predict the healthy firms due to the bias of multicolinearity effects. This study also finds that using univariate t-test, most variables of the two sub-samples (healthy versus nonhealthy firms) are significantly different for all periods, except 1994. Third, the results of predictionmodels are robust. The models provide highly accurate results in matching the classifications of actual observations and the prediction results, range from 86,8% through 100%. Fourth, four strategic attributes, the change of director boards, the composition change of capital ownerships, strategic alliances, and acquisitions, are effective to increase the firm performance. However, surprise that debt restructuring is less powerful to cope with the firm financial distress during three year periods of analysis.Keywords: healthy firm, debt restructuring, corporate strategy, business and financial risks

Understanding Pension Liabilities: A Closer Examination of Discount Rates

The discount rate represents a critical choice in accounting for corporate defined-benefit pension plans due to the long-term nature of pension liabilities. U.S. GAAP and IFRS mandate the AA corporate bond rate. Their requirement is subject to much debate, with the risk-free rate and the expected return on pension assets (EROA) often proposed as alternatives. We examine which of these rates best fits pension values as perceived by equity- and debt-market participants. For equity values, the EROA rate dominates, while for credit ratings, the AA rate dominates. For financially healthy firms, however, discounting at the EROA produces the best fit for both equity values and credit ratings. In contrast, for firms nearing financial distress, discounting at the AA rate provides the best fit. We also find that the accumulated benefit obligation measure consistently dominates the projected benefit obligation in explanatory power for credit ratings. Overall, we find that market participants adjust GAAP-recognized pension obligations in both amount and discount rate, in a manner that appears consistent with firm-specific economic realities.

Financial distress, political affiliation and earnings management: the case of politically affiliated private firms

Using a sample of politically affiliated private firms in China, we explore the relation between corporate financial distress and earnings management. We further examine the joint moderating effects of political affiliation and regional development on this relation. The findings suggest that financially distressed firms engage more in reporting small positive earnings relative to financially healthy firms. In addition, political affiliation weakens the association between financial distress and small positive earnings management. A three-way interaction analysis indicates that the moderating effect of political affiliation is influenced by regional development.

Effect of IFRS adoption on financial reporting quality

Purpose The purpose of this paper is to investigate whether International Financial Reporting Standards (IFRS)-based data improve bankruptcy prediction over Australian Generally Accepted Accounting Principles (AGAAP)-based data. In doing so, this paper focuses on intangibles because conservative accounting rules for intangibles under IFRS required managers to write off substantial amounts of intangibles previously capitalized and revalued upwards under AGAAP. The focus on intangibles is also motivated by empirical evidence that financially distressed firms are more likely to voluntarily capitalize and make upward revaluations of intangibles compared with healthy firms. Design/methodology/approach This paper analyses a sample of 46 bankrupt firms and 46 non-bankrupt (healthy) firms using a matched-pair design over the period 1991 to 2004. The authors match control firms on fiscal year, size (total assets), Global Industry Classification Standard-based industry membership and principal activities. Using Altman’s (1968) model, this paper compares the bankruptcy prediction results between bankrupt and non-bankrupt firms for up to five years before bankruptcy. In the tests, the authors use financial statements as reported under AGAAP and two IFRS-based data sets. The IFRS-based datasets are created by considering the adjustments on the AGAAP data required to implement the requirements of IAS 38, IFRS 3 and IAS 36. Findings This paper finds that, under IFRS, Altman’s (1968) model consistently predicts bankruptcy for bankrupt firms more accurately than under AGAAP for all of the five years prior to bankruptcy. This greater prediction accuracy emanates from smaller values of the inputs to Altman’s model due to conservative accounting rules for intangibles under IFRS. However, this greater accuracy in bankruptcy prediction comes with larger Type II errors for healthy firms. Overall, the results provide evidence that the switch from AGAAP to IFRS improves the quality of information contained in the financial statements for predicting bankruptcy. Research limitations/implications Small sample size and having data available over the required period may limit generalizability of findings. Originality/value Although bankruptcy prediction is one of the primary uses of accounting information, the burgeoning literature on the benefits of IFRS adoption has so far neglected the role of IFRS data in bankruptcy prediction. Thus, this paper documents a new benefit of IFRS adoption. In this paper, the authors demonstrate how the restrictions on the ability to capitalize and revalue intangibles enhance the quality of information used to predict bankruptcy. These results provide evidence to international standard setters of what they can expect if their efforts to remove non-restrictive accounting practices for intangibles are abandoned.

A study of credit risk of Chinese listed companies: ZPP versus KMV

ABSTRACTThe Zero-Price Probability (ZPP) model is applied to evaluate the credit risk of listed companies in China and its performance is compared to that of the Kealhofer-McQuown-Vasicek (KMV) model. The sample includes 34 financially distressed companies and a comparison group of 34 financially healthy companies. The performances of ZPP and KMV models are compared using various descriptive statistics and statistical tests. The empirical analyses show that the ZPP model is superior to the KMV model in terms of discriminatory power. Compared to the KMV model, the ZPP model performs much better in distinguishing between financially challenged and healthy firms. Among different specifications of the ZPP model, the naïve constant variance zero-price probability model outperforms those with generalized autoregressive conditional heteroskedasticity specifications. This article is among the very first studies that provide evidence on the performance of the ZPP model.

Relative Informativeness of Top Executivess Trades in Financially Distressed Firms Compared to Financially Healthy Firms

Relative Informativeness of Top Executivess Trades in Financially Distressed Firms Compared to Financially Healthy Firms

ANALISIS KINERJA KEUANGAN SEBAGAI ALAT PREDIKSI KEBANGKRUTAN DENGAN MODEL DISKRIMINAN

The purpose of this study was to determine whether the Current Ratio (CR), Debt Equity Ratio (DER), Total Assets Over Turen (TATO), net profit margin (NPM), Debt to Assets Ratio (DAR), Return on Assets (ROA) , Return on Equity (ROE), Gross Profit Margin (GPM), Operating Profit Margin (OPM) influential in distinguishing healthy firms and perusahaa bankruptcy discriminant model. Based on discriminant analysis of known groups of healthy companies and a group of companies that went bankrupt differ significantly, from 9 (nine) variables are in use only 4 (four) variable Current Ratio, Debt Equity Ratio, Net Profit Margin, and Gross Profit Margin is selected and able to differentiate healthy companies and companies go bankrupt, while the 5 (five) of the variables, Turn Over Total Assets, Debt to Assets Ratio, Return on Assets, Return on Assets, and Operating Profit Margin are not able to differentiate healthy and bankrupt companies.
 
 Keywords: Current Ratio ,Debt Equity Ratio, Total Assets Turen Over , Net profit Margin , Return on Assets, Return on Equity

Should zombie lending always be prevented?

It has been argued that zombie lending might have been one of the main culprits behind the sluggish Japanese recovery in the so-called “lost decade”. Among others, zombie lending may lead to misallocation of capital, reduction of profits for healthy firms, and lower employment. The only remaining question is: Why do banks engage in zombie lending practices? Is it due to wrong incentives for bank managers, or perhaps misguided government policies? Using a simple model, the paper exposes a strong link between collateral value and the strategic importance of zombie lending. The author shows that zombie lending may be an optimal strategy for a bank in some cases as it leads to greater lending ex-ante and prevents further losses from fire sales. Consequently, it can be argued that zombie lending is a side effect of market incompleteness and is ex ante welfare improving, so that it may not be possible or even desirable to prevent its occurrence. Another policy implication is that capital injection into the banks would not solve any problem. However, direct purchase of the collateral on the market would certainly alleviate the problem of zombie lending.

Impending Bankruptcy: Examining Cash Flow Pattern of Distress and Healthy Firms

Abstract Studies have proven that information on earnings has become less relevant to measure company performance during distressed situation. A relatively simple and convenient way to analyze a company's financial status is by using cash flow information. The present study examines eight types of cash flow patterns used as an alternative tool to predict financial distress incidence. The cash flow patterns derived from positive and negative signs of cash flow components which consist of operating, investing and financing activities. The data collected consists of 124 Malaysian public listed companies covering the period of 2006 until 2013. The main objective of the study is to find out whether there is any significant relationship between cash flow patterns and financial distress incidence. The results found that companies are more likely to experience financial distress situation when the company generates positive cash inflow from daily operation activities and use the cash generated to finance future investment and long term debt. Besides, the companies are also more likely in distressed situation when they are unable to cover its short term obligation due to insufficient cash inflows generated from the main operating activities. Distressed companies are more likely to acquire external financing since the excess of cash generated from operating activities is insufficient. When the company experienced outflows in all operating, investing and financing activities, there is high tendency for the company to go bankrupt. The results also revealed that there is a significant difference between distressed and healthy companies in incidence of different patterns of cash flow.

THE U.S. TREASURY'S CAPITAL PURCHASE PROGRAM: TREASURY'S SELECTIVITY AND MARKET RETURNS ACROSS WEAK AND HEALTHY BANKS

AbstractWe evaluate firms that voluntarily participated in the Treasury's Capital Purchase Plan (CPP), focusing on the market impact of their decision to participate. For healthy firms, abnormal stock returns are negative. For weak firms, CPP was a cheap source of funding, as demonstrated by their significant positive returns. Despite gains for weak firms, not all were permitted to participate. The Treasury made funding available to institutions with low levels of capital only if they also had better performing loan portfolios. Providing further evidence of the Treasury's selectivity, weak firms not participating in the CPP had significantly lower long‐term returns than did weak firms that participated.

Logit Regression Based Bankruptcy Prediction of Korean Firms

In this article, we develop a bankruptcy prediction model for Korean firms that utilize logit regression. We find that not only financial accounting ratios but equity market inputs and macro-economic variables are also important predictors of bankruptcy. However, unlike the findings in Campbell et al. (2008), using market value of equity in computing total assets did not improve the model. We compare the model with a Merton type structural model and find that our model demonstrates a higher prediction power in distinguishing distressed firms from healthy firms. Though our model proves to perform better, we are careful to make a conclusion and rather suggest to use several models for the purpose of risk management to reduce model risk.

Voluntary audit committee characteristics in financially distressed and healthy firms: a study of the efficacy of the ASX corporate governance council recommendations

The aim of this paper is to address the impact of certain audit committee characteristics identified by the ASX Corporate Governance Council on improving the effectiveness of corporate audit committees on the likelihood of financial distress. Using a sample of 155 listed Australian firms, this paper finds support for the argument that the adoption of some, but not all, recommendations concerning the formation of an audit committee is beneficial for firms, which in this paper is reflected in a reduced likelihood of financial distress. In particular, the presence of a financial expert and solely non-executive directors on audit committee are associated with lower financial distress likelihood. By contrast, chairperson duality is significantly positively related to the probability of financial distress