Comparing Financial Distress and Bankruptcy
Review of Applied Economics, Vol. 2, No. 2, 2006
27 Pages Posted: 23 Jan 2006 Last revised: 5 Nov 2013
Date Written: January 1, 2006
Abstract
For the most part, research purporting to address the issue of financial distress has actually studied samples of bankrupt companies. Financial distress and bankruptcy are different. In contrast, this paper starts with a sample of companies that are financially distressed but not yet bankrupt. The sample was obtained by screening the Compustat industry database with a three-tiered identification system. The screen bifurcated companies into financially and non-financially distressed groups. A multi-tiered screen reduces the incidence of mistakenly identifying a non-distressed company as financially distressed. The paper then compares factors indicating the likelihood of future bankruptcies to those indicating future financial distress. To do this, an early warning financial-distress model was developed and compared to a methodologically similar existent model of bankruptcy. The final financial distress model included only one variable present in the bankruptcy model and four new variables. The limited overlap of explanatory factors between the models questions the similarity of financial distress and bankruptcy. Statistical tests lend support to the notion that the bankruptcy process is not just a continuation of a downward spiraling cycle of financial distress. Our hypothesis is that financial distress is something that happens to companies as a consequence of operating decisions or external forces while bankruptcy is something that companies choose to do to protect their assets from creditors.
Keywords: Financial Distress, Early Warning Model, Renewal
JEL Classification: G30, G33
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Anatomy of Financial Distress: An Examination of Junk-Bond Issuers
By Paul Asquith, Robert H. Gertner, ...
-
Asset Sales, Firm Performance, and the Agency Costs of Managerial Discretion
By Annette B. Poulsen, Larry Lang, ...
-
Understanding Stock Price Behavior Around the Time of Equity Issues
By Robert A. Korajczyk, Deborah J. Lucas, ...
-
Understanding Stock Price Behavior Around the Time of Equity Issues
By Robert A. Korajczyk, Deborah J. Lucas, ...
-
A Theory of Corporate Financial Structure Based on the Seniority of Claims
By Oliver Hart and John Moore
-
Financial Distress Comparison Across Three Global Regions
By Harlan D. Platt and Marjorie Platt
-
Equity Returns, Bankruptcy Risk and Asset Pricing Models
By Syed I. Hussain, Steve Diacon, ...