A three-stage dynamic model of financial distress
ISSN: 0307-4358
Article publication date: 14 August 2018
Issue publication date: 14 August 2018
Abstract
Purpose
The purpose of this paper is to explain the multi-stage dynamic process of financial distress. An attempt is made to explore multiple adverse heterogeneous events of financial distress leading a firm closer to bankruptcy progressively.
Design/methodology/approach
Sample comprises 321 ongoing, 54 suspended and 91 delisted non-financial firms from Pakistan Stock Exchange. Financial distress is segregated into three stages, i.e. profit reduction, mild liquidity (ML) and severe liquidity (SL). Flow diagrams are used to explain the transition of healthy firms through proposed stages of financial distress.
Findings
Results showed that firms liquidated/winding-up by court documented SL problems and closed their operations well before the delisting year. It is found that healthy firms are more likely to face SL when faced ML problem at first stage. Distressed firms can recover to a healthy position at any stage, however after approaching to SL, recovery is less expected.
Practical implications
The proposed process will provide a foundation for future studies to develop more relevant, robust and accurate early warning system of corporate failure that will help stakeholders to respond potential crisis accordingly and timely.
Originality/value
Previously, most of the studies used the ex post definition of bankruptcy that is criticized due to the contextual application, sample bias and non-segregation by the degree of liquidity problems. The originality of the proposed ex ante model is its segregation into a three-stage process that can be generalized regardless of specific bankruptcy law.
Keywords
Citation
Farooq, U., Jibran Qamar, M.A. and Haque, A. (2018), "A three-stage dynamic model of financial distress", Managerial Finance, Vol. 44 No. 9, pp. 1101-1116. https://doi.org/10.1108/MF-07-2017-0244
Publisher
:Emerald Publishing Limited
Copyright © 2018, Emerald Publishing Limited