Excess corporate payouts and financial distress risk

Firms that follow excessive payout policies (over-payers) are higher on the financial distress spectrum and have lower survival rates than under-payers. In addition, over-payers endure lower future sales and asset growth than under-payers and experience negative abnormal returns in the bond and stock markets. Exogenous import tariff reductions and commodity price jumps reduce the likelihood of overpayment. We interpret this as evidence consistent with financial flexibility considerations, rather than risk-shifting, explaining the decision to overpay. We also find that CEO overconfidence and catering incentives affect overpayment.     

Incomplete contracts,renegotiation, and the choice between bank loans and public debt issues

In a two-period model where an investment project is funded with standard debt, the probability distribution of final cash flow is determined, at the interim date, by an unverifiable state of nature together with a choice by the controlling party (entrepreneur or creditor). With a control allocation contingent on a noisy default signal, renegotiation may improve efficiency in two ways: (i) reduce excessive risk-taking – due to the entrepreneur's moral hazard – through debt forgiveness; (ii) avoid the costs of financial distress associated with excessive liquidation or underinvestment by debt-holders, by letting them receive an equity stake in the firm. Such efficiency gain is an advantage of bank loans over publicly traded debt, given that the former are more easily renegotiated than the latter. The difference between the two types of debt is increasing in the degree of contractual incompleteness (noise present in the default signal) and in the portion of project value accounted for by future discretionary investment options.     

Financial distress,outside directors and corporate tax aggressiveness spanning the global financial crisis: An empirical analysis

We examine financial distress and tax aggressiveness spanning the global financial crisis (GFC) of 2008 and the impact of the interaction between board independence and firm-specific financial distress on tax aggressiveness. Our regression results show that both financial distress and the GFC are positively associated with tax aggressiveness. More importantly, we find that the positive association between financial distress and tax aggressiveness is magnified by the GFC. We also observe that the interaction between board independence and financial distress is positively associated with tax aggressiveness. Our results are robust to multiple measures of financial distress and tax aggressiveness.     

Estimating financial distress with a dynamic model: Evidence from family owned enterprises in a small open economy

Employing earnings shortfall as a financial distress indicator, we formulate a dynamic nonlinear model, implementing Wooldridge's conditional maximum likelihood estimator and accounting for potentially endogenous covariates. Likewise, we not only achieve a significant improvement in consistency and classification accuracy over static approaches, but we also manage to understand better the evolution of the financial distress process. In our sample of Greek listed firms the higher the positive performance and the lower the leverage at the initial period the greater the chance that a company enters financial distress further down the road, possibly due to manager–owner overconfidence and debt-imposed discipline by company's creditors.     

Accounting information and the valuation of Seasoned Equity Offerings (SEOs)

This study investigates the association between publicly available information disclosed in the SEO prospectus and offer prices of SEOs, as well as the association between this type of publicly available information and stock returns subsequent to an SEO after controlling for self-selection bias. The empirical evidence shows that disclosure of the planned uses of the SEO proceeds reveals value-relevant information which has been incorporated by the underwriters in setting the offer prices. Control for self-selection bias appears necessary to obtain unbiased estimates in the regression model explaining the determinants of offer price in SEOs.     

Estimating the Model for Seasoned Equity Offering Underpricing: Application to the Chinese Financial Market

We estimate the binomial probit model to examine the significance of important explanatory variables documented in seasoned equity offering (SEO) underpricing literature using two statistical approaches: maximum likelihood estimation and Bayesian estimation. In particular, our estimation relies on SEO-related data in the Chinese financial market, where the pricing mechanism is less transparent compared to that in the U.S. market. We find that the signs of coefficients for the explanatory variables in each model are not different, but their magnitudes appear to be different. Our finding also shows that estimation results are generally consistent with the results observed in the U.S. market.     

A Note on Selecting a Response Measure for Financial Distress

Since 1966, researchers have examined financial distress prediction models to determine the usefulness of accounting information to lenders. These researchers primarily used legal bankruptcy as the response variable for economic financial distress, or included legal bankruptcy with other events in dichotomous prediction models. However, theoretical models of financial distress normally define financial distress as an economic event, the inability to pay debts when due (insolvency). This study uses a loan default/accommodation response variable as a proxy for the inability to pay debts when due. The purpose of this note is to empirically test whether or not using the inability of a firm to pay debts when due, loan default/accommodation, as a response measure produces different results than using legal bankruptcy as the response measure. The study's empirical results show that legal bankruptcy and loan default/accommodation financial distress prediction models produce different statistical results, thus suggesting that the responses measure different constructs. A loan default/accommodation model also fits the data better than a bankrupt model. Our results suggest that a loan default/accommodation response may be a more appropriate measure to determine which accounting information is most useful to lenders in evaluating a firm's credit risk.     

Predicting distress in European banks

The paper develops an early-warning model for predicting vulnerabilities leading to distress in European banks using both bank and country-level data. As outright bank failures have been rare in Europe, the paper introduces a novel dataset that complements bankruptcies and defaults with state interventions and mergers in distress. The signals of the early-warning model are calibrated not only according to the policymaker’s preferences between type I and II errors, but also to take into account the potential systemic relevance of each individual financial institution. The key findings of the paper are that complementing bank-specific vulnerabilities with indicators for macro-financial imbalances and banking sector vulnerabilities improves model performance and yields useful out-of-sample predictions of bank distress during the current financial crisis.     

Anomalies and financial distress

This paper explores commonalities across asset pricing anomalies. In particular, we assess implications of financial distress for the profitability of anomaly-based trading strategies. Strategies based on price momentum, earnings momentum, credit risk, dispersion, idiosyncratic volatility, and capital investments derive their profitability from taking short positions in high credit risk firms that experience deteriorating credit conditions. In contrast, the value-based strategy derives most of its profitability from taking long positions in high credit risk firms that survive financial distress and subsequently realize high returns. The accruals anomaly is an exception. It is robust among high and low credit risk firms in all credit conditions.     

Equity issues and temporal variation in information asymmetry

We investigate the intertemporal relation between information asymmetry and equity issues, and particularly focus on which firms drive this relation. We find that when information asymmetry for a particular firm is low compared to the recent past, the firm is more likely to issue equity as opposed to debt. Importantly, this intertemporal association is driven by firms with high levels of information asymmetry. These firms are more prone to adverse selection costs and thus have more to gain by issuing equity after a narrowing of the information gap between managers and investors. Our findings are robust to various firm-specific proxies for information asymmetry.     

The impact of target firm financial distress in Australian takeovers

Of the motives that have been advanced to explain corporate acquisitions, the least explored is the acquisition of a target experiencing financial distress. This study addresses this void by examining whether target firm financial distress is related to takeover: attitude, premiums, payment method, competition and outcome. Despite inconsistent findings across our distress measures the tenor of the results suggest that distressed targets receive higher premiums and are less likely to be offered cash consideration. Additionally, takeover completion is lower and takeover competition higher for targets in financial distress. Financial distress does not influence whether a takeover is hostile or friendly.     

Taper Tantrum and Emerging Equity Market Slumps

In the post-global financial crisis period, the central banks of the advanced economies pursued unconventional monetary policies, such as the United States (U.S.) Federal Reserve’s quantitative easing (QE). Those policies and their unwinding may significantly affect cross-border capital flows and thus destabilize the financial systems of emerging markets. For example, emerging markets experienced substantial financial instability during the taper tantrum triggered by U.S. Federal Reserve Chairman Ben Bernanke’s May 2013 announcement of the potential unwinding of QE. In this article, we examine the spillovers from the taper tantrum on emerging markets more rigorously by using econometric analysis to empirically assess the effect on equity markets in emerging markets. Our central finding that virtually all emerging-market equity markets were affected by the taper tantrum highlights the need for emerging-market authorities to remain vigilant about the effects of advanced-economy monetary policies on their financial stability.     

The influence of managerial incentives on the resolution of financial distress

This study investigates the influence of managerial incentives on the resolution of financial distress. Our model predicts that when creditors and equityholders prefer different resolution methods, the likelihood of choosing Chapter 11 over private renegotiation is related to the ownership structure of the distressed firm. Empirical test results using a sample of 81 voluntary Chapter 11 firms and 65 private workout firms support the model’s prediction. We show that managerial ownership is positively related to the incidence of Chapter 11 filing when there is conflict between equityholders and creditors over the choice between Chapter 11 and a private renegotiation. Consistent with prior literature, we also find that the choice of resolution methods depends on the extent of creditor holdout problems and the level of economic distress. We also performed the analysis of a subsequent 5 years of post-distress performance for all sample firms. The majorities of firms that file for Chapter 11 lose their independence and are either acquired or liquidated. However, more than half of firms in private workouts survived as independent firms.

An empirical comparison of bankruptcy models

Four types of bankruptcy prediction models based on financial statement ratios, cash flows, stock returns, and return standard deviations are compared. Based on a sample of bankruptcies from 1980 to 1991, results indicate that no existing model of bankruptcy adequately captures the data. During the last fiscal year preceding bankruptcy, none of the individual models may be excluded without a loss in explanatory power. If considered in isolation, the cash flow model discriminates most consistently two to three years before bankruptcy. By comparison, the ratio model is the best single model during the year immediately preceding bankruptcy. Quasi-jack-knifing procedures suggest that none of the models can reliably predict bankruptcy more than two years in advance.     

Valuing Debt in a Complex Capital Structure

This article extends previous bond valuation models to account for more realistic assumptions regarding financial distress. Realized value of an individual bond under severe financial distress will reflect the expected outcome of credit-event negotiations and the relative priority listing of the security. We explicitly represent the probability rate of credit-event occurrence as a function of firm value relative to the fixed overall debt obligations of the firm. Risk premiums generated under reasonable parameter value choices fall within the range of observed bond risk premiums. Our model also provides an explanation as to why observed bond risk premia are positive after adjustment for default.     

Equity issues and aggregate market returns under information asymmetry

We propose a simple time-series model based on information asymmetry that allows us to test the predictive power of equity and debt issues with respect to future market returns. Using this method, we find that managers’ new equity and debt issue decisions have predictive power for future market returns, when we take into account potential feedback from past market returns and structural breaks. We also take into account a cointegration relation among stock prices, equity issues and debt issues. This finding is robust with respect to various measures of market returns and consistent with the managerial timing hypothesis.     

Secured Creditor Recovery Rates from Management Buy‐outs in Distress

Buy‐out literature suggests that secured creditors will recoup substantial proportions of the funds they extend to finance the initial buy‐out. This paper uses a unique dataset of 42 failed MBOs to examine the extent of credit recovery by secured lenders under UK insolvency procedures and the factors that influence the extent of this recovery. On average, secured creditors recover 62 per cent of the amount owed. The percentage of secured credit recovered is increased where the distressed buy‐out is sold as a going concern and where the principal reason for failure concerns managerial factors. The presence of a going concern qualification in the audit report and the size of the buy‐out reduce the recovery rate by secured creditors.     

Financial distress and the accrual anomaly

We find that the accrual anomaly is concentrated in healthy firms and is absent in financially distressed firms. The differential persistence between accruals and cash flows is the main driver of the relationship. Prior studies propose two explanations for the accrual anomaly: (1) accounting distortions of accruals and (2) investment mispricing. Our empirical evidence supports the former and challenges the latter. Our findings also disagree with the idea that the accrual anomaly is distress risk premium in disguise.     

Feedback Trading and Autocorrelation Patterns in Sub-Saharan African Equity Markets

This article examines feedback trading and autocorrelation pattern of stock returns in the equity markets of Ghana, Kenya, Nigeria, and South Africa. We find evidence that positive feedback trading induces negative autocorrelation in the stock returns of Ghana, Kenya, Nigeria, and South Africa. The negative autocorrelation occurs during periods of increasing volatility, and all the four equity markets exhibit volatility asymmetry. We also find that Ghana, Nigeria, and South Africa were influenced by the 2008–2009 global financial crisis, and South Africa experienced the largest impact. These findings may have implications for risk management and price discovery in these equity exchanges.     

Seasoned Equity Offerings: Stock Market Liquidity and the Rights Offer Paradox

This paper examines the impact of market liquidity on seasoned equity offerings (SEO) characteristics in France. We find that, besides blockholders’ takeup, liquidity is an important determinant of SEO flotation method choice. We document higher direct equity offering flotation costs, but also improved stock market liquidity after public offerings and standby rights relative to uninsured rights. After controlling for endogeneity in the choice of SEO flotation method, we find that pure public offerings and standby rights are comparable in terms of direct costs and liquidity improvement. Our results provide new insights as to why firms choose public offerings despite apparently higher costs.