Investigation of financial distress with a dynamic logit based on the linkage between liquidity and profitability status of listed firms

Abstract

The scope of this paper is to investigate the predictability of financial distress, adopting a survival model based on dynamic logit for a sample of NYSE listed firms. The main assumption of this study is that liquidity and profitability constitute the key criteria for the configuration of financial distress status of a firm. Specifically, two independent models are applied for the period after the financial crisis of 2007–2008. The first model is constructed on the pillar of liquidity, and the classification into the subgroup of distressed firms is based on specific criteria such as current ratio, current liabilities / total liabilities, Equity / Liabilities and Total Debt / Total Asset. The second model is based on the pillar of profitability where the specific criteria for the classification from the primary group into the subgroup of distressed firms are ROE < ROA and Net Profit Margin ≤ 0. Finally, a third model is established as a result of the combination of the two previous models. A further purpose of this work is to ascertain whether during the period of crisis there has been a differentiation in the policy of listed companies, namely whether their efforts have been shifted to addressing liquidity problems at the expense of profitability.

Keywords:

• Financial distress
• financial ratios
• dynamic logit
• liquidity
• profitability