Survival prediction of distressed firms: evidence from the Chinese special treatment firms

ABSTRACT

In the Chinese stock market, firms experiencing financial distress have been imposed on a Special Treatment (ST) cap by the China Securities Regulatory Commission. Using a sample of 441 ST firms tracked from 1998 to 2011, this paper employs a Cox proportional hazards model to predict turnaround probability for a distressed firm to remove the ST cap. The predictor variables incorporate (1) accounting-driven ratios, (2) market-driven variables, and (3) information on ownership structure and restructuring status throughout the process. In contrast to previous distress studies, this paper finds that market variables do not add predictive power to the model when combined with accounting variables. Also, incorporating the time effect, the results show that the survivor function for an ST firm's survival is negatively related to the duration, and that the Cox hazards model outperforms the logit model in the out-of-sample forecast.

KEYWORDS:

• Chinese special treatment firms
• financial distress resolution
• Cox proportional hazards model
• survival analysis
• corporate turnaround prediction

JEL codes:

• C41
• C53
• G17
• G32
• G33

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. On 4 July 2014, the CSRC promulgated the solicited version ‘Reform, Improve and Strictly Implement the Delisting Rule of Listed Companies’.

2. Negative duration dependence on the hazard function has been found in Li (1999).

3. All firm-year observations of a firm that enters ST system between 1998 and 2005 are used for model estimation. The others are included in a holdout sample to test the predictive accuracy of a model.

4. A detailed explanation of the ROC curve can be found in Mason and Graham (1999).

5. A detailed explanation of the Brier Score can be found in Yates (1982).

6. Kim (2011) found that both high liquidity and low liquidity can increase the probability of financial distress of a firm.

Additional information

Notes on contributors

Maria Heui-Yeong Kim

Maria Kim is a lecturer in the School of Accounting, Economics and Finance at the University of Wollongong. She received the PhD degree in finance from the University of Sydney. Her research interests are primarily centred on the default risk modelling, credit rating assessment, survival analysis, and market microstructure.

Shiguang Ma

Shiguang Ma is a senior lecturer in the School of Accounting, Economics and Finance, the University of Wollongong. His research interests are corporate finance, earnings management, and Chines securities market. He has recently published papers in European Accounting Review and Pacific Basin Finance Journal.

Yanran Annie Zhou

Yanran Zhou is a strategy analyst in the corporate strategy team in Telstra Corporation. She graduated from the University of Wollongong.