Predicting financial distress: Importance of accounting and firm-specific market variables for Pakistan’s listed firms

Abstract

This study is intended to identify the predictors of financial distress for the Pakistani firms. Variables used are the financial ratios representing profitability, liquidity, leverage, and cash flows, as well as two important market factors which are size and idiosyncratic standard deviation of each firm’s stock returns (SIG). The sample consists of 290 firms stretching from 2007 to 2016 and logit regression is applied to predict financial distress. The findings reveal that profitability, liquidity, leverage, cash flow ratios, and firm size are significant, while SIG is insignificant in predicting financial distress. Results of the estimated logit model I, model II, and holdout model reveal that the models perform consistently. This study contributes to the literature by testing the market variables in relation to financial distress as these variables were ignored by the previous studies in Pakistan. Findings of this study are precise as the study covers a longer time horizon and a larger sample size.

Keywords:

• financial distress
• bankruptcy
• logit regression
• financial ratios
• cash flow ratios
• market variables
• emerging market
• Pakistan

JEL codes:

• G01
• G33

PUBLIC INTEREST STATEMENT

Financial distress refers to the vulnerable financial position of firms that may result bankruptcy. A large number of firms have shut their operations around the globe due to financial distress. Moreover, the situation is worst in developing countries. Therefore, it is necessary to predict financial distress on early stages. This early prediction may help managers in taking appropriate measures to avoid the potential bankruptcies. Various financial distress prediction models exist in literature that employ important financial ratios and firm-specific market variables to predict financial distress. Financial distress prediction models provide help for the credit rating agencies, debt providers and equity holders to analyze the financial health of the firms.

Competing interests

The author declares no competing interests.

Additional information

Funding

The author received no direct funding for this research.

Notes on contributors

Hamid Waqas

Hamid Waqas is currently perusing PhD (Finance and Banking) at Universiti Utara Malaysia. Earlier, he completed his Masters in Finance. Afterward, He served as Project Manager in an NGO, Sangtani Women Rural Development Organization. Later, he served as Visiting Lecturer in Bahaudin Zakriya University (Layyah Campus). His research interests include financial distress, bankruptcy predicting, portfolio risk management, corporate governance, and financial economics.

Rohani Md-Rus

Rohani Md-Rusis is an Associate Professor of Finance at School of Economics, Finance and Banking, Universiti Utara Malaysia.She received her PhD in Corporate Finance from University of Manchester, UK in 2003. She is specialised in financial distress, corporate governance, and capital structure. She has published many articles in Scopus and international refereed journals and has over 25 years of teaching experience.