Corporate Financial Portfolio and Distress Risk: Forewarned is Forearmed

ABSTRACT

This paper explores how corporate financial portfolio influences distress risk. We define distress risk as a dummy variable determined by whether firms need external subsidies to repay the interest payable. Spanning our analysis with 3,698 listed firms in China between 2007 and 2019, our findings are twofold. First, financial portfolio is associated with less distress risk. Second, the impact is more pronounced for firms with higher levels of liquidity of financial portfolio. We provide evidence that corporate financial portfolio prevents distress risk by reducing financial expenses and by improving investment income. Our findings post a challenge to the existing view in China that financial portfolio would harm corporate operation. The implication is that companies could allocate more liquid financial assets than illiquid ones to mitigate forewarned risk.

KEYWORDS:

• Financial assets
• distress risk
• financial expenses
• investment income

JEL:

• G31
• G32
• L25

Acknowledgments

We are very thankful to the Editor and two anonymous reviewers for many helpful comments and suggestions to improve this article.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Examples of support from the government: (1) Six times comprehensive required reserve ratio cuts implemented by the People’s Bank of China from 2020 to 2021. (2) Guidance on National Fiscal, Taxation and Financial Policies and Measures to Benefit Enterprises. Available online: http://www.chinacoop.gov.cn/news.html?aid=1512948. (in Chinese).

2. ST & PT : When a company has suffered losses for two consecutive years or its net assets are lower than the par value of the stock, “ST” will be prefixed before the stock name, which means “special treatment.” PT is the abbreviation for particular transfer. If a listed company has suffered losses for three consecutive years, its stock will be suspended from listing and the Shanghai and Shenzhen Stock Exchanges implement particular transfer services for such suspended stocks and prefix their stock names with PT.

3. We really appreciate the suggestions from the anonymous reviewer. We refer to Karavias, Narayan, and Westerlund (2022), Su et al. (2021), and Westerlund et al. (2021), conducting structural break tests and find that our sample does not have structural break exists.

4. The assets here mainly include entrusted loans and wealth management products. We search keywords, which are asset management, entrustment, financial management, trust and investment, from financial statement appendix to filter out the information.

Additional information

Funding

The National Social Science Foundation of China [18BJY236].