Las Dos Principales Corrientes de la Economía Solidaria

Financial distress can cause large economic and social losses for different groups of firms’ stakeholders. Many firms fall into financial distress every year and the causes are many including the fact that their markets mature, new competitors and technologies emerge, management malfunctions and demand for what they sell declines.Although a financially distressed firm has trouble raising the cash to meet the payments on its current financial obligations, particularly concerning those with contractual agreements that are enforceable by law including that of loans, debts to suppliers, salaries of employees and interest payments, there is no commonly accepted definition of financial distress. Thus, different scholars give different definitions to the meaning of financial distress according to their own study purposes (Sun et al. 2014). It is therefore not surprising that early researchers on financial distress in the 1980s and 1990s defined financial distress differently. From Baldwin and Scott (1983), when a firm’s business deteriorates to the point where it cannot meet its financial obligations, the firm is said to have gone into a state of financial distress. Gilson (1989) defines financial distress of a firm as the firm’s

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inability to meet its fixed payment obligations on debts and thus, within a given firm- year, a firm is financially unhealthy if it is in default on its debts, bankrupt or privately restructuring its debts to avoid bankruptcy. Earlier, Beaver (1966) stated that an enterprise is like a reservoir formed by the cash flow, composed of cash inflows and outflows and therefore an enterprise in financial distress is just like a reservoir whose water is drained. Beaver (1966) defines financial distress as the inability of a business firm to pay its financial obligations as they mature. According to Doumpos and Zopounidis (1999), financial distress does not only involve an inability to repay important obligatory payments due to inadequate cash but also include the situation of negative net asset value, which means a firm’s total assets are less than its total liabilities from the view of accounting. Also, while Whitaker (1999) defines financial distress as the first year in which a firm’s cash flow is less than the current maturities of long-term debt, Chen et al. (1995) define financial distress as the condition where a firm’s liquidation of total assets is less than the value of creditors’ claims.

Recent researchers do not significantly differ in terms of their definitions of financial distress. Wu et al. (2008) define the financial distress of a firm as a condition where obligations are not met or are met with difficulty. From Geng et al. (2015) financial distress of a company usually refers to the situation that operating cash flow of a company cannot supersede the negative net assets of the firm. According to Fawzi et al. (2015), financial distress occurs when companies suffer negative cash flows from operating, investing and financing activities and as a result, those companies default in loan payment due to the insufficient cash flow. However, Altman and Hotchkiss (2011) are of the view that corporate financial distress is a vague term which can be attributed to four generic terms commonly used in business research: failure, insolvency, bankruptcy, and default. These definitions indicate that there is no commonly accepted definition of financial distress but what is common is that when a firm lacks funds to pay its debts when due, then the firm is said to be in a state of financial distress.

The main issue in identifying firms facing financial distress is their inability to honour their contractual debt obligations. This is confirmed by the UK Insolvency Act 1986 (section 123) which states that a company is deemed unable to pay its debts: (i) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due and (ii) if it is proved to the satisfaction of the court that the value of the company’s assets is less than the value of its liabilities, taking into account its contingent and prospective liabilities. However, as long as the firm’s cash flow exceeds current debt

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obligations, then the firm has enough funds to pay its creditors (Elloumi and Gueyie 2001). If a firm’s financial distress situation is prolonged, it can lead to forced liquidation or bankruptcy and because of this, financial distress is often recognised as the likelihood of bankruptcy, which is dependent on the non-availability of liquidity and credit. It is not surprising that Wruck (1990) identified that there are many stages that a firm can go through before it is stated as dead and these include financial distress, insolvency, the filing of bankruptcy, and administrative receivership. Hence, financial distress is best outlined as a continuum ranging from being financially weak to bankrupt, with the possibility of various degrees of financial weakness. Financially distressed firms are different from failed firms in the sense that the failure of a firm to meet its financial obligations does not inevitably lead to a filing for bankruptcy and that bankruptcy is the widely used outcome of financial distress of a company (Geng et al. 2015). Although bankruptcy, failure, insolvency, and default are the most common terms use to describe financial distress situation, many financially distressed firms never file for bankruptcy. From the above definitions and explanations, this study adopts the meaning of financial distress that explains a firm’s inability to honour its contractual debt obligations when they fall due. The study neither considers distressed firms as bankrupt nor failed since these are the final stages of the firms’ decline whereas financial distress is the beginning of a firm’s decline.

3.2.1. FINANCIAL DISTRESS IDENTIFICATION BASED ON ACCOUNTING AND FINANCIAL INDICATORS

Balcaen and Ooghe (2006) acknowledged that the accounting and finance criteria that have been used in identifying firms as financially distressed include several years of negative net operating income, suspension of dividend payments, major restructuring or layoffs, low- interest coverage ratio, and negative earnings before interest and tax. The rest are negative net income before special items, losses, selling shares to private investors, entering into a capital restructuring or a reorganisation and a few years of negative shareholders’ funds or accumulated losses. Empirical studies by some researchers on financial distress indicate that they use a combination of these criteria to classify firms as financially distressed. For instance, Manzaneque et al. (2016) in their research on the role of institutional shareholders as owners and directors and the financial distress likelihood in Spain, use the conceptual approach of financial distress, meaning a firm’s lack of capacity to meet its financial obligation to identify their financially distressed firms. The criteria for identifying their financially distressed firms were defined

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by two conditions: (i) earnings before interest and taxes, depreciation and amortisation (EBITDA) are lower than the firm’s financial expenses for two consecutive years and (ii) a fall in the firm’s markets value occuring between two consecutive periods. Using these criteria, their study sampled 70 financially distressed and 70 financially non-distressed firms from a sample population of 734 listed firms on the continuous market of Spanish computerised trading system from 2007 to 2012.

Also in a study of risk effects of acquiring distressed firms, Bruyland and de Maeseneire (2016) define financial distress as failure to meet financial obligations in line with Asquith et al. (1994), Rajan and Zingales (1995), Claessens et al. (2003) and Pindado et al. (2008). Their study identifies firms as financially distressed using a measure of interest coverage ratio calculated as the earnings before interest, taxes, depreciation, and amortisation divided by interest expense on debt. A firm was regarded as financially distressed if its interest coverage ratio was less than one in the first and the second year preceding the deal announcement and that this measure of identifying financially distressed firms was preferred since it proxied for distress and did not necessarily predict the event of bankruptcy. Using the interest coverage criterion, the study identified a subsample of 15.9% distressed targets and seemed huge compared to the 2% reported by Meier and Servaes (2014), who use a severe and ex-post measure of distress classifying target firms as distress if they are in bankruptcy or liquidation at the time of the transaction, if the target is undergoing a restructuring, or if bankruptcy court approval is needed for the transaction to be completed. Nonetheless, the percentage of distressed firms that were obtained in the study of Bruyland and de Maeseneire (2016) was reasonable when compared to other empirical work on the topic: Ang and Mauck (2011) classify 34.7% of their sample as distressed based on negative net income, while this is 18.7% in Eisdorfer (2008), who uses Altman Z-score.

In the UK, Poletti-Hughes and Ozkan (2014) studied the ultimate controllers, ownership and the probability of insolvency in financially distressed firms. The study focused on financially distressed firms and as such the analysis adopted the same criteria as that of Claessens et al. (2003), where financially distressed firms are those with an interest coverage ratio (earnings before interest and taxes divided by interest expense) of less than one. In addition, as in Asquith et al. (1994), to include a firm in the financial distress sample, their study required that financial distress should remain for at least two consecutive years during the period of analysis. Using the above criteria, their study obtained a final sample of an unbalanced panel of 3092 firm-year observations, consisting

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of 484 different companies. Also, in another UK study of financial distress and bankruptcy prediction among listed companies using accounting, market and macroeconomic variables, Hernandez et al. (2013) define financial distress by focusing on the ability of a firm to repay its financial obligations. The study identifies financially distressed firms based on two conditions. First, a firm is regarded as financially distressed whenever its earnings before interest and taxes, depreciation, and amortisation are lower than its financial expenses for two consecutive years and second, whenever the firms suffer from negative growth in market value for two consecutive years. These two conditions justify the fact that, first, whenever earnings before interest and taxes, depreciation, and amortisation are lower than the interest expense on the firm’s debt then it can be concluded that the operational profitability of the firm is not sufficient to cover its financial obligation. Second, the market as well as stakeholders are likely to judge negatively a firm that suffers from operational deficit until an improvement in the financial condition is perceived again and that the fall in market value for two consecutive years is interpreted as an indication that a firm is in effect in financial distress (Pindado et al. 2008). However, in order to complete the concept of financial distress and to enhance the scope and the discriminating power of the model for practical purposes, a definition based on Christidis and Gregory (2010) was used. With this, a firm was regarded as being in financial distress not only when it satisfies the two conditions above, but also when it is deemed to have formally defaulted on its obligations. With the above criteria, the study had 1254 firm-years observations.

In Australia, Miglani et al. (2015) examined the role of voluntary adoption of corporate governance mechanisms in mitigating the financial distress status of firms. The study identifies financially distressed firms as those experiencing five consecutive years of negative net income from 1999 to 2003, while the sample of financially healthy firms is identified as those which have experienced five consecutive years of positive net income within the same period. From a population of all Australian Securities Exchange listed firms as at June 1998, the study sampled 215 financially distressed firms and 123 financially healthy firms. Although using the negative net income to define financial distress has limitations including the fact that management may reduce reported earnings during labour negotiations to improve their bargaining position, generally, however, companies are more likely to increase rather than decrease earnings and to create value through earnings management. In using negative net income to classify financially distressed firms, the researchers are of the view that, a firm reporting loss is taken as a

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sign of an important event and as such, the use of a very strict definition of consecutive negative net income for 5 years is likely to serve as a suitable proxy of financial distress.