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 determined by whether firms need external subsidies to repay the interest payable. Spanning our analysis with 3,698 listed firms in China during 2006 and 2019, our findings are twofold. First, financial portfolio is associated with less distress risk, especially in start-up firms and degenerating firms. Second, the impact is more pronounced for firms with higher consumption of liquid financial portfolio, which is weakened for firms with lower consumption of that. Besides, the impact is enhanced for firms with seniors who had financial vocation previously. The findings suggest that corporate financial portfolio reduces distress risk by relaxing borrowing constraints and by improving profitability. While corporate financial portfolio is found to squeeze out non-financial investment, it can alleviate over-investment for firms.

Keywords: Financial portfolio; Distress risk; Corporate life cycle; Senior’s financial vocation; Financing constraints; Corporate profitability.

JEL Classification: G31; G32; L25.