The Characteristics of Corporate Distress in an Emerging Market: The Case of China

Abstract

This paper is one of the first studies to empirically examine the nature and cause of financial distress in an emerging market context. This is important given the impact of the recent global privatization phenomenon. These privatized firms have since been subject to a new competitive environment, redefined objectives and management incentives. In this context, we investigate the characteristics of a sample of 100 distressed firms in China between 1999 and 2003. Existing bankruptcy and distress literature cites two main causes of financial distress: debt overhang and economic distress. By comparing the distressed firms' financial and operating performance with that of their respective industries, we conclude that corporate distress in China is caused predominantly by firm level poor operating performance, not by leverage. Our evidence indirectly speaks to the debate that financial renegotiations between distressed firms and their creditors are inefficient. In addition, our sample provides a unique opportunity to study how (partial) government ownership affects firm performance and efficiency in the context of financial distress and soft budget constraints.

Keywords: Financial distress, economic distress, performance, operating efficiency, emerging markets, SOE

JEL Classification: P27, G34, G32, L25, G33