Comparing Financial Distress and Bankruptcy

Review of Applied Economics, Vol. 2, No. 2, 2006

27 Pages Posted: 23 Jan 2006 Last revised: 5 Nov 2013

See all articles by Harlan D. Platt

Harlan D. Platt

Northeastern University - Finance and Insurance Area

Marjorie Platt

Northeastern University - Accounting Group

Date Written: January 1, 2006

Abstract

For the most part, research purporting to address the issue of financial distress has actually studied samples of bankrupt companies. Financial distress and bankruptcy are different. In contrast, this paper starts with a sample of companies that are financially distressed but not yet bankrupt. The sample was obtained by screening the Compustat industry database with a three-tiered identification system. The screen bifurcated companies into financially and non-financially distressed groups. A multi-tiered screen reduces the incidence of mistakenly identifying a non-distressed company as financially distressed. The paper then compares factors indicating the likelihood of future bankruptcies to those indicating future financial distress. To do this, an early warning financial-distress model was developed and compared to a methodologically similar existent model of bankruptcy. The final financial distress model included only one variable present in the bankruptcy model and four new variables. The limited overlap of explanatory factors between the models questions the similarity of financial distress and bankruptcy. Statistical tests lend support to the notion that the bankruptcy process is not just a continuation of a downward spiraling cycle of financial distress. Our hypothesis is that financial distress is something that happens to companies as a consequence of operating decisions or external forces while bankruptcy is something that companies choose to do to protect their assets from creditors.

Keywords: Financial Distress, Early Warning Model, Renewal

JEL Classification: G30, G33

Suggested Citation

Platt, Harlan D. and Platt, Marjorie, Comparing Financial Distress and Bankruptcy (January 1, 2006). Review of Applied Economics, Vol. 2, No. 2, 2006, Available at SSRN: https://ssrn.com/abstract=876470

Harlan D. Platt (Contact Author)

Northeastern University - Finance and Insurance Area ( email )

Boston, MA 02115
United States
617-373-4740 (Phone)
617-373-8798 (Fax)

Marjorie Platt

Northeastern University - Accounting Group ( email )

360 Huntington Ave.
Boston, MA 02115
United States

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