An empirical analysis of financially distressed Australian companies: the application of survival analysis

Abstract

This thesis provides an empirical analysis of financially distressed companies in the Australian context using survival analysis techniques. Three main assays are developed and presented in the thesis. The first assay explores the effect of financial ratios and other variables on corporate financial distress and identifies the probability of corporate survival in a given time frame. The four main categories of financial ratios are profitability, liquidity, leverage and activity ratios and control variables which are a market-based variable and company-specific variables; for example, company age, company size and squared size are employed in the analysis. The Cox proportional hazards model was estimated using time-varying variables based on a sample of 1,117 publicly listed Australian companies over the period 1989 to 2005. Empirical results found that financially distressed companies have higher leverage measured by debt ratio, lower past excess returns and larger size compared to active companies. Researchers argue that a company may exit the market in several different ways, such as through merger, acquisition, voluntary liquidation and bankruptcy and each type of exit is likely to be affected by different factors. Consequently, the second assay investigates the determinants of multiple states of financial distress by applying a competing risks Cox proportional hazards model. The unordered three-state financial distress model is defined as follows: state 0: active companies, state 1: distressed external administration companies and state 2: distressed takeover, merger or acquisition companies. The effect of financial ratios, market-based variable and company-specific variables including company age, company size and squared size on three different states of corporate financial distress are investigated based on a sample of 1,081 publicly listed Australian companies over the period 1989 to 2005. The results indicate that it is important to distinguish between the different financial distress states. Additionally, the results suggest that distressed external administration companies have higher leverage, lower past excess returns and a larger size while distressed takeover, merger or acquisition companies have lower leverage, higher capital utilization efficiency and a bigger size compared to active companies. In addition to examining financial ratios as the main variables, this thesis further explores the effect of corporate governance attributes on IPO companies’ survival focusing on a particular sector. Accordingly, the third assay examines the influence of corporate governance mechanisms on the survival of 127 new economy IPO companies listed on the ASX between 1994 and 2002. In addition to the three main categories of corporate governance attributes include board size, board independence and ownership concentration; control variables, for example, offering characteristics, financial ratios and company-specific variables, are also included in the model. The Cox proportional hazards model estimation results found ownership concentration significantly negative related to the survival of new economy IPO companies. For offering characteristics variables, the offering size and the underwriter backing are a significant variable in explaining IPO companies’ survival; however, the estimated signs are in contrast to the expectations. Specifically, those IPO companies with a larger offering size are less likely to survive than are those that offer a smaller size. Furthermore, the results found that the hazard of financial distress for companies with an offer that is underwritten is greater than the hazard for those for which the offer is not underwritten. For financial ratios, the results indicate that the debt ratio is statistically significant in explaining IPO firms’ survival. In particular, IPO companies with a low total debts to total assets ratio are less likely to fail.

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