The Importance of Cash‐Flow News for Financially Distressed Firms

Assaf Eisdorfer

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Financial Markets and Investment Strategies Corporate Finance and Governance Corporate Insolvency and Governance

Abstract

Previous studies have shown that stock prices are moved primarily by news about discount rates (expected returns). I argue that when a firm experiences financial distress, news about cashflows becomes more dominant in driving its stock returns. Applying Campbell's (1991) variance decomposition framework to financially distressed firms supports this argument. Furthermore, I find that more bankruptcies occur after negative shocks to expected cashflows than after positive shocks to discount rates; and that stock prices of distressed firms are less sensitive than those of sound firms to changes in equity risk.

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1968FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY 1973Risk, Return, and Equilibrium: Empirical Tests 1989Business conditions and expected returns on stocks and bonds 1988The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors 1988Dividend yields and expected stock returns 1977Asset returns and inflation 1986The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors 1990A VARIANCE DECOMPOSITION FOR STOCK RETURNS

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