Search

Unstable economic conditions have an adverse impact on the financial performance of firms, leading to financial distress, which is an unfavourable situation for investors as it may affect their investment returns. Thus, this study attempted to predict financial distress and to examine the effect of financial distress on stock returns by using firms listed on Bursa Malaysia from 1990 to 2020. This study used the logit model to find the probability of bankruptcy and also as a proxy for financial distress risk in the asset pricing model. From this study, financial distress risk was found to be insignificant in pricing stock returns in all tested models. This finding demonstrates that financial distress risk does not affect stock returns since this risk may be eliminated through diversification.

The main objective of the paper is to find out whether bankruptcy risk is a systematic risk. In particular, we investigate the contribution of size, bookto-market, excess market returns and bankruptcy probability in explaining returns. We allocate stocks into portfolios according to the probability of bankruptcy from the hazard model. Results show that bankruptcy risk is not a systematic risk. The results consistently show that excess market returns and size have strong power to explain returns in the UK for the period from 1988 to 1997. Book-to-market and bankruptcy risk only matt er in portfolios with higher probability of bankruptcy. Keyword: Bankruptcy risk, bankruptcy probability, hazard model. JEL Classification: G12, G33

By using a total of 52 distressed and non-distressed listed companies during the period 1990 to 2000, debt to total assets was found to be significant in predicting distressed companies for the multiple discriminant analysis (MDA), logit and hazard models. It appears that the higher the debt, the higher is the probability of defaulting among the financially distressed companies. MDA identified net income growth as another predictor whereas the logit and hazard model found that return on asset (ROA) to be an important predictor. Nevertheless, the sign of the ROA coefficient differred between the two models. Furthermore, company size was also identified as a contributing factor to financially distressed companies for the hazard model.