THE ESTIMATION OF FINANCIAL TURNAROUND LIKELIHOOD OF FINANCIALLY DISTRESSED FIRMS

Abstract

Dynamic economic conditions combined with increasingly rapid pace of change nowadays bring special challenges to any firm in which this condition often drag them into the state of insolvent or bankruptcy. There are several stages before firms reach the state of bankruptcy including financial distress, insolvency, filing of bankruptcy, and administrative receivership. There are three possibilities when firms fall into financial distress condition, one of them is the firm may continue its operations and expect to regain financial stability in which firm may then will be faced by two outcomes: 1) Successful financial turnaround; and 2) Unsuccessful financial turnaround. This research aimed to figure out factors that may influence the probability of financial turnaround for financially distressed firms and use logistic regression in conducting the research. This research also adopted the principle of parsimony that aim to create the simplest model with the least assumptions and variables but with greatest explanatory power which lead to three models generated: 1) Base model; 2) Alternative model 1; and 3) Alternative model 2. Results of the research found that three of five independent variables including free assets, asset retrenchment, and level of leverage had significant impact toward the likelihood of financial turnaround. Meanwhile, two other independent variables including prospective earnings and firm size had no significant impact. Results of the research also found that only firm size and asset retrenchment that gave positive impact toward the likelihood of financial turnaround. Conversely, prospective earnings, free assets, and level of leverage give negative impact. The best model in estimating the likelihood of financial turnaround of financially distressed firm was alternative model 2 which yield the greatest explanatory power as presented by overall predictions accuracy of 83.33%.