Financial Characteristics of Distressed Firms: An Application of the Altman Algorithm Model

Date01 January 2019
Published date01 January 2019
Financial Characteristics
of Distressed Firms: An
Application of the Altman
Algorithm Model
Karikari Amoa-Gyarteng
Financial distre ss
is the situation where
arm is incapable of
meeting nancial
obligations (Brealey,
Myers, & Marcus,
2009). When rms
default, creditors may
take over through a
legal mechanism
referred to as bank-
ruptcy (Brealey et al.,
2009). Bankruptcy
has become a vital
subject in corporate
nance because of the
Global Financial Cri-
ses of 2007 and 2008
(Avenhuis, 2013).
According to Steyn-
Bruwer and Hamman (2006),
rms may le for bankruptcy
when they are in nancial dis-
tress and cannot continue to
exist in their original forms.
Bankruptcy may lead to
either liquidation or reorgani-
zation (Bernstein, Colonnelli,
Giroud, & Iverson, 2017). In
the United States, rms that
seek to reorganize may le
for Chapter 11
bankruptcy (Bracewell
& Giuliani, 2012).
Firms that seek to liq-
uidate, le for Chap-
ter 7 bankruptcy.
Chapter 7 bankruptcy
may be voluntary or
enforced by creditors.
Reasons for cor-
porate nancial dis-
tress are manifold.
They include manage-
rial incompetence
(Aasen, 2011), illi-
quidity (Pruitt &
Gitman, 1991), over
leverage (Andrade &
Kaplan, 1998), and
low protability
(Altman, 2000).
External factors as
explained by Altman and
Hotchkiss (2006) may also
cause nancial distress. They
include deregulation of indus-
tries, industry saturation leading
This article uses the discrete variables in the
Altman algorithm model to describe the charac-
teristics of rmsastheyapproachbankruptcy.
Data are drawn from 144 mining and oil and
gas rms that declared Chapter 11 and Chap-
ter 7 bankruptcy in the United States between
2006 and 2016. Part of the population eligibility
criteria for the study is that rms should be
publicly traded and should have led form 10-K
reports with the Securities and Exchange Com-
mission. A paired samples t-test shows that
the Altman Zscore, solvency, protability, and
asset productivity become statistically signi-
cantly worse when bankruptcy becomes immi-
nent. The article further nds that there is no
statistically signicant change in liquidity and
activity ratios of distressed rms as nancial
performance deteriorates. © 2019 Wiley Periodicals, Inc.
© 2019 Wiley Periodicals, Inc.
Published online in Wiley Online Library (
DOI 10.1002/jcaf.22367 63

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