Aggregate economy risk and company failure: An examination of UK quoted firms

摘要

Considerable attention has been directed in the recent finance and economics literature to issues concerning\udthe effects on company failure risk of changes in the macroeconomic environment. This paper examines the\udaccounting ratio-based and macroeconomic determinants of insolvency exit of UK large industrials during\udthe early 1990s with a view to improve understanding of company failure risk. Failure determinants are\udrevealed from estimates based on a cross-section of 369 quoted firms, which is followed by an assessment\udof predictive performance based on a series of time-to-failure-specific logit functions, as is typical in the\udliterature. Within the traditional for cross-sectional data studies framework, a more complete model of\udfailure risk is developed by adding to a set of traditional financial statement-based inputs, the two variables\udcapturing aggregate economy risk - one-year lagged, unanticipated changes in the nominal interest rate and\udin the real exchange rate. Alternative estimates of prediction error are obtained, first, by analytically\udadjusting the apparent error rate for the downward bias and, second, by generating holdout predictions.\udMore complete, augmented with the two macroeconomic variables models demonstrate improved out-ofestimation-\udsample classificatory accuracy at risk horizons ranging from one to four years prior to failure,\udwith the results being quite robust across a wide range of cut-off probability values, for both failing and\udnon-failed firms.\udAlthough in terms of the individual ratio significance and overall predictive accuracy, the findings of the\udpresent study may not be directly comparable with the evidence from prior research due to differing data\udsets and model specifications, the results are intuitively appealing. First, the results affirm the important\udexplanatory role of liquidity, gearing, and profitability in the company failure process. Second, the findings\udfor the failure probability appear to demonstrate that shocks from unanticipated changes in interest and\udexchange rates may matter as much as the underlying changes in firm-specific characteristics of liquidity,\udgearing, and profitability. Obtained empirical determinants suggest that during the 1990s recession, shifts\udin the real exchange rate and rises in the nominal interest rate, were associated with a higher propensity of\udindustrial company to exit via insolvency, thus indicating links to a loss in competitiveness and to the\udeffects of high gearing. The results provide policy implications for reducing the company sector\udvulnerability to financial distress and failure while highlighting that changes in macroeconomic conditions\udshould be an important ingredient of possible extensions of company failure prediction models.