Financial distress and relationship lending

Stephenson, Nadine (2010): Financial distress and relationship lending. Dissertation, LMU München: Fakultät für Betriebswirtschaft

Abstract

The first study addresses the question of how to measure financial distress. I discuss different identification models used in the literature in order to develop a criterion for financial distress suitable for investigations in corporate finance such as the question of valuation of restructuring methods. The empirical part of this study focuses on the widely known logit regression models (e.g. Ohlson (1980)) and the Merton model (Merton (1974)) to identify financial distress. Logit regression models used in the literature predominantly apply annual report data-based predictor variables. The main determinant of the Merton model is the firm’s leverage ratio and the volatility of the asset value. To estimate the market value of equity in this context, the share price of the firm is used. This considers future expectations of the capital market. By taking asset volatility into account risk is also considered. Application of ROC (receiver operating characteristic) curve analysis indicates a higher predictive power for the Merton model compared to the logit regression model in terms of bankruptcy cases. Furthermore, I find that the Merton model is less sensitive in terms of the accounting policy the management chooses than the logit regression model is. Hence, this study uses the Merton model to develop a financial distress identification criterion. To calibrate and validate the Merton model-based financial distress criterion, I use bankruptcy information as well as information about restructuring. Bankruptcy and restructuring information indicate that the developed Merton model-based criterion is a reasonable criterion to identify a financial distress situation. The second study examines whether or not having a relationship lender affects the firm’s probability of financial distress. I use German Credit Register information provided by the German central bank (Deutsche Bundesbank) for the period 1993-2007 to identify the relationship lending status of a firm. To identify financial distress, a criterion based on the Merton model is derived. I apply probit regression models to identify determinants of financial distress and relationship lending. Finally, a bivariate probit regression model is performed, to address the aspect of endogeneity of firm-bank relationships and financial distress. The regression models indicate that having a relationship lender has no significant influence on the firm’s probability of financial distress. This finding supports the equilibrium structure hypothesis, stating that having a relationship lender is an endogenous outcome of a selection of advantages and disadvantages of having a relationship lender arrived at a bank-relationship equilibrium. The regression models indicate that profitability, liquidity, size and efficiency lower the probability that a firm will enter financial distress. The third study examines whether having a relationship lender matters if firms are in financial distress. Due to the private information possessed by a relationship lender about firm quality, borrowers face high switching costs if they terminate the bank-borrower relationship. This in turn suggests that the relationship lender will make different distress decisions (i.e. to terminate or support the firm) compared to an arm’s length lender. We test this prediction by analysing the determinants of the outcome of financial distress, controlling for relationship lending and several potential restructuring measures such as management turnover, recapitalisations, ownership change, and others. We also test whether relationship lenders are more willing to provide financial support to distressed firms, or whether receiving financial support from a relationship lender affects the likelihood of a successful restructuring. All these tests unequivocally show that relationship lending does not matter to the outcome of financial distress, while other restructuring activities, in particular ownership changes and capital infusions, systematically increase the likelihood of surviving financial distress.

• Dokumententyp: Dissertationen (Dissertation, LMU München)
• Keywords: Financial Distress
• Themengebiete: 300 Sozialwissenschaften ; 300 Sozialwissenschaften > 330 Economics
• Fakultäten: Fakultät für Betriebswirtschaft
• Sprache der Hochschulschrift: Englisch
• Datum der mündlichen Prüfung: 7. August 2010
• 1. Bericht­erstatter:in: Elsas, Ralf