Corporate Financial Distress

Going Concern Evaluation in Both International and U.S. Contexts

Marisa Agostini

• Publisher: Palgrave Pivot
• Year: 2018
• ISBN:
  9783319785004
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

This book, divided into three main parts, will offer a complete overview of the concept of corporate financial distress, emphasizing the different typologies of corporate paths included in this broad concept. It will reorganize and update academic literature about the evaluation of corporate financial distress from the first studies about failure prediction to the most recent contributions. It will also provide evidence about the evolution of going concern standards in both international and U.S. contexts. Moreover, an in-depth analysis of this broad concept will permit the identification of a set of research questions to be investigated from both theoretical and empirical points of view, and will be of interest to academic researchers and doctoral students of accounting, auditing and finance, professionals, and standard setters.

© The Author(s) 2018

Marisa AgostiniCorporate Financial Distresshttps://doi.org/10.1007/978-3-319-78500-4_1

Begin Abstract

1. Introduction

Marisa Agostini¹ 

(1)

Department of Management, Ca’ Foscari University, Venice, Italy

 

Abstract

The introduction provides a map of the entire book, which focuses on going concern evaluations of companies in financial distress. A complete overview of this corporate path is relevant for both academic debate and the professional world. The classification and updating of the existing academic literature allow us to highlight the key features, types, and signals of corporate financial distress. The evaluation of companies in financial distress and the respective roles of auditors and managers are explored first of all in the US context, where going concern assessment has for years been exclusively the responsibility of auditors. The book analyses the timing of going concern evaluation during corporate financial distress, in order to introduce the recent modifications of accounting and auditing standards in both US and international contexts.

Keywords

Corporate financial distressCorporate life cycleCorporate risksCorporate statusFirm failure

End Abstract

This book examines corporate financial distress, as a negative corporate status. The importance of focusing on negative corporate situations, rather than only on successful ones, has been emphasized by authoritative literature in the field (Sitkin 1992; McGrath 1999; Thornhill and Amit 2003). Specifically, corporate financial distress is still considered a vague term (Altman and Hotchkiss 2010) and related (in imprecise ways) to different terms such as failure and bankruptcy . This book aims at shedding some light on this state of affairs and also on such terminological distinctions. In particular, this study aims to back up “the view that there is value to be gained from the study of failed organizations. Just as medical science would be unlikely to progress by studying only healthy individuals, organization science may be limited in the knowledge attainable only from the study of successful firms. While these results shed new light on why firms fail at different ages, much remains to be learned about firm failure” (Thornhill and Amit 2003, p. 506). According to the concepts introduced and developed in the second chapter of this book, failure represents a specific type of corporate path in the experience of financial distress. A complete overview of this corporate path is relevant for both academic debate and the professional world. The classification and updating of the existing academic literature allow us to highlight recurring features, types, and signals of corporate financial distress (Koh et al. 2015). It does not coincide with precisely timed legal events, such as bankruptcy , because it represents a continuing corporate status. Its extension in time makes difficult its ex ante prediction through statistical methods because of difficulties in catching the complex dynamics of such processes in actual practice. After introducing the concept of corporate financial distress, the book analyses its causes, consequences, and timing. More than one step is identified in the path of financial distress, and the distinction between temporary and severe financial distress is introduced. The symptoms of both these types may be either truly and fairly represented in financial statements or fraudulently concealed. Such symptoms (or consequences) are financial ones (as highlighted by the term itself—‘corporate financial distress’), but the causes and the corrective measures can be of different types, as pointed out in Chap. 2. Moreover, there is a relationship between corporate financial distress and managers’ propensity to take on more risk (Edwards et al. 2013). Corporate financial distress, therefore, represents a negative lasting corporate status that implies risks and uncertainties for all the parties, both internal and external, who have an interest in the distressed company. The time factor is crucial. Authoritative literature has emphasized the relation between the increase in the time of corporate paths of financial distress and the costs of the default , the already noted managers’ propensity to embark on risky reactive initiatives, and the difficulties of corporate recovery. These difficulties also influence the end result of the corporate path of financial distress: recovery is possible after a temporary distress, while a case of severe financial distress entails a failing process leading to either bankruptcy or another major mutation (e.g. merger, absorption, dissolution, liquidation, etc.). The analysis implemented in the following chapters also points to an order of preference for distressed entities regarding such final events. This observation is made possible by a full consideration of the time variable, entailing a change of focus beyond mere prediction towards an explanation of corporate financial distress. The present book first analyses the progressive development of statistical prediction models, from univariate discriminant analysis to artificial intelligent systems and from bankruptcy prediction to the assessment of corporate financial distress. These are all static modelling prediction tools. The next chapter highlights both their drawbacks and their possible uses. Such considerations go some way towards explaining the progressive shift of academic focus from mere prediction to fuller evaluations of corporate financial distress . Traditionally, prediction and explanation have been kept separate: this book proposes to apply both together. The evaluation of distressed companies and the respective roles of auditors and managers are firstly explored in the US context (Chap. 3). Here, the going concern assessment has for years been the auditors’ responsibility, but investors have complained that by the time auditors make their assessment, a deteriorating business is on the verge of bankruptcy or a delisting from its stock exchange. The book aims to empirically verify this complaint in order to introduce recent developments in updating accounting and auditing standards in the US. These changes relate to the converging process being implemented by International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) regarding going concern assumptions with a view to overcoming substantial and potentially problematic differences between international standards and US principles. The present work (Chap. 4) considers this project of convergence and the applied statements in both (US and international) contexts.

Bibliography

1. Altman, E. I., & Hotchkiss, E. (2010). Corporate financial distress and bankruptcy: Predict and avoid bankruptcy, analyze and invest in distressed debt (Vol. 289). Hoboken, NJ: John Wiley & Sons.
2. Edwards, A., Schwab, C., & Shevlin, T. (2013, February). Financial constraints and the incentive for tax planning. In 2013 American Taxation Association midyear meeting: New faculty/doctoral student session (Vol. 2216875). Retrieved October 6, 2017, from http://​papers.​ssrn.​com/​abstract
3. Koh, S., Durand, R. B., Dai, L., & Chang, M. (2015). Financial distress: Lifecycle and corporate restructuring. Journal of Corporate Finance, 33, 19–33.Crossref
4. McGrath, R. G. (1999). Falling forward: Real options reasoning and entrepreneurial failure. Academy of Management Review, 24(1), 13–30.Crossref
5. Sitkin, S. B. (1992). Learning through failure: The strategy of small losses. Research in Organizational Behavior, 14, 231–266.
6. Thornhill, S., & Amit, R. (2003). Learning about failure: Bankruptcy, firm age, and the resource-based view. Organization Science, 14(5), 497–509.Crossref

© The Author(s) 2018

Marisa AgostiniCorporate Financial Distresshttps://doi.org/10.1007/978-3-319-78500-4_2

Begin Abstract

2. Corporate Financial Distress: A Roadmap of the Academic Literature Concerning its Definition and Tools of Evaluation

Marisa Agostini¹

(1)

Department of Management, Ca’ Foscari University, Venice, Italy

Abstract

Global financial crises have emphasized the importance of understanding current and future corporate financial states. A literature review about financial distress permits us to define it independently from the financial nature of its causes: companies may also face financial distress as a consequence of non-financial factors characterizing its starting point. After this initial step, a firm may either recover its financial situation (temporary distress) or embark on a failure path (severe financial distress). Both these cases may correspond to either a no tort or a fraud (either disclosed or undetected). The cases examined here are also relevant for understanding the passage of the focus of academic debate from prediction to explanation in order to minutely examine how companies mutate from successful into distressed ones.

Keywords

AuditorsBankruptcyCorporate financial distressFailure predictionUndetected fraud

End Abstract

2.1 Financial Distress: Definition and Main Features

Since first devoting its attention to the subject, academic literature has emphasized the difficulties in defining corporate financial distress because of the incomplete and arbitrary nature of any criteria by which to classify it (Keasey and Watson 1991). There is no consensus on how financial distress affects corporate performance, but it is costly (Opler and Titman 1994) and needs to be investigated. Altman (1993) relates corporate financial distress to unsuccessful business enterprise and defines four generic terms that are commonly used in the literature about it: failure, insolvency, bankruptcy , and default .¹ Corporate financial distress remains, none the less, a vague term (Altman and Hotchkiss 2006) that does not correspond to an absolute condition such as bankruptcy or insolvency (Sun et al. 2016). This chapter aims at shedding some light on the matter.

Corporate financial distress ...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• 2. Corporate Financial Distress: A Roadmap of the Academic Literature Concerning its Definition and Tools of Evaluation
• 3. Going Concern Evaluation in the US Context: The Respective Roles of Auditors and Managers
• 4. The International Accounting Convergence Promoted by IASB and FASB Regarding Going Concern Status
• 5. The Role of Going Concern Evaluation in Both Prediction and Explanation of Corporate Financial Distress: Concluding Remarks and Future Trends
• Back Matter