Investigating the Factors Predicting the Financial Distress of Firms: A Study Based on Pakistani Firms

Abstract

This study tries to investigate the determinants of financial distress or bankruptcy prediction of the non-financial firms listed on the Pakistan Stock Exchange 100 Index. The study has taken a sample of 21 non-financial firms representing the cement, sugar, and textile sectors for analysis in the period spanning from 2014 to 2023. Altman's Z-score is considered as proxy for financial distress. This study applies the Panel Least Squares (PLS) approach to test the hypotheses besides the Fixed Effect (FEM) and Random Effect (REM) models. A comparative assessment of PLS, FEM, and REM was also performed in comparing the model performance. The results indicate that the liquidity, efficiency, and solvency ratios are positively associated with the financial distress measured using the Altman Z-score. On the other hand, leverage and firm size show a very important negative relationship with financial distress; this may further mean that even large firms may become distressed due to other contributing factors. Profitability, as represented by profit margins, does not show any significant impact on financial distress in this study. The study underscores the importance of using bankruptcy prediction models to enable firms to identify likely financial distresses early. Companies also need to look forward toward other factors that may cause distress and focus on if cash flow and debt management practices need improvement to meet their financial obligations efficiently.