Financial Distress and Tail Risk

Abstract

Considering the declining number of bankruptcy filings, and increasing out-of-court negotiations and debt reorganisations, we argue in favour of penalising firms for becoming sufficiently close to bankruptcy that they have questionable going-concern status. Thus, we propose a definition of financial distress contingent upon firms’ earnings, financial expenses, market value and operating cash flow. Subsequently, we investigate the role of tail risk measures (Value-at-risk and Expected Shortfall) in aggravating likelihood of financial distress. Our results show that longer horizon (three- and five-year) tail risk measures contributes positively toward firms’ likelihood of experiencing financial distress.