Pinpointing the early stages of corporate decline: A prediction model for business distress in large Nordic listed firms

Abstract: This paper attempts to analyze the multidimensional nature of corporate decline for large, publicly held firms in Denmark, Finland, Norway and Sweden to determine (i) whether early stage decline can be clearly distinguished and (ii) whether it can be predicted in advance by investors and analysts using cross-disciplinary determinants. In doing so, we attempt to standardize commonly used key terms pertaining to corporate failure, and to aggregate the various approaches used by academia, credit rating firms, and turnaround professionals to investigate firms using data from 2001 to 2011. Early stage decline is herein referred to as business distress, and it precedes financial distress and insolvency, which are defined as the subsequent stages of the decline progression. We find evidence supporting the notion that business distress is a distinguishable sub-stage of decline that can be objectively identified using qualitative determinants, and classified as it occurs through the use of accounting ratios related to financial gearing, covenants, profitability, and liquidity, as well as market factors, and company characteristics. We conclude that business distress can be predicted by logistic regression using various combinations of these factors up to five years prior to the occurrence of a "distress event", with an in-sample classification accuracy ranging from 72% to 78%.