Title: Determinants of indirect financial distress costs.

Intro:

Given the fact that increasingly many listed companies are falling into financial distress and
bankruptcy, research on financial distress costs has become the focus of the academic debate.

Importance of this topic:

1. The understanding of this topic is very important for at least two reasons. First, even
though the theoretical debate on financial distress costs is rooted in the study of capital
structure (Pindado, Rodrigues, & de la Torre, 2008), the potential contribution of the study
goes beyond capital structure literature. Financial distress costs were found to be an
important factor in determining the optimal capital structure (Ahmed & Hisham, 2009),
demand for conventional and Islamic insurance (Hamid, Osman, & Nordin, 2009; Hamid et
al., 2009) (Mohamad Abdul Hamid, 2008, 2010; Hamid, Osman, Ariffin, & Nordin, 2009),
corporate hedging practices (Ertugrul, Sezer, & Sirmans, 2008; Judge, 2004), and trade
receivables policy (Molina & Preve, 2009).
2. Second, the potential value of understanding this topic is also emphasized by the
extremely costly failure of high-profile companies in the recent past. Examples of such
failure (and the dollar costs involved) are WorldCom ($657 million), Global Crossing ($174
million), LTV Corporation ($ 237 million) and Kmart ($135 million) (Business Week, March,
2005). Commented [U1]: Importance

Brief summary of previous literature (to identify the pioneer researcher / Guru):

With the view of understanding and estimating the financial distress costs, following the
pioneering work of Gruber and Warner (1977) and Altman (1984), academic researchers have
been using different samples (Malaysia (), Indonesia (), ASEAN(), Trading and Services sector
()…) and numerous estimating procedures (Static (), dynamic (). Commented [U2]: Guru

Issues:

The analysis of prior research on this topic leads to the discovery of three major issues:

1. First, despite the significance of this topic, very few researches have quantified the size Commented [U3]: 1st gap
and investigated the determinants of indirect costs (Tshitangano, 2010; White, 1983).
Altman & Hotchkiss (2010) summarize the empirical research on financial distress costs.
Their review shows that the main research concentrates on the direct costs of financial
distress, whereas indirect costs have found less attention in the literature. Thus, lack of
research in this area has necessitated the need for this research. One of the possible
reasons for the lack of research in the indirect financial distress costs is due to its
opportunity costs nature and the difficulty in specifying and empirically measuring such
costs (Altman & Hotchkiss, 2006; Andrade & Kaplan, 1998; Opler & Titman, 1993).
2. In addition to that, the empirical evidence shows that the study of financial distress costs
has been conducted in a sample of financially distressed firms from both developed and
developing countries. Examples are China (Zhang & Gan, 2010), Taiwan (Yen & Li, 2010),
Australia (John, 1993), Canada (Fisher & Martel, 2005), Indonesia (Wijantini, 2007), Latin
 America (Sanz & Ayca, 2006), Italy (Bisogno & De Luca, 2012), Pakistan (Farooq & Nazir,
2012) and the US (Bris, Welch, & Zhu, 2006). However, to the best of my knowledge, there
is no empirical study conducted for Malaysia’s financially distressed companies, which, Commented [U4]: 2nd Gap
contributing to the non-existence of financial distress costs data for Malaysia (Mohd
Norfian Alifiah, Salamudin, & Ahmad, 2013; Mohd Noorfian Alifiah, Salamudin, & Ismail,
2011; Chin, 2005).

Argument on why research on Malaysia is needed (Bonus):

The financial distress costs data that is unique and specific to Malaysia’s legal and listing
requirement is needed for two reasons. First, the study on the impact of different
regulations on the size of financial distress costs is important as any regulatory changes
will substantially increase the financial distress costs (Jensen, 1989). Second, the existence
and significance of the financial distress costs depend on the market setting (Warner,
1977), hence, empirical findings from other countries cannot be generalized to Malaysia.
Besides, a design feature that works well in one country may not be in another.

3. a survey conducted to examine the capital structure practices of the Malaysian Chief
Financial Officers done by Nor, Ibrahim, Haron, Ibrahim, and Alias (2012) found that
bankruptcy or financial distress costs were the fifth most important factors to be
considered by a finance manager in deciding the issuance of a new debt. However, as
stated by Turner (2010), the most frequently omitted variable from capital structure
studies is indirect financial distress costs. This is especially true for Malaysia, as the Commented [U5]: 3rd Gap
financial distress costs is not yet available (Mohd Norfian Alifiah, 2013; Mohd Noorfian Commented [U6]: 3rd Gap
Alifiah et al., 2011; Chin, 2005). For that reason (the unavailability of the indirect financial
distress costs), several authors used other variables as a proxy for indirect financial distress
costs. Examples are working capital to total assets ratio (Hamid, 2010; Hamid et al., 2009),
long term debt ratio and interest coverage ratio, and Ameer (2010) uses liquidity (ratio of
quick assets to total current assets) as the proxy for the indirect financial distress costs.

Argument on why the appropriate proxy for FDC is needed

However, Frydernberg (2004) believes that the indirect costs of financial distress are
rather large and that they vary considerably among firms. If these are the true
characteristics of indirect costs, then omitting the indirect financial distress costs from
those studies will severely damage the reliability of the results obtained. In particular, the
coefficients on the included variables are likely to be biased and inconsistent (Turner,
2010).

4. Third, the findings of previous researches suggest that the level of indirect financial
distress costs is the consequence of many factors. The variables in the models are selected
based on their significance in specific theory, policy or both. But as researchers disagree on
what is the most important, it is usually only partial overlap among the variables Commented [U7]: 3rd gap
considered in different empirical papers. Therefore, it is very important to investigate
which of the independent variables suggested in the literature emerge as the most
significant determinants of indirect financial distress costs. In this thesis, I contend that the
 determinants of financial distress costs for the sample firms will be different due to its
unique firm and country specific characteristics, hence, empirical findings from other
researches cannot be generalized to this study sample. In addition to that, the robustness
of the results of the previous studies needs to be examined against evidence from other
researches and countries such as Malaysia.

In that way, the overall objective of this research is to address the three issues discussed above
by estimating the size and then, to investigating the determinants of the indirect financial distress
costs. Commented [U8]: General obj

This research will provide new insights into this particular field of corporate financial distress
research, and at the same time offer some groundwork upon which a future research could be based
on.