Analysing corporate insolvency in the Gulf Cooperation Council using logistic regression and multidimensional scaling

Layla Khoja (), Maxwell Chipulu and Ranadeva Jayasekera
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Layla Khoja: University of Southampton
Maxwell Chipulu: University of Southampton
Ranadeva Jayasekera: University of Southampton

Review of Quantitative Finance and Accounting, 2016, vol. 46, issue 3, No 2, 483-518

Abstract: Abstract In this paper, we examine corporate insolvency in the Gulf Cooperation Council (GCC) region between 2004 and 2011. Data comprises 28 financial ratio variables from 112 firms. We use Logit regression with best-subset selection criteria to investigate the predictive value of the ratios in the GCC context, particularly cash flow-based ratios. We also examine the main dimensions of the ratios, and the weights firms attach to them, using 3-way Multidimensional Scaling (MDS). We find that a parsimonious Logit model with the profitability ratio EBITTL, the leverage ratio TLTA and the cash flow ratios CFFOTA and CFFOCL can predict insolvency, ex-ante, with 84.8, 95.6 and 73.9 % overall, type I and II accuracy, respectively. From MDS, we uncover four financial-ratio dimensions: (i) ‘Non-strategic sales activities’, (ii) ‘Profitability and financial stability balance’, (iii) ‘Sales activities against capital conversion’; and (iv) ‘Market value against cash generation’. Insolvent firms appear very specific and attach most salience to the ‘Non-strategic sales activities’ dimension, unlike solvent firms which attach more salience to the other three dimensions. Therefore, the results imply that, to reduce susceptibility to insolvency in the GCC, managers should focus less on non-strategic sales activities.

Keywords: Gulf Cooperation Council; Corporate insolvency; Multidimensional scaling; Cluster analysis; Logit; Probit; Financial ratio (search for similar items in EconPapers)
JEL-codes: G33 (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1007/s11156-014-0476-y

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