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Merton-type default risk and financial performance: the dynamic panel moderation of firm size

Author

Listed:
  • Muhammad Mushafiq
  • Syed Ahmad Sami
  • Muhammad Khalid Sohail
  • Muzammal Ilyas Sindhu

Abstract

Purpose - The main purpose of this study is to evaluate the probability of default and examine the relationship between default risk and financial performance, with dynamic panel moderation of firm size. Design/methodology/approach - This study utilizes a total of 1,500 firm-year observations from 2013 to 2018 using dynamic panel data approach of generalized method of moments to test the relationship between default risk and financial performance with the moderation effect of the firm size. Findings - This study establishes the findings that default risk significantly impacts the financial performance. The relationship between distance-to-default (DD) and financial performance is positive, which means the relationship of the independent and dependent variable is inverse. Moreover, this study finds that the firm size is a significant positive moderator between DD and financial performance. Practical implications - This study provides new and useful insight into the literature on the relationship between default risk and financial performance. The results of this study provide investors and businesses related to nonfinancial firms in the Pakistan Stock Exchange (PSX) with significant default risk's impact on performance. This study finds, on average, the default probability in KSE ALL indexed companies is 6.12%. Originality/value - The evidence of the default risk and financial performance on samples of nonfinancial firms has been minimal; mainly, it has been limited to the banking sector. Moreover, the existing studies have only catered the direct effect of only. This study fills that gap and evaluates this relationship in nonfinancial firms. This study also helps in the evaluation of Merton model's performance in the nonfinancial firms.

Suggested Citation

  • Muhammad Mushafiq & Syed Ahmad Sami & Muhammad Khalid Sohail & Muzammal Ilyas Sindhu, 2022. "Merton-type default risk and financial performance: the dynamic panel moderation of firm size," Journal of Economic and Administrative Sciences, Emerald Group Publishing Limited, vol. 40(2), pages 168-181, January.
    • Handle: RePEc:eme:jeaspp:jeas-09-2021-0181
    DOI: 10.1108/JEAS-09-2021-0181
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    Citations

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    Cited by:

    1. Bernardelli Michał & Korzeb Zbigniew & Niedziółka Paweł, 2024. "What drives the profitability of banking sectors in the European Union? The machine learning approach," International Journal of Management and Economics, Warsaw School of Economics, Collegium of World Economy, vol. 60(4), pages 272-284.

    More about this item

    Keywords

    Default risk; Distance-to-default; Probability of default; Financial performance; Profitability; Generalized method of moments; G32; G33;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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