Main Causes and Process of Financial Distress – An Empirical Analysis of Hungarian Firms

Abstract

The purpose of our research series is to examine issues related to the economic efficiency of the Hungarian bankruptcy procedure. Based on a broad-based representative sample, we empirically test and prove our hypothesis that corporate defaults are the consequence of a specific financial/economic process. Our results confirm that the primary cause of corporate bankruptcy in Hungary is the firms’ inability to create value (e.g. inefficient use of the asset portfolio), the first signs of which become visible as early as 4–5 years prior to default. As a result of poor operational efficiency, firms increase their financial leverage and, due to the two factors described above, companies tend to encounter liquidity shortage in the last year of operation (they face default in legal terms). This research contributes to shedding light on the economic content of bankruptcy, allowing for a more accurate appraisal of the efficiency of bankruptcy procedures. Our study points out that the success of reorganisation depends on the restoration of value creation rather than on debt restructuring arrangements.