Identification of Financial Distressed Firms at Pakistan Stock Exchange Through Infusion of Corporate Social Responsibility Information into Altman Z-Score

Abstract

Financial distress is one of the leading reasons for corporate default, foreclosure, and subsequent bankruptcy. Traditionally accounting information-based models have been used to identify the financially distressed firms. Inaccurate identification results in type-I and type- II errors. These errors are attributable to the elements of conservatism and prudence within the accounting information. Enclosure of market information into these models may reduce the quantum of errors and improve the existing ability of these models to accurately identify the financially distressed firms. This study has infused the Corporate Social Responsibility information into the Altman Z-Score. The enclosure has been made using additive index methodology, resulting in formation of a Composite Default Index. 161 non- financial firms listed on the Pakistan Stock Exchange have been taken as the sample over the study period of 2010-2016. The accuracy of Composite default Index has been found significantly better as compared to the Z-Score Default Index as the type-I and type-II errors are reduced by 41% and 132% respectively. This study has implication for the corporate regulators, practitioners, stakeholders and researchers in form of providing a better mechanism to identify the financially distressed firms, future studies may consider other forms of market information and the accounting information-based models to improve upon the same, further.