Financial Risk Management

Grover's G-Score Analysis: An Indian Perspective on Financial Distress

Article Details

Pub. Date	: Mar, 2023
Product Name	: The IUP Journal of Financial Risk Management
Product Type	: Article
Product Code	: IJFRM030323
Author Name	: Shubham Kumar
Availability	: YES
Subject/Domain	: Finance Management
Download Format	: PDF Format
No. of Pages	: 10

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Abstract

In 1968, when the bankruptcy prediction model was introduced, it became significant for every type of business entity to predict the future using the information available to them at the time. Taking corrective measures and reducing financial distress is achieved through its early detection. In this paper, listed Indian companies are analyzed to determine their financial health or levels of financial distress. Grover's G-Score prediction model effectively predicts a company's financial distress level. For the study, 88 companies representing various sectors were selected, and four years of data was analyzed. Grover's G-Score correctly predicted the occurrence of non-financial distress by 95.81%, while financial distress was correctly predicted by 67.35%. The number of distressed companies is also increasing yearly, which is alarming for our economy, and significant regulatory reforms are therefore needed to counter these trends.

Introduction

Financial distress is a situation where the liabilities exceed the assets of a company. It is generally due to undercapitalization, insufficient cash, improper utilization of resources, inefficient management in all activities, sales decline, and adverse market situations (Panigrahi, 2019). Ross et al. (1999) summarized distress as one of the following four conditions: (a) business failure, i.e., a company cannot pay its outstanding debt after liquidation; (b) legal bankruptcy; i.e., a company or its creditors apply to the court for a declaration of bankruptcy; (c) technical bankruptcy, i.e., the company cannot fulfill the contract to repay principal and interest; and (d) accounting bankruptcy, i.e., the company's book net assets are negative. Financial distress is the stage before bankruptcy (Baisag and Patjoshi, 2020). Bankruptcy is a state of insolvency wherein the company or the person cannot repay the creditors the debt amount (Rao, 2013). A company's financial distress not only makes it suffer a substantial economic loss, but also makes investors and the government suffer significant economic losses (Xiao et al., 2012). The economic consequences of a company's failure is great (Sarlija and Jeger, 2011). A firm's failure also harms its stakeholders (Muzir and Calar, 2009).

Financial distress prediction models have been developed and used for more than five decades for their ability to forecast whether a company will have some economic issues or even go bankrupt in the next period, i.e., usually one year (Sarlija and Jeger, 2011). Predicting financial distress is essential to protect the interests of the stakeholders, including investors,