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    An empirical diagnosis of multiple state financial distress in the Chinese equity market : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

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    The Chinese equity market where firms do not die is saddled by an increasing number of zombie financially distressed firms resulting from a relatively low delisting rate, a weak Enterprise Bankruptcy Law process and a profit-based delisting system that is undermined by earnings management. As a result, it is difficult for investors and creditors to assess or predict the financial distress state of firms to reduce loss. This research uses panel data of 1,415 Chinese non-financial listed firms on the Shanghai and Shenzhen Stock Exchanges for the period 2009 to 2018. Using a two-stage multinomial logit model, this research models financial distress as a multiple state process of four financial distress states (NFDIS, FWEAK, FWEAK, FDIST) which is an improvement on the conventional binary state approach. The empirical findings show a nonlinear relationship between financial ratios and corporate governance factors and financial distress. Specifically, a change in a firm’s financial leverage and cash flow from finance has a significant positive effect on the probability of the firm in a financially distressed state: FDECL, FWEAK or the FDIST state. Inversely, a change in a firm’s asset management efficiency, profitability, liquidity, cash flow from operations, dividend payment, market valuation, board structure or ownership structure has a significant negative effect on the probability of the firm in a financially distressed state: FDECL, FWEAK or the FDIST state. Notably, the further a firm’s financial health deteriorates, the lesser its probability of recovery. Further to the two-year consecutive loss criteria, this research found that firms in the early FDECL state (ST firms) do experience distress symptoms of poor asset management efficiency, high cash flow from finance, low dividend pay-out, poor board structure and low percentage of institutional ownership. Firms in the FWEAK state also experience, in addition to the same symptoms as firms in the FDECL state, poor liquidity, cash flow from operations and poor market valuation. Firms in the terminal FDIST state experience the same symptoms as firms in the FDECL and FWEAK states in addition to high financial leverage. Although firms across the four financial distress states may experience similar distress symptoms, the magnitude of these symptoms at each distress state is significantly different as they are incremental. The empirical findings imply that early financial distress may not be detected relying solely on accrual or market information as the case of the ST delisting criteria. This is because accrual-based ratios and market-based ratios are less effective in diagnosing the symptoms experienced by firms in the early FDECL state than they are in identifying the symptoms in the late FWEAK state or terminal FDIST state. Cash flow-based ratios and corporate governance factors improve the predictive and explanatory power of accrual and market-based ratios assessing aspects of financial distress not assessed by accrual-based ratios or market-based ratios
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