Review of Accounting and Finance

Bankruptcy risk, productivity and firm strategy

Daniel Bryan Guy Dinesh Fernando Arindam Tripathy

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Bankruptcy risk, productivity

and firm strategy

Bankruptcy risk
and productivity

Daniel Bryan
Milgard School of Business, University of Washington Tacoma,
Tacoma, Washington, USA

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Guy Dinesh Fernando

School of Business, State of University of New York, Albany,
New York, USA, and

309
Received 1 June 2012
Revised 3 September 2012
4 January 2013
Accepted 15 January 2013

Arindam Tripathy
Milgard School of Business, University of Washington Tacoma,
Tacoma, Washington, USA
Abstract
Purpose The purpose of this paper is to examine the relationship between productivity, firm
strategy and bankruptcy risk.
Design/methodology/approach This paper uses data envelopment analysis to compute
productivity of firms and uses archival data to empirically examine the relationship between
productivity, firm strategy and bankruptcy risk.
Findings The results indicate that productivity has a positive effect on reducing bankruptcy risk,
and the results also indicate that pursuing either of the generic strategies successfully has a positive
effect on reducing bankruptcy risk. The study also brings to light the mediating effect of productivity
in the relationship between strategy and bankruptcy risk.
Research limitations/implications The effect of productivity and firm strategy on bankruptcy
risk is of importance to external stakeholders such as lenders and investors to evaluate the bankruptcy
risk of such a firm. Internal stakeholders (managers and management consultants) will find this study
expedient by using productivity enhancements and effective strategy implementation to mitigate
bankruptcy risk.
Originality/value This is the first paper to highlight the link between productivity and
bankruptcy risk, firm strategy and bankruptcy risk and the mediation effects of productivity on the
link between a cost leadership strategy and bankruptcy risk.
Keywords Data envelopment analysis, Bankruptcy risk, Firm strategy, Mediation effect
Paper type Research paper

1. Introduction
Bankruptcy is an important fact of life in the modern business environment. Bankruptcy
occurs when a firm is unable to meet its obligations and applies to a federal court either
for a period of relief to reorganize its debts or to liquidate its assets. It has an extremely
disruptive effect on the firm undergoing bankruptcy and also on its various stakeholders
such as employees, creditors, suppliers and customers. The ripple effects of a
bankruptcy can spread far and wide. For example, in GMs 2009 bankruptcy,
shareholders lost all of their value, bondholders received their payout in stock at a
fraction of their investment, retirees health benefits were cut, and unions traded some of
their benefits for ownership of the new GM. Additionally, many dealerships were closed
and several units (Saturn, Hummer, Pontiac, and Saab) were sold or closed resulting in

Review of Accounting and Finance

Vol. 12 No. 4, 2013
pp. 309-326
q Emerald Group Publishing Limited
1475-7702
DOI 10.1108/RAF-06-2012-0052

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310

job losses and affecting suppliers. The effects were lessened because the government
extended funding to the new GM and assisted with the process ensuring the protection of
customer warranties. Therefore, it is important to broaden our understanding of the
causes that lead to, or may indicate, future bankruptcy.
Although bankruptcy is a one-off discrete event, financial distress in firms that may
lead to bankruptcy is generally evident long before the event. Early indicators of
bankruptcy include losses in multiple consecutive years, cash flows drying up, declining
sales, etc. Research in the past 50 years has resulted in objective measures of bankruptcy
risk. The most famous of these measures, the Altman-Z score combines several measures
of performance and risk to come up with a score that denotes the bankruptcy risk
inherent in a firm. For this measure, and most other bankruptcy risk measures,
performance is an important contributor to bankruptcy risk. However, performance that
is analyzed with respect to bankruptcy and bankruptcy risk has almost without
exception been accounting related measures. Productivity measures which highlight a
different aspect of performance have not been used to predict bankruptcy.
In this study, we investigate the relationship between bankruptcy risk, productivity
and firm strategy. Productivity at its most basic, is the ratio of outputs to inputs and
demonstrates how proficiently a firm uses its inputs (raw material, assets and people)
to generate output. The firm that is able to generate a unit of production using lower
inputs than competitors (or alternatively use the same inputs to produce a greater
output) will be able to either generate superior profits or lower their selling prices to
drive out competitors. In either case, superior productivity will reduce bankruptcy risk.
Using data from the Compustat Annual database, we compute the bankruptcy risk
using the Altman Z score (Altman, 1968) and a productivity score using data
envelopment analysis (DEA). Our analysis shows a positive correlation between a
firms productivity and the Altman Z-score indicating a negative relationship between
higher productivity and bankruptcy risk.
The second dimension of our study investigates the implications of firm strategy on
bankruptcy risk. Porter (1980) posits two generic strategies, cost leadership and
differentiation. Research shows that firms that successfully implement either strategy
will be able to outperform competitors and achieve superior contemporaneous
performance. Since superior performance is very closely linked to lower bankruptcy
risk, we expect a successful implementation of either generic strategy to result in lower
bankruptcy risk. Again, using data from Compustat, we compute proxies for realized
strategy using the methodology in Balsam et al. (2011) and show that pursuing the
strategies successfully is related to lower bankruptcy risk.
Our final analysis investigates a mechanism through which cost leadership impacts
bankruptcy risk. Research has shown that firms that follow cost leadership have
higher productivity. Moreover, we predict and find that higher levels of productivity
result in lower bankruptcy risk. We also show that being able to pursue cost leadership
successfully result in lower bankruptcy risk. Hence we predict that one of the
mechanisms through which cost leadership strategy impacts bankruptcy risk is
though productivity enhancements. Using mediation analysis we formally evaluate
and confirm this prediction.
Our results have implications for bankruptcy prediction. By showing the link between
productivity and bankruptcy risk, we add a new arrow to the quiver in predicting
bankruptcy. This implies that investors and lenders who want to evaluate the

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bankruptcy risk of a potential investment will also need to take productivity of the firm
into account. Furthermore, our results show that firms which are striving to avoid
bankruptcy need to look at productivity improvements as part of overall performance
improvements. Finally, we show that one potential benefit of a successful implementation
of either generic strategy is a lower bankruptcy risk and we also highlight that for cost
leadership, the lower risk is in part mediated through productivity improvement.
The rest of the paper is organized as follows. In the next section we outline the
literature review and develop our main hypotheses. In Section 3, we discuss our
research methodology including the computation of productivity using DEA, the
bankruptcy risk and the strategy measures. Section 4 discusses the empirical results
from our analysis and Section 5 presents our concluding remarks.
2. Literature review and hypothesis development
Bankruptcy risk
Extant bankruptcy literature has generally focused on predicting which firms will file
for bankruptcy protection. Altman (1968), Ohlson (1980), Zmijewski (1984) and
Hillegeist et al. (2004) and others show that the accounting information available prior
to a bankruptcy filing predicts whether a firm will file for bankruptcy protection. One
of the more popular and robust accounting based bankruptcy prediction models is the
Altmans Z-score model first discussed in Altman (1968). The Altman model uses
discriminant analysis (DA) to combines five ratios into a score that represents the
firms financial strength which is used to predict bankruptcy.
Altman Z score has been used to proxy for many bankruptcy related measures.
Piotroski (2000) uses the Altman Z score to proxy for financial distress and Elliott et al.
(2010), uses it to measure default risk. In addition to the firm level research,
macroeconomic events have also been found to be related to bankruptcy risk. There
has been substantial research on the macroeconomic impacts on bankruptcy risk. In
early studies Altman (1971) finds economic decline, credit tightness, and decreased
market performance are related to bankruptcy risk. More recently Bhattacharjee et al.
(2009) combine both macroeconomic variables and firm specific financial variables to
examine UK and US bankruptcies and acquisitions. They find that the legal system of
the USA, through Chapter 11, can mitigate the effects of macroeconomic conditions by
sheltering distressed firms until the market becomes active again. Even though the
model was introduced in the late 1960s, it is still used in cutting edge financial research
to proxy for financial distress and bankruptcy/default risk (Aslan and Kumar, 2012;
Becker and Stromberg, 2012; Elliott et al., 2010).
These bankruptcy models typically use financial information which summarizes a
firms overall performance and financial condition. However, there is scarce
researchthat uses productivity variables to examine the effect of performance or
strategy on bankruptcy risk. Becchetti and Sierra (2003) find that productive efficiency,
measured using a stochastic frontier model is related to bankruptcy risk. We extend
this research by examining the effects of the productivity and the strategy of a firm on
bankruptcy risk.
Productivity
Productivity is the ratio of total outputs to total input. It measures how proficiently a
unit combines different inputs to generate a specified output. Improvements in

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productivity are the only source of continuous improvement in the standard of living in
a country. Krugman (1990) assets that [. . .] while productivity isnt everything, in the
long run it is almost everything. The economic malaise of the 1970s in the US is
widely attributed to a decline in productivity (Lichtenberg, 1992). Partly as a result,
78 percent of the CEOs of the 500 largest US firms in the 1980s identified productivity
improvement and cost control as the most important strategic initiative for that decade
(McComas, 1986), possibly leading to the renaissance the US economy enjoyed during
that period.
Higher productivity enables firms to produce output using less inputs, resulting in a
cost saving. This saving can either be passed onto the customer in the form of lower
prices, leading to greater market share, or retained within the firm in order to enjoy
greater margins. The Altman Z score, which is the popular measure for bankruptcy
risk is a composite measure of five performance measures, including sales and
profitability, both of which will be positively impacted by higher productivity. Based
on the above discussion, we posit that higher productivity leads to lower bankruptcy
risk and state our first hypothesis as follows:
H1. Higher productivity reduces bankruptcy risk.
Strategy
Porters framework (Porter, 1980) posits that a firm can outperform its competitors by
pursuing either of two generic strategies, cost leadership or differentiation. Porter also
discusses the characteristics of the firm in terms of structure, processes and practices
that are necessary to successfully implement either cost leadership or differentiation.
According to this framework, a cost leader is the firm that has the ability to be the
lowest cost producer in an industry for a given level of quality. Firms can adopt
different methods to achieve cost leadership such as large-scale manufacturing to
achieve economies of scale (both production and purchasing), target costing,
benchmarking, JIT, TQM, and statistical process control. According to Hambrick
(1983) cost leadership is achieved through cost efficiency (using the lowest amount of
input for a given level of output) and asset parsimony (using the lowest amount of
fixed assets to generate a given level of output). Thus, a cost leadership strategy is
closely linked to productivity improvements, since productivity is the proficiency with
which different inputs are combined to generate a specified output. Further, Chang et al.
(2012) find that firms that follow a cost leadership strategy have higher levels of
productivity.
On the other hand, firms pursuing a differentiation strategy create value using a
different paradigm with the focus being primarily on generating high margins through
the uniqueness of products, price inelasticity, customer loyalty and innovative
distribution channels. Hence, there is heavy emphasis on R&D expenses and
advertising to create unique product features and also generate customer awareness
and brand loyalty. Productivity is not essential for a differentiator; in fact, the process
of implementing a differentiation strategy (such as product uniqueness, emphasis on
quality, etc.) may actually be detrimental to a focus on productivity. Chang et al. (2012)
formally demonstrate that firms that concentrate on differentiation do so at the
expense of productivity.
To summarize, Porter shows that there are two generic strategies either of which
if successfully implemented will enable firms to have competitive advantage over

their competitors. Numerous studies have empirically confirmed this contention.

Although the implementation of the two strategies will be different, with cost
leadership relying on productivity enhancements, while differentiation seeks
innovation and brand loyalty, successful implementation of either strategy will lead
to better performance. Since better performance leads to lower risk of bankruptcy, we
state our second hypothesis as follows:

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H2. Firms pursuing higher degrees of cost leadership or differentiation reduces

bankruptcy risk.

Bankruptcy risk
and productivity

313

Chang et al. (2012) show the heterogeneous relationship between productivity and firm
strategy. They show that cost leadership (differentiation) firms are associated with a
higher (lower) level of productivity. Our preceding hypotheses posit that higher levels
of productivity lead to lower bankruptcy risk and moreover, higher levels of either cost
leadership or differentiation lead to lower bankruptcy risk. Combining the different
ideas, we propose that one of the mechanisms by which firm strategy impacts
bankruptcy risk is through productivity. Chang et al. (2012) find a positive link
between cost leadership and productivity implying that as the level of cost leadership
increases, the productivity also increases. We expect higher levels of productivity to
lower risk of bankruptcy. Hence we expect the impact of cost leadership on bankruptcy
risk to be at least partially mediated through productivity. The relationship is shown in
Figure 1. We do not have any a priori expectations for differentiation since the
relationship between differentiation and productivity shown by Chang et al. (2012) is
negative. Therefore, our third hypothesis is stated as follows:
H3. The relationship between the cost leadership strategy and bankruptcy risk is
partially mediated by productivity.
3. Data and research methodology
Data
We use publicly available data from the Compustat database for this study. Our
dataset contains all firm-years that are available on the Compustat dataset for which

Independent
Variable
Cost Leadership
Strategy

c = 0.1288; p = 0.0002

Mediator
Productivity
a = 0.0387; p = 0.0000
Independent
Variable
Cost Leadership
Strategy

c = 0.0864; p = 0.0204

Dependent
Variable
Bankruptcy
Risk

b = 1.0736; p = 0.0074
Dependent
Variable
Bankruptcy
Risk

Figure 1.
Mediator link between
firm strategy and
bankruptcy risk

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314

the relevant variables have valid figures (non missing valid observations). Following
standard practice, we exclude firms from regulated industries in the sample (Ozbas and
Scharfstein, 2010). The dataset spans 1993-2006 and contains 17,636 firm year
observations.
Firm productivity
Firm productivity, the independent variable in our H1 and the mediating variable in
our H3 is estimated using DEA. DEA is a non-parametric linear programming method
of estimating the productive efficiency of decision making units (DMU). Traditional
parametric methods (such as log-linear or trans log models) of determining
productivity imposes an exogenous production function on each DMU. However,
DEA does not have to impose a specific functional form for the production process in
its estimation model, thereby avoiding potential distortions. DEA is becoming widely
accepted both in academics as well as in practice (Emrouznejad et al., 2008). We use the
DEA model of Banker et al. (1984) in the first stage of the empirical analysis to estimate
the productivity scores of the firms in the Compustat database. Following prior studies
that utilize the DEA methodology to estimate firm productivity (Thore et al., 1994;
Tsai et al., 2006; Saranga, 2009), we use three inputs cost of goods sold (Compustat
item COGS), selling and distribution expenses (Compustat item XSGA) and capital
expenditure (Compustat item CAPX) and one output sales revenue (Compustat item
SALE). Since DEA is a comparative measure that is computed relative to all other
firms in the comparison set, we partition our main dataset into the different industry
categories, based on the Fama-French 12 industry classification and compute the DEA
variable for each category separately.
The productivity measure of firm k, uk is computed as the reciprocal of the
inefficiency measure Fk which is obtained from the following linear program models
(1a)-(1e):
Fk max F
s:t: X ik $

N
X

lk X ik

1a
i 1; 2; 3

1b

k1

FY k #

N
X

lk Y k

1c

k1
N
X

lk 1

1d

k1

lk $ 0
where:
Xik

input i consumed by Firm k.

Yk

output produced by Firm k.

lk

weight placed on inputs/output of Firm k.

The linear program is solved for each observation j.

1e

Bankruptcy risk
We use Altman Z-score as a measure of bankruptcy risk. Altman (1968) was the
seminal contribution in the bankruptcy literature. This study introduced the first
bankruptcy evaluation model using multiple DA to discriminate between bankrupt
and non-bankrupt firms. The statistical DA uses a linear combination of independent
variables to assign a score, referred to as the Z-score to a particular firm. The
summary Z-score score provided by the model represents a firms risk of bankruptcy. It
is computed as:

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Z 1:2WC 1:4RE 3:3EBIT 0:6MVE 0:999S

where:
WC

working capital scaled by total assets.

RE

retained earnings scaled by total assets.

EBIT earnings before interest and taxes scaled by total assets.

MVE market value of equity scaled by total liabilities.
S

sales scaled by total assets.

WC is included as a measure of liquidity. RE reflects cumulative profitability while

providing implicit information about the age of the firm. EBIT is, naturally, a measure of
profitability. MVE is a measure of leverage, and S represents the sales-generating ability of
the firms assets. Recently, Altman (1993) has extended his original idea on the
default/non-default classification into various credit rating issues such as credit rating
migration (Altman and Kao, 1992) and credit rating of agencies (Altman and Rijken, 2004).
We use this alternative specification of the Z-score to evaluate the robustness of our results.
Firm strategy measures
Following Balsam et al. (2011) and Asdemir et al. (2013) we capture the strategic
positioning of the firms using realized indicators obtained from the firms financial
statements. Accordingly three variables SG&A/SALES (selling, general and
administrative expenses scaled by net sales), R&D/SALES (research and
development expenses scaled by net sales) and SALES/COGS (net sales scaled by
cost of goods sold) are used to measure strategic positioning based on the
differentiation dimension. Three additional variables SALES/CAPEX (net sales scaled
by capital expenditures on property, plant and equipment) SALES/P&E (net sales
scaled by net book value of plant and equipment) and EMPL/ASSETS (the number of
employees scaled by total assets) are used to measure strategic positioning based on
cost leadership. These measures capture the firms long-term strategic orientation
along the dimensions of differentiation and cost leadership.
We compute the mean of the previous five years of data for each of the above six
variables to capture the long-term strategic orientation of the firms and conduct a
confirmatory factor analysis (CFA) to construct the two strategy variables, Cost
Leadership and Differentiation. The result of our CFA, tabulated in Table I, are
similar to prior literature, indicating reasonable levels of reliability and validity for
the two strategy variables. The factor loadings, which range from 0.52 to 0.93, and the
t-statistics for the two factors suggest that the indicator measures satisfy the convergent

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316

Table I.
CFA to determine
strategy constructs

SG&A/SALES
R&D/SALES
SALES/COGS
SALES/CAPEX
SALES/P&E
ASSETS/EMPL
Goodness of fit measures
Goodness of fit index
Goodness of fit index adjusted
for degrees of freedom
Bentlers comparative fit index
Bentler & Bonetts non-normed
index

Cost leadership
factor loading
(t-value)

Confirmatory factor analysis

Average
Differentiation
variance
factor loading Composite
(t-value)
reliability extracted (AVE)
0.91 (126.20)
0.62 (80.23)
0.76 (105.30)

0.86 (124.30)
0.93 (135.40)
0.52 (71.97)

0.81

0.59

0.83

0.63

0.9177
0.8315
0.9135
0.8241

Notes: Definitions: SG&A/SALES average of SG&A/net sales from t 2 1 to t 2 5; R&D/SALES

average of R&D exp/net sales from t 2 1 to t 2 5; SALES/COGS average of net sales/cost of goods
sold from t 2 1 to t 2 5; SALES/CAPEX average of net sales/capital expenditure from t 2 1 to
t 2 5; SALES/P&E average of net sales /net book value of plant and equipment from t 2 1 to
t 2 5; ASSETS/EMPL average of total asset/no. of employees from t 2 1 to t 2 5

validity thresholds suggested in prior literature (Bagozzi et al., 1991; Phillips, 1981). The
average variance extracted (AVE), used to establish the discriminant validity of
constructs by indicating the amount of variance that is captured by an underlying factor
in relation to the amount of variance due to measurement error, was well above the
recommended threshold of 0.5 for all factors (Fornell and Larcker, 1981). The composite
reliability which measures the internal consistency of the factors also exceeded the
recommended threshold of 0.7 (Werts et al., 1974; Nunnally, 1978) for the two factors.
The goodness of fit index and the adjusted goodness of fit index, which evaluate whether
the measurement model providesa good fit, are also above the cut-off range of 0.90 and
0.80, respectively, ( Joreskog and Sorbom, 1989). Additional fit measures such as the
comparative fit index (Bentler, 1989) and the non-normed index (Bentler and Bonett,
1980) are also in the acceptable range. The two strategy constructs are continuous
variables which are orthogonal to each other. Thus, each firm will have both a
differentiation score and a cost leadership score. In other words, we capture both
dimensions of differentiation and cost leadership for each firm because, consistent with
the views of Porter (1980, 1985) and others, the two strategies are not viewed as two ends
of the same continuum, but rather as two distinct platforms that can be used in isolation
or in combination with each other (which is captured by having two strategy constructs,
one for differentiation and one for cost leadership, both of which are continuous
variables). Thus, firms in our framework may choose to compete based on either
differentiation or cost leadership or choose to compete based on both strategies.
Empirical model
To evaluate our hypotheses on the effect of productivity on bankruptcy risk, we adopt
a two-stage procedure involving DEA followed by an OLS regression. Banker and

Natarajan (2008) prove that the use of this two-stage method yields consistent
estimators of the regression coefficients. Further, this two-stage approach has been
validated by many studies such as Hoff (2007) and McDonald (2009). Specifically, we
estimate the following regression model:

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AltmanZkt a0 a1 Productivitykt a2 Losskt a3 Leveragekt

3
a4 LnMVkt a5 Cashkt Year & Industry Dummies 1kt
where AltmanZkt represents the bankruptcy risk of firm k in year t calculated based on
Altman (1968). A lower value of AltmanZ denotes a higher level of bankruptcy risk.
Productivitykt denotes the productivity of the firm k in year t, and is obtained from the
DEA model shown in equations (1a)-(1e). We expect the a1 the coefficient on the
Productivity variable to be positive and significant in accordance with H1. Following
prior research, we include several controls identified as determinants of bankruptcy
risk (Shumway, 2001; Uhrig-Homburg, 2005; Campbell et al., 2008; Eberhart et al.,
2008). These are the leverage ratio (Leveragekt), calculated as ratio of book value of
long- and short-term debt to total assets, firm size (Ln(MV)kt) calculated as the natural
logarithm of market capitalization at the end of the fiscal year, liquidity (Cashkt)
calculated as the ratio of cash holdings to total assets and an indicator of loss firms
(Losskt) which is set to 1 if the firm has a loss during the year, otherwise 0. Consistent
with Shumway (2001), Uhrig-Homburg (2005), Campbell et al. (2008) and Eberhart et al.
(2008), we expect higher bankruptcy risk to be associated with leverage and loss and a
lower bankruptcy risk to be associated with firm size and liquidity. Finally, industry
dummies are determined using the Fama-French 12 industry classification.
Our H2 examinesthe relationship between the strategic positioning of firms and
bankruptcy risk. We estimate the following regression model (4), which is a
modification of the above equation (3), to evaluate the effect of strategic positioning of
firms on bankruptcy risk:
AltmanZkt a0 a1 CostLeadershipkt a2 Differentiationkt a3 Losskt
a4 Leveragekt a5 LnMVkt a6 Cashkt
Year & Industry Dummies 1kt

where CostLeadershipkt and Differentiationkt represents the strategic positioning of

firm k in year t constructed based on Balsam et al. (2011). Based on our H2 we expect
the coefficients on the two strategy variables a1 and a2 to be positive and significant,
indicating that there is lower risk of bankruptcy for firms which are able to
successfully pursue either of the strategies.
Mediation analysis
Mediation analysis evaluates whether the impact of an independent direct variable on a
dependent variable is conveyed by means of a third variable. We use mediation
analysis to evaluate our H3 which posits that the link between strategy and
bankruptcy risk is mediated by productivity. Three conditions are necessary to
establish full or partial mediation (Baron and Kenny, 1986; Guymon et al., 2008), which
are examined using the three regression models below.
Equation (5A) shows the link between productivity and strategy. The link between
bankruptcy risk and strategy is examined using equation (5B). Finally, the link

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between bankruptcy risk and both Strategy and Productivity together is evaluated in
equation (5C):
Productivity i1 aCostLeadership Control Variables Error

5A

AltmanZ i2 cCostLeadership Control Variables Error

5B

AltmanZ i3 c CostLeadership bProductivity Control Variables

Error

5C

The mediation effect is the product of a (the coefficient of CostLeadership in equation

(5A)) and b (the coefficient of Productivity in equation (5C)) (Bai et al., 2010). Following
standard literature, we determine the statistical significance of ab in two ways, namely
the Sobel (1982) test and bootstrapping (Preacher and Hayes, 2004). Of the two methods,
bootstrapping has been acknowledged as the superior one (Zhao et al., 2010).
4. Empirical results
Descriptive statistics and correlations
Panel A in Table II provides the descriptive statistics for the variables in our estimation
model. The mean productivity of the firms in our sample is 0.65. Considering that our
measure of productivity is computed using DEA, and the maximum possible
productivity level is 1, most firms are operating at well below their maximum possible
level. The bankruptcy risk variables AltmanZ and AltmanZ93 have similar statistics
with mean of 5.24 and 4.09, respectively. Our main analysis uses the AltmanZ variable
and we evaluate the robustness of our results using AltmanZ93. The strategy variables
CostLeadership and Differentiation are standardized factor scores with mean 0.00 and
standard deviation of 1. The mean Leverage of the firms in our sample is 0.21 indicating
that on an average the firms have a low reliance on external funding. The mean value of
Ln(MV) which captures the size of the firm is 6.33 and the firms on an average appear to
have a cash holding of 0.12 to the total assets, as captured by the Cash variable.
Panel B in Table II tabulates the correlation coefficients between the variables used in
our analysis. The correlation coefficients show that both the bankruptcy risk variables
(AltmanZ and AltmanZ93) have the expected correlations with all control variables. The
correlation between productivity and the bankruptcy risk variables is positive and
significant indicating that higher productivity results in lower bankruptcy risk. The
correlations between the strategy variables, cost leadership and differentiation, and the
bankruptcy risk variables are also positive and significant, which again indicates that
firms pursuing the strategies successfully will have lower bankruptcy risk. These
correlations are per our expectations and in line with our hypothesis.
Impact of productivity on bankruptcy risk
Next we estimate equation (3) to evaluate the relationship between productivity and
bankruptcy risk. The results of our estimation are tabulated in Table III. In line with
our expectations, the coefficient on the productivity variable is positive and significant
(coefficient 1.258; t-statistics 3.34). The coefficients on the other control variables
are also consistent with the findings in the prior literature and in the direction of our
expectations. The coefficients on loss and leverage are negative and significant
(coefficient 2 0.954;
t-statistics 2 11.76
and
coefficient 2 8.148;
t-statistics 2 27.91, respectively), while the coefficients on size and liquidity are

STD
0.17
4.93
3.48
1.00
1.00
0.17
1.94
0.14
0.19

AltmanZ
0.0863
, 0.0001
1

Mean
0.65
5.24
4.09
0.00
0.00
0.21
6.33
0.12
0.04

Productivity
1

AltmanZ93
0.1210
, 0.0001
0.9923
, 0.0001
1

Min.
0.15
2 6.14
2 3.23
2 11.30
2 1.36
0.00
2 4.45
0.00
0.00

Panel A: descriptive statistics

Q1
Med.
0.52
0.67
2.81
4.01
2.32
3.24
2 0.10
0.27
2 0.61
2 0.24
0.05
0.20
4.92
6.31
0.02
0.06
0.00
0.00
Panel B: correlation coefficients
Spearson correlation
Cost Leadership
Differentiation
0.1219
2 0.2338
, 0.0001
, 0.0001
0.2462
0.2833
, 0.0001
, 0.0001
0.2931
0.2447
, 0.0001
, 0.0001
1
0.0881
, 0.0001
1
Leverage
0.0653
, 0.0001
2 0.7208
, 0.0001
2 0.6945
, 0.0001
2 0.1997
, 0.0001
2 0.2760
, 0.0001
1

Q3
0.77
5.91
4.69
0.49
0.24
0.32
7.63
0.17
0.00

Ln(MV)
0.3890
, 0.0001
0.0712
, 0.0001
0.0521
, 0.0001
2 0.3011
, 0.0001
0.1008
, 0.0001
0.0640
, 0.0001
1

Max.
1.00
112.54
78.99
0.94
3.78
1.61
13.05
0.98
1.00

Cash
2 0.0813
, 0.0001
0.4854
, 0.0001
0.4511
, 0.0001
0.0620
, 0.0001
0.3677
, 0.0001
2 0.5571
, 0.0001
0.0507
, 0.0001
1

Loss
2 0.0483
, 0.0001
2 0.1434
, 0.0001
2 0.1373
, 0.0001
0.0463
, 0.0001
0.0040
0.5897
0.0692
, 0.0001
2 0.0971
, 0.0001
2 0.0331
, 0.0001
1

Notes: Total observation 17,636; definitions: Productivity, productivity of the firm (measured using DEA); AltmanZ is the bankruptcy risk denoted by Z-score calculated per Altman
(1968); AltmanZ93 is the bankruptcy risk denoted by Z-score calculated per Altman (1993); CostLeadership is a construct to capture the cost leadership strategy; it is a continuous variable,
based on the factor analysis of the t 2 1 to t 2 5 average of the ratios of sales to capital expenditure; sales to net book value of plant and equipment and number of employees to net book
value of plant and equipment; Differentiation is a construct to capture the differentiation strategy; it is a continuous variable based on the factor analysis of the t 2 1 to t 2 5 average of
the ratios of SG&A expense to sales; R&D expense to sales and sales to cost of goods sold; Leverage is measured as the ratio of book value of long- and short-term debt to total assets;
Ln(MV)t is the natural logarithm of market capitalization at the end of the fiscal year; Cash is the ratio of cash holdings to total assets; Lossis set to 1 if the firm has a loss during the year,
otherwise 0

Loss

Cash

Ln(MV)

Leverage

Differentiation

Cost Leadership

AltmanZ93

AltmanZ

Productivity

Variable
Productivity
AltmanZ
AltmanZ93
CostLeadership
Differentiation
Leverage
Ln(MV)
Cash
Loss

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Bankruptcy risk
and productivity

319

Table II.

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320

Table III.
Bankruptcy risk
and productivity

AltmanZkt a0 a1 Productivitykt a2 Losskt a3 Leveragekt

a4 LnMVkt a5 Cashkt Year & Industry Dummies 1kt
Dependent variable
Variable

Coefficient

Intercept
3.7967
Productivity
1.2581
Loss
20.9537
Leverage
28.1480
Ln(MV)
0.1268
Cash
7.3162
Year and industry dummies included
Adj. R 2
0.4598
n
17,636

AltmanZ
t-stat.
16.95
3.34
211.76
227.91
4.74
16.81

p-value

Coefficient

AltmanZ93
t-stat.

p-value

0.0000
0.0008
0.0000
0.0000
0.0000
0.0000

3.0078
1.5879
2 0.6915
2 5.9406
0.0533
4.7626

18.39
5.86
2 11.31
2 27.23
2.76
15.27

0.0000
0.0000
0.0000
0.0000
0.0058
0.0000

0.4433
17,636

Note: See Table II for variable definitions

positive and significant (coefficient 0.127; t-statistics 4.74 and coefficient 7.316;
t-statistics 16.81, respectively). The results indicate that productivity has a positive
effect on lowering bankruptcy risk, thus higher productivity leads to lower bankruptcy
risk. Further, the results also indicate that loss firms and firms with high leverage have
higher bankruptcy risk and large firms and firms with higher liquidity at their disposal
have lower risk of bankruptcy. Overall the results confirm our H1 which posits that
productivity has a predictive effect on bankruptcy risk and that firms with high
productivity will have lower bankruptcy risk.
Firm strategy and bankruptcy risk
We evaluate the relationship between firm strategy and bankruptcy risk by estimating
equation (4). The results of our estimation are tabulated in Table IV. Panel A tabulates
the results with the equation estimated with only the cost leadership variable and Panel B
tabulates the results using only the differentiation variable. Panel C shows the results for the
estimation of equation (4) with both the cost leadership and the differentiation variables.
The results are in the expected direction with the coefficients for both the strategy variables
being positive and significant across the three panels. The coefficient for the cost leadership
strategy is 0.129 (t-statistics 3.75) in Panel A and 0.127 (t-statistics 3.71) in Panel C
when we include both the strategy variables in the estimation. Similarly, the coefficient for
the differentiation strategy is 0.223 (t-statistics 3.00) in Panel B and 0.222
(t-statistics 2.98) in Panel C when we include both the strategy variables in
the estimation. The coefficients on the other control variables are also consistent with the
findings in the prior literature and in the direction of our expectations. The loss and the
leverage variables are negative and significant across the three panels. The coefficients for
the loss variable are 20.991, 20.975 and 20.987 with t-statistics of 212.13, 211.62 and
211.77 across Panels A-C, respectively, and the coefficients for the leverage variable are
28.037, 28.105 and 27.994 with t-statistics of 227.10, 227.83 and 227.06 across
Panels A-C, respectively. The coefficients on the size and liquidity variables are positive and
significant. The coefficients for the size variable are 0.184, 0.169 and 0.176 with t-statistics of
8.44, 7.72 and 8.08 across Panels A-C, respectively, and the coefficients for the liquidity

0.0000
0.0000
0.0000
0.0000

2 12.13
2 27.10
8.44
16.81

Note: See Table II for variable definitions

0.0000
0.0002

20.16
3.75

Panel A cost leadership

Coefficient
t-stat.
p-value

Intercept
4.0995
CostLeadership
0.1288
Differentiation
Loss
20.9907
Leverage
28.0370
Ln(MV)
0.1835
Cash
7.2116
Year and industry dummies included
Adj. R 2
0.4595
n
17,636

Variable

3.00
2 11.62
2 27.83
7.72
15.62

0.2234
2 0.9748
2 8.1051
0.1690
6.8573
0.4592
17,636

20.44

4.2887
0.0027
0.0000
0.0000
0.0000
0.0000

0.0000

Panel B differentiation
Coefficient
t-stat.
p-value

0.4608
17,636

4.2811
0.1268
0.2217
2 0.9870
2 7.9941
0.1758
6.8618

Coefficient

AltmanZkt a0 a1 CostLeadershipkt a2 Differentiationkt a3 Losskt a4 Leveragekt

a5 LnMVkt a6 Cashkt Year & Industry Dummies 1kt

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0.0000
0.0002
0.0029
0.0000
0.0000
0.0000
0.0000

p-value
20.45
3.71
2.98
211.77
227.06
8.08
15.64

Panel C both
t-stat.

Bankruptcy risk
and productivity

321

Table IV.
Bankruptcy risk and
firm strategy

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322

variable are 7.212, 6.857 and 6.862 with t-statistics of 16.81, 15.62 and 15.64 across,
respectively. The results indicate that firm strategy has a positive effect on lowering
bankruptcy risk. Further, similar to the earlier findings the results also indicate that loss
firms and firms with high leverage have higher bankruptcy risk and large firms and firms
with higher liquidity at their disposal have lower risk of bankruptcy. Overall the results
confirm our H2 that posits a lower bankruptcy risk for firms pursuing higher levels of the
cost leadership or differentiation strategy.
We find that the VIF in our estimations are within the acceptable levels, indicating
that multicolinearity is not an issue in our estimations. We corrected for
heteroscedasticity and auto-correlation by estimating our regressions models using
clustering by firm as per Petersen (2009). As a sensitivity analysis, we re-estimated our
model using alternative specifications for the bankruptcy risk using the specifications
per Altman (1993). Our results remain qualitatively similar to this alternative
specification of the Bankruptcy risk variable.
The mediating effect of productivity
The mediation analysis results are presented in Table V and Figure 1. The results of
regression equations (5A)-(5C) for Cost Leadership are shown in Panel A of Table V. As
expected, both the Sobel test and the bootstrapping test confirm the mediation effects
of productivity on the relationship between a cost leadership strategy and bankruptcy.
Mediating link of productivity between cost leadership strategy and bankruptcy

Model/test

Productivity i1 aStrategy* Control Variables Error

5A

AltmanZ i2 cStrategy* Control Variables Error

5B

AltmanZ i3 c 0 Strategy* bProductivity Control Variables Error

5C

Variable Coefficient estimate t-stat./Z-stat. p-value

Panel A cost leadership

Model 5A
Model 5C
Model 5B
Model 5C
Sobel test results
Bootstrapping results
Panel B differentiation
Model 4A
Model 4C
Model 4B
Model 4C
Sobel test results
Bootstrapping results
Table V.
Mediation analysis

a
b
c
c0
ab
ab

0.0387
1.0736
0.1288
0.0864
0.0415
0.0646

17.00
2.68
3.75
2.32
2.65
5.33

0.0000
0.0074
0.0002
0.0204
0.0081
0.0000

a
b
c
c0
ab
ab

2 0.0593
1.7466
0.2234
0.3210
2 0.1036
2 0.1296

217.65
4.65
3.00
4.24
24.50
26.43

0.0000
0.0000
0.0027
0.0000
0.0000
0.0000

Confidence
intervals
0.5th
99.5th

0.0329

0.0956

2 0.0819 2 0.1883

Notes: *Strategy is a set of two variables, CostLeadership and Differentiation; in Panel A, Strategy
Cost Leadership and in Panel B, Strategy Differentiation; see Table II for definitions of
CostLeadership and Differentiation

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The Sobel test shows ab to be positive and significant (Z-score 2.65;

p-value 0.01). Moreover, the results from bootstrapping show that zero is not in
the relevant interval for Cost Leadership firms with 99 percentile confidence intervals,
enabling us to conclude that the indirect effect tested above is significantly different
from zero at p , 0.01 (Preacher and Hayes, 2004). Therefore, the mediation results
confirm that productivity acts as a conduit in transmitting the impact of a cost
leadership strategy on to bankruptcy risk. These results confirm our H3.
As discussed earlier, since productivity is not an important characteristic for
achieving differentiation, we do not have an explicit hypothesis for the mediation
effects of productivity on the relationship between differentiation and bankruptcy risk.
Nevertheless, for completeness sake, we conduct a mediation analysis for the
mediating effects of productivity on the link between differentiation and bankruptcy
risk. The results shown in Panel B of Table V show that while ab is negative and
significant, both c and c0 are positive and significant, with c0 . c. The results indicate
that differentiation and differentiation mediated by productivity have opposing effects
on bankruptcy risk of a firm and the overall effect is the combination of two separate
impacts. While pursuit of a differentiation strategy in and of itself serves to lower the
bankruptcy risk (first impact), differentiation has a negative effect on productivity
leading to an increase in bankruptcy risk (second impact). Thus, the second impact
attenuates the effect of the first impact. However, even with that attenuation, the
overall impact of a differentiation strategy is to lower the risk of bankruptcy. While a
detailed analysis on the three way interaction between differentiation, productivity and
bankruptcy risk will be interesting, it is beyond the scope of our study.
5. Conclusion and discussion
Bankruptcy occurs when a firm is unable to meet its obligations and appeals to the
courts for protection from debtors while it reorganizes or liquidates its assets. It is a
very commercially traumatic experience for the firm undergoing bankruptcy as well as
for its stakeholders such as employees, creditors, customers, and suppliers. Therefore,
the study of bankruptcy, the factors that contribute to the risk of bankruptcy, and any
factors that mitigate such risk are important and relevant fields of study.
In this paper we investigate two factors, productivity and firm strategy, and show
how they relate to bankruptcy risk. Productivity is the proficiency with which an entity
can convert inputs into outputs. Using DEA to measure productivity and the Altman Z
score to proxy for bankruptcy risk, we show that bankruptcy risk decreases with an
increase in productivity. Next, we use the methodology specified in Balsam et al. (2011)
to compute proxies for the two generic strategies posited by Porter (1980). Using publicly
available data, we show that as firms successfully implement these strategies, their
bankruptcy risk reduces. Finally, we show that for a firm following a cost leadership
strategy, part of the relationship between strategy and bankruptcy risk is mediated by
productivity. To the best of our knowledge, this is the first paper to highlight the link
between productivity, firm strategy and bankruptcy risk, and the mediation effects of
productivity on the link between a cost leadership strategy and bankruptcy risk.
Thereby we put forth a three-fold contribution to the body of knowledge on bankruptcy.
Our study is of importance to external stakeholders of a firm such as shareholders,
lenders, investors and also to internal stakeholders such as managers and firm
strategists. All these stakeholders are interested in analyzing the bankruptcy risk of

Bankruptcy risk
and productivity

323

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324

a particular firm. Hence different ways in which current productivity and firm strategy
impact bankruptcy risk will be of importance to external stakeholders such as lenders
and investors to evaluate the bankruptcy risk of such a firm. Internal stakeholders
(managers and management consultants) will find this study expedient by using
productivity enhancements and effective strategy implementation to mitigate
bankruptcy risk.
One extension of this study is to develop a strong theoretical explanation for the
observed interactions between differentiation and productivity on bankruptcy risk.
Although prior research, namely Chang et al. (2012) has shown that productivity is not
an important characteristic for firms pursuing differentiation, our findings indicate
that differentiation (in fact both cost leadership and differentiation) and productivity
are associated in reducing bankruptcy risk. Future research could focus on addressing
the three-way relationship between productivity, differentiation and bankruptcy risk;
this would provide further insights for stakeholders of firms that pursue a
differentiation strategy.
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Corresponding author
Guy Dinesh Fernando can be contacted at: gfernando@albany.edu

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