Corporate governance is an important determinant of corporate performance. Poor corporate governance can damage the interests of shareholders, and may lead to business collapse. This paper expands the literature on credit risk management by assessing the effectiveness of aspects of corporate governance for predicting financial distress in a dynamic discrete-time survival analysis model. It is a comprehensive, up-to-date and thorough study, which uses a large range of corporate governance measures, financial ratios and macroeconomic variables in a panel data structure over a 17-year period. Furthermore, the paper addresses the relationship between government ownership and the risk of financial distress in China. The results suggest that although corporate governance alone is not sufficient to accurately predict financial distress, it can add to the predictive power of financial ratios and macroeconomic factors. In addition, the model provides insights into the role of state ownership, independent directors, institutional investors and some personal characteristics of the Chair of the board. Implications are made regarding them and the debt and bankruptcy problem in China and Asia.

Introduction

Predicting corporate bankruptcy or financial distress has been a vibrant topic in banking, business and finance because of its importance to creditors such as banks. For corporate debtors, management quality is a key factor in their performance. A firm’s bankruptcy or financial performance will affect investments and debt repayments, and therefore needs to be accurately predicted. It is not surprising that this topic has received a lot of attention in academic and practical work. Risk-taking decisions of creditors will depend on their ability to analyze or predict the risk involved. There is a vast body of literature on bankruptcy prediction models that can be classified into accounting based models using financial ratios (e.g. Altman (1968) and Bonfim (2009)) and market based models using share prices (e.g. Milne (2014) and Campbell et al. (2008)) respectively. Corporate governance measures are less common in bankruptcy prediction literature, as they do not represent hard information such as financial ratios, but rather soft information, although behaviors such as default on debt, financial distress and bankruptcy have been found to be linked to corporate governance (see e.g. Daily et al. (2003)). The research which aims to understand the role of corporate governance and subsequent company performance is summarized in the next section of this paper.