Determinants of Financial Distress: The Case of Government-Linked Companies in Malaysia

Abstract

This study examined the relationship between financial distress level and liquidity, profitability and leverage for the 30 Government-Linked Companies (GLCs) in Malaysia using financial data for the period of 2016 until 2020. Financial distress level is measured using Altman Z-score, while liquidity, profitability and leverage are proxied by current ratio, return on assets (ROA) and debt ratio, respectively. Total assets, representing company size, is also included as a control variable. Panel regression analysis was conducted using Eviews 13.0. The findings revealed that all three independent variables are significantly related to Altman Z-score, with the hypothesized relationships, supporting the theory and also previous empirical studies. This further reinforces the importance of profitability, liquidity and leverage in ensuring that a company does not experience financial distress. About three-quarter of the GLCs are in financial distress, as evidenced by the Altman Z-score of below 1.81, and it is recommended that the government take prudent measures to improve their financial conditions. The negative correlation between ROA and debt ratio suggests that optimal capital structure does not exist because the marginal increase in debt level erodes profitability, instead of increasing it through tax benefits. The findings of this study also reinforce the M&M Theory and Trade-off theory in which optimal debt level is imperative in ensuring that a company maximizes its value while at the same time minimizing the risk of financial default. Future studies are recommended to compare the GLCs with other public-listed companies and also to extend the time period.