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1. Introduction
Bankruptcy is defined as a legal term where business operations are terminated under the specific legal framework. Prediction of this utmost adversity remained a hot topic among researchers, especially after the seminal work of Altman (1968). The early literature of corporate failure emphases to forecast the ex post event of legal bankruptcy (Altman, 1968; Barniv et al., 1997; Ohlson, 1980). However, these studies are criticized due to their contextual application (Pindado et al., 2008), sample bias (Balcaen and Ooghe, 2006) and ex post approach (Opoku et al., 2015) that fails to provide early and noisy warning of failure. Therefore, later studies tried to develop early identification model of financially troubled firms for some specific investigation purposes (Campbell et al., 2011; Gulsun and Umit, 2010).
These studies used the term “financial distress” to express financially troubled firms and defined it as a mediator between the financial soundness and bankruptcy. Purnanandam (2008) argued that financial distress is a state where firms do not have enough proceeds to pay their financial obligations while at the maturity they become insolvent. When creditors take legal action then the court may officially declare default firm as bankrupt. In other words, financial distress is a leading indicator of failure and provides the early signal of expected bankruptcy. Therefore, later studies shifted their focus to financial distress from bankruptcy to develop ex ante early warning system.
Sun et al. (2014) further recommended that future studies should not define financial distress using a single criterion. They argued that financial distress should be segregated by the degree of adversity such as mild, intermediate and severe financial distress. Prediction of such adversity-based financial distress will help the stakeholder to take remedial measures more accurately. Very few studies applied multi-stage approach to define financial distress (Tsai, 2013; Turetsky and McEwen, 2001). For instance, Turetsky and McEwen (2001) proposed that the process of distress starts from dividend reduction and turns into technical default and then to trouble debt restructuring. Similarly, Tsai (2013) differentiated between slight financial distress, reorganization, and bankruptcy.
The limited literature of multi-stage financial distress provides less information about the empirical measurements and dynamic transition of different stages of financial distress. This research intends to explain the dynamic nature of...