Determinants of Financial Distress in Manufacturing Firms of Ethiopia

Abstract

It is not uncommon to see manufacturing firms struggling to turnaround from their financial distress.  Debt Service Coverage ratio is presumed to play a role in addressing this problem. With this in mind, the main objective of the study is to investigate the determinants of financial distress of manufacturing firms in Ethiopia for the period from 1999 to 2005. Due to data heterogeneity, non-continuity and because the Hausman test favors it over the Random Effect technique, the panel data General Least Square  (GLS) regression method is used. The result proves that liquidity, profitability, and efficiency have positive and significant influence on debt service coverage.  On contrary, leverage has negative and significant influence on Debt Service coverage.To save infant manufacturing firms, policy makers have the opportunity to influence the financing policy of the firms in the promotion of equity financing by controlling leverage. Banks should supervise the liquidity, solvency, profitability and efficiency of firms in mitigating the debt burden through application of various techniques during loan evaluation process. The appropriate firm executives should consider improving efficiency of firm’s performance through retrenchment of assets and replacing, liquidity through improving cash collection, profitability through replacement of departments, products or lines of the business. FD have a negative impact on DSC and leading firms to bankruptcy and liquidation and can cause economic, social and political impact on manufacturing firms and contribute to the CEO resignation, employee’s layoff or loss of jobs, dividend reduction, plant closing and related consequential health and moral distress.

Keywords: Financial Distress, Debt Service Coverage, Ethiopia