1. Financial Distress Announcement, Transaction Mode Change, and Aggregate Shareholder Wealth ： Empirical Evidence from TAIEX-Listed Companies Gili Yen University Professor Department of Business Administration Chaoyang University of Technology and Jian-fa Li Assistant Professor Department of Finance Chaoyang University of Technology

2. Presentation Outlines 1. Research motive, research objective & structure of the paper 2. Definition of financial distress costs 3. Establishment of hypotheses 4. Test statistics 5. Empirical findings from raw returns 6. Conclusions

3. 1. Research motive, research objective & structure of the paper (1/2)  Why is the estimation of the financial distress costs of importance? ◆ Because debt-financing is double-edged: 1. in company with a larger amount of debt financing, the interest payments deductible from taxes becomes larger, hence, here comes in the tax shield effect. 2. in company with a larger amount of debt financing, the default risk of unable to pay principal and interest payments due become larger, hence, here comes in the possibility of financial distress, or even, bankruptcy.

4. 1. Research motive, research objective & structure of the paper (2/2)  Why is a correct estimation of the financial distress costs of importance? ◆ An underestimation of financial distress costs ◆ An overestimation of financial distress costs ◆ It can be clearly seen that a correct estimation of the sub-amount of each component as well as the total amount of financial distress costs is crucial to a sound business management. will mislead the decision makers in pursuing too aggressive an external financial strategy which in turn will enhance the occurrence of financial distress. will mislead the decision-makers in adopting too conservative an external financial strategy which in turn will suppress earnings than it could be achieved otherwise

5.  During late 1980s, researchers make use of highly leveraged companies which encounter debt default and file for bankruptcy, the literature suggest conceptually financial distress cost as the sum of: 3. The cost of filing for bankruptcy 1. The cost of reducing profitable investment expenditures 2. The loss of selling assets at the deteriorating price 2. Definition of financial distress costs(1/2)

6.  During Andrade & Kaplan (1998) operationally define financial distress cost  In the present study, the term “financial distress costs” would be therefore defined as as change in total value of assets during the period of two months prior to highly leveraged transactions to the end of financial distress. average percentage decrease in stock price during the period from the date of reporting financial distress to 20 transaction days after the date of changing transaction mode, relative to the average stock prices of the base period. 2. Definition of financial distress costs(2/2)

7. 3. Establishment of hypotheses(1/6)  Estimates of Financial Distress Cost for Entire Sample ◆ Three observed sub-periods are formed:  Accordingly, we estimate the average percentage change in stock price for the three sub-periods relative to the average stock prices of the base period. (The audience are asked to refer to hypotheses appearing on pp. 5-6.) 3. the period between the date of changing transaction mode and 20 transaction days after the date of changing transaction mode. 1. the period of the neighborhood of reporting financial distress 2. the period between the date of reporting financial distress and the date of changing transaction mode

8. 3. Establishment of hypotheses(2/6)  Hypothesis 1:  H 0 1 ： The average percentage reduction in the stock price for the financially distressed companies during the entire observation period (three sub-periods) is equal to zero when compared with the arithmetic stock price of various base periods.  H 1 1 ： The average percentage reduction in the stock price for the financially distressed companies during the entire observation period (three sub-periods) is larger than zero when compared with the arithmetic stock price of various base periods.

9. 3. Establishment of hypotheses(3)  Estimates of Financial Distress Cost from Paired Comparisons among Three Groups ◆ On the basis of different transaction modes of sample companies, we classify the financially distressed companies into three mutually exclusive groups: ◆ Then, we calculate the average stock price during the period from the date of changing transaction mode to 20 transaction days after that date relative to the average stock prices in the various base periods. (The audience are asked to refer to hypotheses appearing on pp. 6-7.) 3. “delisting”. 1. “maintaining normal trading” 2. “cash transaction only/suspended trading”

10. 3. Establishment of hypotheses(4/6)  Hypothesis 2:  H 0 2 ： The average percentage reduction in the stock price for the group of “cash transaction only/suspended trading” upon the date of changing transaction mode up to the 20th transaction day after the change is equal to the average percentage reduction in the stock price for the group of “maintaining normal trading” during the same period.  H 1 2 ： The average percentage reduction in the stock price for the group of “cash transaction only/suspended trading” upon the date of changing transaction mode up to the 20th transaction day after the change is greater than the average percentage reduction in the stock price for the group of “maintaining normal trading” during the same period.

11. 3. Establishment of hypotheses(5/6)  Hypothesis 3:  H0 H 0 3 ： The average percentage reduction in the stock price for the group of “delisting” upon the date of changing transaction mode up to the 20th transaction day after the change is equal to the average percentage reduction in the stock price for the group of “maintaining normal trading” during the same period.  H 1 3 ： The average percentage reduction in the stock price for the group of “delisting” upon the date of changing transaction mode up to the 20th transaction day after the change is greater than the average percentage reduction in the stock price for the group of “maintaining normal trading” during the same period.

12. 3. Establishment of hypotheses(6/6)  Hypothesis 4:  H04 H 0 4 ： The average percentage reduction in the stock price for the group of “delisting” upon the date of changing transaction mode up to the 20th transaction day after the change is equal to the average percentage reduction in the stock price for the group of “cash transaction only/suspended trading” during the same period.  H14 H 1 4 ： The average percentage reduction in the stock price for the group of “delisting” upon the date of changing transaction mode up to the 20th transaction day after the change is greater than the average percentage reduction in the stock price for the group of “cash transaction only/suspended trading” during the same period.

13. 4. Test statistic (1/2)  Test statistic for the entire sample where is the actual average percentage change in stock price, while is the expected average percentage change in stock price in the observation period (assumed to be zero). n 1 denotes the entire sample companies and 2n 1 -2 is degree of freedom.

14. 4. Test statistic (2/2)  Test statistic for the paired comparisons where and denotes average percentage change in stock price in the observation period of those two paired groups, respectively. n 1, n 2 are sample size of those two groups under the paired comparison. The degree of freedom is n 1 + n 2 – 2.

15. 5. Empirical findings: Estimates of Financial Distress Cost for the Entire Sample(1/5)  Figure 1 Trend of Average Percentage Change in Stock Price for the Entire Sample Covering the Period from the Announcement of Financial Distress up to 20 Transaction Days after the Date of Changing Transaction mode

16. Table 4 Average Percentage Change in stock Price for the Entire Sample during the Period from the Date of Reporting Financial Distress to 20 Transaction Days after the Date of Changing Transaction Mode A base period covering one year prior to the date of reporting financial distress A base period covering half a year prior the date of reporting financial distress A base period covering one quarter prior the date of reporting financial distress A base period covering one month prior the date of reporting financial distress Date average percentage change in stock price t statistic average percentage change in stock price t statistic average percentage change in stock price t statistic average percentage change in stock price t statistic A-1-34.40%-11.18-23.40%-6.80-16.93%-6.08-11.20%-6.72 A-36.50%-11.89-25.87%-7.43-19.78%-6.95-14.39%-8.18 A+1-38.25%-12.04-27.16%-7.40-21.11%-7.15-15.98%-8.91 C-51.98%-12.46-44.05%-9.86-39.43%-8.28-35.03%-7.43 C+20-62.99%-14.67-56.75%-11.70-53.44%-10.95-50.81%-10.77 Notes: 1. Date A is the date of reporting financial distress, and Date C is the date of changing transaction mode. 2. The t-statistics are statistically significant at 0.01 significance level Data source: this study

17.  The primary empirical findings are as follows: Concerning the first research issue  As expected, the financially distressed companies are experiencing a continuous deterioration, of which the magnitude in the reduction of shareholders’ wealth has all reached statistical significance in three observed sub-periods. 5. Empirical findings: Estimates of Financial Distress Cost for the Entire Sample for the entire sample, this study finds that the financially distressed companies during the period from the date of reporting financial distress in the press up to 20 transaction days after the date of changing transaction mode have registered a huge reduction in stock price.

18. Table5 Average Percentage Changes in Stock Price of Cash Transaction Only/Suspended Trading and Maintaining Normal Trading Date Average percentage change in stock price for group of cash transaction only/suspended trading Average percentage change in stock price for group of maintaining normal trading Difference in average percentage change in stock price of these two groups right hand side t statistic Panel A ： A base period covering one year prior to the date of reporting financial distress C-59.89%-27.61%-32.28%-2.68 *** C+20-76.95%-27.94%-49.01%-4.25 *** Panel B ： A base period covering half a year prior to the date of reporting financial distress C-53.00%-16.51%-36.49%-2.71 *** C+20-72.74%-16.58%-56.16%-4.35 *** Panel C ： A base period covering one quarter prior to the date of reporting financial distress C-49.20%-9.72%-39.48%-3.01 *** C+20-70.56%-10.42%-60.14%-4.83 *** Panel D ： A base period covering one month prior to the date of reporting financial distress C-44.94%-5.45%-39.49%-3.20 *** C+20-68.26%-6.95%-61.31%-5.48 *** Notes ： 1. Date C is the date of changing transaction mode. 2. “***” indicates t statistic are significant at 0.01 significance level. 3. Data source: this study

19.  Again, as expected, different types of financially distressed companies are associated with different degree of financial deterioration, of which the differences in magnitude in the reduction of shareholders’ wealth arising from paired comparisons have all reached statistical significance. 5. Empirical findings: Estimates of Financial Distress Cost Paired Comparisons among Three Groups(5/5) the present study finds that the financial distress costs of the “delisting” group are largest, the financial distress costs of the “maintaining normal trading” group are lowest, and those of “cash transaction only/suspended trading” group fall somewhere in between.

20.  This study covers two principal research issues: 6. Conclusions(1/3) First, the present study employs stock prices for TAIEX-listed financially distressed companies to estimate financial distress costs. Second, in Taiwan, besides “ maintaining normal trading ”, the Securities and Futures Commission, Ministry of Finance is empowered to decide the modes of transaction for financially distressed companies including “cash transaction only”, “suspended trading ”, and “ delisting ” which allows us to further estimate financial distress costs under different categories.

21.  After collecting 104 TAIEX-listed financially distressed companies, the primary empirical findings are as follows: 6. Conclusions (2/3) Concerning the first research issue, for the entire sample, this study finds that the financially distressed companies during the period from the date of reporting financial distress in the press to 20 transaction days after the date of changing transaction mode have registered a huge reduction in stock price.

22.  As expected, the financially distressed companies are experiencing a continuous deterioration in the aggregate shareholder wealth of which the magnitude has reached statistical significance.  Concerning the second research issue  Again, as expected, different types of financially distressed companies are associated with different degree of financial deterioration of which the paired differences in the financial distress costs have all reached statistical significance. We have good reasons of thinking that the financial distress cost is substantially underreported in the literature because of underestimating reduction in asset value. 6. Conclusions(3/3) the major findings are as follows: the present study finds that the financial distress costs of the “delisting” group are largest, the financial distress costs of the “maintaining normal trading” group are lowest, and those of “cash transaction only/suspended trading” group fall somewhere in between.

23. That is all, folks. Thank you for your attention.