Financial Distress in Small and Medium-Sized Enterprises in Jamaica: A Note

By Rhodd, Rupert; Lawrence, William et al. | Indian Journal of Economics and Business, June 2005 | Go to article overview

Financial Distress in Small and Medium-Sized Enterprises in Jamaica: A Note


Rhodd, Rupert, Lawrence, William, Scott, Gerald, Indian Journal of Economics and Business


Abstract

Financial distress is a global phenomenon of paramount importance to small enterprises in small open economies such as those of the Caribbean. However, the debate on the causes of financial distress has not reached a consensus as the literature presents conflicting perspectives on the sources of this adversity. Attempting to resolve the dilemma, this study explores the association between financial distress, macroeconomic conditions and firm-specific factors at publicly listed small and medium-sized enterprises in Jamaica. The major finding of our study is that, for small enterprises operating with a non-tradable currency in a small open economy, financial distress arises from a combination of firm-specific and macroeconomic factors. The implications from this study are (1) managers should exploit operating efficiency in place of debt as a primary source of finance (2) managers should take deliberate actions to avert the adverse effects of currency devaluation and interest rate volatility, and (3) national policymakers should adopt profitability as a key criterion for selecting strategic industries.

Introduction

Cash deficiency is a major reason for business failure in any country [Al-Shaikh (1998)]. With limited sources of funding for business development and operation in developing countries, managers are forced to pay great attention to their firm's cash flow. In this era of globalisation and volatile prices, managers need to intensify efforts to avert financial distress.

Researchers hold conflicting views on the reasons for financial distress. Some propose that macroeconomic conditions are main determinants of financial distress for small and medium-sized enterprises in Latin America and the Caribbean [Peres and Stumpo (2000)]. Others underscore firm-specific factors as paths to success [Honig (1998); and Huck and McEwen (1991)].

The conflicting views on financial distress might be attributed to the paucity of systematic evidence, and research is yet to explore whether these two views complement rather than contradict each other. Nonetheless, this issue must be resolved because financial distress destroys business investment and causes creditors to act in ways that can be detrimental to firms. From a Caribbean perspective, there is a fundamental question for research. For small enterprises operating with a non tradable currency in a small open economy, it is important to determine if financial distress arises primarily from firm-specific factors or macroeconomic factors.

In this research we assume that financial distress is a separate phenomenon from related issues such as organizational decline and bankruptcy. More specifically, the distressed firm is at the latter stages of organizational decline but has not filed a bankruptcy petition nor contemplated asset liquidation.

This study explores the sources of financial distress at small and medium-sized enterprises in Jamaica. This country was chosen because it is a critical, stable and important player in the Caribbean Basin [Walsh (1998)]. The research uses a sample of firms listed on the Jamaica Stock Exchange.

Theoretical Foundation

Financial distress refers to the inability of the firm to pay current obligations on the dates they are due [Baldwin and Mason (1983)]. Any enterprise is susceptible to financial distress if it has frequent cash shortages and few revenue streams. Therefore, small enterprises are more likely to experience financial distress. Companies facing insolvency often liquidate assets to settle debts [Wruck (1990)]. However, small enterprises have few assets to sell and tend to fall victim to secured creditors who focus on debt collection to the detriment of the firm [Gopinath (1995)].

Several streams of research have explored financial distress. The literature on organizational decline describes this phenomenon in terms of a loss of slack or the surplus resources that cushion the firm against environmental jolts. …

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