A Competing Risks Analysis of Corporate Survival

A Competing Risks Analysis of Corporate SurvivalAuthor(s): Qing He, Terence Tai-Leung Chong, Li Li and Jun ZhangSource: Financial Management, Vol. 39, No. 4 (WINTER 2010), pp. 1697-1718Published by: Wiley on behalf of the Financial Management Association InternationalStable URL: http://www.jstor.org/stable/40963525 .Accessed: 19/06/2014 15:13

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A Competing Risks Analysis of Corporate Survival

Qing He, Terence Tai-Leung Chong, Li Li, and Jun Zhang*

This paper investigates how the characteristics of a Hong Kong-listed firm influence its odds of going bankrupt, being acquired, and going private. A competing risks model is estimated. Our results reveal that larger firms are more vulnerable to bankruptcy, and that fast-growing firms are more likely to be acquired. We also demonstrate that undervaluation is a key driver of going private. Despite the low agency cost due to the concentrated ownership structure, the propensity of Hong Kong-listed firms to go private still increases with the level of free cashflow.

The survival of public firms has attracted increasing academic attention in recent years. Fama and French (2004) demonstrate that although the number of new firms listed on major US stock markets had increased from 156 per year from 1973 to 1979 to 549 per year from 1980 to 2001, over two-fifths (44.1%) were delisted within 10 years. A good number of studies have attempted to infer the relationship between the fundamentals of a listed firm and its survival. The characteristics of delisted firms are likely to differ from one another. Firms that are targets of merger and acquisition tend to be smaller in size (Schwert, 2000). Bankrupt firms generally register lower profitability, slower total assets growth, and poorer financial performance (Platt and Platt, 1990). In contrast, firms going private enjoy reasonable profits and abundant cash flow (Lehn and Poulsen, 1989; Denis, 1992; Opler and Titman, 1993). Most of the previous studies regarding delisting behavior focus on cases in the United States. Our study adds to the literature by investigating the delisting decisions of public firms in Hong Kong, a rising global financial center.12 The cases in Hong Kong are of interest for several reasons. First, unlike their Western counterparts, Hong Kong-listed firms are marked by a unique feature: many of them

We thank Bill Christie (editor) and two anonymous referees for helpful comments. We would also like to thank Hongbin Li, Nan-kuang Chen for helpful comments, and Chi-man Wong, Mansfield Wong, Kun Ma, Daniel Law, and Tsz-hang Siufor able research assistance. All remaining errors are ours. Financial support from the National Social Science Foundation of China (Grant Number 10CGL011) and Key Projects in Philosophy and Social Sciences Research program of the Ministry of Education of the People s Republic of China (Grant Number 08JZD0011) is gratefully acknowledged.

* Qing He is an Assistant Professor in the School of Finance, Renmin University of China, China Financial Policy Research Center, Renmin University of China, Beijing, 100872, China. Terence Tai-Leung Chong is an Associate Professor in the Department of Economics, The Chinese University of Hong Kong, Shatin, N. T., Hong Kong. Li Li is a Graduate Student in the Department of Economics, The Chinese University of Hong Kong, Shatin, N T, Hong Kong. Jun Zhang is an Assistant Professor in the Department of Economics, The Chinese University of Hong Kong, Shatin, NT, Hong Kong.

According to the Rules Governing the Listing of Securities in the Stock Exchange of Hong Kong Ltd. (Stock Exchange of Hong Kong, 2002), the Stock Exchange can delist a company for the following reasons: 1) breach of listing rules, 2) insufficient securities in the hands of the public, 3) insufficient level of operations or assets, 4) business is no longer suitable for listing, and 5) suspension for a prolonged period without actions to restore the listing. These regulations imply that delistings in the Hong Kong stock market can be voluntary (via merger and acquisition or privatization) or involuntary (due to breach of the rules or poor performance). 2In 2007, the Hong Kong stock market ranked fifth in the world, with a total market capitalization of over US$2.124 trillion. Moreover, its warrant market ranks first globally in terms of turnover, followed by Germany and Italy.

Financial Management Winter 2010 pages 1697 - 1718


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1698 Financial Management Winter 201 0

are family businesses where the majority of shares are held directly by a handful of individuals and their family members.3 This highly concentrated ownership structure implies that agency costs arising from the separation of ownership and control are less severe. However, conflicts of interest between the controlling and minority shareholders are likely to arise in this case (Cheung, Rau, and Stouraitis, 2006). Conventional studies, including those of Lehn and Poulsen (1989), Opler and Titman (1993), and Kieschnick (1998) investigate the impact of agency costs and growth prospects on going-private transactions. Other considerations for going private include tax benefits (Kaplan, 1989a; Newbould, Chatfield, and Anderson, 1992) and undervaluation of the share price (Halpern, Kieschnick, and Rotenberg, 1999; Weir, Laing, and Wright, 2005a, 2005b). Because concentrated ownership leads to lower agency costs and also provides entrenched controlling shareholders with an incentive to divert the resources of firms to engage in self-dealing transactions (Claessens, Djankov, and Lang, 2000; Morck, Yeung, and Yu, 2000; Fan and Wong, 2002), conventional agency cost explanations for going-private transactions may not apply to Hong Kong in the presence of the managerial entrenchment effect, thus allowing this case to contribute to the existing literature.4 Second, because of this special ownership structure, hostile takeovers are likewise less likely to occur, making Hong Kong an ideal case for testing whether friendly takeovers are intended to create wealth through synergies (Lambrecht and Myers, 2007).5 Moreover, as small cap corporations dominate in Hong Kong, our study also differs from the others in that we focus on the delisting behavior of these firms.6 Finally, as the governance and disclosure regulations in Hong Kong are influenced by the United Kingdom, our results can be compared with those of the United Kingdom and the United States.7

Previous studies tend to separately investigate the decision to go bankrupt, go private, or to be acquired. Very few of them have examined the different types of exits (Agarwal and Audretsch, 2001). Because different forms of exits have different causes and consequences, the use of pooled data to investigate the delisting behavior of firms may provide misleading results. This paper contributes to the literature by employing an advanced econometric methodology to investigate the determinants of different forms of exits in a unified setting. A competing risks model is developed to analyze the determinants of the life span of listed firms under different forms of exits. The model can account for the censoring problem and allow the delisting probability to depend on its listing duration.8 Moreover, it enables analysis of the impact of different time- dependent variables on the probability of stock market delisting.

Results of this study suggest that financial characteristics continue to influence whether a firm is acquired, goes private, or goes bankrupt. In particular, bankrupt firms are observed to

3 Claessens, Djankov, and Lang (2000) report that merely 0.6% of public listed companies in Hong Kong are widely held. 4 We thank a referee for pointing this out. 5 Rossi and Volpin (2004) find that the number of attempted hostile takeovers merely account for 0.41% of the total publicly traded companies from 1990 to 2002. 6Kotewall and Kwong (2002) report that as of May 2002, approximately 73% of Hong Kong stocks are traded below US $0.2 compared with 20% in London and Taiwan, below 1% in Tokyo and Korea, and none in New York.

7The Stock Exchange of Hong Kong (HKEx) was established in 1980 by unifying four separate exchanges. It commenced trading in 1986. Before unification, each exchange had its own listing rules and trading polices making information disclosure and government supervision difficult. The HKEx has developed rapidly over the last two decades, and a series of listing regulations has been adopted to protect investors' interests. An example is the "Code on Takeovers and Mergers" revised in 1981. The Securities (Stock Exchange Listing) rules commenced in 1986, and "The Securities and Futures Commission Ordinance" came into effect in 1989. As the framework of governing the listing of securities was established when Hong Kong was a colony of the United Kingdom, it shares a number of similarities with UK rules. 8 Previous studies have employed a logistic regression approach, which may produce biased estimates due to data censoring (Efron, 1977).



He et al. * A Competing Risks Analysis of Corporate Survival 1699

underperform relative to the market, whereas firms in the process of acquisition outperform the market before delisting agreeing with the findings of Lambrecht and Myers (2007). However, owing to the unique features of the Hong Kong stock market, larger firms are observed to take the path to privatization or insolvency. This is contrary to the observations of Platt and Platt (1990) and Shumway (2001).

As a majority of publicly listed firms in Hong Kong exit the market by going private, particular emphasis is placed on the factors motivating these public-to-private (PTP) transactions.9 Our results reveal that firms going private are significantly undervalued. Their shares normally trade below the fair value before going private, which is consistent with the findings of Halpern, Kieschnick, and Rotenberg (1999) and Weir, Laing, and Wright (2005b). Moreover, firms with strong profitability and greater asset growth rates are more likely to go private. This is inconsistent with the observations of Lehn and Poulsen (1989), Halpern, Kieschnick, and Rotenberg (1999), and Weir, Laing, and Wright (2005a, 2005b). It is also found that privatized firms are financially healthier and have a higher level of free cash flow. Given the concentrated ownership structure, the controlling shareholders are capable of using the free cash flow to engage in a variety of self-dealing transactions. In particular, when they perceive that the shares are significantly undervalued, entrenched controlling shareholders may use the free cash flow to privatize the firm at the expense of minority shareholders. We also demonstrate that tax benefit is not a major consideration for those firms going private in agreement with the findings of Weir, Laing, and Wright (2005a).

The remainder of this paper is structured as follows. Section I provides the literature review and develops some testable hypotheses. Section II introduces the competing risks model. Section III describes the data and variables of interest. Section IV reports the estimation results and different CRM models are estimated to provide a detailed picture of the relationship between profitability and the survival rate under the three different exits. Section V provides our conclusions.

I. Literature Review and Hypotheses

A. Bankruptcy

Various studies have endeavored to identify the causes of corporate bankruptcy. Izan (1984) shows that the interest coverage and market value of equity/total liabilities are negatively correlated with the odds of corporate bankruptcy. Platt and Platt (1990) demonstrate that the likelihood of going bankrupt increases with the leverage level and capital intensity, but decreases with the liquidity level and growth prospect of a firm. Siegfried and Evans (1994) and Caves (1998) provide a review of prior literature. Shumway (2001) finds that market variables are more useful than financial ratios in predicting bankruptcy. The smaller the firm size and stock return, the greater the chance for the firm to go bankrupt. Aziz and Dar (2003) argue that the probability of a firm to go bust decreases with its size. More recently, Li (2007) argues that the odds of going bankrupt increases with the level of restrictions imposed on corporate internal control.

The majority of the aforementioned bankruptcy predictors clearly indicate that weak firms are naturally predisposed to go bust. Following the literature, financial variables such as growth, profitability, and firm size are employed in this paper to predict the bankruptcy probability. We expect that weak firms in Hong Kong are also more likely to go bust. Therefore, the following hypothesis is proposed:

9From 1986 to 2001, 48.32% of Hong Kong firms were delisted due to privatization, 29.21% due to M&A, and 22.47% due to bankruptcy.



1700 Financial Management * Winter 2010

Hypothesis 1 : The likelihood of going bankrupt is higher for firms experiencing financial distress, poor growth prospects, and worsening profitability.

As small cap corporations dominate in Hong Kong, we predict that firms with a relatively larger size may have a greater chance to go bust. Compared with small cap, family-run firms, relatively large-scale firms in Hong Kong are generally more capable of raising their leverage ratios by borrowing. As such, they are more likely to be insolvent during an economic recession. To confirm this, we test the following hypothesis:

Hypothesis 2: The likelihood of a firm to go bankrupt increases with its size.

B. Merger and Acquisition (M&A)

A number of studies have developed models to predict the odds of corporate acquisition (Morck, Shleifer, and Vishny, 1988; Ambrose and Megginson, 1 992; Comment and Schwert, 1 995). Clarke and Ioannidis (1996) posit that acquisition activity is positively related to aggregate share price levels. Powell (1997) provides a review of the acquisitions literature. Schwert (2000) offers evidence that firm size negatively influences the chances of acquisition. Jovanovic and Rousseau (2002) confirm that firms with a low Tobin 's Q are more likely to be acquired. Shleifer and Vishny (2003) suggest that the volume of stock acquisition increases with the dispersion of valuations across firms. Hietaia, Kaplan, and Robinson (2003) analyze the stock price information revealed around takeover contests and find no significant effect on M&A. Thus far, there is no general agreement regarding the determinants of acquisition (Goktan, Kieschnick, and Moussawi, 2009).

Recently, Lambrecht and Myers (2007) argue that friendly takeovers create wealth through synergies. The targets are likely to be better firms with growth potential. Hostile takeovers, however, aim to disinvest the targets, as a majority of them are poorly governed and tend to expend cash flow on value-dissipating investments. Due to the highly concentrated ownership of Hong Kong firms, only a small proportion of takeovers are hostile. We predict that growing firms with higher market valuations are more likely to be the targets of acquisition. Thus, the following hypotheses are proposed:

Hypothesis 3: The likelihood of acquisition increases with Tobin' Q and stock market performance.

Hypothesis 4: Fast-growing firms are more likely to be acquired.

C. Privatization

Privatization has long been used as a mechanism for restructuring deficient corporations. Jensen (1986) points out that agency conflicts stemming from the separation of ownership and control are more prevalent in low-growth firms with substantial cash flow. Privatization can prevent free cash from being funneled into value dissipating investments.10

Prior studies on the free cash flow hypothesis have obtained mixed results. Lehn and Poulsen (1989), Denis (1992), and Opler and Titman (1993) support the free cash flow hypothesis, while Servaes (1994) and Kieschnick (1998) argue that it cannot explain public firms' decisions to go private. Weir and Laing (2002) and Weir, Laing, and Wright (2005a) investigate the United Kingdom and find no evidence of excess free cash flow in firms going private.

10Lehn and Poulsen (1989) and Lee et al. (1992) report that significant premiums are paid to shareholders of firms that went private.



He et al. A Competing Risks Analysis of Corporate Survival 1701

Owing to a highly concentrated ownership structure, agency problems between ownership and control are less severe in Hong Kong firms. Alternatively, conflicts of interest between entrenched controlling and minority shareholders are more likely to arise. Different from Jensen (1986), the concentrated ownership enables the entrenched controlling shareholders to engage in self-dealing transactions and divert firm resources at the expense of minority shareholders (Claessens, Djankov, and Lang, 2000; Morck, Yeung, and Yu, 2000; Fan and Wong, 2002). In particular, they can use the cash flow to privatize the firm when the cost of freezing out minority shareholders is low.11 Thus, we expect that the more financial resources a firm has, the more it is likely to go private. We propose the following:

Hypothesis 5: The likelihood of a firm going private increases with the amount of free cash flow and its level of financial health.

However, the controlling shareholders may not realize the benefits of going private unless they can buy the corporation at low prices. Halpern, Kieschnick, and Rotenberg (1999) and Weir, Laing, and Wright (2005b) identify evidence that corporations going private underperform relative to the market prior to privatization, and their market-to-book ratios remain low. This suggests that managers will privatize the firm when the shares are trading below fair value. Therefore, the following hypothesis is put forward:

Hypothesis 6: The likelihood of a firm to go private decreases with Tobin' Q and stock performance.

Recently, Mehran and Peristiani (2010) examine the characteristics of firms going private at initial public offering (IPO) and over their public life, and argue that firms with falling institutional ownership and low turnover rate are less likely to benefit from the stock market and are more likely to go private. We expect that the diminishing benefit of remaining public may likewise influence the decision to go private. The following hypothesis for going private is thus proposed:

Hypothesis 7: The likelihood of going private decreases with the trading activity of the firm.

Other considerations for going private include tax reduction (Kaplan, 1989b; Newbould, Chat- field, and Anderson, 1992). With a subdued tax environment (16.5% for profit tax), we conjecture that firms in Hong Kong are unlikely to go private for tax benefits.

D. Competing Risks Models

A growing body of literature has examined exit hazards in the context of competing risks models. For example, Wheelock and Wilson (2000) estimate competing risks hazard regression models for failure and acquisition, identifying characteristics that trigger either the failure or acquisition of individual US banks. Dickerson, Gibson, and Tsakalotos (2003) conduct a competing risks analysis of acquisition activity in the United Kingdom. Powell and Yawson (2007) demonstrate that ignoring competing risks can lead to estimation bias. Goktan, Kieschnick, and Moussawi (2009), meanwhile, employ a discrete time hazard model with competing risks to explore how the corporate governance of a firm affects its survival. In this paper, the risks of going private, bankruptcy, and M&A are incorporated in a unified framework. A competing risks model is developed, in which the hazard rates of these three mutually exclusive risks are codetermined

11 For example, the controlling shareholders of Shaw Holdings, Inc. use internal cash flow to take the corporation private at a low price (Hong Kong Exchanges and Clearing Limited, privatization announcement, 2008).



1702 Financial Management Winter 2010

by firm-level factors.12 The model allows for the assessment of the impact of different time dependent variables on the probability of different exits. Using the competing risks framework, one can also examine how the duration of the listing is related to the odds of different forms of exits.

II. Research Methodology

Suppose that firm / can exit the public market via bankruptcy, M&A, or privatization. The time to exit tj and the exiting route y are observed, where y = 1 corresponds to the case of bankruptcy, y = 2 corresponds to the case of acquisition, and j = 3 corresponds to the case of privatization. For each type of risk, there is a latent duration 7), which is the time elapsed before the spell ends via route y in the absence of any other risks. This, in turn, may cause the spell to end before this time. Thus, the actual exit time and exit mode can be interpreted as the realizations of random variables T and /, which are defined as follows:

T = mm(TjJ = 1,2,3)

J = argmin,(7),7 = 1,2,3).

At each point in time, the hazard function for risky is

i /a r hm Pr( 3)' (3)

where kOj is the baseline hazard function specific to type y hazard at time t, xjt{t) is a vector of time-dependent covariates for firm / specific to type y hazard at time t, and j is the vector of

12 Very few studies have analyzed these three forms of exits in a unified setting. A notable exception is Gompers, Ishii, and Metrick (2003) who find that firms where managers are in greater control are more likely to go private and are less

likely to be acquired or go bankrupt.




unknown regression parameters to be estimated. The partial likelihood function for each specific hazard y is given by

/efi(r,7)

where #, refers to the number of firms in specific hazard j, and tj' < < tj denotes the k ordered failures of hazard j. R(tj) = {/ 1 ti > tjt] is the set of firms that have not exited the

security market at time tj. The likelihood function for Cox CRM is13

lR(ji)

To incorporate the unobserved heterogeneity, we include a multiplicative term v into the Cox CRM. Equation (3) can be rewritten as

kji{t | X; (i), j) = koj(t) GVlx'jiWrfVji , (6)

where Vjt is the denotation of risk specific and unobserved individual effects. It is assumed that the unobserved heterogeneity follows a Gamma distribution with unit mean and variance theta, and it is independent of the observed characteristics.

III. Data and Variables

A. Data Description

The data on individual listed firms and macroeconomic variables are obtained from the Hong Kong data profile of the Pacific-Basin Capital Markets (PACAP) database. The annual balance sheet and income statement for each firm are extracted from PACAP 's financial statement file, whereas the history and stock performance of individual firms are retrieved from the monthly stock price and returns file.

Security market size and market performance are collected from the key economic statistics file, PACAP's monthly market returns file, and the annual reports of listed firms. The sample consists of all public corporations that are actively traded in the Hong Kong security market at the beginning of 1981; each is followed up to the year that it exited from the public market or until the end of the study period (2001), whichever comes first. Because most of the firms in our sample went public after 1981, these firms can be tracked throughout their entire public life. The sample covers the main expansionary period of the Hong Kong financial market and the financial crises of 1987 and 1997, as well as the period of gradual transition of regulatory and governing policies in the late 1980s.14

13 The model is semi-parametric in the sense that the vector can be estimated without imposing any assumption on the baseline hazard function. l4Both the implementation of the deregulation policy in the late 1980s and the ensuing financial crisis in 1997 have led to an accelerating wave of restructuring and consolidation among existing firms in Hong Kong. This provides a




Table I. Summary Statistics on Listed Firms' Duration

Existing Type Full Sample Bankruptcy M&A Privatized Number of failed firms 89 20 26 43 Number of censored firms 659 Mean of duration 9.9773 8 9.3462 10.1861 Median of duration 9 7 8.5 10 Minimum duration 3 3 3 3 Maximum duration 20 20 19 20 Std 6.0439 3.7975 3.8879 3.8313

Table II. Annual Summary Statistics on the Number of Delisted Firms

Year Total Bankruptcy M&A Privatized 1986 6 14 1 1987 5 3 2 0 1988 6 14 1 1989 11 2 1 8 1990 11 0 4 7 1991 2 0 0 2 1992 6 2 0 4 1993 10 10 1994 10 10 1995 10 1 3 6 1996 4 112 1997 4 0 13 1998 5 13 1 1999 5 2 0 3 2000 4 2 11 2001 8 4 0 4 Sum 89 20 26 43

In this study, the date of exit is defined as the official announcement date of the delisting process instead of the actual delisting date.15 To explore the delisting pattern further, exits are classified into three types: 1) bankruptcy, 2) M&A, and 3) privatization. After dropping the firms without complete accounting information, the final sample has a total of 748 firms. Table I provides the summary statistics of the durations for different types of exiting firms.

It should be noted from Table I that during the sample period from 1981 to 2001, the shares of 748 firms were being trading in the Hong Kong security market, 89 of which left the market for various reasons. It should also be noted that the mean and median of the firm's survival period are the shortest for firms that go bust, followed by firms being acquired or merged, and firms that go private. Detailed information regarding the distribution of exits for each year is illustrated in Table II.

unique opportunity to observe how listed firms exit the market. Further, there has been a substantial change in the

political environment since the British government handed over Hong Kong's sovereignty to China, which has created an

important impact on delisting decisions. 15 As there is a long-time placement for the stock of any delisting transaction required by the HKEx, the actual reorgani- zation date may provide a misleading and prolonged survival period of delisted firms.




Table III. Survival Distribution Across Industries

Industry Obj. Survival Rate Survival Rate Survival Rate Survival Rates N 2 Years 5 Years 10 Years 15 Years

Utilities 18 1.0000 0.8462 0.6663 0.4760 Properties 129 1.0000 0.9827 0.8726 0.7961 Consolidated 255 1.0000 0.9765 0.8997 0.8163

enterprises Industrials 313 1.0000 0.9848 0.9041 0.8324 Hotels 20 1.0000 1.0000 0.8235 0.6373 Others 13 1.0000 NA 0.5303 0.5303 Total 748 1.0000 0.9793 0.8702 0.7769

Although the stock exchanges unification ordinance was established in 1980, the four stock exchanges remained in operation only until 1986. It should be noted from Table II that during the first three years of HKEx's operation in the stock market with an exclusive right, M&A transactions dominated the stock market. The surge of bankruptcy in 1987 can be traced to the global financial crisis. It should likewise be noted that a number of publicly listed firms were delisted in 1989, 1990, and 1995.16 During the first four years following the handover of Hong Kong to China (1997-2001), the economic environment deteriorated due to the 1997 Asian Financial Crisis and the bursting of the technology bubble in 2000. As a result, a number of firms were delisted from the stock market. Table III reports the survival rates of different industries.

The survival rates are stable across industries, especially in the three main industries (real estate, consolidated, and industrial).17 To examine the general distribution of exits, a preliminary analysis without explanatory variables is conducted using standard nonparametric Kaplan-Meier estimators (Kaplan and Meier, 1958). Figures 1 and 2 illustrate the estimated Kaplan-Meier survival function and hazard function, respectively.

It can be observed from Figures 1 and 2 that there are two periods when public corporations experience a significant decline in their survival rates. One is around the seventh year, and the other is around the fourteenth year. Figure 2 demonstrates that the delisting hazards accelerate after the fifth year. Note that the three forms of exits reflect different survival patterns. The overall survival rate of PTP exits is lower when compared to other exits. It can be observed that the survival rates are quite stable for M&A firms and firms that go bankrupt. Additionally, we can see from Figure 2 that the hazard functions are overlapping. In the initial stage, more firms undergo bankruptcy or merge with other firms. Very few of them opt to go private. However, a rise of PTP transactions is recorded after the eighth year.

16The June 4th incident in 1989 played an important role in delisting transactions from 1989 to 1990. The delisting activities in 1995 were caused by the political reform introduced by Chris Patten, the last governor of Hong Kong, causing considerable annoyance for the Chinese government. Further, the Jardine Matheson Group, the largest conglomerate in Hong Kong, was delisted from the HKEx (Hang Seng Index) in 1994, placing its primary listing in London. This was regarded as a vote of no confidence in the future of Hong Kong. Apart from the Jardine group, a great number of firms likewise relisted in other security markets or went private. 17The financial services industry is not included as the measurements of financial performance in this industry are completely different from those in other industries.




Figure 1. Kaplan-Meier Estimates of Survival Function

Figure 2. Kaplan-Meier Estimates of Hazard Function

B. Covariates

Fama and French (2004) argue that a drop in profitability and a rise in growth rate contribute to the sharp decline in survival rates. Thus, these two covariates are included in the model. Following Fama and French (2004), profitability is defined as the ratio of earnings (before interest, but after

taxes) to total assets and is denoted as E/A, which measures the capacity of a firm's core business to generate earnings.18 The growth of a firm is defined as the growth rate of a firm's assets. Assets acquired via mergers and investments in short-term assets are included. In contrast to Fama and French (2004), Figures 3 and 4 demonstrate that the survival rates are higher for firms with lower profitability as compared to those firms with higher profitability. One possible

18 Following Fama and French (2004), earnings before interest is the income before extraordinary (PACAP Item Ine 10) plus the interest expense (PACAP Item Hkf40) plus income statement deferred taxes (PACAP Item Hkfl7), if available. Asset is PACAP Data Item Bal9.




Figure 3. Survival Function Estimates by Profitability Status

H-Profit denotes the firms whose profitability is higher than the median of the whole sample. L-Profit denotes the group with a lower profitability.

Figure 4. Survival Function Estimates by Growth Status

H-Growth denotes the firms whose growth rate is higher than the median of the whole sample. L-Profit denotes the group with a lower growth rate.

explanation is that the majority of firms leave the stock market voluntarily, especially for going- private transactions.19 As a result, weak firms only account for a small portion of the delisting samples.

Other variables of interest are listed below.

19Firms going bankrupt account for merely 22.5% of the sample.




1 . Free Cash Flow

Free cash flow is cash flow in excess of what is required to fund all positive net present value (NPV) projects (Jensen, 1986). It is calculated as the net operating cash flow adjusted by the equity scale (Lehn and Poulsen, 1989; Gupta and Rosenthal, 1991; McLaughlin, Safieddine, and Vasudevan, 1996). This net operating cash flow is defined as:

CF = Income - Tax - Interests - Dividends,

where Income is the operating income before depreciation, (PACAP Item Inc5), Tax is the total income taxes (PACAP Item Inc7) minus the change in deferred taxes from the previous year to the current year (PACAP Item Hkfl7), Interests is the gross interest expense on short- and long-term debt (PACAP Item Hkf40), and Dividends is the total dollar amount of dividends declared on common stock (PACAP Items Mktl, Mkt2).

CF evaluates posttax cash flow that is not distributed to the security holders either as interest or dividend payment.20 As previously mentioned, given the highly concentrated ownership, controlling shareholders who consider the firm undervalued have every incentive to use free cash flow to privatize the firm. Thus, the amount of free cash flow is expected to be positively associated with the odds of going private, ceteris paribus.

2. Financial Leverage

The previous literature suggests that the use of financial leverage increases the likelihood of bankruptcy (Zmijewski, 1984) but reduces the propensity for acquisition (Palepu, 1986). Further, the underutilization of leverage increases the odds of privatization (Jensen, 1986). Following Bhandari (1988), financial leverage is defined as the ratio of the book value of a firm's long-term debts to its common stock's market value. Firms with low leverage are expected to have a greater likelihood of being taken over and going private, but have a smaller chance of going bankrupt.

3. Tax

Tax reduction is an important source of gains in going-private transactions (Kaplan, 1989a; Newbould, Chatfield, and Anderson, 1992). The effective tax liability for each firm is measured in the sample. The effective tax liability has been calculated as the TAX item listed above. TAX is divided by the asset value to adjust for the firm-size effect. Given the low tax environment in Hong Kong, we expect the coefficient to be insignificant.

4. Investment Expenditures

A firm's expenditures on plant and equipment are adjusted by the asset value to control for influence of firm size. The free cash flow hypothesis suggests that firms have a proclivity to

spend free cash flow on negative NPV projects. If the gain from privatization originates from the reduction of unprofitable investment expenditures, then firms that go private should maintain a

higher level of investment expenditures when compared with M&A firms and those that remain

public.

20This whole CF construction is similar to that of Lehn and Poulsen (1989). The results for each period are simple averages of annual values.




5. Theq-Ratio

The q-ratio compares the market value of a firm with its equity's book value. It is calculated by dividing a company's market value by the replacement value of its assets. It captures the market assessment of the growth prospects of a firm. Lambrecht and Myers (2007) suggest that hostile takeover targets tend to be firms with low profitability, whereas friendly takeover targets are firms with high growth potential. As friendly takeovers are less likely to be prevalent in Hong Kong, a positive correlation between M&A and the q-ratio is expected. Further, from the findings of Halpern, Kieschnick, and Rotenberg (1999) and Weir, Laing, and Wright (2005b), we expect firms with low q-ratios to be more likely to go private.

6. Stock Performance

The difference between individual stock return and market return is employed as a proxy of stock performance over the survival period ending one year prior to the first official announcement of takeover transactions.21 Weir, Laing, and Wright (2005b) demonstrate that the odds of a firm going bankrupt or private are negatively correlated with its market performance. Firms exhibiting poor stock performance are unable to avoid financial distress by raising funds in the public market. High listing expenses and thin liquidity may drive firms out of the public market as well. Thus, a negative relationship between stock performance and the hazard to go private and bankrupt is expected.

7. Firm Size

Firm size is believed to be negatively correlated with the odds of a takeover or bankruptcy because takeover costs are high. Larger firms can avoid financial distress through public financing. Following Wheelock and Wilson (2000), firm size is measured by the natural logarithm of a firm's total assets.22 As small cap corporations dominate in Hong Kong, the impact of firm size on the odds of going bankrupt, M&A, and going private is expected to be somewhat different from those of earlier studies.

8. Turnover

In addition to the aforementioned firm-specific variables, two measures of market sentiment, turnover of the market and individual stock, are included.23 These indicators reflect the degree of speculative behavior. Moreover, the turnover of an individual stock represents its financial interest and visibility in the public market. As firms with a low stock turnover are more likely to go private (Mehran and Peristiani, 2010), a negative correlation between stock turnover and the probability of going private is expected.

Table IV compares going-private firms with others using the variables listed above. Firms opting for privatization grow faster and register a higher profitability and free cash flow, but have lower leverage than others do. It is interesting to note that the investment expenditures of going

2 'Individual stock return is measured by the monthly return's average. Market return is measured by equally weighted returns. 22 Apart from taking the logarithmic transformation of the total asset value, the percentage of total assets relative to that of the industry is used as an alternative measure of size effects. Results are robust in both specifications. 23 The turnover of the market (individual stock) is measured as the monthly average total value (in thousand HK dollars) traded in the market (individual stock).




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Figure 5. Baseline Survival Function of Competing Risks Model

private firms are not significantly higher than those of other firms. Additionally, the average stock performance of going-private firms is negative.24

IV. Empirical Results

A. General Results

In this section, a competing risks analysis is conducted for the three different causes of delisting. Figures 5 and 6 present the annualized baseline hazard estimates for the three different ex-

its. It should be noted that these share a similar pattern with the Kaplan-Meier estimates in Figures 1 and 2, respectively. As demonstrated in Figure 7, the year-to-year variation does not follow any smooth parametric distribution. Thus, the baseline hazard is estimated semi- parametrically.

B. Causes of Delisting

The estimates for the standard Cox CRM model under two different specifications are reported in Table V.

In Specification 1, the same variables as the Cox PH model are employed. The robustness of these results is assessed by adding other firm-specific attributes to Specification 2. This enables us to identify the causes of delisting. The estimated coefficients of the observed covariates, however, vary across different modes of exit. It should be noted from Table V that the coefficient of profitability is significantly negative in the case of insolvency, whereas it is positive in the case of going private and insignificant in the case of M&A. Thus, profitable firms are more likely to go private and less likely to go bankrupt. This affirms Hypotheses 1 and 5 stated in Section I.

24Zingales (1995) suggests that the share prices of a firm going private should weaken before the actual transaction takes place.




Figure 6. Baseline Hazard Function of Competing Risks Model

Figure 7. Conditional Hazard Function of Competing Risks Model

Moreover, fast-growing firms are riper for privatization as they are usually financially healthier. These firms can obtain financing from banks without the public firm status. The highly concentrated ownership structure likewise eases the path towards privatization when their shares are undervalued. Note that the coefficient of the free cash flow variable is positive and significant for going-private exits, whereas it is insignificant in the cases of bankruptcy and M&A. Thus, a rise in a firm's free cash flow increases the probability of going private. The results are consistent with Hypothesis 5.

From Specification 2, the coefficient of the q-ratio for the case of going-private firms is observed to be negative, implying that firms with less profitable future reinvestment opportunities and lower market valuation tend to go private. The coefficient of the stock performance variable is negative, indicating that poor stock performance is a major reason for going private. These are




Table V. Determinants of Firms' Hazard Rate (CRM Model without Heterogeneity)

Specification 1 Specification 2

Bankruptcy M&A Privatized Bankruptcy M&A Privatized

Profitability -3.0515*** 1.1989 4.9439*** -4.0443*** -8.3243 3.4121*** Growth -0.9699 0.3095** 0.3105*** -1.2629 0.3638** 0.5734*** Size 0.5173*** 0.1940 0.5300*** 0.6507*** 0.2093 0.5177*** Turnover (market) -0.0051 -0.0011** -0.0019** -0.0046 -0.001** -0.0017** Turnover (stock) -0.2964 0.0361*** 0.0042 -0.5475 0.02586* 0.0004 Stock performance -24.74*** 12.14** -5.928 -25.46*** 12.05* -9.9944 FCF 0.3675 10.90 15.02*** Tax 31.58* 26.49 -5.8077 q-ratio 0.1767*** 0.1231 -0.4449*** Leverage -0.1151 -1.3721 -1.3365* Investment -0.3223 -1.4312 0.0621 -lnL 458.44 416.37

*** Significant at the 0.01 level. ** Significant at the 0.05 level. * Significant at the 0.10 level.

consistent with Hypothesis 6. However, there is no evidence for Hypothesis 7. The coefficient of the trading activity variable is insignificant in all specifications, signifying that the diminishing benefits of staying public may not be a major reason for firms to go private.

There is widespread empirical evidence to support the notion that poor stock price performance causes firms to go private.25 The results of this study support the undervaluation hypothesis. How- ever, the leverage and investment variables are insignificant. As the tax variable is insignificant, the tax incentive hypothesis cannot explain the PTP transactions.26 The coefficient of the size variable is significantly positive for firms that go private and insolvent. This partially supports Hypothesis 2. A possible explanation is that small cap corporations with a certain scale can easily raise their leverage ratios through borrowing, but they are at a greater risk of insolvency as well. When compared with small cap firms that remain public, larger firms have a lower cost of financing and are more likely to be bought out when they are undervalued.

A competing risks model accounting for heterogeneity is estimated, and the results are reported in Table VI.

We have found that the main estimates are almost identical to those of the standard model. Furthermore, all the thetas, with the exception of the going-private case in Specification 1, are close to zero. Therefore, the heterogeneity problem is less severe in this model. In Specification 2, the coefficients of the q-ratio, the stock market performance variable, and the growth variable for M&A firms are all significantly positive, supporting Hypotheses 3 and 4. To check the robustness of the results, the same empirical analysis is repeated on firms listed after 1980. The survival information and the summary statistics of these newly listed companies are presented in Table VII. When compared with the previous results, 171 seasoned firms (which have been listed in the market long before 1980) are removed. Forty-two delisted firms, which are seasoned firms

25Halpern, Kieschnick, and Rotenberg (1999) and Weir, Laing, and Wright (2005b) provide evidence that going-private firms experience a deterioration of share price relative to those firms that remain public before delisting. 26Due to the low tax environment in Hong Kong (16.5% for profit tax), there is little to gain from the tax deducibility of interest payments by taking a firm private.




Table VI. Determinants of Firm's Hazard Rate (CRM Model with Heterogeneity)

Specification 1 Specification 2

Bankruptcy M&A Privatized Bankruptcy M&A Privatized

Profitability -3.0515*** 1.1989 4.8089*** -4.0443*** -8.3243 3.3639*** Growth -0.9699 0.3095*** 0.3141** -1.2629 0.3638** 0.5135*** Size 0.5173** 0.1941 0.5691*** 0.6507*** 0.2093 0.5431*** Turnover -0.0051 -.0012** -0.0019* -0.0046 -0.0011* -0.0017

(market) Turnover -0.2964 0.0361*** 0.0050 -0.5475 0.0258** 0.0011

(stock) Stock -24.7409*** 12.1353** -11.6351 -25.4561*** 12.0528** -15.6056**

performance FCF 0.3675 10.9011 14.7894*** Tax 31.5831 26.4934 -4.1489 q-ratio 0.1767* 0.1232** -0.4229*** Leverage -0.1151 -1.3721 -1.2611* Investment -0.3223 -1.4312 0.1066 Theta 2.11e-16 2.11e-16 0.1638* 2.11e-16 2.11e-16 0.1173 -lnL 456.86 421.20


Table VII. Summary Statistics on New Lists' Duration

Existing Type Full Sample Bankruptcy M&A Going Private

Number of failed firms 47 9 12 26 Number of censored firms 530 Mean of duration 7.6499 7.4444 9.4167 7.2692 Minimum duration 2 4 3 2 Maximum duration 15 13 14 15 Std 4.3131 3.2059 4.3371 3.3413

and occupy 47% of the entire delisting samples, are excluded as well. The estimation results are

reported in Table VIII. These are largely consistent with those of the full sample. Thus, our results are robust to the use of an alternative sample.

V. Conclusion

The literature on privatization, bankruptcy, and merger has developed along separate tracks, with very few empirical studies analyzing them in a unified setting. This paper provides the first

attempt to explain the influence of the various attributes of listed firms in Hong Kong regarding the decision to leave the public market. A competing risks model is developed to evaluate the

probability of going private, being acquired, and going bankrupt based on the characteristics of a firm. We find that firms with faster growth are more likely to be acquired or go private. Additionally, firms with higher profitability are more likely to go private and less likely to go




Table VIII. Determinants of New Lists' Hazard Rate (CRM Model without Heterogeneity)

Risk for Bankruptcy Risk for M&A Risk for Privatization Coef. Coef. Coef.

Profitability -4.4447*** -35.9983** 4.1963*** Growth -1.6741* 1.0958*** 0.6401*** Size 0.6145* 0.7172* 0.5634*** Turnover (market) -0.0003 -0.0005 -0.0023 Turnover (stock) -0.3911 0.0043 -0.0056 Stock performance -12.7366 13.4557* -16.9729** FCF 0.5059* 42.9285** 13.8738*** Tax 32.9826 64.1161 11.8803 q proxy 0.1467*** 0.1763*** -0.3886** Leverage -1.5149*** -1.9267 -0.8838 Investment 1.7926*** 0.8638 1.1821 -lnL 192.71


bankrupt. The results serve as important complements to the study of Fama and French (2004), who argue that lower profitability leads to a decline in the survival rate of listed firms. As the majority of the exits in our sample are PTP transactions, particular emphasis is placed on addressing the motivations of firms listed in the Hong Kong stock market to engage in going- private transactions. It is found that undervaluation is a key driver of going private. However, despite the low agency cost due to the concentrated ownership structure, the propensity of Hong Kong-listed firms to go private still increases with the level of their free cash flow. This may be explained by the fact that controlling shareholders in Hong Kong are more capable of using the free cash flow to privatize the firm. Finally, we demonstrate that the tax incentive hypothesis does not hold in the case of Hong Kong, which agrees with the finding of Weir, Laing, and Wright (2005a).

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Article Contentsp. [1697]p. 1698p. 1699p. 1700p. 1701p. 1702p. 1703p. 1704p. 1705p. 1706p. 1707p. 1708p. 1709p. 1710p. 1711p. 1712p. 1713p. 1714p. 1715p. 1716p. 1717p. 1718

Issue Table of ContentsFinancial Management, Vol. 39, No. 4 (WINTER 2010), pp. 1307-1753Front MatterConglomerate Structure and Capital Market Timing [pp. 1307-1338]Financial Flexibility, Investment Ability, and Firm Value: Evidence from Firms with Spare Debt Capacity [pp. 1339-1365]What Matters in Venture Capital? Evidence from Entrepreneurs' Stated Preferences [pp. 1367-1401]Are Initial Returns and Underwriting Spreads in Equity Issues Complements or Substitutes? [pp. 1403-1423]The Certification Role of Large Customers in the New Issues Market [pp. 1425-1474]Retail Trading and IPO Returns in the Aftermarket [pp. 1475-1495]The Effects of Ambiguous Information on Initial and Subsequent IPO Returns [pp. 1497-1519]Acquisition Activity and IPO Underpricing [pp. 1521-1546]Merger-Motivated IPOs [pp. 1547-1573]Seasoned Equity Offers: The Effect of Insider Ownership and Float [pp. 1575-1599]Management Quality and Equity Issue Characteristics: A Comparison of SEOs and IPOs [pp. 1601-1642]Executive Stock Option Exercise and Seasoned Equity Offerings [pp. 1643-1670]Gains from Mergers and Acquisitions Around the World: New Evidence [pp. 1671-1695]A Competing Risks Analysis of Corporate Survival [pp. 1697-1718]Emerging from Chapter 11 Bankruptcy: Is It Good News or Bad News for Industry Competitors? [pp. 1719-1742]Back Matter

Documents

A Competing Risks Analysis of Corporate Survival