Non Financial Factor Theory

CHAPTER TW0
LITERATURE REVIEW
2.1 Introduction
This chapter summarized the information from the available literature in the same field of study. The specific areas covered here are theoretical review, conceptual framework, financial factors, non-financial and systematic risk variables, critique of the existing literature, chapter summary and research gaps.
2.2 Theoretical review
There are three theories which support the research objectives. These theories discuss the effects of financial factors, non-financial and systematic risk variables on financial distress.
2.2.1 Pecking order Theory
Many theories have been developed in line with the financial decisions process. Among these theories is the Peking order theory by Myers and Najluf (1984),

The theory relates to decisions made within a firm by managers (C.EOs) and the shareholders. This is the principal agent relationship. The theory states that, with low monitoring level to the organization and low discipline in decision making, managers might decide to invest in projects and with negative net present values. In situations where shareholding is regulated by few individual being the major shareholders, decision making power, vests with them unlike the CEOs. In such case the managers have no say on the firms’ growth direction. Alternatively, where the B.O.D has corporate governance problems, the firm is faced with financial decision problems. According to Ngugi (2008), shareholders can manipulate liquid asset at the expense of debt-holders using it as a proxy for asset substitution. According to Jensen (1986) availability of free cash flow makes managers invest in projects with negative NPVs due to conflict of interest. Decisions on non-financial factors may affect the firm heavily in the long run and if no interventions are made, this may lead to financial

The study incorporated all listed manufacturing sectors on Karachi stock exchange. The study used Zmijewski model to test the distress level on these companies. The findings revealed that the probit model performed well on predicting financially distressed firms and non-distressed firms, based on; Net income, Shareholders equity and cash flows. This study however relied heavily on ratios ignoring other factors that lead to financial distress.
Warutere (2013) conducted a study on the applicability of logistic regression in financial distress prediction in Nairobi security exchange. The study was conducted on sixteen companies between the ranges 1997-2011. The findings revealed that logit regression was successful in prediction of business failure one year before it occurred. The study relied on secondary data obtained from CMA and NSE. The study should have factored in other factors that cause financial distress in the regression model so as to make it more reliable such as corporate