Factors Affecting Financial Difficulty

Abstract

This theory describes two conflicting economic actors, namely the principal (owner) and agent (manager). Firms can be thought of as links to a series of contractual relationships between individuals, whereas classical economics considers firms as single product entities to maximize profits [9]. To make this contractual relationship run smoothly, an owner will delegate the decision-making authority to manager and an agency relationship is a contract whereas one or more people (employer or principal) hires another person (agent) to perform a number of services and delegates decision-making authority to that agent. Management is a party contracted by shareholders to work in the interests of them. Because of being elected, the management must be accountable for all the works they conduct to the shareholders. Agency theory is very useful to prevent the occurrence of financial distress, because of the difference in interests between the principal and the agent which can cause errors in decision making and the decisions taken can cause the company to be threatened with financial distress. 2.2. Signalling Theory According to [10], the signal theory discusses why companies disclose information to external parties, one of which is investors. Signal theory is extremely useful for forecasting financial distress; both shareholders and investors can see signals in financial statements that indicate how things are currently and in the future. Financial statements are the most critical component of a company's fundamental analysis, specifically financial ratio analysis, which is an interpretation of the presented financial statements. 2.3. The Effect of Liquidity on Financial Distress Financial distress is attributed to the absence of liquidity. The more liquid the business, the less likely financial distress will occur. According to research conducted by [8], [11], [12], the higher the current ratio value of a business, the less likely it is to experience financial distress. While [4] demonstrate that liquidity has a positive and significant effect on financial distress, On the other hand, [13] found that the current ratio or liquidity results have no significant effect on financial distress. 2.4. The Effect of Leverage on Financial Distress Leverage is counterproductive to financial distress. This means that the more current and long-term debt a business pays, the less likely it is to experience financial distress. This is reinforced by the findings of [4], [13], [14], which demonstrate that leverage negatively and significantly affects financial distress. In contrast to [11], [12], leverage positively affects financial distress. Meanwhile, [8] research indicates that leverage does not affect financial distress. 2.5. The Effect of Operating Capacity on Financial Distress Operating capacity is a ratio that indicates a business's ability to manage its assets for operational purposes. The better the financial performance of the business is, the lower the risk of financial distress will occur. This is affirmed by [8] findings that operating capacity negatively and significantly affects financial distress. According to [14], operating capacity positively and significantly affects financial distress. In contrast to [13] findings, which indicate that operational capacity has no effect on financial distress. 2.6. The Effect of Firm Size on Financial Distress The term "company size" refers to the total value of the company's assets. The greater the company's total assets, the more capable it is of meeting future obligations, thereby avoiding problems, particularly financial difficulties. According to [11], firm size negatively affects financial distress. This is in contrast to [4] and [12], who found that firm size does not affect financial distress. 2.7. The Effect of Sales Growth on Financial Distress The higher the institutional ownership is, the more efficiently the company's assets are utilized in order to minimize financial distress, as the company can demonstrate strong supervisory capabilities. According to [15], institutional shareholders can effectively replace or strengthen the board of directors' supervisory function. According to [14] research, institutional ownership has a beneficial effect on the occurrence of financial distress. In contrast to [4], [12] research, institutional ownership has a limited impact on financial distress.