Impact of Debt Composition and Accounting Conservatism on Financial Distress in Emerging Markets

Abstract

Aims: This study investigates the impact of debt composition, specifically short-term and long-term debt, on corporate financial distress, focusing on the moderating role of accounting conservatism. It aims to understand how firms in emerging markets, particularly Kenya, can achieve financial stability through prudent debt structuring and conservative accounting practices. Study Design:  The research adopted an explanatory research design. Place and Duration of Study: The study utilized financial data from firms listed on the Kenyan Securities Exchange between 2008 and 2021. Methodology: The study analyzed a sample of 45 firms trading at the Nairobi Stock Exchange over 14 years from 2008 to 2021. The study used panel logistic regression, a statistical method for analyzing data with multiple observations over time, to test its hypotheses. Results: The results show that both short-term and long-term debt increase the likelihood of financial distress, with accounting conservatism further intensifying the risk for firms heavily reliant on short-term debt while mitigating it for those with long-term debt. This suggests that conservative accounting practices, which promote early recognition of losses, may exacerbate financial distress for firms heavily reliant on short-term debt. In contrast, for long-term debt, accounting conservatism has a mitigating effect helping firms manage their debt obligations more effectively over time. This highlights a nuanced role of accounting conservatism, where it increases the pressure on firms with short-term debt while providing stability for those with long-term obligations. Conclusion: The findings suggest that corporate managers in emerging markets should carefully balance short- and long-term debt to minimize financial distress risks. Additionally, adopting conservative accounting practices can serve as a safeguard, providing early warning signals for financial trouble and enhancing corporate stability. Managers should therefore carefully balance short-term and long-term debt to reduce financial distress while adopting conservative accounting practices to enhance financial transparency and risk management. Policymakers can support firms by promoting responsible debt management and offering incentives for conservative financial reporting to strengthen overall financial stability.