Pacific Accounting Review

Emerald Article: An Exploratory Study of the Company Reorganisation

Decision in Voluntary Administration
James Routledge, David Gadenne

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James Routledge, David Gadenne, (2004),"An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration",
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Pacific Accounting Review Vol. 16, No. 1, June 2004

31

An Exploratory Study of the Company

Reorganisation Decision in Voluntary Administration
JAMES ROUTLEDGE *
DAVID GADENNE **
A primary purpose of the voluntary administration legislation is to
provide a flexible procedure by which a company can attempt to
reorganise its affairs and continue trading. Informed decision-making
regarding which companies should attempt reorganisation is critical
to the efficient operation of company rescue legislation. This paper
explores decision-making associated with the voluntary administration
process, with a focus on the relevance of financial information to the
reorganisation decision. Statistical models are developed to provide
some insight into the reorganisation decision and the problem of
identifying suitable (successful) reorganisation candidates from a pool
of distressed companies. Additionally, insolvency experts decisions
regarding companies prospects in reorganisation are examined. The
decision accuracy of insolvency experts was found to be significantly
lower than statistical model accuracy, indicating that further
development of statistical models may be a useful aid to insolvency
experts.

James Routledge is at the School of Business, Bond University

**

David Gadenne is at the Faculty of Business and Law, Central Queensland

University

The authors would like to thank delegates from the 2002 AAANZ conference in
Perth, two anonymous reviewers and Martin Lally (the editor) for their helpful comments and constructive advice.

32

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

(1) INTRODUCTION
The voluntary administration (VA) insolvency procedure1 was introduced as part of
Australias corporate insolvency regime in June 1993. The objectives set out for the
VA regime were twofold. First, VA was intended to provide a flexible and relatively
inexpensive procedure by which an insolvent company could attempt to formulate an
arrangement with creditors to rescue the companys business. Second, when rescue is
not possible, the VA procedure was intended to provide a flexible winding-up process
so as to achieve a greater return to creditors than would result from immediate
liquidation.2 The Australian approach to company rescue legislation was heavily
influenced by the existing restructuring regimes operating in the United Kingdom
and United States.3
A study by Hodson and McEvoy (1995) estimated that 20 percent of companies that
enter VA attempted to reorganise their affairs and continue trading. Despite the
extensive use by distressed companies of the reorganisation provision in VA, there is
a lack of empirical research that has examined its operation. Accordingly, an important
contribution of this paper is that it provides one of the few references on the
reorganisation alternative available under VA. With any company rescue or
rehabilitation legislation the decision as to which companies should attempt
reorganisation is critical to its efficient operation. This is because insolvency legislation,
which provides the opportunity for company reorganisation, can create adverse
incentives to prolong the existence of non-viable firms (Martel, 1991). Our analysis
focuses on how the information content of historical financial information can explain
and inform decision-making associated with the VA procedure. The motivation for
this research is to provide a reference that will serve to inform future decision-making
associated with the VA regime.
(2) METHOD
Exploring the reorganisation option for companies that enter VA requires consideration
of two events. The first event, which we have called the reorganisation event, occurs
when the decision is made as to whether a company that has entered VA will attempt
to reorganise or proceed to liquidation. The second event, which we have called the

Part 5.3A of the Australian The Corporations Law (Cth).

The objectives are outlined in s 435A of The Corporations Law (Cth).

In the United Kingdom, the Insolvency Act 1986 (UK), and in the United States Chapter 11 of the
Bankruptcy Code 1978 (US). For comparative discussion of the regimes, refer to Crutchfield (1994).

Routledge and Gadenne

33

performance event, is the event of success or failure for companies that proceed
with reorganisation. The two events and their relationship to the VA procedure are
summarised in Diagram 1 below.
Diagram 1 Summary of Events in Voluntary Administration

In this paper, we explore decision-making at the time of the reorganisation event by

conducting multivariate statistical analysis. Using a sample of companies that have
entered VA, we perform a logistic regression to distinguish companies that reorganise
from companies that liquidate. The purpose of this analysis is to identify the financial
characteristics, if any, that are relevant to determining whether a company will proceed
with reorganisation upon entering VA.
Statistical analysis of the performance event is conducted that is intended to distinguish
between successful and unsuccessful companies that attempt to reorganise. For this
analysis we review the post VA financial performance for each company that attempts
reorganisation and classify its performance as either successful or unsuccessful.
Logistic regression analysis is then conducted to identify financial characteristics
that distinguish between the successful and unsuccessful reorganised companies. This
analysis is informative in identifying the unique financial characteristics, if any, of
suitable reorganisation candidates from a pool of distressed companies.
For the performance event we also conduct an experimental task that compares the
performance of the statistical analysis with that of human decision-makers in
distinguishing companies that reorganise successfully. Jointly examining financial
distress decisions using statistical models and human information processing is well

34

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

established,4 and has generally been based on the Brunswik Lens Model (see Brunswik
1952). The Lens model approach is used in this study and its application is summarised
in Diagram 2 below.
Diagram 2 The Lens Model Framework

Information Cues
(Accounting Ratios)
Environmental
Predictability

Model/Human
Utilisation

Houghton and Woodliff (1987, pp.538-539) noted that a critical aspect of the Lens
Model is that imperfect human decisions have two causes. First, they may be a product
of imperfect information describing the criterion variable, that is, the information
cues fail to reflect exactly the criterion event. Second, they may be attributed to suboptimal processing of data or imperfect cue utilisation by the decision-maker.
Comparing the performance of statistical analysis and human judgement in identifying
successful reorganisation candidates will provide some insight into the relevance of
statistical models as an aid to decision-makers in VA.5

4
Libby (1975) provided one of the first examples of the application of the Brunswik Lens Model framework
in accounting research. He analysed the judgement accuracy of bank loan officers in a business failure
prediction task. Subsequent studies have extended the application of Libbys seminal work (see, for example,
Zimmer 1980, Abdel-khalik and El-Sheshai 1980, Casey 1980 and 1983, and Houghton 1984). Other
studies have jointly considered the performance of statistical models and neural network expert systems in
bankruptcy prediction tasks. See, for example, Lenard et al. (1995).
5
Successful application of prediction models have been reported in similar studies concerned with auditor
assessments of going-concern status for companies (see, for example, Altman and McGough 1974, Deakin
1977, Kida 1980, Simnett and Trotman 1989, and Koh 1991).

Routledge and Gadenne

35

Determining suitable predictor variables to include in this type of study is problematic

due to the lack of a theoretical basis on which selection can be based. The selection of
variables for the development of statistical models and the administration of an
experimental task is therefore subjectively based on a review of prior studies. The
next section reviews prior financial distress studies that are informative with respect
to locating a suitable set of predictor variables.
(3) VARIABLE SELECTION

There is a considerable body of prior financial distress research that has focused on
insolvency (or bankruptcy) prediction. These studies have developed and refined
multivariate financial distress prediction models since the seminal research in this
area by Altman (1968). Prior studies of both Australian listed companies (Lincoln
1984, Izan 1984, Castagna and Matolcsy 1981), and unlisted companies (Cybinski
1995, Shailer 1990, McNamara et al. 1988) have confirmed the usefulness of financial
ratio data in the bankruptcy prediction task in the Australian setting. More recently,
financial distress studies have focused on the problem of distinguishing between types
of distressed firms rather than distinguishing distressed firms from healthy firms.
This research has demonstrated that different types of financial distress are
characterised by different underlying constructs (Gilbert et al. 1990, Ward and Foster
1997). This body of research is particularly informative in respect to variable selection
for this study.
Frost-Drury et al. (2000) conducted one of the few Australian studies that have focused
on different types of distress in VA. Their study investigated the propositions that (1)
companies entering VA could be distinguished from healthy companies and, (2)
companies entering VA can be distinguished from companies that directly entered
liquidation. The propositions were tested by logistic regression analysis using financial
predictor variables. Their model results indicated that poor profit performance and
greater proportions of assets tied to working capital distinguished financially distressed
from healthy companies. Importantly, Frost-Drury reported that the financial
characteristics of VAs differed from liquidations. Their results indicated that a firm
with greater proportions of assets tied to working capital was more likely to liquidate
than enter VA.
Further research that has focused on distinguishing types of financial distress and its
subsequent resolution has considered the operation of the United States Chapter 11
bankruptcy procedure. Comerford (1976) examined the financial characteristics of
52 firms that had filed bankruptcy petitions under the United States Chapter 11
procedure. The objective of Comerfords study was to identify financial characteristics

36

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

that distinguished firms that liquidated from those that successfully reorganised. His
sample comprised 26 firms that had filed Chapter 11 petitions and were subsequently
liquidated, and 26 firms that had reorganised their affairs and continued operation for
a period of two years. Comerfords study used the principal components data reduction
method to extract factors representing financial dimensions for companies in the
sample. This approach to determining relevant financial ratio independent variables
has been used extensively since the seminal work of Pinches et al. (1973).6 Eighteen
original ratios were reduced to six significant factors. The highest loading ratio for
each factor was included as an independent variable in a multivariate discriminant
analysis. The six ratios that comprised the significant discriminant function included
three ratios representing measures of liquidity, two ratios representing profitability
and one leverage ratio.
Casey et al. (1986) used financial variables to discriminate between a group of
liquidated firms and a group of restructured firms under the US Chapter 11 bankruptcy
procedure. The variables used in the study were selected based on a model of creditor
and equity holder coalition behaviour that had been developed by White (1983 and
1989). Casey et al. (1986) found that prior profitability and the percentage of
uncollateralised (free) assets were important predictors of whether a firm would
liquidate or reorganise.
Campbell (1996) undertook a similar study using a sample of distressed US closelyheld firms that entered the Chapter 11 procedure. His study extended the Casey et al
(1986) study by using both financial and non-financial variables as predictor variables.
Campbell (1996) reported profitability, the percentage of uncollateralised (free) assets,
and firm size (measured by assets) to be significant financial predictor variables.
With respect to non-financial variables, the study reported that the composition of a
firms creditors affected the financial distress resolution. Consistent with earlier
findings by Hotchkiss (1995) and Lo-Pucki (1983), Campbell (1996) found industry
classification to be a significant predictor of the Chapter 11 outcome.
Kennedy and Shaw (1991) also extended the model tested by Casey et al. (1986) by
including the firms going-concern audit opinion as a predictor of distress resolution.
They found limited evidence that distressed firms with unmodified going-concern
audit opinions were more likely to be reorganised than to be liquidated. Kennedy and
Shaw (1991) reported that the audit opinion had incremental predictive value in
addition to past profitability and free assets. However, the predictive ability of the
model was limited to instances where the firm had filed for bankruptcy within one

See also Zavgren (1985) for use of this technique.

Routledge and Gadenne

37

year of the issuance of the financial report from which data was taken. Casterella et
al. (2000) also applied the Casey et al. (1986) model in the development of a proxy
for auditors expectation of bankruptcy resolution.
The effect of non-financial variables on distress resolution has been considered in
some detail. For example, a recent study by Barniv et al. (2002) used financial and
non-financial data to predict whether a firm entering the US Chapter 11 procedure
would be acquired, emerge, or proceed to liquidation. Several non-financial variables
were found to be significant predictors of the Chapter 11 outcome. The study reported
that size (measured by assets), composition of firm debt, management change, evidence
of fraudulent activity, and change in the market price of securities in the period leading
to the bankruptcy filing, were significant predictors. Prior research has also provided
evidence that macroeconomic conditions affect distressed firms and the process of
reorganisation, and that the predictive power of multivariate models can be increased
by the inclusion of macroeconomic variables. For, example Rose et al. (1982) found
a strong association between macroeconomic variables and United States bankruptcy
rates. Altman (1971) and Levy and Barniv (1987) found that bankruptcy rates in the
United States correlated with changes in the Gross National Product and general
price levels. Levy (1992) demonstrated analytically the effect of interactions among
financial, industrial and macroeconomic factors on the timing of liquidation for
distressed firms.
It is evident from the review of prior studies that numerous financial and non-financial
variables have been found to be useful predictors of financial distress resolution. In
this study, it has been necessary to limit the number of variables included in our
analysis for three reasons. First, we are interested in considering the predictive value
of data that can be easily accessed in a companys financial statements. Secondly,
extensive use of predictor variables could have a detrimental effect in the experimental
task due to problems associated with high information load. Thirdly, the relatively
small sample size would not support large numbers of predictor variables in the
statistical models, and could lead to overfitting.
While there is variation in the financial variables used in prior relevant studies, the
significant predictors have consistently operationalised the financial constructs of
equity, leverage, liquidity, profitability and size. Accordingly, financial variables for
each of these constructs will be included in the statistical analyses and as information
cues in the experimental task. In addition, we have included industry classification as
a non-financial component in the model due to its significance in prior studies.

38

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

(4) STATISTICAL ANALYSES

The independent variables included in the statistical analyses are summarised in Table
1.
Table 1
Independent Variables
Financial Construct
Financial Leverage/
Equity Commitment
Short-Term Liquidity
Earnings Prospects
Industry Classification
Size

Ratio or Variable
Total Liabilities/Total Assets (TLTA)
Total Liabilities/Owners Equity (TLOE; coded 1 to 5,
1 lowest ratio, 5= negative equity)*
Current Assets/Current Liabilities (CACL)
Current Liabilities/ Total Assets (CLTA)
Operating Profit / Total Assets (OPTA)
Indicator Based on ANZSIC Grouping
Total Assets (LNTA; natural log of total assets)

* TLTA and TLOE are similar variables, however, both were included as many companies in the sample
had negative owners equity and inclusion of TLOE in the categorical form provides incremental information
regarding the existence and extent of equity commitment

Calculation of the ratio TLOE is problematic because some of the companies have
negative equity values and their ratios would be misleading. To overcome this problem,
a categorised form of the ratio was calculated. The categorised variable was coded
with a value of one to five: five representing ratios with a negative equity position,
and values of one to four being quartile groups for ratios with a positive equity value.
The effect of applying this method of addressing problems with ratio calculation was
tested by Cybinski (1995), who found the original ratio information value was
preserved in models developed using categorised independent variables.7 The
dependent variables for statistical models required classification of subject companies
based on (1) whether the company reorganised or was liquidated (for the decision
event), and (2) whether a company was successful or unsuccessful in reorganisation
(for the performance event). For the liquidation/reorganisation dichotomous variable,
a company was classified as a liquidation if the administration ended in liquidation,
or the administration ended with a deed of company arrangement that provided for

Cybinski (1995) tested groupings consisting of three and five categories, and found that the five category
grouping gave a slightly superior goodness of fit of the model to data. Cybinskis study did not aim to
find the best categorisation regime, however, it did indicate that reliable models could be developed using
discrete categorisation of financial ratio independent variables.

Routledge and Gadenne

39

winding-up (often referred to as a liquidating deed). The dependent variable was

coded zero for liquidation and one for reorganisation. The decision event model is
shown below.
DECISION = b0 + b1TLTA +b2TLOE +b3CACL +b4OPTA
+b5LNTA +b6INDUSTRY + error

(1)

For the performance event analysis, companies were classified as successful if their
average return on assets over the three years subsequent to reorganisation equalled or
exceeded the industry average. Return on assets (OPTA) is a continuous variable;
however, we have assigned it a dichotomous value to enable comparison between
statistical models and the experimental task results. The dependent variable was coded
zero for an unsuccessful reorganisation and one for a successful reorganisation. The
performance event model is shown below.
PERFORMANCE = b0 + b1TLTA +b2TLOE +b3CACL +b4OPTA
+b5LNTA +b6INDUSTRY + error

(2)

The sample used for the development of models included companies that entered
voluntary administration between July 1993 and 1995. The selection of this earlier
time period was necessary for sufficient post VA performance data to be obtained.
Financial data was obtained from company annual returns and financial reports lodged
with the Australian Securities and Investments Commission. Ratios were calculated
for the financial year that ended immediately before the companys entry to VA.
Data screening for outliers among independent variables was performed by reviewing
the Studentized residuals and Cooks Distance. One case was identified as an outlier
using these diagnostic techniques. This company had been capitalising large amounts
of expenditure up to the time of appointment of the administrator. Considering the
unusual nature of the companys financial profile it was deemed appropriate to remove
the case from the sample.8 The final sample of 66 companies was comprised of 33
reorganised companies and 33 liquidated companies, and included 45 proprietary
companies, 17 unlisted public companies and 4 listed public companies.
Correlations among independent variables are reported in Table 2. The highest
correlation was between total liabilities/total assets and current liabilities/total assets

The company capitalised $6.4 million of Exploration and Evaluation Expenditure over two years; this
amount was written down to $1.15 million in the year of administration by revaluation of assets and loss
on disposal of tenements.

40

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

at r=0.70. A correlation of this order may lead to problems with multicollinearity for
statistical analysis. To check for potential problems with multicollinearity, the
Correlation of Estimates output provided by the SPSS logistic regression procedure
was reviewed. Problems are likely to be present if the Correlation of Estimates value
approaches one. The Correlation of Estimates value between total liabilities/total assets
and current liabilities/total assets was 0.166. To further test for the effects of
multicollinearity, logistic regression analysis was run with and without the significantly
correlated variables. Results of models with and without the variables were not
substantially different. It was concluded that problems with multicollinearity were
not evident, and all independent variables were retained in the final model.
Table 2
Correlation Matrix for Independent Variables

TLTA
TLOE
CACL
CLTA
OPTA
INDUSTRY*
LNTA

TLTA

TLOE

CACL

CLTA

OPTA

INDUSTRY LNTA

1.000
0.400
-0.111
0.700
-0.149
0.498
-0.400

1.000
-0.320
0.296
-0.184
0.265
-0.183

1.000
-0.122
0.171
0.105
0.033

1.000
0.107
0.635
-0.343

1.000
0.377
0.269

1.000
0.326

1.000

*For the categorical variable industry, the value for Eta is reported as a measure of the strength of association
between this variable and other interval scaled variables. The Eta statistic is appropriately used when one
of the variables is measured on a non-ratio scale. In all other cases within the table, Pearson correlation
coefficients are reported.

4.1 Results Reorganisation Event Analysis

Summary statistics relevant to the reorganisation event analysis are presented in Table
3. To identify statistically significant differences between mean values in the univariate
setting, t-tests and a Chi-square test were performed on interval scaled and categorical
variables respectively. Significance values, based on a two-tailed test as each
comparison had two possible directions, show only INDUSTRY to be significantly
different between the groups.

Routledge and Gadenne

41

Table 3
Summary Statistics for Liquidation and Reorganisation Outcomes
Liquidations
(n=33)

Reorganisations
(n=33)

Variable

Mean

S.Dev.

Mean

S.Dev.

TLTA
TLOE
CACL
CLTA
OPTA
LNTA
INDUSTRY

1.593
3.788
1.367
0.946
-0.227
14.225

2.485
1.474
2.695
2.144
0.778
1.920

1.625
3.879
2.739
0.967
-0.194
14.010

2.178
1.453
10.424
1.588
0.615
1.888

t-value/
Chi-square
-0.117
-0.252
-1.070
-0.107
-0.426
0.923
11.917**

** denotes significant at p<0.05

Chi-square statistic is reported for Industry categorical variable. Fishers Exact test is reported, as cell
counts are less than 5 for some categories.
Industry coverage (cell counts) for test were: mining 4, manufacturing 16, wholesale 2, retail 12,
construction 2 and service 30.

Results of the reorganisation event analysis are summarised in Table 4. The ChiSquare to remove statistic was used to determine the significance of coefficients in
the model. This test statistic is determined by calculating the amount that the model
fit changes if a variable is removed. Coefficients for the leverage variables (TLTA
and TLOE) were both significant at p<.01, and indicate that reorganisation is more
likely for companies with a higher debt to assets ratio (TLTA) and a lower debt to
equity ratio. Coefficients for both short-term liquidity variables are significantly
different from zero (at p<.05), and show that companies with higher levels of shortterm liquidity are more likely to reorganise. The past profitability indicator (OPTA)
was not significant (p=.33). This suggests that the going concern value of the company
is not of primary concern to decision-makers at the time of the reorganisation event.
Industry classification was a significant variable, which is consistent with findings in
prior studies. However, the result here may be a consequence of the small sample
size, disproportionate numbers in various industry groups and heterogeneous company
characteristics rather than indicating true industry differences.

42

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

Table 4
Logistic Regression Results - Liquidation and Reorganisation Outcomes
Estimated Coefficients for Equation (1)
(Dependent Variable is 0 for Liquidation and 1 for Reorganisation)
Variable
TLTA
TLOE
CACL
CLTA
OPTA
LNTA
INDUSTRY
Mining
Manufacturing
Wholesale
Retail
Construction
Service
Model Results
-2 Log Likelihood
c2 (11, n=66)
Significance
Nagelkerke Pseudo R2

b
(n=66)
3.658
-1.935
0.193
5.388
-1.465
0.548
-42.204
-2.915
0.597
-1.524
109.60
0.000

S.E.
1.490
0.636
0.192
1.839
1.519
0.304

c2
to remove
10.845
14.538
4.339
14.963
0.937
3.815
41.744

Sig.
0.001**
0.001**
0.037**
0.001**
0.333
0.051
0.001**

36.216
1.086
2.082
1.095
56.112

46.853
44.913
0.000
0.658

** denotes significant at p<0.05

The results may be explained by creditor bargaining and coalition behaviour among
stakeholders affecting the reorganisation decision. This would be consistent with the
finding of coalition behaviour in studies that have considered reorganisation decisions
under the United States Chapter 11 procedure. Where the levels of debt to equity are
high, yet some value in equity still exists, management and equity holders would be
likely to form a coalition in support of reorganisation as both parties would be worse
off in liquidation due to the high debt to equity ratio and costs associated with company

Routledge and Gadenne

43

liquidation. Moreover, higher levels of liquidity would provide the company with
greater capacity to bargain with unsecured creditors at the time of the reorganisation
event.
Classification results for the model are presented in Table 5. Overall, the model
correctly classified 80 percent of companies in the sample.
Table 5
Classification Table for Liquidation and Reorganisation Outcomes

Observed
0 (liquidation)
1 (reorganisation)

Predicted
0 (liquidation)
1 (reorganisation)
26
7
6
27

Percent Correct
78.79%
81.82%
80.30% Overall

(The cut value is 0.50)

Lachenbruchs (1975) leave one out holdout procedure was employed to test the
validity of the models predictive ability. Results of the holdout testing procedure are
presented in Table 6. Classification results for the holdout test were lower than for the
estimation sample at 68 percent, which may suggest some model overfitting.
Table 6
Model Validation Testing:
Classification Table for Liquidation and Reorganisation Outcomes

Observed
0 (liquidation)
1 (reorganisation)

Predicted
0 (liquidation)
1 (reorganisation)
21
12
9
24

Percent Correct
63.63%
72.72%
68.18% Overall

(The cut value is 0.50)

9
The holdout procedure involves removing each case from the sample, calculating estimation model
coefficients from the remaining cases and subsequently classifying the holdout case based on the calculated
coefficients. If overfitting is a problem the prediction model will achieve a substantially higher level of
predictive accuracy on the estimation sample than it does for the holdout procedure.

44

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

4.2 Results - Performance Event Analysis

Summary statistics presented in Table 7 indicate some differences between companies
grouped according to successful and unsuccessful reorganisation. A t-test was used to
identify significant differences between mean values. Probability values indicate that
mean company profitability (indicated by return on assets) is significantly different
between groups at p<0.05. Mean leverage, measured by TLTA, is marginally
significantly different at p<0.10.
Table 7
Summary Statistics for Successful and Unsuccessful Reorganisations
Successful
(n=13)

Unsuccessful
(n=19)

Variable

Mean

S.Dev.

Mean

TLTA
TLOE
CACL
CLTA
OPTA
LNTA
INDUSTRY

2.693
3.789
3.889
1.012
0.210
13.663

3.482
1.273
9.681
0.852
0.942
1.841

1.272
3.923
0.774
0.823
-0.308
14.027

S.Dev.
0.691
1.605
0.630
0.502
0.363
2.047

t-value/
Chi-square
-1.742*
-0.262
-1.409
-0.792
-2.218**
0.177
4.754

* denotes significant at p<0.1, ** denotes significant at p<0.05

Chi-square statistic is reported for Industry categorical variable. Fishers Exact test is reported, as cell
counts are less than 5 for some categories.
Industry coverage (cell counts) for test were: mining 1, manufacturing 7, wholesale 1, retail 7, and
service 16.

Results for the performance event model are presented in Table 8. The coefficients
for CACL (short-term liquidity) and OPTA (profitability) were significant at p<.01.
The sign of coefficients indicates that reorganisation success is associated with higher
levels of short-term liquidity and past profitability. Again, the industry classification
indicator variable was significant at p<.01. The results suggest that companies that
successfully reorganise have underlying profitable business operations and greater
levels of liquidity.
Classification results for the performance model are presented in Table 9. Overall,
87.5 percent of companies in the sample were correctly classified.

Routledge and Gadenne

45

Table 8
Logistic Regression Results For Successful and Unsuccessful Reorganisations
Estimated Coefficients for Equation (2)
(Dependent Variable is 0 for Unsuccessful Reorganisation
and 1 for Successful Reorganisation)

b
(n=66)
13.673
6.607
14.667
-0.488
40.549
-2.631

Variable
TLTA
TLOE
CACL
CLTA
OPTA
LNTA
INDUSTRY
Mining
Manufacturing
Wholesale
Retail
Service

17.031
-1.889
5.812
-33.542
0.000

Model Results
-2 Log Likelihood
c2 (10, n=32)
Significance
Nagelkerke Pseudo R2

S.E.
18.622
7.738
17.920
3.388
55.653
4.002

c2
to remove
3.477
4.256
13.547
0.022
9.662
2.720
14.215

Sig.
0.062
0.039**
0.001**
0.882
0.001**
0.099
0.007**

737.205
3.182
736.207
218.682

11.669
31.561
0.0005
0.846

** denotes significant at p<0.05

Table 9
Classification Results For Successful and Unsuccessful Reorganisations

Observed
0 (unsuccessful)
1 (successful)
(The cut value is 0.50)

Predicted
0 (unsuccessful)
1 (successful)
17
2
2
11

Percent Correct
89.47%
84.62%
87.50% Overall

46

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

Results of the Lachenbruch (1975) holdout testing procedure are presented in Table
10. The classification results for the holdout test were similar to results for the
estimation sample at 83.2 percent.
Table 10
Model Validation Testing: Classification Table for Successful
and Unsuccessful Reorganisations

Observed
0 (unsuccessful)
1 (successful)

Predicted
0 (unsuccessful)
1 (successful)
17
2
3
10

Percent Correct
89.47%
76.92%
83.20% Overall

(The cut value is 0.50)

Analysis of the performance event indicates that there is a relationship between the
selected variables and the performance event. Therefore, the variables should provide
relevant information to decision-makers regarding the prospects of companies that
reorganise under voluntary administration. Comparison of the reorganisation and
performance event analyses suggests that VA decision-making may not be based on a
full consideration of a companys future prospects. Perhaps most striking is the absence
of the past profitability as a significant characteristic of companies for which the
decision is to attempt reorganisation.
The following section of this paper investigates the ability of insolvency experts to
utilise the variables (information cues) in a reorganisation decision experimental task.
(5) EXPERIMENTAL TASK
Subjects for the experimental task were Australian insolvency practitioners. These
practitioners are an important party to the voluntary administration decision process
in their role as appointed administrators. The Corporations Act requires that the
appointed administrator assess the prospects of a company and make a
recommendation to creditors regarding the companys future.10 From a listing published
by the Insolvency Practitioners Association of Australia, contact details for
approximately 136 insolvency firms were obtained. Firms were contacted and

10

See section 438A of The Corporations Act 2001 (Cth).

Routledge and Gadenne

47

requested to participate in the experimental task.11 Twenty-one firms provided

completed responses for the experimental task (fifteen percent of firms contacted).
All of the subjects held senior positions within the firms and had undertaken voluntary
administration engagements. Accordingly, the subjects have considerable experience
in decision-making relevant to the task. Table 11 provides a subject description
summary.
Table 11
Experimental Task Subject Descriptions

Years of insolvency experience

Engagements where reorganisation/
liquidation has been at issue
Age
Present Position

Mean
17
143

Minimum
8
1

Maximum
40
1000

44

29

62

Partner
Manager

15
6

The approach to administering the experimental task and instructions provided to

subjects was based on the extensive body of prior behavioural accounting studies
(see, for example, Libby 1975 and 1976, Zimmer 1980, and Casey 1980). Each subject
was provided with financial profiles of twenty real but disguised companies that had
entered voluntary administration between 1993 and 1996. This was a sub-sample of
companies included in the statistical model. The smaller but more manageable number
of companies was deemed more appropriate for the experimental task to minimise
problems associated with subjects experiencing information overload or fatigue during
the task.12 Ten of the companies had concluded administration by liquidation; the
other ten had concluded administration with a deed of company arrangement that
provided for reorganisation of the companys affairs. Of the companies that had

11
12

The experimental task was administered in September 1999.

No time constraint was imposed for completion of the task, although subjects were advised that it was
estimated the task could be completed in about thirty minutes. Where completion time differed significantly
from that suggested it is possible that fatigue or decline in level of interest in the task may have had an
adverse effect on the quality of subjects results. As only a small number of subjects took marginally
longer than the suggested time, the probability of bias due to fatigue or loss of interest was minimal.

48

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

attempted reorganisation, five were categorised as successful.13 Financial profiles

contained the same information cues as those used in the statistical model. Data were
provided for two years prior to the year in which the company entered voluntary
administration.
Subjects were required to identify companies that should attempt reorganisation, and
companies that should be liquidated. Where subjects identified a company as one
that should attempt reorganisation, they were requested to estimate the probability of
the company achieving a return on assets that equals or exceeds the industry average
in the first three years after reorganisation. Subjects were also requested to estimate
the probability of the outcome they had indicated, and to rate their confidence in each
prediction. A debriefing questionnaire followed the completion of financial profiles.14
5.1 Predictive Accuracy
In determining subjects prediction accuracy for the performance event, a correct
prediction was deemed to have been made when:
1. a liquidation or unsuccessful reorganisation was correctly predicted;
2. an unsuccessful reorganisation was classified as a liquidation; and
3. a successful reorganisation was correctly predicted.
This classification determined the ability of subjects to distinguish between companies
with suitable and unsuitable prospects in reorganisation. The accuracy of subjects
prediction in this task is summarised in Table 12.
The binomial theorem indicates that, at the 95 percent confidence level, a subject
predicts at a rate better than random accuracy if he or she correctly predicts the status
of at least fourteen companies. Table 12 indicates that five subjects performed better
than random accuracy, correctly predicting the outcome for fourteen or more
companies. With respect to comparison of the predictive accuracy of the human judges
and the accuracy rates of the statistical model, the average accuracy of human decisionmakers was 10.52 (out of 21 tasks) or 52.61 percent, compared to 87.5 percent for the
statistical model.
Accuracy in identifying companies that were liquidated or were unsuccessful in
reorganisation was 59.4 percent. This was nearly double the 32.3 percent accuracy
for identifying companies that successfully reorganised.
13

Each subject was advised that (a) the firms had been randomly drawn from a population containing
equal proportions of liquidated/reorganised firms, the latter containing 50% deemed successful
reorganisations, and (b) the cost of misclassifying (i) a liquidation/reorganisation and (ii) a successful/
unsuccessful reorganisation was the same

14

Details of the research instrument are available on request from the authors.

Routledge and Gadenne

49

Table 12
Experts Prediction Success
(Successful/Liquidation and Unsuccessful Reorganisation)
Correct Predictions Overall
(20 Cases / 21 Subjects = 442 Predictions)
6
8
9
10
11
12
13
14
15
17
Correct Predictions = 221 out of 442 (52.61%)
Mean = 10.52 (20), Standard Deviation = 3.15,
Max = 17, Min = 6
Correct Predictions
Liquidation and Unsuccessful Reorganisation
(15 Cases / 21 Subjects = 315 Predictions)
4
5
6
7
8
10
11
12
13
14
Correct Predictions = 187 out of 315 (59.37%)
Mean = 8.91 (15), Standard Deviation = 3.29,
Max = 14, Min = 4

Number of Subjects (n=21)

3
4
2
1
4
1
1
3
1
1

2
1
5
1
1
3
1
4
2
1

Correct Predictions
Successful Reorganisation
(5 Cases /21 Subjects = 105 Predictions)
1
2
3
Correct Predictions = 34 out of 105 (32.3%)
Mean = 1.62 (5), Standard Deviation = 1.02,
Max = 3, Min = 0

7
6
5

50

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

Results indicated that experts prediction of successful reorganisation from the cues
provided was a difficult (if not impossible) task. The results are consistent with those
reported by Houghton and Woodliff (1987) for a task that required classification of
firms based on predicting high or low earnings per share. Their study reported an
average prediction success of only 54.2 percent.
5.2 Self-Insight into Accuracy of Each Prediction
Subjects were also requested to indicate their degree of confidence in each prediction.
The usefulness of financial profile information to subjects is supported if their accuracy
is positively associated with confidence in prediction (Zimmer 1980, p.633). Table
13 provides the proportion of correct responses for each level of confidence. Overall
the results show little change in accuracy for differing levels of confidence. This
suggests the information cues were not perceived to be that useful to subjects in
carrying out the task. Accurate prediction of successful reorganisations was associated
with subjects reporting higher levels of confidence, however, the overall accuracy
was poor at 20.5 percent.
Table 13
Subjects Correct Response for Confidence Level
(Successful/Unsuccessful Reorganisation)
Prediction
Confidence

Liquidation/Unsuccessful
Very
Confident
Confident

Successful Reorganisation

Not Very
Very
Confident Confident

Confident

Not Very
Confident

Fraction
Correct

61/96

101/175

25/41

9/44

8/44

1/10

Percentage
Correct

63.5%

57.7%

61.0%

20.5%

18.2%

10.0%

Overall
Very
Confident
Confident

Not Very
Confident

Fraction
Correct

26/51

109/219

70/140

Percentage
Correct

50.0%

49.8%

51.0%

Routledge and Gadenne

51

5.3 Individual Differences

In an attempt to explain individual differences in prediction accuracy, responses to
the task questionnaire were correlated with prediction accuracy. The correlation matrix
is presented in Table 14. Where it is likely that many variables are correlated with
another variable, potential problems exist with interpreting results of the significance
of univariate correlation as they may not be independent. Accordingly, only correlations
at p<.01 were deemed to be significant. Individual differences including age, years of
experience and number of voluntary administration engagements were not significantly
correlated with prediction accuracy by subjects. This result is consistent with the
majority of financial distress behavioural studies that have considered the effect of
individual differences (see, for example, Libby 1975, Zimmer 1980, and Houghton
and Sengupta 1984).
Table 14
Correlation Between Experimental Task Prediction Scores
and Task Questionnaire Response

Liquidation

TLTA

TLOE

CACL

CLTA

OPTA

TA

IND

Years

Engag.

Age

*-0.666

-0.423

-0.094

*-0.569

0.145

-0.008

-0.072

**0.493

0.005

0.194

Reorganisation

0.153

0.221

0.256

0.250

0.248

0.288

-0.289

0.221

0.266

0.187

Total Liq./Reorg.

-0.365

-0.154

0.154

-0.231

0.306

0.217

-0.337

*0.568

0.282

0.313

Successful Reorg.

-0.191

-0.061

-0.093

-0.382

0.197

0.355

-0.293

0.358

0.357

0.058

Unsuccessful and Liqs. -0.180

-0.136

-0.125

**-0.462

0.072

0.224

-0.173

0.260

0.239

-0.008

*Denotes Pearson Correlation is significant at p<.01; ** Denotes Pearson Correlation is significant at p<.05

TLTA = total liabilities / total assets

TLOE = total liabilities / owners equity
CACL = current assets / current liabilities
CLTA = current liabilities / total assets
OPTA = operating profit / total assets

TA= total assets

Years = Years of insolvency experience
Engag.= Number of engagements
Age = Age in years

The task questionnaire also requested subjects to rate the value of each information
cue in relation to its usefulness. Table 15 summarises information provided by subjects
regarding their use of the cues in making decisions. Subjects rated measures of liquidity,
profitability, size and leverage respectively as the most useful items of information in
making their decision. Subjects assessment of the value of each information cue was
correlated with prediction accuracy, and no significant correlation between prediction
accuracy and subjects emphasis on particular information cues was found.

52

An Exploratory Study of the Company Reorganisation Decision in Voluntary Administration

Table 15
Summary: Subjects Usefulness Rating of Information Cues
Information
Cue
CACL
OPTA
TA
TLTA
INDUSTRY
CLTA
TLOE

Mean
(10 point scale)
7.881
7.452
7.214
6.929
6.214
5.500
5.119

Std. Deviation
2.156
1.774
2.171
2.087
1.586
2.388
2.155

Low
1
4
2.5
1
2
1
2

Range
High
10
10
10
10
8
10
10

(6) LIMITATIONS AND CONCLUSION

Data collection for analysis presented in this paper proved difficult and costly. As a
result, the small sample size is a major limitation with respect to the generalisability
of results for the statistical analysis. The estimation sample may also be subject to
problems of data bias due to the non-random sample selection method. The final
sample of companies may not properly represent the prior probability of reorganisation/
liquidation in the population, which can lead to inconsistent and biased estimates,
and result in overstatement of model prediction accuracy (Zmijewski 1984, Piesse
and Wood 1992). A further limitation is the reliance on accounting measures that are
subject to bias from managerial manipulations or differences in accounting procedures
or policy choices.
The nature of the experimental task also presents some limitations. The delivery of
the experimental task may have lacked practical realism, as the financial profiles
provided to subjects may not represent the type of information used by insolvency
experts in assessing a companys prospects. Accordingly, results from the experiment
would not be completely generalisable to other situations.
Overall, the results of this exploratory study have several implications. The main
contribution of this paper is the insight it provides regarding the relevance of financial
information to VA decision-making.
With respect to the reorganisation decision for companies that enter VA, our analysis
indicates that financial characteristics differ between companies that reorganise and
companies that proceed to liquidation. The ability to distinguish between
reorganisations and liquidations is useful for stakeholders whose costs systematically

Routledge and Gadenne

53

differ between the two outcomes. Significant variables in the reorganisation event
model may reflect the existence of bargaining or coalition behaviour between
stakeholders prior to the reorganisation event. Future research might focus on
investigation of the reorganisation event with a view to gaining a greater understanding
of how financial position affects decision-making.
The analysis presented also indicates that financial characteristics differ between
companies that have successful and unsuccessful reorganisation outcomes. Statistical
analysis conducted indicates that success in reorganisation is associated with higher
levels of past profitability and short-term liquidity.
In comparing the predictive performance of the statistical analysis and human decisionmakers we found that, although the statistical model had high classification accuracy,
the decision accuracy of insolvency experts in an experimental task (using the same
financial variables) was poor. The results indicated that experts prediction of successful
reorganisation from the financial cues provided was a difficult (if not impossible)
task. A limitation of this comparison arises because the statistical models are developed
using information about actual outcomes, while the expert decision-makers were only
provided with information about prior probabilities of the outcomes. However, the
result suggests that the experts use of information cues is less than optimal, and that
utilization of statistical models may improve the performance of decision-making.
While the problem of deciding whether a company should attempt reorganisation is
not likely to be reduced solely to consideration of financial variables, our findings
suggest that it might be advantageous to employ an appropriate statistical model to
assist those required to make decisions or give advice on company reorganisation.
Furthermore, informed decision-making in VA may contribute to minimising the
incidence of prolonging the existence of non-viable firms, thereby reducing costs
associated with the VA insolvency regime. Future research might address the
development and refinement of suitable models.
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