Probability of bankruptcy in small firms and cost efficiency: the case of Slovenia

Recent entrepreneurship praxis as well as entrepreneurship research have concentrated on one of the fundamental issues: business failures. Existing research has focused on investigating determinants of the mortality of firms (Beaver, 1966, Altman, 1968, Zmijewsky, 1984, Frydman et al., 1985, Gentry et al., 1987) in two samples of firms, namely firms that survive in a particular year and firms that went bankrupt in this particular year. They aim to classify a sample of firms on the basis of balance sheet data (financial data) and nonfinancial data. Despite different opinions expressed by authors, these research activities argue that financial data alone could not explain the failure or nonfailure of the firm (Zavgren, 1987, Keasey and Watson, 1987). As one of the determinants of bankruptcy risk Becchetti and Sierra (2003) have investigated productive efficiency by adopting stochastic frontier approach (Battese and Coelli, 1995). Their findings indicate that a firm's productive efficiency has significant explanatory power in predicting bankruptcy. In this perspective, the authors try to answer three questions: (1) whether the probability of bankruptcy could be explained by cost efficiency, measured by data envelopment analysis (DEA), (2) with what time lag cost efficiency effects bankruptcy, and (3) in what way cost efficiency must be analyzed to be able to estimate its predictive power on the probability of bankruptcy. According to the opinion of the authors, the inclusion of cost efficiency as the determinant of bankruptcy risk enables the analysis of the determinants, which arise from inside of firms (the combinations of factors of production, the scale of their use for producing a unit of production and their prices) and determinants arising from the market (output level and sales market prices), as cost efficiency indicates technical as well as allocative efficiency, both being the result of business process inside of firms. In this perspective, by analyzing the probability of bankruptcy among small firms on the basis of cost efficiency authors determine the fault of bankruptcy as the consequence of business process inefficiency inside the firms and bad business performance on the sales markets. On the basis of financial ratios, we consider the following indices as determinants of business performance on the sales markets: liquidity, profitability, turnover, export, sales/industry sales rate and break- even point. The research is limited to a sample of small firms in Slovenia.