Research Article

Financial constraints and the financial distress puzzle: Evidence from a frontier market before and during the Covid-19 pandemic


We are the first ever to examine the financial constraints and distress risk puzzle of listed manufacturing firms in Vietnam. We employ different estimation methods such as portfolio sorting, Fama Macbeth regression, and asset pricing models to analyse a sample containing 27 300 firm-month observations from 2008 to 2021. Our empirical evidence figures out that the Z-score anomaly exists in the Vietnam stock market before the Covid-19 pandemic. The distress risk puzzle also exists after controlling for financial constraints and other firm characteristics. Moreover, the asset pricing model results conjecture that the distress risk is a priced factor. The average raw returns difference and risk-adjusted returns difference between stocks in the highest and lowest Z-score terciles are around 1% per month. However, we figure out that the Z-score puzzle disappears during the pandemic. Finally, our study employs a two-way sorting methodology to examine the causality between the distress puzzle and financial constraints. Our study figures out that distress risks cause higher financial constraints, not the other way around. Our findings support managers and policymakers in managing the default risk, especially during the pandemic.

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