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Liquidity And Leverage As Nonlinear Determinants Of Risk Of Default

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  • CRINGASU Oana Irina

    (Lucian Blaga University of Sibiu)

Abstract

This study investigates the empirical relationship between liquidity and leverage as nonlinear determinants of risk of default as reflected by Altman Z" score. The analysis performed on a set of financial data for 291 Romanian corporates applying Generalized Additive Models ("GAMs") and Exploratory Factor Analysis ("EFA") uncovered significant non-linear relationships: the benefit of liquidity (Current Assets/ Current Liabilities) diminishes beyond a ratio of 2.0, while the negative impact of leverage (Total Liabilities/Equity) accelerates sharply beyond a threshold of 3.0. Moreover, a significant interaction effect reveals that high liquidity loses its protective value when funded by excessive leverage, a condition perceived as "debt-funded cash". EFA results also reinforce the importance of financial structure. The fact that the Z" score is almost exclusively driven by measures of financial robustness—liquidity, profitability, and solvency—rather than operational efficiency (Turnover/ Total Assets) has significant implications on corporates financial management and decision making. The present study brings an important contribution to the existing literature dedicated to the impact of specific financial indicators -liquidity and leverage - over the risk of default of Romanian corporates, as well as to the assessment of the underlying factors composing Altman Z" score, providing at the same time an in-depth analysis tool for professionals and managers focusing on sustainable financial management and resilience.

Suggested Citation

  • CRINGASU Oana Irina, 2025. "Liquidity And Leverage As Nonlinear Determinants Of Risk Of Default," Revista Economica, Lucian Blaga University of Sibiu, Faculty of Economic Sciences, vol. 77(3), pages 106-120, December.
    • Handle: RePEc:blg:reveco:v:77:y:2025:i:3:p:106-120
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    File URL: http://economice.ulbsibiu.ro/revista.economica/archive/77309cringasu.pdf
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    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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