Unraveling dynamic interplay between diversification and bankruptcy risk in an emerging market: a GMM-PVAR approach

This study investigates the dynamic and bidirectional interplay between distinct forms of business diversification and bankruptcy risk within the context of an emerging market. Drawing on a balanced panel of 480 non-financial firms listed in Vietnam from 2014 to 2023, we employ a robust methodological framework combining two-step System Generalized Method of Moments (Sys.GMM) for analyzing direct effects and Panel Vector Autoregression (PVAR) for exploring systemic feedback loops. Bankruptcy risk is primarily measured using an ex-ante, model-based Expected Default Frequency (EDF), providing insights into firms’ forward-looking default probabilities. Our Sys.GMM estimations reveal that related diversification (RDIV) significantly and dynamically heightens EDF, suggesting an accumulation of risk from strategies involving closely connected industries. Conversely, current unrelated diversification (UDIV) is found to significantly reduce EDF, consistent with portfolio theory, although this risk-mitigating effect does not appear to persist significantly through its lagged term. The PVAR analysis, further corroborated by Impulse Response Functions (IRFs), uncovers significant bidirectional dynamics: while diversification strategies influence future bankruptcy risk, heightened bankruptcy risk, in turn, demonstrably constrains subsequent related and unrelated diversification activities. By illuminating the complex, time-dependent, and reciprocal relationships between diversification choices and firm solvency, this research offers actionable insights for corporate managers, investors, and policymakers navigating the volatile landscape of emerging economies, emphasizing the need for nuanced strategic considerations and proactive financial management.