Bankruptcy Risk, Financial Flexibility and Investment

Corporate bankruptcies have emerged as a growing concern which questions the credibility of financial reporting, analysts forecast and rating agencies. This credibility depends on whether corporate investments effectively reflect information about future risk of financial distress. As a result, we examine whether and how investment efficiency affects bankruptcy risk. Using a sample of listed firms from G20 countries over the period 2009–2023, we establish a negative relationship between investment efficiency and bankruptcy risk. Rising cashflows and reducing operating costs are two intervening mechanisms between investment efficiency and the risk of bankruptcy. Furthermore, we analyse the effect of financial flexibility on this relationship since it allows firms to adjust their investments to generate incremental value. In financially flexible firms, we find that the adverse effect of overinvestment on financial health of firms deteriorates significantly. Additionally, the negative relationship between investment efficiency and the risk of bankruptcy strengthens in firms pursuing innovation and conservative working capital while this relationship diminishes in firms undertaking M&A activities and cash accumulation. These findings assist corporate managers, investors, regulators and policymakers to evaluate future risk of financial distress from investments for prudent decision-making.