Sampling procedure

The overall framework is constructed in order to classify genuine turnaround candidates. The following sample procedure builds on this approach and outlines the specific characteristics that a firm’s performance is required to follow.

2) Three consecutive years of ROA below the risk free rate during the 3-year decline. The decline occurs after the base period, when the firm’s performance was above the risk-free rate. This conservative benchmark is employed to ensure the turnaround firms are failing in economic terms during the downturn in performance. This 3-year period is considered as the decline period.

3) During the decline period, the firm’s performance have to become low enough to cause negative net income (i.e. negative ROA) for at least one year. This additional criterion is an attempt to strengthen the validity of the definition and ensure that the firms not only have experienced a performance decline, but have additionally experienced net losses that could have potentially threatened the viability of the business.

4) During the decline period, the firms had to experience an Altman’s Z-score of less than 2.99 for manufacturing firms and 2.60 for non-manufacturing firms for at least one year in the downturn period. As the previous criteria, Altman’s Z-score is to ensure that the firms are experiencing a significant performance decline of such a severe character that it could threaten the viability of the firm and warrant a turnaround attempt. Consistent with prior studies, Altman’s Z-score is used to express the financial soundness of the individual firm (e.g. Abebe et al., 2011; Barker & Duhaime, 1997), and as described, lower values generally indicate lower financial health.

Hence, all firms included in the sample have experienced declining and deteriorating performance measured by ROA for 3 consecutive years, with ROA being below the risk-free rate of return for 3 consecutive years, experienced an accounting loss measured by net income in at least one year in the 3-year decline period, and have had an Altman’s Z-score below the threshold limit in at least one of the years during the 3-year decline period.

Classification of recovery

As consequence of the variety of turnaround definitions in the literature, Pandit (2000) and Pearce and Robbins (1993) recommend using a generally agreed conceptualisation of the phenomenon turnaround. Therefore, I define successful recovery, and thus successful turnaround, in three ways. The main approach is defined to maximize the sample size due to data availability constraints, while the two subsequent definitions in greater detail will be consistent with the approaches used in the turnaround literature. The two subsequent definitions

will act as a robustness check and to test the relation between ownership aspects and turnarounds outcome.

In line with the approach used by Bruton et al. (2003), the degree of turnaround success is measured by the following definition:

1) The degree of corporate turnaround success is measured by the turnaround performance (ROA). Thus, I am not restricting the dependent variable into discrete choices, i.e. either turnaround or non-turnaround, but I am instead using the actual performance in the turnaround period.

Contrary to the definition above, the two following definitions will classify the firms into turnarounds and non-turnarounds. Consistent with Abebe et al. (2011) and Abebe (2010), a firm is defined to have achieved a successful turnaround if the firm comply with the following recovery characteristics:

2a) Three consecutive years of positive and increasing return on assets (ROA) above the risk-free rate of return during the recovery period. By increase in ROA in this criterion is meant that ROA is above the risk-free rate of return, i.e. the minimum threshold, while it does not necessarily mean that ROA occur in an actual increasing pattern.

2b) At least three consecutive years of increasing return of assets (ROA) with performance in the last year (year 6) at least being above the minimum threshold and profitable, i.e.

positive net income and thus positive ROA.

Similar, non-turnaround firms were identified in 2a by replacing the recovery characteristics with the fact that ROA was decreasing and below the benchmark during the recovery period (i.e.

year 4, 5, and 6). In 2b non-turnaround firms were characterized by experiencing deteriorating and fluctuating ROA below the risk-free rate of return during the entire recovery period (i.e.

year 4, 5, and 6). The sampling procedure allows me to follow the individual firm through the turnaround process. The underlying ideas are illustrated in the figure below.

Figure 3: Illustration of the turnaround process including sampling criteria

Source: The illustration is adopted from Francis and Desai (2005) and is adjusted to the sampling criteria for my thesis. The actual turnaround- and performance-pattern depend on the definition and the figure has only an illustrative purpose.

4.2.2. Final Sample

The turnaround definition and sample selection criteria’s were applied to the COMPUSTAT database for the period 1995 to 2010, which resulted in a general population consisting of 3.227 publicly-held firms, where 301 firms were identified as meeting the specified sample selection criteria’s. Missing ownership information reduced the sample by 10, while another two was restricted from the sample due to irregular values. The final sample consists of 289 firms that have experienced severe performance decline. The two additional definitions for the robustness analysis resulted in a sample size of respectively 152 and 199 firms.

Table 2: Summary of the number of companies in the analysis

Characteristics of the sample # number of companies

Total observations extracted from Compustat as the general population 3.227

Companies meeting the sample criteria 301

Companies eliminated due to missing ownership information 10

Companies eliminated due to irregular values 2

Total sample size for analysis (definition 1) 289

Sample size for definition 2a 152

Sample size for definition 2b 199

The table summarizes information regarding the observations and sample size for each definition. Observations are extracted from Compustat and reduced by applying the given sample selection criteria. The companies restricted from the sample due to irregular values were as a consequence of no operational revenues in periods of the turnaround cycle.