The relationship between book-to-market ratio of equity and distress risk for stocks quoted at the NSE

Abstract

This paper examines the relationship between book-to-market ratio of equity, distress risk and stock returns. The distress risk is proxied by Ohlson's score (O-score), a measure devised by Ohlson (1980) to find the probability of a stock being delisted in stock exchange. The book-to-market ratio of equity and distress risk as proxied by O-score are also compared with other variables thought to be related to distress including leverage, return on assets and SIze. Stocks are ranked every year on the basis of the probability of distress and book-to-market ratio of equity with the spearman's rank correlation co-efficient being calculated between the ranks. The results show that book-to-market ratio of equity and distress risk are both negatively related to variables thought to be associated with distress i.e. return on assets, market leverage and size as measured by market capitalization of equity. Moreover, the sorts reveal that both distress.risk and the book-to-market ratio of equity are positively related to returns though not very strongly.