Unconventional Views on Indonesian Financial Crisis: Minsky and Régulation Theory

Transcription

1 Unconventional Views on Indonesian Financial Crisis: Minsky and Régulation Theory By Agustinus Prasetyantoko Ecole Normale Supérieure Lettres et Sciences Humaines, Lyon France & Atma Jaya Catholic University Abstract: This paper responds to the 1997 financial crisis in Indonesia by unconventional views. I consider Minsky on Financial Instability Hypothesis and Régulation theory on the evolution of capitalist system for understanding the intricacy of problem behind the financial collapse in Indonesia. I basically argue that economic crisis has a structural root embedded in the evolution of the capitalist system itself and that the evolution of the firm capital structure and corporate behaviour evolve during this structural development. Meanwhile, several conventional explanations are still inconclusive about the root of crisis, the linkage between Minsky on micro behaviour and Régulation theory on structural evolution, in my argument, can explain clearly this great phenomenon. I. Introduction Inspired by Jawaharlal Nehru -an Indian prominent scholar- on his famous statement on history and the victors, Radelet and Sachs (1998) lead their analysis on Asian financial crisis by following statement: Financial history, it seems, is written by the creditors. When a financial crisis arises, it is the debtors who are asked to take the blame. It is true that in most analysis of Asian crisis, internal problem which usually refers to incomplete internal market system is commonly cited as the main source. It includes typical problems such as unsound regulation, weak supervision, partial deregulation and liberalization, rampant corruption, weak corporate governance etc. These systemic market discrepancies led to inefficient investment spending and unsafe property right system which subsequently underscored the stability of banking and financial system by provoking bank runs and panic behaviour. In this paper, I argue that financial crisis in Asia, especially in Indonesia, is a complex phenomenon which can not be viewed by single conventional explanation. In such a case, unconventional perspectives are needed for a better understanding. The foundation of thinking proposed by Minsky is important to understand how finance influences the economic fluctuation. Then, how economy evolves in the long term period is conceptualized well by Régulation theory (RT). In this paper, I focus on the capital structure evolution of corporate sector in Indonesia for gaining explanation about the structural evolution of micro sector behaviour related to the macro

2 Oeconomicus, Volume IX, economic fluctuation. In other sense, this paper is trying to figure out the micro structural root of crisis by accentuating on the corporate financing behaviour in Indonesia. I begin with an endogenous financial instability hypothesis described by Minsky which followed by the explanation of crisis by RT. The paper subsequently enters into debates on Asian crisis and some explanations of crisis as well as several data for describing the case of Indonesia. II. Minsky s Innovation: Finance and Investment Hyman Minsky made a seminal contribution to the development of Financial Keynesianism during his lifetime ( ). Minsky s research emphasized the central role of finance in modern economies at a time when finance was not important in most mainstream macroeconomic research (Fazzari, 1999). Considering Minsky s thoughts for understanding the relation between finance, investment, and the crisis is therefore inevitable. Minsky believes that productive or real sector as well as investment level should be defined by micro units of production. The financial condition of these micro units is subsequently important to have an impact on investment activities. Before the wave of crises in 1990s, Minsky (1975) has developed a simple model to explain financial risk in which the evolution of the liability structure of firms over the course of a boom becomes a pivotal factor affecting financial crises. Related to the 1997 Asian crisis, Arestis and Glickman (1999) point out that Minsky s Financial Instability Hypothesis (FIH) would seem to have obvious application to the recent experience of financial crisis in Asia. They argued that Minsky s works does indeed offer the basis for a convincing interpretation of the crisis in Asia and on which has important implication for policy. The normal dynamic of a capitalist economy increases financial opportunities, which then enhance speculative behaviour. FIH attempts to provide a theory of systemic financial fragility, arguing that phases of over-caution and over-exuberance in financial practices are generated not by random causes but rather by the internal workings of the economic system (Sethi, 2002). During booms of the dynamic capitalist economic system, an undervaluation of risks and an expansion of the supply of funds, which could boost speculative activities, are common. Arza and Espanol (2006) provide an empirical evidence of the Argentian firm behaviour and argue that in a context of full financial liberalization, defined in terms of both international capital mobility and domestic financial deregulation, these mechanisms might be exacerbated because with less intervention there might be fewer quality control (i.e. more indiscriminate credit), and with a larger supply of funds from different sources there will be increased liquidity. Schroeder (2002) heightens that these structures become increasingly fragile over the duration of a boom simply through their (seemingly) independent finance and investment decisions as they strive to accumulate. Kregel (1998) argues that an open (developing or developed) economy is vulnerable to a financial crisis much earlier in the business cycle than what Minsky s closed, developed economy 63

3 Agustinus Prasetyantoko model suggests. Arestis and Glickman (1999) put forth a Minskian analysis which suggests that, like Kregel, financial crisis in an open economy arrives earlier than in a closed economy by arguing that the Minskian stages be redefined to include the effects of exchange rate fluctuations along with vulnerability to increases in the interest rate. Weller (1999) using Minskian approach argues that the vulnerability of emerging economies to currency and banking crisis increase after financial opening. Vulnerability of both crises (currency and banking) increased to follow liberalization in both, internal and external financial system. External liberalization means that domestic market receives more liquidity, which increases both productive and speculative projects. Internal liberalization characterized by deregulation and liberalization policies enhanced banking development in domestic market as well as credit channelling to corporate sector. For Minsky, a firm s financial structure is crucial to its investment. Furthermore, according to him capital market assets generate cash as a compensation for their participation in the production process; financial assets generate cash as the maker is able to fulfill commitments. Minsky have indicated that micro sector behaviour or corporate finance behaviour could be an important factors affecting macro economic fragility. Minsky (1980) has developed the distinction between Hedge, Speculative and Ponzi financial postures. Hedge financing has the normal cash flow large enough to meet both principle and interest that are due on debts; Speculative financing has the income of the debtor large enough to meet the interest but not the principle payment and Ponzi finance takes place when not enough is earned to meet the interest due on debts. Speculative finance involves rolling over debts and Ponzi finance involves the capitalization of interest. Financial crisis therefore can be identified if the financial structure needs to be heavily indebted, involving a large element of either Ponzi finance or Speculative finance which can become Ponzi. Hedge financing is robust but Speculative and Ponzi financial structures are fragile. In the liberalized financial system, firms can borrow short-term foreign debt to finance domestic long-term assets which should enhance the speculative behaviour of the firms. According to Arestis and Glickman (1999), financial liberalization motivates firms to be super-speculative financing units. In globalize financial system, Minsky s taxonomy on financing profile provides an important indicator for the appraisal of the potential for a financial crisis or the borrower and the impact on the lender when there is a change in external factors, such as interest rate or exchange rate. Kregel (2004) explains that a hedge profile requires the largest change in receipts or commitments to become a speculative profile, while a firm that starts out in speculative financing may become a ponzi financing profile with a much smaller variation in internal or external conditions since its margin of safety represented by the excess of expected receipts over certain commitments is lower. 64

4 Oeconomicus, Volume IX, III. Financial Crisis on Régulation Theory Crisis is not a new phenomenon. It happens along history of humankind. Two crises are usually cited as important events, which could illustrate the prototype of crisis in early history of economy and society, namely Tulip-mania ( ) and The Mississippi and South Seas Bubbles (1720). After that, a great crash in 1929 or Black Tuesday when Dow Jones Index fell dramatically is referred to as an important prototype of crisis in the world with modern financial system. Tulip-mania resulted from the arriving of tulip from Turkey to Holland in 1593 and it became a symbol of status and prosperity in Holland. Hence, the increasing of tulips price provoked the mania among the agents in the market of tulips. Meanwhile, in the 1929 great crash, the factor of speculation, panic and mimetic behaviour are important ingredient resulted in dramatic downturn in financial market, and then in great recession in the world economy. In those cases, tulip-mania as well as black Tuesday, crisis entails panic behaviour or animal spirit in Keynes terminology. For the perspective of Régulation Theory (RT), there is no capitalism without crisis (Boyer, et al., 2004), since crisis is really a result of a contradiction between several modes of regulation within an economy and an early stage of the emergence of new configurations 1. As a consequence, crisis would be always embedded in an economic fluctuation withstanding along history within a society. However, the recent crisis has new features with regard to the previous generation of crisis. Recently, crises are citius, altius and fortius 2. Since financial liberalization in 1980s, financial crises were followed by immediate international repercussion or that crises had high contagion effects. The question is therefore what really is the source of such a virulent crisis. There are three important problems intervenes in the recent crisis, which are innovation of financial products (derivatives market), national deregulation policies and international financial integration (Boyer et al. 2004). It comprises the three different levels, namely firm, national and global-level sources of instability, which result in the high fragility in the nowadays-global financial system. Boyer et al. (2004) provide seven propositions to understand the crisis which could be regarded as the new features of the recent crisis. 1. The presence of the asymmetric information in financial market which implies in the inefficiency of market allocation and enhances the incertitude. 2. The pro-cyclical risk taking behaviour which is referred to as a main source of the most recent crises. 3. The financial factor which plays an important role in the mechanism of crises by its financial accelerator multiplied by the coincidence with other combination factors. 4. The banking system which plays a determinant role in the mechanism of financial crises. 5. The incoherence of macro economic regime which bears the systemic severe crises. 65

5 Agustinus Prasetyantoko 6. The compatibility of national financial institutions with international ones. For example, financial deregulation policies in national level have preceded the prudential code of conduct in international level. 7. The innovation of financial product and internationalisation of financial operation are regarded as important factors by which financial instability transformation should be determined. This following Figure 1 show how optimism, state of confidence, and financing behaviour of economic agents (households, firms or governments) brings fragility in the continuous cycles. Optimism will lead to risk taking behaviour resulting in financial fragility and default probability. The evaluation of action will be a turning point from the fragility and if the level of confidence returns, the optimism will be present again. And the cycle of fragility will be reproduced again. Figure 1. Cycle of Financial Fragility Optimism Emergence of fragility Gearing effect Risk taking behavior Debt overhang Default probability Return of Confidence Re-evaluation of financial fragility Endogenous reversal Re-evaluation of risk taking Note: dashed line is a zone of fragility Source: Boyer et al. (2004) In the figure above, gearing ratio or ratio of debt to equity indicating the ratio of external and internal finance is an important indication of the financial fragility. It is due to that the higher a company's degree of leverage, the more the company is at risk to be bankrupt. The recent analysis of crises commonly acknowledges the role of agency behaviour, asymmetric information and financial factor in propagating the crises. Accordingly, there will be a multiple equilibria occurring in the relation between exchange rate and banking crisis but also with investment or productive sector crisis. There is an intricacy of relation between the choice of exchange rate regime, bank supervision, lender of the last resort, price stability, credit cycle and macro economic stability. 66

6 Oeconomicus, Volume IX, IV. Debates on Asian Crisis For most scholars, the emergence of the third generation of crises is neither predictable nor understandable. When Asian crisis hit, Krugman (1999) said, The truth is that nobody really imagined that something like the Asian financial crisis was possible, and even after the fact there is no consensus about why and how it happened. Intense debates on the causes, onset and evolution of the 1997 East Asian financial crisis have been sparking among scholars. One of the stylized central debates is on the fundamental versus panic view. The question of whether Asian crisis was caused by fundamental factor rather than by speculative attack of liquidity holders became important central debate. Fundamental view (Corsetti, Pesenti and Roubini, 1998) accuses that the structural imbalances deeply rooted on the economies across Asian countries since long-time before the date of crisis is the main factor causing the Asian financial crisis. They contend that all indications are of structural fragility in the financial and corporate sectors. Corsetti et al. (1998) summarize this vicious cycle, the Asian tigers collapsed under the excessive weight of the paper liabilities which had financed projects of doubtful profitability, covered losses, and led to unsustainable external imbalances. Meanwhile self-fulfilling or panic view (Radelet and Sachs, 1998) assumes that the panic of the liquidity holder across Asian countries is the main source of the width and depth of crisis. Since globalization, financial liberalization and capital market integration enhance capital mobility; countries integrating their domestic financial market into global market would become more fragile and prone to crisis. Theoretically, the panic behaviour of liquidity holders is exacerbated by the asymmetric information and agency problem giving rise to the herd behaviour of economic agents. It should be to date an important explanation why severe crisis happened in such fairly performing economy across Asian countries. Some scholars convince that even though structural imbalances in economy played an important role in most Asian countries, the herd behaviour of economic agents (self fulfilling prophecy) amplifies the crisis (Kumar and Debroy, 1999). However, the distinction is between those who believe that the crisis was due purely to structural weaknesses in the affected economies, and those who believe it was structural weaknesses combined with financial panic. Krugman (1999) reveals the anecdotal description of this opposing approach as a debate of fundamentalist and self-fulfilling crisis stories. In line with the fundamental view, Krugman (1999) identified the link between moral hazard and over-investment in the presence of asymmetric information of the financial sector as an important factor affecting crisis in the developing countries such as South East Asian countries. Meanwhile, Furman and Stiglitz (1998) also accentuate the fundamental factor in which premature financial sector liberalization and weak institution should be the main source of crisis in South East Asian countries. Even after more than ten years of Asian crisis, it is still unclear the root of the problem. Whether internal fundamental economic system rather than global financial system; macro factors 67

7 Agustinus Prasetyantoko rather than micro factors; liquidity problem rather than solvability problem the essential reason of crisis. Or should corruption and political governmental system be responsible to the turbulence? V. The Case of Indonesia In Indonesia, business sector developed rapidly after financial liberalization in In the financial-reform period, some policies are taken to liberalize the financial market through several deregulation and liberalization policies. On June 1, 1983 the first banking deregulation package was issued including (a) the lifting of credit ceiling for all banks that had been imposed in 1974, (b) the elimination of deposit interest rate controls on state banks, and (c) the phasing out of Bank Indonesia liquidity credit. The main impact of the banking reform is the increased freedom for banks to mobilize deposits in support of new lending. On October 27, 1988 government of Indonesia launched the second major policies package for bank deregulation. These reforms had the main goal to enhance financial sector efficiency by encouraging competition and increasing the availability of long-term finance by promoting the development of a capital market. Hofman, Rodrick-Jones and Thee (2004) describe that the policy package of the October 1988 policies entailed (a) an easing of restrictions on the opening of new private banks, bank offices, and non-bank financial institutions. This included permitting joint ventures with foreign banks, allowing domestic banks to open offices throughout Indonesia and foreign banks to open offices in major cities, and permitting rural banks to establish themselves on districts outside the provincial capital; (b) another significant banking policy enabled state-owned enterprises to place up to 50 percent of their total deposits with private banks. Removing barriers to entry resulted in the opening of a large number of new private banks, both domestic and joint venture that would compete with public financial institutions; and (c) The package included a reduction in the required reserve ratios from multiple set rates that averaged 11 percent to a uniform level of 2 percent of all third-party liabilities. Deregulation in October 1988 was followed by several aggressive policies taken in December 1988 and March 1989 with the main objective to accelerate the capital market development. The reforms contributed to a burst of financial system activity. Domestic credit jumped from Rp. 3.9 trillion in 1988 to 6.2 trillion in 1989 and 9.3 trillion in 1990 (up from just Rp. 1 billion in 1984) 3. And the number of banks increased from 111 in 1988 to 171 in 1990 and 240 in This drastic increase of the number of banks was accompanied by unhealthy business competition and low respect to banking system. It was very common that the new emerging banks were owned by businessmen with poor knowledge on banking system and its operational risks. They even tended to use their banks as the business cashiers for their business group (conglomerate). They had no real banker s way of thinking, which should be independent in nature -thinking and behaving independently is the main requirement for a banker. 68

8 Oeconomicus, Volume IX, Figure 2 describes the interrelated factors affecting the corporate governance practices as described by corporate sector financing behaviour. I argue that basically, corporate behaviour could not be alienated from the institutional context where they operate. In this case, I mention macro governance as an interrelated factor such as political and social system. In Indonesia, the way in which business is conducted becomes a complex issue due to weak supervision, unsound regulation, rampant corruption, high bureaucratization, family business system etc. For instance, before crisis, corporate sector was able to access directly the external debt without reporting to the monetary authority. The informality of doing business in Indonesia was very common. Meanwhile, the conglomeration system of business in Indonesia, where business empires owned by several business groups only, enabled business owners to have a special treatment from the government, such as licences, tax, credit facilities etc. by their connection with the important political leaders of the country. As a consequence, financial liberalization with rapid banking sector development in the weak governance was resulting in imprudent financing choices of the firms. This imprudent behaviour enhanced gearing ratio or leverage of most corporate sector which is accompanied by relatively low profitability level. In Minsky s terminology, most firms in Indonesia were speculative and ponzi style rather than hedge. All of these factors resulted in financial fragility and economic vulnerability. In such a condition, macro fluctuation could be exaggerated by micro factors into deep crisis. Figure 2. Interrelated factors Social/ institutional factors Macro governance Ownership/business system Political factors Debt ratio / gearing effect Firm profitability Corporate governance Financing behavior Fundamental macro economic factors Hedge, Speculative, Ponzi Fundamental micro vulnerability Crisis 69

9 Agustinus Prasetyantoko In the figure above, we can see that financing behaviour as represented by firm debt behaviour is important in order to understand the financial turbulence. In the following graphs, it is shown how firm debt behaviour evolves in pre and post-1997 financial crisis. Graph 1 demonstrates that in the aftermath of crisis, firms in non-tradable sector have more excessive debts than those of tradable sector. In general, non-tradable sector rose faster than tradable sector following a financial crisis in Indonesia which subsequently gave birth to another kind of economic vulnerability. It is especially due to that debts are still the main source of their financing. Graph 1. Median (%) Total Debt 5 4,5 4 3,5 3 2,5 2 1,5 1 0, T N Source: author s calculation based on JSX s database In graph 2, we can see that during or before crisis period, Indonesian firms have diminished their profitability. In this period, it is likely true that high investment with low profitability has resulted in high debt ratio. It can be said that on the onset of crisis, Indonesian firms have been in danger since several early warning system in micro level have shown indications of financial distress. At least firm level data provides evidence that before crisis, firms have experienced unhealthy conditions. Graph 2. Median (%) Profitability - Return on Assets (ROA) 0,08 0,06 0,04 0,02 % 0-0, ,04-0,06 Note: Profitability is measured by ROA (Return on Assets) Source: author s calculation based on JSX s database 70

10 Oeconomicus, Volume IX, The following graph (3) shows the collapse of firm-level investment for both tradable and nontradable sector. Most firms in Indonesia faced a dismal condition from both sides, internal and external. Graph 3. Firm-investment level 1,2 Investment 1 0,8 0,6 0,4 T N 0,2 0-0, Source: author s calculation based on JSX s database Graph (4) shows how Altman Z score fluctuates overtimes 4. Firms with Altman Z-score >2.99 are healthy companies, 1.81< Z <2.99 are grey zone and >1.81 are unhealthy companies. By these categorizations, actually in pre-crisis period most Indonesian firms were in grey zone which means that they had unhealthy financial status. Graph (5) demonstrates the fluctuation of profit margin measured by the ratio of earning before tax (EBIT) to total sales. Graph 4. Median 2 1,8 1,6 1,4 1,2 1 0,8 0,6 0,4 0,2 Altman-Z score Source: author s calculation based on JSX s database 71

11 Agustinus Prasetyantoko Graph 5. Median (%) Profit Margin 0,08 0,06 0,04 0,02 0-0,02-0,04-0, ,08 Profit margin is earning before tax (EBIT) deflated by total sales Source: author s calculation based on JSX s database In Graph (6) we can see that investment credit in foreign currency from commercial banks to the non-tradable sector is more volatile than credit to the tradable sector. However, it is important to note that credit for non-tradable sector rose significantly since It could be an important indication that non-tradable sector moved faster than tradable one. Graph 6. Outstanding of Investment Credit of Commercial Banks in Foreign Currency (in Billions of Rupiah) Tradable Nontradable Source: author s calculation based on data from the Indonesian central bank. Data on debt, profitability, investment, fragility of the corporate sector as well as credit supply from commercial banks show that economic vulnerability is still present following a financial in The behaviour of corporate sector did not change sufficiently to prevent the other crisis which rooted in the economic fluctuation during the following years. Micro economic foundation is still unsound. VI. Conclusion In this paper, I argue that the 1997 financial crisis should be understood as a structural evolution of the market system in Indonesia. It began with financial liberalization which followed by excessive 72

12 Oeconomicus, Volume IX, borrowing behaviour of the corporate sector. In such a situation, micro agents play an important role in propagation of the financial vulnerability. Our argument is based upon two foundations of thinking, namely Minsky s perspective on financial instability hypothesis and Régulation Theory on the evolution of the capitalist system. Both theories give clearer explanation compared to the conventional explanation. In this paper, I argue that the roots of crisis are embedded on the evolution of capitalist market system itself; and that the economic agents as actors and the economic system as a structure interrelate in a whole system of economic development. Most conventional views accentuate on the role of agency problem and internal side of the source of crisis by neglecting the big picture of the global financial system. There are some typical problems mentioned by conventional views, such as incomplete financial liberalisation, unsound regulation, corruption, weak governance system and many other internal problems of emerging countries. They do not deal with the interrelationship between financial globalisation, national deregulation and firm innovation in derivative products resulting in the high volatility and vulnerability of the global system. By samples of 278 listed companies in Jakarta Stock Exchange, we can find that before crisis hit in 1997, the debt ratios tend to increase, whereas profitability tend to decline. The analysis also confirmed that some measurements of performance or healthiness were also under performed. By Altman Z-score for measuring the risk to bankruptcy of firms it seem that in the onset of crisis, most of Indonesian firms had been in grey zone. Theoretical foundation supported the empirical evidence that macro fluctuation is based upon micro behaviour (Minskian perspective) and that structural evolution (Régulation perspective) affects directly the both sectors in the economy, micro and macro. There is therefore an interrelated mechanism between micro and macro sector in an economy during a long period of time embedded in the history of a certain country. References Arestis, P. and M. Glickman. Financial Crisis in South East Asia: Dispelling Illusion the Minskyan Way. Working Paper, No.22, Department of Economics, UEL, Arza, V, and P. Espanol. Deadly Relations between Credit and Investment in Argentina during the 1990s. mimeo, Boyer, R., M. Dehove and D. Plihon. Les Crises Financières. Conseil d Analyse Economique, La Documentation Français, Paris, France, Corsetti G., P. Pesenti and N. Roubini. Paper Tigers? a Preliminary Assessment of the Asian Crisis. NBER Bank of Portugal International Seminar on Macroeconomics, June, Fazzari, S.M., Minsky and the Mainstream: Has a Recent Research Rediscovered Financial Keynesianism. Working Paper, No. 278, The Jerome Levy Economics Institute,

13 Agustinus Prasetyantoko Furman, J., J. E. Stiglitz, B. P. Bosworth, S. Radelet. Economic Crisis: Evidence and Insights from Asia. Brookings Papers on Economic Activity, Number 2 (1998): Hofman, B., E. Rodrick-Jones, K. W. Thee. Indonesia: Rapid Growth, Weak Institutions. In Reducing Poverty, Sustaining Growth What Works, What Doesn t, And Why, The World Bank, Keynes, J. M. The General Theory of Employment, Interest, and Money. Prometheus Books, Kindleberger, C. P. Manias, Panics and Crashes. Ed. Wiley: USA, Kregel, J.A. Can We Create a Stable International Financial Environment that Ensures Net Resource Transfers to Developing Countries? Journal of Post Keynesian Economics, vol. 26, no.4 (2004): Yes It Did Happen Again a Minsky Crisis Happened in Asia. Working Paper, No.234, The Jerome Levy Economics Institute, Krugman, P. Analytical Afterthoughts on the Asian Crisis. MINICRIS ( Kumar, R. and B. Debroy. The Asian Crisis: an Alternative View. Economic Staff Paper, No. 59, Asian Development Bank, Philippines, Radelet, S. and J. D. Sachs. The East Asian Financial Crisis: Diagnosis, Remedies, Prospect. Brookings Papers on Economic Activity, Number 1, (1998): Schroeder. A Minskian Analysis of Financial Crisis in Developing Countries. Working Paper, Center for Economic Policy Analysis, Sethi. The Evolutionary Dynamics of Financial Practices. Metroeconomica, Vol. 46 Issue 3 (2002): Minsky, H. Financial Crises: Systematic or Idiosyncratic. Working Paper, No.51, The Jerome Levy Economics Institute of Bard College, Capitalist Financial Processes and the Instability of Capitalism. Journal of Economic Issues 14 (June 1980): John Maynard Keynes. New York: Columbia University Press, Weller, C. Financing Constraints and Investment in Poland During the Transition Period: Evidence From Panel Data. Working Paper, Center for European Integration Studies, Editorial, La Lettre de Régulation, N 52, April Citius = faster, altius = higher and fortius = stronger. 3 Rupiah (Rp) is a currency of Indonesia. Recently (in the early 2008) US $1 = Rp 9,000 4 We use the following equation for Altman score. Z Score =1.2(X1) + 1.4(X2) + 3.3(X3) + 0.6(X4) + 1.0(X5) X1 = Working Capital/Total Assets X2 = Retained Earning/Total Assets X3 = Earning Before Taxes/Total Assets X4 = Market Value of Equity/Total Liabilities X5 = Net Sales/Total Assets 74