MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

SAGE Publications Los Angeles/London/New Delhi/Singapore/Washington DC

DOI: 10.1177/097380101100600104

Determinants of Firms Liquidation and

Acquisition in the Indian Electronics Industry
Mohd Irfan

This study examines the determinants of firms liquidation and acquisition in the Indian
electronics industry during the period 19902006. It is argued that liquidation and
acquisition are alternative modes of exit. Therefore, these modes of exit might have dif-
ferent determinants. To explore this possibility, a multinomial logistic (MNL) regression
model is estimated using cross-sectional data of 540 firms. We find that the effects of age,
size, leverage, innovative competence and profitability are significant for the likelihood
of liquidation. In contrast, the effect of profitability was found insignificant for the likeli-
hood of acquisition. Moreover, the effects of size and leverage are dissimilar across the exit
modes, that is, large firms are more likely to be liquidated but less likely to be acquired,
and high leverage firms are more likely to be liquidated but less likely to be acquired. The
findings of this study show that the determinants of liquidation and acquisition modes
of exit are different in the Indian electronics industry.

Keywords: Liquidation, Acquisition, Indian Electronics Industry, Multinomial Logistic

Regression Model
JEL Classification: C25, G33, G34, L63

1. INTRODUCTION

The era of the Indian electronics industry commenced a decade after Indias
independence. The Indian government played a vital role in developing a
domestic electronics industry. For example, in the initial stages of the industrys
development, that is, the 1960s and 1970s, government policies were geared

The author is Senior Research Fellow, Department of Humanities and Social Sciences,
Indian Institute of Technology Kanpur, Kanpur, India-208016, Tel: +919935829507, email:
irfan@iitk.ac.in
An earlier draft of this article was presented at the Second Doctoral Theses Conference
organised by the IBS, Hyderabad, 78 March 2008. The author would like to thank the
conference participants and anonymous referees of this journal for their constructive com-
ments and suggestions.

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76 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

towards direct involvement in production through state-owned enterprises.

During this period, the major concentration of the industry was to develop and
maintain fundamental communication systems such as radio-broadcasting,
telephonic and telegraphic communication, and to enhance defence capabili-
ties. However, in the 1980s, significant economic liberalisation was witnessed
in the electronics industry which was motivated by the achievements of China
and Korea (Love, 2008). The electronics industry was the first Indian industry
to experience the benefits of Indias economic liberalisation which began in the
1980s, while other sectors of the economy were open to economic liberalisation
only after 1991. In the liberalisation policy of the 1980s, foreign and domestic
private investments were encouraged by easing investment norms, namely, 100
per cent equity allotment, a reduction in custom tariffs and the de-licensing
of many electronic products, apart from aerospace and defence electronics. All
the components including raw materials and capital goods were freely import-
able. Sector-specific schemes were introduced to attract foreign investment
and provide a duty-free environment for the export of electronic hardware
and software under export-oriented schemes. India opened itself to foreign
trade and investment and emerged as a mass-market for consumer electronics
and telecommunications. As a result, the electronics industry attracted a large
amount of foreign investment and collaborations.
Despite these early incentives, the Indian electronics industry has managed
only a relatively slow growth rate since its infancy. For example, the growth of
electronics goods production during 200006 was on average around 20 per cent,
but the number of firms engaged in production has declined significantly from
1,355 to 995 firms.1 The decrease in the number of firms in the Indian electronics
industry is linked to intense competition from foreign firms. To overcome this
problem, the industry has received several policy favours in recent years.
The electronics industry is a principal industry and significantly affects the
productivity of other sectors of the economy. The Indian electronics industry
consists of six segmentselectronic components, strategic electronics, com-
munication and broadcasting equipment, consumer electronics, computers and
industrial electronics. Each segment has a definite role to play in the growth and
development of the economy; thus, it is worthwhile to study the firm-specific
factors associated with the survival of firms in the Indian electronics industry.
Examining the factors beyond product price helps firms reduce their risk of exit

1
Authors own calculations based on data provided by the Industry Analysis Service of the Center
for Monitoring Indian Economy (CMIE).

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 Irfan INDIAN ELECTRONICS INDUSTRY 77

and provides some policy-related information to electronics industry organi-

sations and the government to maintain a balanced flow of firms, that is, to
maintain entry and exit and a competitive electronics industry in India.
The decline of firms is termed as exit in industrial organisation literature.
Schary (1991) argues that a firm exits in one of the three modes: voluntary
liquidation, involuntary liquidation or acquisition, and these modes are dif-
ferent economic phenomena. Liquidation is the sale of a firms assets and the
proceeds obtained are used to clear outstanding dues of the claimants (Hudson,
1986). In liquidation, productive capacity is often removed from the industry
and claimants receive partial payment. When the liquidation is initiated by the
creditors it is known as involuntary liquidation, otherwise it is termed voluntary
liquidation. On the other hand, acquisition is the transfer of ownership by the
sale or purchase of a firms equity. In acquisition, much of the productive cap-
acity remains in the industry and the claimants receive full payment. Acquisitions
are considered a more civilised alternative to liquidations (Dewey, 1961). In
addition, the causes of liquidation and acquisition are significantly different
from each other. For example, firms performance (Altman, 1968), leverage
(Zingales, 1998) and size (Harhoff et al., 1998) are identified in the literature
as factors that influence modes of exit in different ways. Previous studies on
firm exit are restricted to developed countries (Audretsch, 1991; Disney et al.,
2003; Evans, 1987; Mahmood, 2000; Shapiro and Khemani, 1987). Therefore,
the empirical observations of previous studies cannot be extended to Indian
electronics industry.
We argue that the determinants of liquidation and acquisition modes of
exit are different in the Indian electronics industry. To the best of our know-
ledge, no previous study on Indian firms has considered the modes of exit in
their analysis. For example, Das and Srinivasan (1997) studied the survival of
firms in the Indian computer hardware industry. However, in their study, the
distinction among the modes of exit was not considered. Therefore, it is now
necessary to examine the determinants of firm exit in a unified framework to
avoid any sample selection problem which could lead to a biased estimation of
results. The present study examines the determinants of firms exit in the Indian
electronics industry taking into account the two modes of exit: liquidation and
acquisition. The sample consists of 540 firms which were active during the
period 19802006. Multinomial logistic (MNL) regression analysis is applied
to examine the firm-specific determinants of liquidation and acquisition in
the Indian electronics industry. The rest of the article is organised as follows:
Section 2 discusses the literature relevant to this study. Details of the sample

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78 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

and variable construction are described in Section 3. Section 4 discusses the

empirical model, and the regression results are presented in Section 5. Finally,
we summarise the findings and conclude the research in the last section.

2. Determinants of Liquidation and Acquisition

In recent years, a growing body of literature examined the factors which deter-
mine the likelihood of firms liquidation and acquisition. Most of the studies
have model firm exit as a function of several firm-specific characteristics. The
commonly used explanatory variables in the literature are described in the
following.

2.1 Age
Age is considered a key determinant of liquidation and acquisition. The gen-
eral consensus of the empirical studies which examine the impact of age on
exit modes is that the likelihood of liquidation decreases with age whereas the
likelihood of acquisition increases with age (Audretsch, 1991; Disney et al.,
2003; Evans, 1987; Mahmood, 2000; Mata and Portugal, 1994). According to
Jovanovic (1982), older firms learn from their past experience and hence are
more likely to survive in adverse situations. The literature suggests that older
firms develop a brand name and reputation in the industry which makes them
attractive targets for acquisitions (Esteve-Prez et al., 2010).

2.2 Size
There is a general agreement that the likelihood of exit declines with firm size.
Large firms are equipped with large amounts of physical, financial, human and
other resources which improve their possibility of exploiting scale economies.
As a result, such firms protect themselves from liquidation by earning higher
profits (Audretsch, 1991; Hall, 1987; Mahmood, 2000). Similarly, acquisition of
large firms requires large investments and thus increases the cost of acquisition.
Shleifer and Vishny (1992) argue that the market for corporate control is less
liquid as firm size increases. So it is expected that an increase in the firm size
reduces the likelihood of liquidation and acquisition.

2.3 Innovative Competence

Under the entrepreneurial regime, innovation is an essential factor for the
firms survival (Audretsch, 1991). Innovation helps firms reduce their costs,
but at the same time it brings uncertainty. Ericson and Pakes (1995) argue
that because of the uncertainty associated with innovation, the risk of exit is

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 Irfan INDIAN ELECTRONICS INDUSTRY 79

higher for innovative firms. In contrast, Mahmood (2000) finds that the effect
of innovative competence varies across industries. Innovative firms are good
acquisition targets because the acquisition of innovative firms supports the
acquirers expansion policy and it is an economical way to expand (Heeley
et al., 2006). Therefore, it is expected that innovative firms are less likely to be
liquidated and more likely to be acquired.

2.4 Leverage
Leverage is the firms reliance on debts to finance its assets, and higher the
reliance on debt the greater the risk of liquidation. On the one hand, excessive
debt leads to a large debt burden on firms and firms with high leverage are
more likely to be liquidated (Pastena and Ruland, 1986). On the other hand,
high leverage firms are less attractive targets for acquisitions, because acquir-
ing a high-leverage firm transfers the risk of the debt burden to the acquirer
(Fotopoulos and Louri, 2000; Kornai, 1998; Pastena and Ruland, 1986). Hence,
we expect that leverage increases the likelihood of liquidation and reduces the
likelihood of acquisition.

2.5 Profitability
A firms profitability is also likely to be an important factor in the exit of firms. If
a firm fails to attain a desired level of profits, its likelihood of survival diminishes
(Bojnec and Xavier, 2007). Altman (1968) observes that low performance firms
are more likely to fail. Dean (1997) argues that firms with poor performance
are more likely to become takeover targets. Besides, acquisitions act as a cor-
porate control measure to improve firms performance (Jensen, 1986; Shleifer
and Vishny, 1992). Hence, it is expected that the least-profitable firms are more
likely to be liquidated and acquired.

2.6 Asset Utilisation

According to the economic shut-down rule, it is expected that firms which are
earning higher returns over their variable costs will be less likely to be liquidated.
Agarwal and Gort (2002) found that efficient firms successfully use their assets
to generate sales and cover their fixed costs. Such efficient firms are less likely
to exit than inefficient firms. Bragg and Dalton (2004) found that the level of
asset utilisation is negatively associated with the exit of firms. Firms which are
unable to efficiently utilise their assets are good targets for acquisitions (Jensen,
1986; Shleifer and Vishny, 1992) as acquisition allows the transfer of resources

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80 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

from low-value usages to high-value usages. Hence, we expect that an increase

in asset utilisation reduces the likelihood of liquidation and acquisition.

3. DATA AND VARIABLE CONSTRUCTION

The analysis of the determinants of firms exit mode is conducted using a sample
of Indian firms which operated in the Indian electronics industry. It is accessed
from Prowess databasea service provided by the Center for Monitoring Indian
Economy (CMIE). The sample includes firms which were engaged in produc-
ing products in various segments of the Indian electronics industry, such as
electronic components, strategic electronics, communication and broadcast-
ing equipment, consumer electronics, computers and industrial electronics. In
the Prowess database, firms are structured by years, thus making us possible to
investigate firms exit over the period 1990 to 2006.
We take firms mode of exit as a dependent variable which takes value 1 for
liquidation, 2 for acquisition and 3 if the firm is a non-exited firm. A firm is said
to have exited in the study period if it was not in activity for two or more years.
To be on safe side in computing the life span, we checked the firms name and
sales to follow its activity status year-to-year. If a firm reappears in the sample
after an exit, we dropped it from our sample to avoid any inconsistency. The
firms mode of exit is explicitly mentioned in this sample; merged or acquired
firms have a merged tag with their name, and hence the rest of the exited firms
were treated as liquidated firms. However, one limitation of this data is that it
does not allow us to distinguish between voluntarily liquidated and involuntarily
liquidated firms and between acquired and merged firms.
Information was collected for 1,562 manufacturing firms on the following
variables: firm name, establishment year, sales, R&D expenditures, total vari-
able cost, and profit after tax and total borrowings. Data on financial variables
are based on balance sheet and profit and loss accounts, and it is expressed in
crores of Indian rupees. Out of the 1,562 firms, only 245 firms have satisfied the
above-discussed criteria of firm exit and have full information on the required
firm-level characteristics. Finally, we have a sample of 540 firms which consists
of 103 liquidated firms, 142 acquired firms and 295 non-exited firms.
Details of the construction of the explanatory variables are given in Table 1.
Firm age (AGE) is calculated by subtracting the firms year of establishment
from the year of exit. Firm size (SIZE) is measured by taking the natural loga-
rithm of total sales. A firms innovative competence (RD) is defined as the ratio
of R&D expenditures to sales. Firm leverage (DEBT) is defined as the ratio
of total borrowings to sales. The profitability (PROF) measure is the ratio of

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 Irfan INDIAN ELECTRONICS INDUSTRY 81

Table 1 Description of the Explanatory Variables

AGE Year of exityear of establishment

SIZE Natural logarithm of sales
RD Ratio of R&D expenditures to sales
DEBT Ratio of total borrowings to sales
PROF Ratio of profit after tax to sales
ASUT Ratio of sales to variable costs

profit-after-tax to sales. Asset utilisation (ASUT) is measured as the ratio of

sales to variable costs. The values of all explanatory variables are collected one
year prior to the firms year of exit.

4. THE MULTINOMIAL LOGISTIC REGRESSION MODEL

To model the modes of exit as a function of firm-specific characteristics, we

use the random utilities model (RUM) suggested by Train (2009). Since firms
are expected to exit in an uncertain environment, we assume a firm exits in
particular mode j (j = 1, 2, 3 representing liquidation, acquisition and non-
exited, respectively) only when the utility is maximised in that mode. Let the
firms utility in exit mode j be Vj(X) and the firm exits in mode j if and only if
Vj(X) > Vk(X) for all j k. This utility is modelled as a function of firm-specific
characteristics, X, that affect the utility associated with each mode of exit dif-
ferently.

Vij = j + X'i j + ij (1)

where subscript i denotes the firm and subscript j denotes the mode of exit. Xi
is a vector of firm-specific characteristics and j represents mode-specific
constant terms. If the errors ij are i.i.d. according to a type I extreme-value
distribution, then the differences in are distributed logistically, and the prob-
ability that firm i exits in mode j is as follows.

j + Xi j
e
Pij = J
; j = 1, 2,..., J (2)
e
j + Xi j

j =1

As we analyse the determinants of liquidation and acquisition as a discrete

choice problem, the probability function in equation (2) resembles the popu-
lar MNL regression model which is generally used for categorical or discrete

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82 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

response data. The MNL model uses one alternative as a reference category,
and any parameter estimate represents the effect of the explanatory variable in
relative to this reference category (Long and Freese, 2001). In the present study,
we use non-exited as a reference category. More specifically, we restrict 3 = 0
and 3 = 0 for reasons of identification of parameters so that the interpretation
of parameters is relative to the non-exited category. Estimation of the MNL
model is best carried out by the maximum likelihood method (Wooldridge,
2003). Accordingly, for firm i the likelihood function can be represented as
J
li ( ) = Pij (X , )Yij (3)
j =1

where Yij is the indicator function and Yij = 1 if firm i exits in mode j otherwise
Yij = 0, and the log likelihood function for all the firms is as follows:
N J
LL = log P Y
i =1 j =1
ij
ij (4)

5. RESULTS AND DISCUSSION

The Subsection 5.1 gives some preliminary evidence on the determinants of

liquidation and acquisition. The results are based on descriptive statistics and
therefore need to be interpreted as indicative only. A more formal causal an-
alysis follows in Subsection 5.2. We compare liquidated and acquired firms with
non-exited firms on a variety of firm-specific characteristics suggested in the
literature as potential determinants of liquidation and acquisition.

5.1 Descriptive Statistics

Table 2 presents the descriptive evidence from our sampled data of 540 firms.
Table 3 compares liquidated firms with acquired firms using the differences in
mean values of explanatory variables. We find that on average, liquidated firms
are older than acquired firms. The mean value of variable AGE is 14.23 years
for liquidated firms and 11.68 years for acquired firms. The difference in mean
values (2.575) is statistically significant at the 5 per cent level. Similarly, liqui-
dated firms are larger in size than acquired firms. The mean values of variable
SIZE are 4.819 and 3.257 for liquidated and acquired firms, respectively, and
the mean difference (1.562) is statistically significant at the 1 per cent level. The
innovative competencies of the liquidated and acquired firms are almost equal.

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 Irfan INDIAN ELECTRONICS INDUSTRY 83

Table 2 Descriptive Statistics

Variables Exit Mode N Mean Std. Dev. Min. Max.

AGE Liquidation 103 14.22 8.829 1 39
Acquisition 142 11.64 7.365 1 35
Non-exited 295 22.03 11.37 2 42
SIZE Liquidation 103 4.819 1.496 0.94 8.03
Acquisition 142 3.257 1.291 0.30 6.57
Non-exited 295 4.424 1.847 0.41 9.16
RD Liquidation 103 0.017 0.059 0 0.49
Acquisition 142 0.016 0.031 0 0.18
Non-exited 295 0.021 0.032 0 0.17
DEBT Liquidation 103 0.574 3.316 0 33.8
Acquisition 142 0.151 0.136 0 0.74
Non-exited 295 0.201 0.137 0 0.82
PROF Liquidation 103 0.095 0.203 1.51 0.31
Acquisition 142 0.133 0.101 0.30 0.42
Non-exited 295 0.133 0.115 0.59 0.43
ASUT Liquidation 103 0.027 0.064 0 0.45
Acquisition 142 0.014 0.039 0 0.24
Non-exited 295 0.020 0.051 0 0.60

Table 3 Mean Comparison across Liquidated and Acquired Firms

Variables Mean Diff. Std. Error t

AGE 2.575 1.037 2.48
SIZE 1.562 0.178 8.74
RD 0.001 0.005 0.20
DEBT 0.422 0.278 1.51
PROF 0.037 0.019 1.90
ASUT 0.012 0.006 1.92
Notes: The test statistics are heteroskedastic t-tests of equal means (liquidated versus
acquired firms) with 243 degrees of freedom; indicates significance at the 1 per
cent level; indicates significance at the 5 per cent level; indicates significance at
the 10 per cent level.

The mean value of variable RD is 0.017 for the liquidated firms and 0.016 for
the acquired firms and the mean difference is statistically insignificant.
The mean values of variable DEBT are 0.574 and 0.151 for the liquidated
and acquired firms, respectively. Liquidated firms therefore seem to be high-
leveraged firms than acquired firms. However, the mean difference (0.422) is
statistically insignificant. In terms of profitability, liquidated firms perform
worse than acquired firms. The mean values of variable PROF are 0.095 and

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84 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

0.133 for the liquidated and acquired firms, respectively and the mean difference
(0.037) is statistically significant at the 10 per cent level. The asset utilisation
of acquired firms is lower than liquidated firms. The mean value of ASUT is
0.014 for the acquired firms and 0.027 for the liquidated firms, and the mean
difference (0.012) is statistically significant at the 10 per cent level.

5.2 Regression Results

The descriptive evidence discussed in Subsection 5.1 provides an initial indica-
tion of the possible determinants of firms liquidation and acquisition in the
Indian electronics industry. However, this evidence is preliminary only as the
reported results do not imply any causal relationship. Therefore, we now analyse
the effects of the explanatory variables on the modes of exit in a multivariate
analysis, controlling for the fact that different variables can simultaneously
affect the probability of liquidation and acquisition. Table 4 shows the results
of the two MNL regression models.2 Model 1 includes the variable innovative
competence (RD) without any lag specification and Model 2 includes the vari-
able innovative competence with a one-year lag (RDt1) specification.
In Model 1, we find that the logit coefficients for variable age (AGE) are 0.074
and 0.113 for the liquidation and acquisition modes of exit, respectively, and
these coefficients are statistically significant at the 1 per cent level. This implies
that an increase in age decreases the likelihood of liquidation and acquisition.
The result is consistent with the past findings of Jovanovic (1982). Older firms
are less likely to be liquidated because they learn from their past experiences
and therefore manage economic shocks more efficiently than younger firms.
Regarding the likelihood of acquisition, the result contradicts the prediction of
Esteve-Prez et al. (2010). The reason could be that older firms in the Indian
electronics industry were not able to build any brand or repute and thus be-
came unattractive targets for acquisitions.
The effect of variable size (SIZE) is found positively related with the likeli-
hood of liquidation and negatively related with the likelihood of acquisition.
The values of logit coefficients are 0.188 and 0.523 for the liquidation and
acquisition mode of exit, respectively, and these coefficients are found statisti-
cally significant at the 1 per cent level. This suggests that the larger the size the
more likely a firm is to be liquidated but less likely to be acquired. Large firms
have less flexibility in adjusting to changes in the market and therefore suffer
larger losses than smaller firms (Majumdar, 1997). In contrast, the acquisition of

2
The parameters of the MNL models are estimated using mlogit command in STATA 10.

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 Irfan INDIAN ELECTRONICS INDUSTRY 85

Table 4 Logit Coefficient Values in the Multinomial Logistic Regression Models

Independent Model 1 Model 2

Variables Liquidation Acquisition Liquidation Acquisition
Constant 0.364 3.698 0.365 3.672
AGE 0.074 0.113 0.072 0.114
(0.013) (0.014) (0.012) (0.014)
SIZE 0.188 0.523 0.195 0.518
(0.076) (0.086) (0.076) (0.085)
RD 9.428 8.072 2.398 16.712
(3.778) (3.750) (10.29) (10.01)
RDt1 17.912 10.866
(14.341) (4.355)
DEBT 1.671 2.652 1.487 2.618
(0.843) (0.902) (0.859) (0.906)
PROF 4.093 0.332 3.851 0.325
(1.097) (1.113) (1.117) (1.123)
ASUT 1.054 2.141 0.952 2.085
(2.099) (2.501) (2.099) (2.498)
Log likelihood 427.578 425.901
LR Chi2 222.21 225.57
Prob > Chi2 0.0000 0.0000
Pseudo R2 0.2063 0.2094
Notes: Sample consists of N = 540 firms, including 103 liquidated, 142 acquired and
295 non-exited firms; reference category is non-exited; standard errors in brackets;
significant at 1 per cent level; significant at 5 per cent level; significant at 10 per
cent level. Degrees of freedom for the likelihood ratio test in Model 1 and Model 2 are
12 and 14, respectively.

large firms requires large funds and thus such firms are less likely to be acquired
(Shleifer and Vishny, 1992).
Innovative competence (RD) is negatively related with the likelihood of
liquidation as well as acquisition. The logit coefficients for liquidation and
acquisition modes of exit are 9.428 and 8.072, respectively. The coefficient
for liquidation is statistically significant at the 1 per cent level but the coefficient
for acquisition is statistically significant at the 5 per cent level. The effect of
innovative competence in the Indian electronics industry is inconsistent with
the findings of Ericson and Pakes (1995) and Heeley et al. (2006). This is because
the investments in R&D activities are intangible or sunk costs (Rosenbaum
and Lamort, 1992) and therefore cannot be fully recovered in the liquidation
process or transferred in acquisition. In addition, R&D plays an important
role in increasing profits by increasing sales or reducing costs and thus reduces

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86 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

the likelihood of liquidation. Hence, more innovative firms are less likely to
be liquidated and acquired. To examine the lagged effect of innovative com-
petence, we estimated another MNL model (that is, Model 2) with a one-year
lag specification for the variable innovative competence (RDt1). Since R&D
impacts with a lag, it is necessary to examine such effects.3 The results of this
model are presented in the last two columns of Table 4. We find that the effect
of variable RDt1 is statistically insignificant for the modes of exit.
The effect of leverage (DEBT) is found positively associated with the likeli-
hood of liquidation and negatively associated with the likelihood of acquisition.
The logit coefficients are 1.671 and 2.652 for the liquidation and acquisition
modes of exit, respectively. These coefficients are statistically significant at the
5 per cent level (for liquidation) and 1 per cent level (for acquisition). The results
are consistent with past findings and imply that an increase in debt increases
the likelihood of liquidation but decreases the likelihood of acquisition. High-
leveraged firms have to pay large interests on their debt, which in turn reduces
their profits and increases their chances of liquidation (Pastena and Ruland,
1986). The increase in debt also increases the risks, namely, liquidity, high cost
of financing and a decrease in the acquirers financial performance involved in
acquiring a leveraged firm (Pastena and Ruland, 1986). Importantly, a greater
part of the acquirers revenue will be exhausted in repaying the debt (Fotopoulos
and Louri, 2000; Kornai, 1998). Hence, an increase in leverage reduces the pos-
sibility of a firm to be acquired.
Though profitability is an important determinant of exit in the literature, we
find that in the Indian electronics industry it affects the liquidation mode of exit
only. The logit coefficient for the variable PROF is 4.093 and it is statistically
significant at the 1 per cent level. For the acquisition mode of exit it is insig-
nificant. This suggests that an increase in profitability reduces the likelihood of
liquidation. This finding supports the argument that large profit earnings allow
a firm to develop the distinct capabilities, that is, enhances its ability to adapt
to a changing competitive environment and removes the liquidity constraint,
and hence improves the firms survival prospects (Altman, 1968). The impact
of asset utilisation on the likelihood of liquidation and acquisition is found
insignificant in the Indian electronics industry. This suggests that the survival
prospects in Indian electronics are presumably not governed by the firms ability
to cover their fixed costs over variable costs.

3
The author is thankful to an anonymous referee for suggesting the lag effect of R&D activities
on exit modes.

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 Irfan INDIAN ELECTRONICS INDUSTRY 87

5.3 Goodness-of-Fit Analysis and Robustness Check

To assess the goodness-of-fit of our empirical models, we utilise McFaddens
pseudo R2 values. The pseudo R2 values of the MNL models are 0.2063 (for
Model 1) and 0.2094 (for Model 2), which suggest that both models almost
explain the same level (20 per cent) of variations in the dependent variable.
Moreover, we conducted the likelihood ratio (LR) test to assess the fit of our
MNL models (with all covariates) relative to the initial model (with the intercept
only). The calculated LR test statistics are 222.21 and 225.57 for Models 1 and
2, respectively, and these statistics are found statistically significant at the 1 per
cent level with 12 and 14 degrees of freedom, respectively. The results advocate
that adding all covariates in our MNL model provides a better fit than not add-
ing them for our sampled data of 540 firms.
In contrast, one drawback of the MNL model is that it relies on a relatively
strong assumption regarding the stochastic structure of the model. More specifi-
cally, the assumption is the i.i.d. error terms, which is behaviourally equivalent
to the assumption of independence from irrelevant alternatives (IIA) (Hensher
et al., 2005). The IIA assumption implies that the ratio of probabilities of choos-
ing any two alternatives is independent of a third choice, that is, Pj /Pk remains
unaffected by the presence or absence of any other alternative within the set
of alternatives modelled. According to Hensher et al. (2005), a violation of
the IIA assumption in MNL models provides inefficient parameter estimates.
Therefore, alternative models such as the multinomial probit, nested logit and
mixed multinomial logit models are preferred to get more efficient parameter
estimates.
Hence, we conducted the Hausman specification test proposed by Hausman
and McFadden (1984) to test the IIA assumption of our MNL model. This is
a test of the hypothesis that the odds of any two exit modes are independent
of the other exit mode. To conduct this test, first we estimated an unrestricted
model with all exit modes and then we estimated a restricted model using
restricted number of exit modes with the same specification (Hensher et al.,
2005). The test statistic is

q = [bu br] [Vr Vu]1 [bu br] (5)

where bu is a column vector of parameter estimates for the unrestricted model,

br is a column vector of parameter estimates for the restricted model, Vr is the
variancecovariance matrix for the restricted model and Vu is the variancecova-
riance matrix for the unrestricted model. We have highlighted the test results in
Table 5. The test results did not reject the null hypothesis and it is accepted that

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88 MarginThe Journal of Applied Economic Research 6 : 1 (2012): 7590

Table 5 Hausman Specification Test Results for the IIA Assumption

Omitted Exit Mode Chi2 d.o.f. P > Chi2 Evidence

1 11.2 7 0.130 for Ho
2 2.961 7 0.886 for Ho
3 5.456 7 0.604 for Ho
Notes: Ho: Odds (Outcome-J versus Outcome-K) are independent of other alternatives;
d.o.f.: degrees of freedom.

the exit modes are independent. Hence, the Hausman test for IIA assumption
strongly recommends MNL model to estimate the parameters.

6. CONCLUSION

Previous research studies argue that low demand and low prices are the driv-
ing forces behind the exit of firms. In contrast, the present study has identified
additional factors that affect the exit of firms in the Indian electronics industry.
We have considered two modes of exit, liquidation and acquisition, and utilised
cross-sectional data of 540 firms including 245 non-exited, 103 liquidated
and 142 acquired firms to identify such factors. An MNL regression model is
employed to examine the firm-specific determinants of liquidation and acquisi-
tion in the Indian electronics industry during the period 19902006.
We find significant differences in the determinants across exit modes in the
industry. For example, firm size and leverage affect these two modes of exit
differently. An increase in the firm size increases the chances of liquidation
but decreases the chances of acquisition. Similarly, an increase in the leverage
reduces the chances of being acquired but increases the chances of liquidation.
Moreover, profitability affects the likelihood of the liquidation only. The effects
of firm age and innovative competence are found similar for the two modes
of exit. Our findings suggest that the empirical regularities of previous stud-
ies related to developed countries cannot hold true for the Indian electronics
industry. Therefore, the study of factors beyond product price provides powerful
policy-making information to both the government and electronics industry
organisations. This information can be used to focus on balanced flow of firms,
that is, maintained entry and exit and a competitive electronics industry.

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