LIQUIDITY AND LEVERAGE AS NONLINEAR DETERMINANTS OF RISK OF DEFAULT

This study investigates the empirical relationship between liquidity and leverage as
nonlinear determinants of risk of default as reflected by Altman Z” score. The analysis performed on
a set of financial data for 291 Romanian corporates applying Generalized Additive Models (“GAMs”)
and Exploratory Factor Analysis (“EFA”) uncovered significant non-linear relationships: the benefit
of liquidity (Current Assets/ Current Liabilities) diminishes beyond a ratio of 2.0, while the negative
impact of leverage (Total Liabilities/Equity) accelerates sharply beyond a threshold of 3.0. Moreover,
a significant interaction effect reveals that high liquidity loses its protective value when funded by
excessive leverage, a condition perceived as "debt-funded cash". EFA results also reinforce the
importance of financial structure. The fact that the Z" score is almost exclusively driven by measures
of financial robustness—liquidity, profitability, and solvency—rather than operational efficiency
(Turnover/ Total Assets) has significant implications on corporates financial management and
decision making. The present study brings an important contribution to the existing literature
dedicated to the impact of specific financial indicators -liquidity and leverage – over the risk of default
of Romanian corporates, as well as to the assessment of the underlying factors composing Altman Z”
score, providing at the same time an in-depth analysis tool for professionals and managers focusing
on sustainable financial management and resilience.