The Effect of COVID-19 on Firms’ Financial Performance and Distress: Evidence from Southern Europe

Abstract

This study uses regression analysis to explore the impact of the COVID-19 pandemic on the financial performance and distress of firms in four Southern European countries— Portugal, Italy, Greece, Spain, and Cyprus—covering the period of 2019 to 2021. The results show that the financial performance of firms based on return on assets (ROA) and return on equity (ROE) deteriorated by -1.3% and -5.7% respectively in 2020 compared to the pre- and post-COVID-19 periods. Specifically, Cyprus and Spain experienced the largest decline in ROA, -3.2% and ROE -4.0% respectively, both of which are statistically significant. The Altman Z-Score for firms in the region deteriorated by 19% during the COVID-19 period, with Italy experiencing the highest negative impact of 34%. In the pandemic period overall, the retail trade sector (particularly the retail-eating places segment) experienced the steepest decline in ROA, marking it as the worst-performing sector—a result influenced by limited progress in digital transformation and heavy reliance on tourism. Meanwhile, the manufacturing sector faced the highest bankruptcy risk, evidenced by a statistically significant drop in the Altman Z-Score when compared to the pre- and post-pandemic periods. Decomposing the Altman Z-Score, we identify weak market sentiment and sharp revenue declines as the primary drivers of firms’ deteriorating financial health during the pandemic.