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Banktuptcy prediction

Banktuptcy prediction

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Journal of Contemporary

Accounting & Economics

journal homepage: www.elsevier.com/locate/jcae

Research Note

Y. Wu *, C. Gaunt, S. Gray

Clive Gaunt, Stephen Gray, UQ Business School, University of Queensland, Australia

a r t i c l e i n f o a b s t r a c t

Article history: Early models of bankruptcy prediction employed ﬁnancial ratios drawn from pre-bank-

Received 16 April 2009 ruptcy ﬁnancial statements and performed well both in-sample and out-of-sample. Since

Revised 16 November 2009 then there has been an ongoing effort in the literature to develop models with even greater

Accepted 16 November 2009

predictive performance. A signiﬁcant innovation in the literature was the introduction into

Available online 3 April 2010

bankruptcy prediction models of capital market data such as excess stock returns and stock

return volatility, along with the application of the Black–Scholes–Merton option-pricing

Keyword:

model. In this note, we test ﬁve key bankruptcy models from the literature using an up-

Bankruptcy prediction models

to-date data set and ﬁnd that they each contain unique information regarding the proba-

bility of bankruptcy but that their performance varies over time. We build a new model

comprising key variables from each of the ﬁve models and add a new variable that proxies

for the degree of diversiﬁcation within the ﬁrm. The degree of diversiﬁcation is shown to be

negatively associated with the risk of bankruptcy. This more general model outperforms

the existing models in a variety of in-sample and out-of-sample tests.

Ó 2010 Elsevier Ltd. All rights reserved.

1. Introduction

Since Beaver (1966), a large literature on bankruptcy prediction has emerged, and its inﬂuence has spilled into the com-

mercial world, where it has been used in the development of several commercially employed bankruptcy prediction models.

Out of this literature have come a number of competing empirical models with alternative explanatory variables and alter-

native statistical methodologies for model estimation.

The dependent variable in these models is commonly a dichotomous variable where ‘‘ﬁrm ﬁled for bankruptcy” is set to 1

and ‘ﬁrm remains solvent’ is set to 0. The independent variables are often accounting ratios drawn from ﬁnancial statements

and include measures of proﬁtability, liquidity, and leverage. Some studies also include market-driven variables such as the

volatility of stock returns and past excess returns. The accounting-based models developed by Altman (1968) and Ohlson

(1980) have emerged as the most popular bankruptcy prediction models and are often used by empirical accounting

researchers as indicators of ﬁnancial distress.1

Altman (1968) employs multivariate discriminate analysis (MDA) on a list of ﬁnancial ratios to identify those ratios that

are statistically associated with future bankruptcy. Ohlson (1980) uses a logit model, which uses less restrictive assumptions

than those taken by the MDA approach. Zmijewski (1984) adopts a probit approach that is also based on accounting data but

uses a different set of independent variables. All of these approaches predict future bankruptcy based on accounting ratios

drawn from publicly available ﬁnancial statements.

More recently, Shumway (2001) has proposed a discrete-time hazard model to predict a ﬁrm’s bankruptcy using both

accounting and market variables. The main difference between this model and the static logit model is that the hazard model

* Address: UQ Business School, University of Queensland, Brisbane 4072, Australia. Tel.: +61 (0) 733 469 318.

E-mail address: y.wu@business.uq.edu.au (Y. Wu).

1

See, for example, Dichev (1998), Stone (1991), Francis (1990) and Burgstahler et al. (1989).

1815-5669/$ - see front matter Ó 2010 Elsevier Ltd. All rights reserved.

doi:10.1016/j.jcae.2010.04.002

Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45 35

can be estimated within the logit framework while using the entire life span of information (all ﬁrm-years) for each ﬁrm. By

contrast, the static logit model can only incorporate one ﬁrm-year for each observation (i.e., each observation consists of a

single set of variables observed at a single point in time).

Another stream of the bankruptcy prediction literature focuses on market-based information. Among others, Hillegeist

et al. (2004) have developed a BSM-Prob bankruptcy prediction model that is based on the Black–Scholes–Merton option-

pricing model. Their results indicate that the BSM-Prob model outperforms the models of Altman (1968) and Ohlson

(1980) in a series of tests.

There are also a number of papers that propose various ﬁrm-characteristics that may be useful additional predictors of

future bankruptcy. For example, Rose (1992) proposes a model of ﬁrm diversiﬁcation in which managers use diversiﬁcation

to reduce the risk of bankruptcy, particularly where the ratio of the manager’s ﬁrm-speciﬁc human capital to his non-ﬁrm-

speciﬁc human capital is high. Denis et al. (1997) measure corporate diversiﬁcation by the number of business segments.

Beaver et al. (2005) propose that, other things equal, large ﬁrms have a smaller probability of bankruptcy and that a part

of this explanation is related to corporate diversiﬁcation. That is, corporate diversiﬁcation and ﬁrm-size are two ﬁrm-char-

acteristics that may help to predict future bankruptcy.

Hillegeist et al. (2004) compare the performance of their BSM-Prob model against the Altman and Ohlson models in a

series of in-sample and out-of-sample tests, concluding that the BSM model outperforms the accounting-based models. Sim-

ilarly, Chava and Jarrow (2004) examine the relative performance of Shumway’s hazard model against the Altman and Zmi-

jewski models, concluding that the hazard model outperforms static logit models.

In this note, we make three contributions to the bankruptcy prediction literature. First, we note that the existing liter-

ature has compared the relative performance of various subsets of models. We perform a more comprehensive examination

of the performance of models that use different data (accounting, market, and ﬁrm-characteristic data) and different econo-

metric approaches (MDA, logit, hazard, and BSM models). Second, we develop a number of additional performance metrics

in various tables and ﬁgures, which provide some new perspectives on the relative performance of the various approaches.

Third, we examine an integrated model that encompasses accounting variables, market information (including the BSM

probabilities from the model proposed by Hillegeist et al.) and ﬁrm-characteristics such as size and corporate

diversiﬁcation.

The extant literature reports that the predictive ability of each model varies over time, and our empirical analysis con-

ﬁrms this result.2 For example, the Ohlson model performs relatively well in the mid- to late-1980s, whereas the Shumway

model performs better in the 1990s. This time-series variation in the performance of different models that use different data

and employ different econometric techniques suggests that each model might be capturing slightly different aspects of corpo-

rate ﬁnancial health. These points towards an integrated model that includes accounting data, market data, and ﬁrm-character-

istics such as size and corporate diversiﬁcation. We develop such a combined model and show that it outperforms the various

existing models in a range of in-sample and out-of-sample forecasting tests. We conclude that each model does indeed capture

slightly different aspects of corporate ﬁnancial health and that a combined model is able to provide more consistent and more

reliable indications of corporate bankruptcies over a broader range of market conditions.

2.1. Models

There are a number of key models that have been developed by various authors and presented in the bankruptcy predic-

tion literature over the last three decades. These are:

(ii) Ohlson (1980) – logit model with accounting ratios.

(iii) Zmijewski (1984) – probit model using accounting data.

(iv) Shumway (2001) – hazard model with both accounting and market variables; and

(v) Hillegeist et al. (2004) – BSM-Prob model based on both accounting and market variables.

Using an up-to-date data set, we compare the performance of these models and propose and test a new, more general,

model that includes accounting information and various ﬁrm-characteristic variables including size and corporate diversi-

ﬁcation. Table 1 provides a brief summary of each model.

2.2. Data

Data on ﬁrm bankruptcies is obtained from New Generation Research (www.bankruptcydata.com), Compustat and CRSP.

The sample contains NYSE- and AMEX-listed Compustat ﬁrms and covers the period from 1980 to 2006. Consistent with the

previous literature, a ﬁrm is deﬁned as bankrupt if the ﬁrm makes a chapter 11 ﬁling within 1 year. The accounting data (i.e.,

2

A more detailed analysis of model performance in various sub-periods, not reported in the main tables, is available upon request.

36 Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45

Table 1

Summary of empirical models and variables employed. This table sets out the various bankruptcy prediction models that we examine. The ﬁrst column lists the

models that are examined. The second column summarizes the model speciﬁcation. The ﬁnal columns document the explanatory variables that are used in the

models.

0

Altman (1968) Z¼bX X1 = Net working capital/total assets

Multiple-discriminant where Z is the MDA score and X represents the X2 = Retained earnings/total assets

analysis variables listed

Cutoff point: X3 = Earnings before interest and taxes/total assets.

Z P 2.675, classiﬁed as non-bankrupt X4 = Market value of equity/book value of total

liabilities.

Z < 2.675, classiﬁed as bankrupt X5 Sales/total assets.

Ohlson (1980) 0

P ¼ ð1 þ expfb XgÞ 1 Ohlsonsize = Log(total assets/GNP price-level index). The

Logit model where P is the probability of bankruptcy and X index assumes a base value of 100 for 1968.

represents the variables listed. The logit function TLTA = Total liabilities divided by total assets.

maps the value of b0 X to a probability bounded WCTA = Working capital divided by total assets.

between 0 and 1. CLCA = Current liabilities divided by current assets.

OENEG = 1 If total liabilities exceed total assets, 0

otherwise.

NITA = Net income divided by total assets.

FUTL = Funds provided by operations (income from

operation after depreciation) divided by total

liabilities.

INTWO = 1 If net income was negative for the last 2 years,

0 otherwise.

CHIN = (NIt NIt1)/(|NIt| + |NIt1|), where NIt is net

income for the most recent period. The

denominator acts as a level indicator. The variable

is thus intended to measure the relative change in

net income.

Zmijewski (1984) P ¼ Uðb0 XÞ NITL = Net income divided by total liabilities.

Probit model where P is the probability of bankruptcy and X TLTA = Total liabilities divided by total assets.

represents the variables listed, and UðÞ CACL = Current assets divided by current liabilities.

represents the cumulative normal distribution

function. The probit function maps the value of

b0 X to a probability bounded between 0 and 1.

Shumway (2001) P i;t ¼ ð1 þ expfyi;t gÞ1 NITL = Net income divided by total liabilities.

Hazard model 2 3 TLTA = Total liabilities divided by total assets.

X 1;t1 :::X 1;tj

yi;t ¼ a þ b0 X i;t1 ¼ b0 4 ::::: 5 Relative Size = Log(the number of outstanding shares

X n;t1 :::X n;tj multiplied by year-end share price then divided

where P is the probability of bankruptcy and X by total market value).

represents the variables listed. This is a logit LagExReturn = Cumulative annual return in year t 1 minus

model, but instead of treating each ﬁrm-year as the value-weighted CRSP NYSE/AMEX index

an independent observation, all prior values of the return in year t 1.

independent variables for a particular ﬁrm are LagSIGMA = Standard deviation of the residual derived from

included in the information set. n Represents the regressing monthly stock return on market return

number of independent variables, and j represents in year t 1.

the number of time periods prior to time t for

which data are available.

Hillegeist et al. (2004) P¼N

lnðV A =XÞþðld0:5rA2 ÞT

pﬃﬃ VE = Current market value of equity.

Black–Scholes option- rA T VA = Current market value of assets.

pricing model where P is the probability of bankruptcy and the X = Face value of debt maturing at time T.

variables are as deﬁned. d = Continuous dividend rate expressed in terms of

VA.

rA ¼ rE V E =ðV E þ XÞ:

l = Continuously compounded expected return on

assets.

T = Debt maturity, set as 1 year.

Multi-period logit model P i;t ¼ ð1 þ expfyi;t gÞ1 EBITTA = Earnings before interest and taxes/total assets.

with expanded set of 2 3 WCTA = Working capital divided by total assets.

X 1;t1 :::X 1;tj

variables yi;t ¼ a þ b0 X i;t1 ¼ b0 4 ::::: 5 TLMTA = Total liabilities divided by market value of total

Hazard model with X n;t1 :::X n;tj assets.

additional explanatory where P is the probability of bankruptcy and X CHIN = (NIt NIt1)/(|NIt| + |NIt1|), where NIt is net

variables represents the variables listed. n Represents the income for the most recent period. The

number of independent variables and j represents denominator acts as a level indicator. The variable

the number of time periods prior to time t for is thus intended to measure the relative change in

which data are available. net income.

Excess = Cumulative annual return in year t 1 minus

Return the value-weighted CRSP NYSE/AMEX index

return in year t 1.

Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45 37

Table 1 (continued)

Sigma = Standard deviation of the residual derived from

regressing monthly stock return on market return

in year t 1.

Price = Log(closing price of previous ﬁscal year).

Segment = Diversiﬁcation factor, which is proxied by the

number of business segments.

ﬁnancial ratios and diversiﬁcation data) are obtained from Compustat, and the daily and monthly stock returns are collected

from CRSP.

We assume that annual ﬁnancial statements are available by the end of the fourth month after the ﬁrm’s ﬁscal year-end.

For each bankrupt ﬁrm, the most recent ﬁnancial statements must be available at least 4 months prior to bankruptcy. If the

bankruptcy is within 4 months, we treat the previous year’s ﬁnancial statements as the last available observation. The infor-

mation will be less informative if the lag between recent available annual ﬁnancial statements and the bankruptcy ﬁling date

is too long, so we exclude bankruptcies with more than 18 months between the most recent ﬁnancial statements and the

bankruptcy ﬁling date. To be consistent with previous studies (see, for example, Begley et al., 1996, and Shumway, 2001),

we only include ﬁrms with a Standard Industrial Classiﬁcation (SIC) code that is less than 4000 or between 5000 and

5999 (effectively, we exclude ﬁnancial ﬁrms).

The number of bankrupt companies with complete accounting data available is 887. Among them, 650 ﬁrms have a bank-

ruptcy ﬁling date available in the New Generation Research database. For those bankrupt companies without an exact ﬁling

date, we treat the delisting date from CRSP or their deletion date from Compustat, whichever is earlier, as the bankruptcy

date. All estimations are on a yearly basis. We exclude ﬁrms that are delisted from CRSP or deleted from Compustat for rea-

sons other than bankruptcy or liquidation. A total of 737 ﬁrm-years are excluded due to missing values. The ﬁnal sample for

estimation consists of 50,611 ﬁrm-years. This data set contains 887 bankruptcies and 49,724 non-bankrupt ﬁrm-years.

We employ both matched-pair and random-sampling methods to ensure comparability with the estimation procedures

of the models under investigation. Similar to Altman’s (1968) procedure, we construct a matched-pair based on ﬁrm-size and

the two-digit SIC industry classiﬁcation code on a yearly basis. We measure ﬁrm-size by total book assets. A match is based

on minimizing the absolute value of the ratio of the difference between the size of the bankrupt ﬁrm and that of the healthy

ﬁrm to the size of the bankrupt ﬁrm.

We also construct a new, more general, model based on a set of selected variables, which includes the sorts of proﬁtabil-

ity, liquidity, and leverage variables that have appeared in the previous literature. Earnings before interest and tax to total

assets (EBITTA) and change in income (CHIN) are two powerful measures that capture the static and dynamic condition of a

ﬁrm’s proﬁtability condition. Working capital to total assets (WCTA) is the most widely used measure of liquidity, and its

explanatory power is evident in the existing bankruptcy literature. We also use a market-based leverage measure, total lia-

bilities to the market value of total assets (TLMTA), which is proposed by Campbell et al. (2008). They ﬁnd that a market-

based measure of leverage performs better that the traditional book value to leverage ratio. They suggest that market prices

may more rapidly incorporate new information about the ﬁrm’s prospects. We also include the lagged stock return (lagEx-

Return) and volatility variables (lagSIGMA) used in the Shumway model. To avoid multicollinearity problems, we only in-

clude one ﬁrm-size variable, the log price per share (PRICE) in our model. In addition, we include a variable to measure

the extent to which the ﬁrm’s operations are diversiﬁed. Our Segment variable measures the number of separate business

segments in each of our sample ﬁrms.

Table 2 presents summary statistics for each variable used in this study over the period 1980–2006. Our data set contains

887 bankruptcies and 49,724 non-bankrupt ﬁrm-years, which are deﬁned as ‘‘healthy” in the table. For each variable, we

display the means in bold if they are signiﬁcantly different at the 5% level between the two sub-samples. To remove the im-

pact of extreme values and outliers, all variables have been winsorized at the 1st and 99th percentiles.

Table 2 groups the variables into a number of categories. The proﬁtability variables measure the ability of the ﬁrm to gen-

erate sufﬁcient proﬁts or returns to remain a viable going concern. EBIT to total assets (EBITTA) and net income to total assets

(NITA) both measure the proﬁtability of the ﬁrm in relation to its asset base. For these measures, our sample of ﬁrms that

became bankrupt in the following year score substantially less than the remainder of our sample.

We follow Ohlson (1980) in measuring change in net income as CHIN = (NIt NIt1)/(|NIt| + |NIt1|) where NIt represents

net income in year t. Where net income was negative in the previous year but positive in the current year, this variable will

take the value 1. Where the opposite occurs, the variables will the value 1. These events occur for a number of observations

in our sample, so we focus more on the median than on the mean for this variable. In this regard, we note that the median

bankrupt ﬁrm sees its net income deteriorate by 36% in the year prior to bankruptcy, whereas net income grows by 6% for the

other ﬁrms in our sample.

38 Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45

The sales to total assets variable (SALES) was originally used by Altman (1968). Other things equal, it would be expected

that ﬁrms with a higher value of this variable would be less likely to experience bankruptcy. However, Table 2 indicates that

the reverse is true. Further analysis reveals that the book value of total assets for the mean bankrupt ﬁrm decreased by 9.8%

over the year prior to bankruptcy.3 Consequently, the ratio of sales over the course of the year to total assets at the end of the

year can be misleading. We retain this variable in our analysis of the Altman model, but we do not use it in our proposed com-

prehensive model.

The liquidity variables measure the ability of the ﬁrm to meet its short-term obligations. On average, our sample of bank-

rupt ﬁrms has lower working capital to total assets (WCTA). The bankrupt ﬁrms also have higher current liabilities relative to

current assets (CLCA)4 and are more likely to have negative net income over the prior 2 years (INTWO). Bankrupt ﬁrms are also

likely to have a lower ratio of funds from operations to total liabilities (FUTL).

The leverage variables measure the relative amount of debt and other obligations of the ﬁrm. On average, the bankrupt

ﬁrms have lower retained earnings relative to total assets (RETA), a lower market value of equity to total liabilities (METL),

and higher total liabilities relative to total assets (TLTA). The bankrupt ﬁrms are also more likely to report total liabilities in

excess of the book value of total assets (OENEG) and to have higher liabilities relative to the market value of total assets

(TLMTA).

The ﬁrm-size variables are drawn from the literature where, other things equal, larger ﬁrms are thought to be more able

to trade through difﬁcult times and are less likely to become bankrupt. Consistent with the ﬁndings in the existing literature,

the ﬁrms that become bankrupt in the following year are, on average, smaller. We include the log of the ﬁrm’s share price

(PRICE) as a ﬁrm-size variable, as share prices tend to be related to ﬁrm-size with larger ﬁrms, on average, commanding a

higher price per share.5 We also measure size as total assets relative to a GNP price index (Ohlsonsize) for the implementation

of the Ohlson model and as the ﬁrm’s market capitalization relative to the entire market (Relative Size) as this is required for the

Shumway model. The share price may also reﬂect liquidity, with the literature documenting that very low-priced stocks exhibit

lower liquidity on average. Table 2 indicates that our sample of bankrupt ﬁrms, on average, has lower stock prices than the

remainder of our sample.

The last panel of Table 2 contains a number of other ﬁrm-characteristics. On average, our sample of bankrupt ﬁrms tends

to have lower and more volatile stock returns (lagSIGMA) than the other ﬁrms in our sample. Our measure of excess returns

(lagExReturn) is the CRSP total return minus the CRSP value-weighted-index total return. The mean and median bankrupt

ﬁrm has exhibited substantial underperformance in the year prior to bankruptcy. The bankrupt ﬁrms also tend to be younger

(logage) and have fewer business segments (Segment), indicating a lower degree of corporate diversiﬁcation.

The various bankruptcy prediction models that have been proposed differ in two ways – they use different explanatory

variables and different econometric techniques (MDA, probit, and logit). We begin by examining the role of the explanatory

variables; while holding the econometric technique constant, we use the logit framework outlined in Shumway (2001). In

the subsequent sub-section we also vary econometric techniques.

Speciﬁcally, we begin by testing the explanatory power of each model with a multi-period logit approach. Initially, all

tests are conducted in-sample. This procedure generates a series of nested models, which allows for model comparison

and signiﬁcance tests among different sets of variables. The multi-period logit model is equivalent to the hazard model in

Shumway (2001), except that we only include one ﬁrm-year observation for each bankrupt ﬁrm but all ﬁrm-year observa-

tions for the surviving ﬁrms. This reﬁnement signiﬁcantly improves model performance. As there are serially correlated

observations included in the model (because the data set contains more than 1 year of data for some ﬁrms), the standard

error will be biased upwards. Consequently, standard errors are adjusted according to Shumway (2001), where the Wald

Chi-Square generated by the logit program is divided by the average number of ﬁrm-years.

Table 3 reports the parameter estimates from each model. Here we only test the variables used in four accounting-based

models. The BSM-Prob model is not based on accounting ratios and therefore does not ﬁt within this framework. In all cases,

we use the same set of variables as the original authors, but we employ the logit framework of Shumway (2001). The esti-

mated coefﬁcients are in bold type when they are statistically signiﬁcant at the 5% level. The adjusted Wald chi-squared sta-

tistics are computed as in Shumway (2001). The dependent variable is set to 1 for bankrupt ﬁrms and 0 otherwise, so a

positive coefﬁcient indicates that a higher value of the relevant variable increases the likelihood of bankruptcy.

All of the models that are examined use a range of proﬁtability, liquidity, and leverage variables. In general, and as ex-

pected, a ﬁrm is more likely to become bankrupt if it has lower proﬁtability, lower liquidity and higher leverage. The majority

of the variables in these categories are statistically signiﬁcant. Some models also include one of the ﬁrm-size variables. Ta-

ble 3 indicates that, other things equal, smaller ﬁrms are more likely to experience bankruptcy.

3

A table of summary statistics for all accounting information is available upon request.

4

Even though the sample has been winsorized, there remain some ﬁrms with very low current assets, resulting in high values of the ratio of current

liabilities to current assets, and this affects the mean estimate. We note that the median value of this variable is also much weaker for the bankrupt ﬁrms.

5

A detailed correlation matrix is available upon request.

Table 2

Summary statistics for explanatory variables. This table reports summary statistics for all of the variables used in this study over the period 1980–2006. Our ﬁnal data set contains 887 bankruptcies and 49,724 non-

bankrupt ﬁrm-years (deﬁned as ‘‘healthy” in the table). Mean values are in bold if the difference between the bankrupt and healthy samples is signiﬁcant at the 5% level. EBITTA = earnings before interest and taxes to

total assets; SALES = sales to total assets; NITA = net income divided by total assets; CHIN = (NIt NIt1)/(|NIt| + |NIt1|), where NIt is net income for the most recent period. WCTA = working capital to total assets;

CLCA = current liabilities to current assets; FUTL = income from operations after depreciation divided by total liabilities; INTWO = 1 if net income was negative for the previous 2 years, 0 otherwise. RETA = retained

earnings to total assets; METL = market equity to total liabilities; TLTA = total liabilities to total assets; OENEG = 1 if total liabilities exceeds total assets, 0 otherwise; TLMTA = total liabilities to market value of total

assets. Ohlsonsize = log(total assets/GNP price-level index), the index assumes a base value of 100 for 1968; Relative Size = log(the number of outstanding shares multiplied by year-end share price then divided by

total market value); price = log of closing price at end of previous ﬁscal year. LagSIGMA = historical idiosyncratic risk; LagExReturn = lagged excess return; logage = log(years for which ﬁrm has traded); Segment = the

number of business segments in the ﬁrm.

EBITTA SALES NITA CHIN WCTA CLCA FUTL INTWO

Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy

Mean 0.18 0.03 1.35 1.22 0.31 0.02 0.33 0.02 0.03 0.3 2.81 0.68 0.79 0.01 0.59 0.19

Standard deviation 0.32 0.21 0.96 0.8 0.41 0.23 0.6 0.55 0.28 0.23 33.2 6.12 12.95 1.38 0.49 0.39

Maximum 0.25 0.32 4.48 4.48 0.24 0.24 1 1 0.81 0.85 979 925 2.81 15.4 1 1

Median 0.06 0.08 1.19 1.09 0.15 0.04 0.36 0.06 0.05 0.28 0.88 0.47 0.07 0.14 1 0

Minimum 1.15 1.15 0 0 1.46 1.46 1 1 0.43 0.43 0.01 0 385 74.88 0 0

Leverage variables Firm-size variables

RETA METL TLTA OENEG TLMTA Ohlsonsize Relative Size Price

Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy

Mean 1.04 0.18 1.43 6.33 0.79 0.47 0.23 0.02 0.69 0.34 4.54 3.64 12.59 10.34 0.49 2.37

Standard deviation 2.05 1.3 4.81 11.99 0.28 0.23 0.42 0.12 0.25 0.23 1.75 2.05 1.64 2.12 1.31 1.19

Maximum 0.83 0.83 67.02 79.33 1.23 1.23 1 1 0.93 0.93 2.06 4.16 5.33 5.33 4.42 4.42

Median 0.24 0.17 0.28 2.25 0.8 0.47 0 0 0.78 0.31 4.58 3.79 12.67 10.48 0.63 2.55

Minimum 8.31 8.31 0.08 0.08 0.05 0.05 0 0 0.01 0.01 9.65 10.76 15.28 15.28 2.08 2.08

Other ﬁrm-characteristics

LagSIGMA LagExReturn Logage Segment

Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy Bankrupt Healthy

Mean 0.21 0.14 0.44 0.09 2.2 2.41 2.14 3.37

Standard deviation 0.11 0.09 0.5 0.69 0.77 0.82 2.42 3.49

Maximum 0.56 0.56 3.29 3.29 4.23 4.23 20.00 42.00

Median 0.19 0.12 0.57 0.04 2.2 2.4 1.00 2.00

Minimum 0.03 0.03 0.95 0.95 1.1 1.1 1.00 1.00

39

40 Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45

The Shumway model and our proposed comprehensive model also include a range of other ﬁrm-characteristics. Table 3

indicates that, other things equal, a ﬁrm is more likely to become bankrupt if it has recently experienced negative excess

returns (i.e., the stock price has fallen after adjusting for the market) (lagExReturn) and if stock price returns are more vol-

atile (lagSIGMA). These results are consistent with Shumway (2001). Table 3 also indicates that the age of the ﬁrm (logage)

has no signiﬁcant explanatory power.

Our proposed comprehensive model includes the sorts of proﬁtability, liquidity, and leverage variables that have ap-

peared in the previous literature. It also includes the lagged return and volatility variables used in the Shumway model.

To avoid multicollinearity problems, we only include one ﬁrm-size variable (PRICE) in our model. In addition, we include

a variable to measure the extent to which the ﬁrm’s operations are diversiﬁed (Segment). Table 3 indicates that more diver-

siﬁed ﬁrms (i.e., those with a greater number of business segments) are less likely to become bankrupt, other things being

equal.

We also compare each of the models based on model-ﬁt criteria such as the Receiver Operating Characteristics area (ROC

area) and Pseudo R2. The ROC curve is a widely used technique for assessing various rating methods in the bankruptcy pre-

diction literature (see, for example, Chava and Jarrow, 2004; Vassalou and Xing, 2004; Agarwal and Tafﬂer, 2008).

The ROC score and Pseudo R2 statistics are higher for the proposed comprehensive model than for any others that are

examined. The ROC score is discussed in Agarwal and Tafﬂer (2008) and Lyandres and Zhdanov (2007). A scaled version

of this score, known as the accuracy ratio, is used by Moody’s and is discussed at some length in Vassalou and Xing

(2004). A perfect model has an ROC score of 1, and a model that has no discriminatory power whatsoever has an ROC score

of 0.5. Thus, a higher ROC score indicates that the model is better able to discriminate between bankrupt and healthy ﬁrms.

The comprehensive model has an RPC score of 0.93 and a Pseudo R2 of 36%, which is superior to all other models that are

examined.

The in-sample logit analysis in Table 3 indicates that the proﬁtability, liquidity, and leverage variables in our proposed

comprehensive model are all statistically signiﬁcant. Other things equal, a ﬁrm is more likely to become bankrupt if it

has lower proﬁtability, lower liquidity and higher leverage. The additional explanatory variables improve the performance

of the model and are jointly signiﬁcant (a likelihood ratio test of the joint signiﬁcance of the other variables is signiﬁcant at

the 1% level). In particular, the lagged excess stock return, the volatility of stock returns, the share price (as a proxy for ﬁrm-

size, and perhaps liquidity) and ﬁrm diversiﬁcation are individually and jointly signiﬁcant.

In the remainder of this section, we compare this proposed new model against other models from the literature in a num-

ber of more formal speciﬁcation and performance tests. That is, having identiﬁed the set of accounting, market, and ﬁrm-

characteristic variables, we next turn to variations in the econometric speciﬁcation of the model.

In this section, we re-estimate each of the models using the econometric speciﬁcation used by the original authors. We

thus use multiple-discriminant analysis (MDA) for the Altman model, standard logit for the Ohlson model and probit for the

Zmijewski model. The Shumway and comprehensive models are estimated in a logit-hazard setting, and the BSM model is

estimated as described in Hillegeist et al. (2004). For all models, we use all available observations. For example, MDA is used

to estimate the Altman model, but it is based on all observations in our sample rather than on the matched-pairs for the

bankrupt ﬁrms as in the original paper.

The result of this procedure is an estimated bankruptcy probability from each model for each observation in our sample.

We rank these model bankruptcy probabilities from lowest to highest. For a given percentile, we then report the frequency of

Type I (classifying a bankrupt ﬁrm as healthy) and Type II (classifying a healthy ﬁrm as bankrupt) errors. For example, at the

50th percentile we consider the incidence of classiﬁcation errors if all observations with a model bankruptcy probability

above the 50th percentile are classiﬁed as bankrupt and all others are classiﬁed as healthy.

In Table 4, we report the rate of Types I and II errors. For each model, we use bold font to report the point at which the

sum of Types I and II classiﬁcation errors is minimized. This procedure is a modiﬁed version of that used by Begley et al.

(1996).6

Table 4 shows that for all models the sum of the classiﬁcation errors is minimized with a cutoff point between the 75th

and 90th percentiles. For our proposed comprehensive model, for example, total classiﬁcation error rates are minimized by

classifying as bankrupt only those ﬁrms with a bankruptcy probability above the 87th percentile. We note that the classiﬁ-

cation error rate for the comprehensive model is lower than that of all other models.

6

Begley et al. (1996) report results based on the bankruptcy probability from the Ohlson model rather than based on percentiles, as we have done. In their

sample, the sum of classiﬁcation errors is minimized using an estimated bankruptcy probability of 3.8%. That is, any ﬁrm with an estimated probability of

bankruptcy more than 3.8% should be classiﬁed as bankrupt. Note that this cannot be directly compared with our percentile ranking, which is not in terms of

raw probabilities but rather in terms of the ranking of this probability relative to the rest of the sample. Of course, minimizing the sum of Type I and Type II

errors is not necessarily optimal. In some circumstances, one type of error might be more costly than another. For example, a corporate regulator seeking

advance warning of impending corporate collapses would be more concerned with Type I errors (bankrupt ﬁrms being classiﬁed as healthy). This might lead the

regulator to set a lower cutoff value to reduce the incidence of Type I errors at the expense of more Type II errors (having to conduct more detailed evaluations

of ﬁrms that turn out to be healthy).

Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45 41

Table 3

Estimation results. This table presents the parameter estimates from various bankruptcy prediction models. Our sample is from 1980 to 2006 and contains 887

bankruptcies and 49,724 non-bankrupt ﬁrm-year observations. Bold font signiﬁes an estimate that is statistically signiﬁcant at the 5% level. The adjusted Wald

Chi-Square statistics from the logistic regression are presented adjacent to each parameter estimate. The ROC statistic measures the ability of a model to

discriminate between bankrupt and healthy ﬁrms, with a higher score indicating a better ability. ***,**, and * indicate statistical signiﬁcance at the 1%, 5%, and

10% levels, respectively.

Altman (1968) Ohlson (1980) Zmijewski (1984) Shumway (2001) Comprehensive model

Estimate Wald Chi- Estimate Wald Chi- Estimate Wald Chi- Estimate Wald Chi- Estimate Wald Chi-

Square Square Square Square Square

Intercept 3.2*** 216.15 7.2*** 162.25 5.81*** 155.69 11.71*** 149.23 5.79*** 104.05

Proﬁtability variables

EBITTA 3.27 34.93 1.75*** 13.52

SALES 0.18*** 7.27

NITA 0.03 0.01 1.47*** 34.93 0.33 1.17

CHIN 1.02*** 24.16 0.44** 5.31

Liquidity variables

WCTA 3.38*** 47.19 1.87*** 13.85 1.69*** 12.69

CLCA* 0 0 0.28** 5.38

FUTL 0.06 1.33

INTWO 1.16*** 19.98

Leverage variables

RETA 0.1 1.04

METL 0.24*** 13.98

TLTA 3.69*** 32.35 3.54*** 56.5 3.71*** 80.23

OENEG 0.54 1.63

TLMTA 4.44*** 52.97

Size Variables

Ohlsonsize 0.17*** 7.63

Relative Size 0.4*** 31.89

PRICE 0.34*** 9.57

Other ﬁrm-characteristics

LagExReturn 1.33*** 21.59 0.54* 3.77

LagSIGMA 2.52** 5.26 2.67** 5.2

Logage 0.04 0.08

Segment 0.18*** 10.34

2 Log- 7125 6623 7188 6284 5705

likelihood

ROC score 0.861 0.887 0.852 0.906 0.929

Pseudo R2 0.202 0.259 0.195 0.297 0.361

*

Zmijewski (1984) uses current assets to current liabilities, whereas Ohlson (1980) uses the reciprocal.

Our next set of tests examines the out-of-sample performance of the various models. We conduct a series of rolling out-

of-sample estimations similar to that of Hillegeist et al.(2004). For example, the ﬁrst estimation is based on ﬁrm-year obser-

vations from 1980 and bankruptcies in 1981. The estimated coefﬁcients are then used to predict bankruptcies in 1982 with

data up to 1981. The second estimation is expanded to use ﬁrm-year observations from 1980 to 1981 and bankruptcies in

1982. The second set of estimated coefﬁcients is then used to predict bankruptcies in 1983 with data up to 1982. The win-

dows continue expanding; the estimated coefﬁcients used to predict bankruptcies in 2006 are based on ﬁrm-year observa-

tions from 1980 to 2004 and bankruptcies from 1981 to 2005.

For the BSM model, all observations are out-of-sample in the sense that no coefﬁcients need to be estimated. Rather,

parameter estimates based on observable data are used for all observations. Although we could therefore consider the entire

sample to be an out-of-sample test of the BSM model, we restrict our analysis to the same out-of-sample period that we use

for the other models. We do this to guard against the possibility that it may have been easier or more difﬁcult to distinguish

between bankrupt and healthy ﬁrms in the estimation period relative to the out-of-sample period. This would give the BSM

model an unfair advantage or disadvantage, as the case may be.

The out-of-sample performance of each model is summarized in Table 5. For each model, we begin by estimating the

bankruptcy probability for each observation in the out-of-sample period. This is based on coefﬁcients estimated from the

earlier data period. We then rank all observations in the out-of-sample period by the estimated bankruptcy probability,

and we group observations into deciles on this basis. Decile 1 represents those ﬁrms with the highest estimated probability

of bankruptcy.

We then report the actual number of bankruptcies from among those ﬁrms classiﬁed in each decile. There were 874 ac-

tual bankruptcies in our out-of-sample period. A perfect model would have all of these ranked in the top decile. Thus, a better

42 Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45

Table 4

Bankruptcy classiﬁcation rates. This table shows the incidence of Type I errors (classifying a bankrupt ﬁrm as healthy) and Type II errors (classifying a healthy

ﬁrm as bankrupt) according to model scores. For each model, the cutoff that minimizes the sum of Types I and II errors is highlighted in bold. For example,

under the Altman model if companies with model scores above the 85th percentile are classiﬁed as bankrupt, and those with model scores below the 85th

percentile are classiﬁed as healthy, Types I and II error rates are 64.8% and 15.6%, respectively. *For comparison, we use the negative Altman’s Z score here.

(percentile) Type I Type II Type I Type II Type I Type II Type I Type II Type I Type II Type I Type II

50 0.348 0.507 0.041 0.502 0.062 0.502 0.564 0.501 0.513 0.502 0.535 0.501

70 0.492 0.306 0.103 0.299 0.122 0.299 0.072 0.298 0.136 0.300 0.049 0.298

71 0.497 0.296 0.106 0.289 0.126 0.289 0.077 0.288 0.145 0.290 0.053 0.288

72 0.504 0.286 0.108 0.279 0.131 0.279 0.080 0.278 0.153 0.280 0.057 0.278

73 0.516 0.276 0.115 0.269 0.142 0.269 0.084 0.268 0.163 0.270 0.058 0.268

74 0.522 0.266 0.118 0.258 0.146 0.259 0.085 0.258 0.172 0.260 0.062 0.257

75 0.527 0.256 0.125 0.248 0.149 0.249 0.091 0.248 0.180 0.249 0.070 0.247

76 0.538 0.246 0.127 0.238 0.157 0.239 0.092 0.238 0.190 0.239 0.075 0.237

77 0.546 0.236 0.133 0.228 0.161 0.229 0.096 0.228 0.199 0.229 0.079 0.227

78 0.565 0.226 0.136 0.218 0.165 0.219 0.102 0.217 0.205 0.219 0.080 0.217

79 0.584 0.216 0.146 0.208 0.172 0.209 0.107 0.207 0.213 0.209 0.083 0.207

80 0.595 0.206 0.153 0.198 0.180 0.199 0.111 0.197 0.222 0.199 0.085 0.197

81 0.603 0.196 0.160 0.188 0.191 0.189 0.117 0.187 0.230 0.189 0.089 0.187

82 0.615 0.186 0.165 0.178 0.201 0.179 0.125 0.177 0.241 0.179 0.092 0.177

83 0.626 0.176 0.173 0.168 0.220 0.169 0.133 0.167 0.252 0.169 0.096 0.166

84 0.637 0.166 0.179 0.158 0.233 0.159 0.144 0.157 0.260 0.159 0.103 0.156

85 0.648 0.156 0.187 0.148 0.247 0.149 0.154 0.147 0.276 0.149 0.114 0.146

86 0.661 0.146 0.198 0.138 0.253 0.139 0.168 0.137 0.293 0.140 0.121 0.136

87 0.673 0.136 0.209 0.128 0.264 0.129 0.183 0.127 0.298 0.129 0.130 0.126

88 0.688 0.127 0.220 0.118 0.274 0.119 0.202 0.117 0.322 0.120 0.142 0.116

89 0.699 0.117 0.238 0.108 0.289 0.109 0.218 0.108 0.350 0.110 0.156 0.106

90 0.707 0.107 0.256 0.098 0.312 0.099 0.232 0.098 0.367 0.100 0.163 0.096

99 0.870 0.018 0.687 0.014 0.760 0.016 0.641 0.014 0.763 0.016 0.547 0.012

model has more of the actual bankruptcies classiﬁed in the top decile(s) and fewer classiﬁed in the bottom decile(s). Table 5

reports the number and proportion of the actual bankruptcies that were classiﬁed into each of the deciles by the estimated

bankruptcy probability. It also reports the proportion of ﬁrms in each decile that did experience bankruptcy.

For our proposed comprehensive model, for example, 683 of the 874 out-of-sample bankruptcies (78%) are classiﬁed into

Decile 1. The top two deciles contain 89% of the out-of-sample bankruptcies. This performance is substantially better than all

of the other models.7

Table 5 also reports a model performance rating for each of the models. This score is based on a weighted-average of the

proportion of bankruptcies in each decile. A model that classiﬁes all of the actual out-of-sample bankruptcies into Decile 1

performs perfectly and receives a rating of 100%. By contrast, a model that classiﬁes all of the actual out-of-sample bankrupt-

cies into Decile 10 is actively incorrect and receives a rating of 100%. A model that allocates the actual bankruptcies evenly

across all 10 deciles is equivalent to a random assignment and receives a rating of 0. On this dimension, the comprehensive

model also performs better than all of the other models that are examined.

We perform two types of information content tests similar to those performed by Hillegeist et al. (2004). First, we esti-

mate a series of discrete hazard models – one for each of our bankruptcy prediction models. In each case, we include the

lagged rate of bankruptcies (the proportion of total sample ﬁrms that experienced bankruptcy during the previous year)

as a proxy for the baseline hazard rate. We then include the score (ﬁtted prediction value) from one of the bankruptcy pre-

diction models and examine the relative explanatory power of the baseline rate and the prediction model.

The results are reported in Panel A of Table 6. In all cases, a positive coefﬁcient indicates that the relevant variable is asso-

ciated with an increase in the likelihood of bankruptcy. For all models, the coefﬁcient on the model score is positive and sig-

niﬁcant at the 5% level. This indicates that the model has explanatory power beyond the baseline lagged bankruptcy rate.

That is, the variables used in the model and the econometric method for combining them into a single bankruptcy score

are useful in predicting bankruptcies – beyond knowing the bankruptcy rate from the previous year. This result is consistent

with Hillegeist et al. (2004).

The results in Table 6 also indicate that the lagged bankruptcy rate is generally not signiﬁcant in combination with the

bankruptcy scores from the various models. This is in contrast with the results of Hillegeist et al., who ﬁnd that the coefﬁ-

7

For the BSM Model, a small number of observations are lost due to the non-convergence of the estimation algorithm or missing data. In an unreported table,

we generate results from a sample that is restricted to those observations for which the BSM model can be estimated, and the overall ranking is unchanged.

Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45 43

Table 5

Out-of-sample forecast accuracy with rolling windows. This table reports statistics relating to out-of-sample performance based on the rolling windows

method. The details of the rolling windows method are in the text. We classify observations into deciles based on these bankruptcy probabilities (Decile 1 being

the highest). Except for the BSM model, each decile contains 4953 observations, 874 of which are bankruptcies (for the BSM model, 727 of which are

bankruptcies). For each model, we report the actual number of bankruptcies in each decile, the proportion of the 874 actual bankruptcies that occur in each

decile, and the proportion of the total ﬁrms in each decile that experienced bankruptcy. We also report a ‘‘model performance rating”: where all bankruptcies

occur in Decile 1, the model performs perfectly and the score is 100%; where all bankruptcies occur in Decile 10, the model is actively incorrect and the score is

100%; where bankruptcies are evenly spread across deciles, the score is 0%, and so on.

Decile 1 2 3 4 5 6 7 8 9 10

Altman model

Number of actual bankruptcies in decile 247 100 94 69 59 74 73 51 56 51

Proportion of bankruptcies in each decile 0.283 0.114 0.108 0.079 0.068 0.085 0.084 0.058 0.064 0.058

Proportion of ﬁrms that experience bankruptcy 0.050 0.020 0.019 0.014 0.012 0.015 0.015 0.010 0.011 0.010

Model performance rating 28.73%

Ohlson model

Number of actual bankruptcies in decile 518 180 72 37 21 22 12 5 2 5

Proportion of bankruptcies in each decile 0.593 0.206 0.082 0.042 0.024 0.025 0.014 0.006 0.002 0.006

Proportion of ﬁrms that experience bankruptcy 0.105 0.036 0.015 0.007 0.004 0.004 0.002 0.001 0.000 0.001

Model performance rating 79.74%

Zmijewski model

Number of actual bankruptcies in decile 511 193 58 35 26 23 8 5 7 8

Proportion of bankruptcies in each decile 0.585 0.221 0.066 0.040 0.030 0.026 0.009 0.006 0.008 0.009

Proportion of ﬁrms that experience bankruptcy 0.103 0.039 0.012 0.007 0.005 0.005 0.002 0.001 0.001 0.002

Model performance rating 78.54%

Shumway model

Number of actual bankruptcies in decile 528 127 76 40 27 15 23 11 16 11

Proportion of bankruptcies in each decile 0.604 0.145 0.087 0.046 0.031 0.017 0.026 0.013 0.018 0.013

Proportion of ﬁrms that experience bankruptcy 0.107 0.026 0.015 0.008 0.005 0.003 0.005 0.002 0.003 0.002

Model performance rating 73.96%

BSM model

Number of actual bankruptcies in decile 412 135 74 30 25 20 8 6 6 11

Proportion of bankruptcies in each decile 0.567 0.186 0.102 0.041 0.034 0.028 0.011 0.008 0.008 0.015

Proportion of ﬁrms that experience bankruptcy 0.095 0.031 0.017 0.007 0.006 0.005 0.002 0.001 0.001 0.003

Model performance rating 75.24%

Comprehensive model

Number of actual bankruptcies in decile 683 94 39 23 13 15 0 2 3 2

Proportion of bankruptcies in each decile 0.781 0.108 0.045 0.026 0.015 0.017 0.000 0.002 0.003 0.002

Proportion of ﬁrms that experience bankruptcy 0.138 0.019 0.008 0.005 0.003 0.003 0.000 0.000 0.001 0.000

Model performance rating 89.22%

cient on the lagged bankruptcy rate is positive and statistically signiﬁcant for the models and sample that they examine.

They conclude that a higher lagged bankruptcy rate is indicative of a generally higher probability of bankruptcy in the cur-

rent year, one that is over and above the bankruptcy probability from the model being examined. We ﬁnd no strong relation-

ship between current and lagged bankruptcy probabilities in our sample. We further examine this in a model that includes

only the lagged bankruptcy probability and no other explanatory variables. In this case, the coefﬁcient is again positive, but it

fails to reach statistical signiﬁcance and has a Pseudo R2 statistic less than 1%. The likely reason for this is the fact that our

sample contains all observations for which data are available. This is in contrast with previous papers that include a rela-

tively small sample of non-bankrupt ﬁrms. The fact that our sample contains many more non-bankrupt ﬁrms means that

the bankruptcy rates in our sample are very small for all years. Although there are more bankruptcies during recessions

and market downturns, the variation in the bankruptcy rate over time is small, making it harder for this variable to reach

statistical signiﬁcance. The information content test shows that the bankruptcy score generated from our comprehensive

model has the highest explanatory power as indicated by the log-likelihood ratio and Pseudo R2 statistics. The signiﬁcance

persists even when we combine all bankruptcy scores in one regression.

Panel B contains a set of Vuong (1989) tests comparing the relative performance of pairs of models. Hillegeist et al. (2004)

argue that prediction-oriented tests cannot determine whether the model performance differences are statistically signiﬁ-

cant, while relative information content tests can. The aim of the relative information content tests is to examine whether

one variable (or a set of variables) contains more information than another variable (or set of variables). The test is designed

to compare the amount of bankruptcy-related information in each model. Following Hillegeist et al. (2004), a discrete hazard

model is used to test for relative information content and the log-likelihood statistics for each case are compared using the

Vuong (1989) logit-based test.

In each case, a positive test statistic indicates that the ‘‘row” model outperforms the ‘‘column” model and a negative test

statistic indicates that the reverse is true. All of the statistics in the table are signiﬁcant at the 5% level. The negative ﬁgures in

the right-hand column indicate that our proposed comprehensive model signiﬁcantly outperforms all other candidate

models.

44

Table 6

Information content tests. Panel A reports relative information content tests as described in Hillegeist et al. (2004). In each case, we estimate a logit regression with an intercept, the lagged bankruptcy rate (the

proportion of total ﬁrms that experienced bankruptcy in the previous year – to proxy for economy-wide factors), and the score from one of the bankruptcy prediction models. The models are estimated on the full

sample from 1980 to 2006. Wald chi-squared statistics are adjusted according to Shumway (2001), and coefﬁcients are reported in bold if they are signiﬁcant at the 5% level. The ﬁnal columns report a combined model

that contains the scores from all individual models. Panel B reports Vuong test statistics. Negative values indicate that the ‘‘column model” beats the ‘‘row model.” For example, the Ohlson model beats the Altman

model. All of the Vuong test statistics are signiﬁcant at the 1% level, where the critical value is 2.33. ***,**, and * indicate statistical signiﬁcance at the 1%, 5%, and 10% levels, respectively.

Parameter Estimate Wald {2 Estimate Wald {2 Estimate Wald {2 Estimate Wald {2 Estimate Wald {2 Estimate Wald {2 Estimate Wald {2

Panel A: information content tests

Intercept 3.93*** 184.16 0.07 0.04 0.00 0.00 0.08 0.05 4.92*** 239.73 0.89*** 6.89 0.63 1.56

Lagged bankruptcy rate 24.70 1.09 8.19 0.11 3.12 0.02 5.14 0.04 38.63 2.31 28.95 1.23 23.31 0.73

Z score (Altman) 0.24*** 16.91 0.04 0.60

O score (Ohlson) 1.02*** 197.13 0.22 1.97

ZM score (Zmijewski) 1.02*** 140.13 -0.02 0.03

S score (Shumway) 1.00*** 202.6 0.06 0.13

BSM score (Hillegeist et al.) 1.21*** 123.07 0.07 0.28

New score 0.91*** 205.03 0.74*** 36.46

2 Log-likelihood 7337.98 5526.85 5921.62 5272.11 6110.67 4781.67 4741.38

Pseudo R2 0.02 0.26 0.21 0.30 0.19 0.36 0.37

Panel B: Vuong test statistics

Altman 166.10*** 138.59*** 164.26*** 110.45*** 198.09***

Ohlson 33.60*** 43.01*** 13.80*** 111.62***

Zmijewski 7.80*** 4.19*** 63.92***

Shumway 12.14*** 81.10***

BSM 59.59***

Y. Wu et al. / Journal of Contemporary Accounting & Economics 6 (2010) 34–45 45

In this paper, we examine the empirical performance of a number of bankruptcy prediction models. The models use a

range of different independent variables (accounting information, market and ﬁrm-characteristic data, and implied proba-

bilities from option-pricing models) and a range of different econometric speciﬁcations (multiple-discriminant analysis, lo-

git, probit, and hazard models).

We ﬁnd that the key accounting information relates to proﬁtability, liquidity, and leverage. Speciﬁcally, ﬁrms are more

likely to experience bankruptcy if they have relatively lower earnings before interest and tax to total assets, a larger decline

in net income, relatively low working capital to total assets, or high market-based leverage – total liabilities to the market

value of total assets.

We also ﬁnd that a number of ﬁrm-characteristic variables assist in forecasting bankruptcies. Firms are more likely to

experience bankruptcy if the lagged stock returns are large and negative or the lagged volatility is relatively high. Smaller

ﬁrms and ﬁrms with fewer business segments are also more likely to experience bankruptcy, other things equal. Firms with

a higher implied probability of bankruptcy (estimated in relation to an option-pricing model) are also more likely to expe-

rience bankruptcy, other things equal.

In this paper, we examine the empirical performance of a range of bankruptcy prediction models using a series of in-sam-

ple and out-of-sample performance metrics. We examine a number of metrics used in the extant literature and develop some

new and modiﬁed performance metrics. Across all of these tests, both in-sample and out-of-sample, we ﬁnd that a compre-

hensive model that includes key accounting information, market data, and ﬁrm-characteristics signiﬁcantly outperforms

models from the extant literature.

Speciﬁcally, the MDA model of Altman (1968) performs poorly relative to other models in the literature. The accounting-

based models of Ohlson (1980) and Zmijewski (1984) perform adequately during the 1970 but their performance has dete-

riorated over more recent periods. The hazard model of Shumway (2001), which includes market data and ﬁrm-character-

istics, generally outperforms models that are based on accounting information only.8 The use of option-implied probability

proposed by Hillegeist et al. (2004) performs adequately but is generally inferior to the Shumway model. We conclude that

a more comprehensive model that draws inferences from key accounting information, market data, and ﬁrm-characteristics

provides the most reliable forecasts of future bankruptcy. This is consistent with the different types of data capturing different

aspects of corporate ﬁnancial distress.

Acknowledgements

The Australian Research Council provided funds for this project under Grant DP0663048. We thank Stephen Hillegeist and

Elizabeth Keating for sharing programs to estimate Black–Scholes probabilities and Vuong test statistics.

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8

An exception are tests of out-of-sample forecast accuracy using the rolling windows method.

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