Modeling default prediction with earnings management
Hsiou-Wei William Lin,
Huai-Chun Lo and
Ruei-Shian Wu
Pacific-Basin Finance Journal, 2016, vol. 40, issue PB, 306-322
Abstract:
This study explores whether taking into account real earnings management improves specification of the default prediction model based on the Z-score methodology for Chinese listed companies. We demonstrate that the model proposed by Altman (1968) overestimates (underestimates) the Z-score and thus the survival probability for firms engaging in aggressive (minor or no) income-increasing manipulation. By contrast, our inclusion of the indicator variable for real earnings management considerably enhances the explanatory power of Z-score factors for firm survival/default. With respect to the ability to predict out-of-sample default, our findings suggest that the accounting-based credit scoring model adjusted for real earnings management unanimously yields a greater prediction accuracy rate and a lower false loan rejection rate than the unadjusted scoring model for financially non-distressed firms.
Keywords: Accrual-based earnings management; Default prediction model; Real earnings management (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (11)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:pacfin:v:40:y:2016:i:pb:p:306-322
DOI: 10.1016/j.pacfin.2016.01.005
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