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Predicting corporate bankruptcy: What matters?

Leon Li and Robert Faff

International Review of Economics & Finance, 2019, vol. 62, issue C, 1-19

Abstract: or market-based information should be employed to predict corporate default is a long-standing debate in finance research. Incorporating a regime-switching mechanism, we establish a hybrid bankruptcy prediction model with non-uniform loadings in both accounting- and market-based approaches to reexamine the issue. We find the following. Creditors should increase the loading on market-based information when large and liquid corporations are considered. Conversely, for companies with incremental information involved in accounting reporting proxied by discretionary accruals, banks could emphasize accounting ratio-based variables more than they are already emphasized. Since managerial discretion in accounting numbers could serve as a tool to bring undisclosed information about the firm to the public, the weight on accounting-based information could be increased for firms with high information asymmetry. In addition, the loading on market-based (accounting-based) information should be increased (decreased) during periods of financial crisis, defined by negative gross domestic product growth.

Keywords: Regime-switching system; Z-score; Distance to default; Bankruptcy (search for similar items in EconPapers)
JEL-codes: G33 C51 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1016/j.iref.2019.02.016

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