What is behind the magic of O-Score? An alternative interpretation of Dichev’s (1998) bankruptcy risk anomaly

Sohyung Kim ()
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Sohyung Kim: Brock University

Review of Accounting Studies, 2013, vol. 18, issue 2, No 1, 323 pages

Abstract: Abstract Using Ohlson’s (J Account Res 18(1):109–131, 1980) measure of bankruptcy risk (O-Score), Dichev (J Fin 53(3):1131–1147, 1998) documents a bankruptcy risk anomaly in which firms with high bankruptcy risk earn lower than average returns. This study first demonstrates that the negative association between bankruptcy risk and returns does not generalize to an alternative measure of bankruptcy risk. Then, by examining the nine individual components of O-Score, I find that funds from operations (FFO) is the only component that is associated with returns. Furthermore, I show that the return-predictive power of FFO is due to cash flows from operations. Taken as a whole, this study provides evidence that Dichev’s bankruptcy risk anomaly is a manifestation of investors’ under (over)-pricing of cash flows (accrual) component of earnings, i.e., the accrual anomaly documented by Sloan (Account Rev 71(3):289–316, 1996).

Keywords: Market efficiency; Bankruptcy risk; Funds from operations; Cash flows; Accruals (search for similar items in EconPapers)
JEL-codes: G14 G33 M41 (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1007/s11142-012-9206-7

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