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Splitting long‐term and short‐term financial ratios for improved financial distress prediction: Evidence from Taiwanese public companies

Asyrofa Rahmi, Chia‐chi Lu, Deron Liang and Ayu Nur Fadilah

Journal of Forecasting, 2024, vol. 43, issue 7, 2886-2903

Abstract: Financial distress occurs when a company cannot meet its financial obligations within a specified timeframe, often owing to prolonged poor operational performance. While studies on financial distress prediction (FDP) use financial ratios (FRs) to forecast distress, they neglect to differentiate long‐term (LT) attributes from FRs. To address this gap, our study introduces a novel model that distinguishes between LT and short‐term (ST) accounting attributes in FRs. Using data from Taiwanese public companies (1991–2018), our proposed model employs a stacking ensemble classifier to split LT and ST Altman's ratios. This study addresses three key questions: (1) Do models involving split of LT and ST ratios outperform those that combine them? (2) How reliable and robust are these proposed models? (3) What is the proposed model's impact on distress prediction? The results show a significant outperformance of the existing solution, with higher accuracy, lower Type I and Type II errors, and reduced misclassification costs. These models are reliable in handling imbalanced data, proving suitable for real‐market investigations. Diverse FR contexts from previous Taiwanese studies validate the distinction between LT and ST features, representing robust performance. This model identifies characteristics of correctly and incorrectly predicted distress in companies, providing nuanced insights into complex distress attributes. This study introduces a pioneering model demonstrating superior predictive accuracy, reliability, and robustness by considering the split between LT and ST accounting attributes. It lays a foundation for future studies to extend and refine the proposed model, offering valuable insights into the complex dynamics of FDP.

Date: 2024
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https://doi.org/10.1002/for.3143

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