Predicting corporate bankruptcy: What matters?

Leon Li*, Robert Faff

*Corresponding author for this work

Research output: Contribution to journalArticleResearchpeer-review

13 Citations (Scopus)

Abstract

Whether accounting: 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.

Original languageEnglish
Pages (from-to)1-19
Number of pages19
JournalInternational Review of Economics and Finance
Volume62
Early online date2 Mar 2019
DOIs
Publication statusPublished - Jul 2019
Externally publishedYes

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