Assessing the Probability of Bankruptcy

Assessing the Probability of Bankruptcy We assess whether two popular accounting-based measures, Altman’s (1968) Z-Score and Ohlson’s (1980) O-Score, effectively summarize publicly-available information about the probability of bankruptcy. We compare the relative information content of these Scores to a market-based measure of the probability of bankruptcy that we develop based on the Black–Scholes–Merton option-pricing model, BSM-Prob. Our tests show that BSM-Prob provides significantly more information than either of the two accounting-based measures. This finding is robust to various modifications of Z-Score and O-Score, including updating the coefficients, making industry adjustments, and decomposing them into their lagged levels and changes. We recommend that researchers use BSM-Prob instead of Z-Score and O-Score in their studies and provide the SAS code to calculate BSM-Prob. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals
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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2004 by Kluwer Academic Publishers
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1023/B:RAST.0000013627.90884.b7
Publisher site
See Article on Publisher Site

Abstract

We assess whether two popular accounting-based measures, Altman’s (1968) Z-Score and Ohlson’s (1980) O-Score, effectively summarize publicly-available information about the probability of bankruptcy. We compare the relative information content of these Scores to a market-based measure of the probability of bankruptcy that we develop based on the Black–Scholes–Merton option-pricing model, BSM-Prob. Our tests show that BSM-Prob provides significantly more information than either of the two accounting-based measures. This finding is robust to various modifications of Z-Score and O-Score, including updating the coefficients, making industry adjustments, and decomposing them into their lagged levels and changes. We recommend that researchers use BSM-Prob instead of Z-Score and O-Score in their studies and provide the SAS code to calculate BSM-Prob.

Journal

Review of Accounting StudiesSpringer Journals

Published: Oct 18, 2004

References

  • Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy
    Altman, E.
  • Relative Valuation Roles of Equity Book Value and Net Income as a Function of Financial Health
    Barth, M.; Beaver, W.; Landsman, W.
  • Investor Valuation of the Abandonment Option
    Berger, P.; Ofek, E.; Swary, I.
  • Valuing Corporate Securities: Some Effects of Bond Indenture Provisions
    Black, F.; Cox, J.
  • The Effect of Accounting-Based Debt Covenants on Equity Valuation
    Core, J.; Schrand, C.
  • Ratio Stability and Corporate Failure
    Dambolena, I.; Khoury, S.

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