Review of Quantitative Finance and Accounting, 17: 151–166, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Limitations of Bankruptcy Prediction Models:
Some Cautions for the Researcher
JOHN STEPHEN GRICE
Associate Professor of Accounting, Troy State University
MICHAEL T. DUGAN
Professor of Accounting, The University of Alabama
Abstract. The purpose of this study is to demonstrate potential problems associated with the use of bankruptcy
prediction models in current research. The tests in this study demonstrate the problems that may arise when
bankruptcy prediction models are inappropriately applied. This analysis evaluated the Zmijewski (1984) and
Ohlson (1980) models using time periods, industries, and ﬁnancial distress situations other than those used to
originally develop the models. The ﬁndings indicated that both models were sensitive to time periods. That is, the
accuracy of the models declined when applied to time periods different from those used to develop the models.
The ﬁndings also suggest that the accuracy of each model continues to decline moving from the 1988–1991 to
the 1992–1999 sample period. Additionally, Ohlson’s (Zmijewski’s) model was (was not) sensitive to industry
classiﬁcations. The ﬁndings of this study also suggest that the Ohlson and Zmijewski models are not sensitive
to ﬁnancial distress situations other than those used to develop the models. Thus, the models appear to be more
generally useful for predicting ﬁnancial distress, not just bankruptcy.
In sum, the results of this study suggest that researchers should use bankruptcy prediction models cautiously.
Applying the models to time periods and industries other than those used to develop the models may result in a
signiﬁcant decline in the models’ accuracies. Additionally, some bankruptcy prediction models may be more
appropriate for evaluating various forms of ﬁnancial distress as opposed to just bankruptcy. To avoid erroneous
applications of bankruptcy prediction models in the future, it is necessary for researchers not only to understand
the uses of prediction models, but also to understand the limitations of the models.
Key words: bankruptcy, bankruptcy prediction models
JEL Classiﬁcation: G33, M41
Introduction and motivation
Bankruptcy prediction models are routinely used by researchers to evaluate the ﬁnancial
health of companies (e.g., Subramanyan and Wild, 1996; Berger et al., 1996; Chen and
Church, 1996; Carcello et al., 1995). Two notable bankruptcy prediction models frequently
cited include the Zmijewski (1984) and Ohlson (1980) models (e.g., Subramanyan and
Address correspondence to: John Stephen Grice, Sr., Sorrell College of Business, Troy State University, 211 Bibb
Graves, Troy, Al 36082, Fax: (334) 670-3708.
Address correspondence to: Michael T. Dugan, Culverhouse School of Accountancy, The University of Alabama,
Box 870220, Tuscaloosa, AL 35487-0220, Fax: (205) 348-8453.