Ratio Stability and Corporate Failure

Ratio Stability and Corporate Failure SEPTEMBER 1980 Ratio Stability and Corporate Failure ISMAEL G. DAMBOLENA and SARKIS J. KHOURY* THIS STUDY PRESENTS ANOTHER model on corporate failure that uses financial ratios and discriminant analysis as its core. We believe the final word on this methodology has not yet been said. The essential attribute of our model is its use of the stability of all financial ratios over time, as well as the level of these ratios, as explanatory variables in the derivation of a discriminant function. Our research indicated a substantial degree of instability, measured by (1) the standard deviation of the financial ratios over the past few years, (2) their standard error of estimate, and (3) their coefficient of variation, in the ratios of firms that went bankrupt when compared with those that did not. This instability showed a significant increase over time as the corporation approached failure (Figure 1). The inclusion of the stability of ratios in the analysis improved considerably the ability of the discriminant function to predict failure. Our model classified firms into failed and non-failed groups with 78 percent accuracy five years prior to failure. This represents a marked improvement over previously reported results. The next section outlines http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

Ratio Stability and Corporate Failure

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Publisher
Wiley Subscription Services, Inc., A Wiley Company
Copyright
1980 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1980.tb03517.x
Publisher site
See Article on Publisher Site

Abstract

SEPTEMBER 1980 Ratio Stability and Corporate Failure ISMAEL G. DAMBOLENA and SARKIS J. KHOURY* THIS STUDY PRESENTS ANOTHER model on corporate failure that uses financial ratios and discriminant analysis as its core. We believe the final word on this methodology has not yet been said. The essential attribute of our model is its use of the stability of all financial ratios over time, as well as the level of these ratios, as explanatory variables in the derivation of a discriminant function. Our research indicated a substantial degree of instability, measured by (1) the standard deviation of the financial ratios over the past few years, (2) their standard error of estimate, and (3) their coefficient of variation, in the ratios of firms that went bankrupt when compared with those that did not. This instability showed a significant increase over time as the corporation approached failure (Figure 1). The inclusion of the stability of ratios in the analysis improved considerably the ability of the discriminant function to predict failure. Our model classified firms into failed and non-failed groups with 78 percent accuracy five years prior to failure. This represents a marked improvement over previously reported results. The next section outlines

Journal

The Journal of FinanceWiley

Published: Sep 1, 1980

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