Explanatory and Predictive Values of the Drivers of Corporate Bankruptcy

Abstract

Purpose: Most bankruptcy prediction models such as Altman, Beaver, and Zmijewski, only focuses on discriminant scores from which a determination is made about the financial health of firms. The most important indicators of financial distress and their order of importance as bankruptcy becomes imminent are not contained in literature. This paper aims to expand the domain of corporate bankruptcy by bringing to the fore the most important financial indicators in times of bankruptcy.

Design: This paper employs the Altman Z score as a proxy for financial distress. The independent variables are the discrete Altman variables. The Altman Z score of 105 firms for the last two years before bankruptcy were computed. A structured coefficient index was used to determine the most critical indicators of corporate distress.

Findings: A number of factors predicates financial distress. This paper focussed on indices in the Altman algorithm model. The paper provides empirical insights into how financial performance, relative to the Altman indices, deteriorates as bankruptcy approached. It suggests that profitability is the most significant predictor of bankruptcy.

Originality: This paper’s foundation is the Altman algorithm model. However, the model does not explain how the discrete variables behave in the last two years before bankruptcy. This study is the first to examine the behavior of distressed firms relative to the Altman indices in the previous two years preceding bankruptcy.