Financial and Nonfinancial Variables As Long-Horizon Predictors of Bankruptcy

30 Pages Posted: 27 Oct 2016

See all articles by Edward I. Altman

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Malgorzata Iwanicz-Drozdowska

Warsaw School of Economics, Institute of Finance

Erkki Laitinen

University of Vaasa, Department of Accounting and Finance, Students

Arto Suvas

University of Vaasa - Department of Accounting and Finance

Date Written: October 26, 2016

Abstract

Reviews of financial distress prediction models indicate that these techniques give highly reliable estimates of probabilities of default only for relatively short horizons, rarely exceeding two years. This is particularly the case when financial variables make up the sole estimate or primary estimates. So far, bank managers have focused on the one-year probability of default estimation required by Basel capital regulations. According to an emerging accounting standard (IFRS 9), banks will be obligated to estimate a probability of default lifetime in order to calculate credit allowances. Moreover, there is a need to improve communication and transparency between small and medium-sized private enterprises and suppliers of capital to overcome the problem of credit rationing, especially in Europe. Thus, it is challenging to search for new tools to extend the distress or failure prediction period. We assess the long-term (up to ten years) predictive ability of both financial and nonfinancial variables, paying special attention to the role of nonfinancial variables. Our study is based on rigorous post development distress and nondistress financial events in the Finnish environment. Our model, built with cross-sectional data from 2003, analyzes results for 2004-13 and shows that measures of solvency, turnover, environmental risk, payment behavior and board member characteristics can be significant predictors of bankruptcies for as long as ten years. Our most accurate long-range prediction results combine financial and nonfinancial variables.

Keywords: bankruptcy prediction, long horizon, financial variables, nonfinancial variables, Finnish firms

Suggested Citation

Altman, Edward I. and Iwanicz-Drozdowska, Malgorzata and Laitinen, Erkki and Suvas, Arto, Financial and Nonfinancial Variables As Long-Horizon Predictors of Bankruptcy (October 26, 2016). Journal of Credit Risk, Vol. 12, No. 4, 2016. Available at SSRN: https://ssrn.com/abstract=2859452

Edward I. Altman

New York University (NYU) - Salomon Center ( email )

44 West 4th Street
New York, NY 10012
United States
212-998-0709 (Phone)
212-995-4220 (Fax)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Malgorzata Iwanicz-Drozdowska (Contact Author)

Warsaw School of Economics, Institute of Finance ( email )

Warsaw
Poland

Erkki Laitinen

University of Vaasa, Department of Accounting and Finance, Students ( email )

Finland

Arto Suvas

University of Vaasa - Department of Accounting and Finance ( email )

P.O. Box 700
FIN-65101 Vaasa, FI-65101
Finland
(358) 61 327-8111 (Phone)
(358) 61 324-8465 (Fax)

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