Predicting Bankruptcy via Cross-Sectional Earnings Forecasts

46 Pages Posted: 10 Mar 2018 Last revised: 8 Feb 2019

See all articles by Dieter Hess

Dieter Hess

University of Cologne - Department of Corporate Finance; University of Cologne - Centre for Financial Research (CFR)

Martin Huettemann

University of Cologne - Cologne Graduate School in Management, Economics and Social Sciences

Date Written: February 2019

Abstract

We develop a model to predict bankruptcies, exploiting that negative book equity is a strong indicator of financial distress. Accordingly, our key predictor of bankruptcy is the probability that future losses will deplete a firm’s book equity. To calculate this probability, we use earnings forecasts and their standard deviations obtained from cross-sectional regression models in the spirit of Hou, van Dijk, and Zhang (2012). We add variables that we find to discriminate between bankrupt and non-bankrupt firms. As our model requires only accounting data, we can provide bankruptcy predictions for a wide range of firms, including firms that have no access to capital markets. In strictly out-of-sample tests, we show that our accounting model performs better than alternative corporate failure models that use only accounting information. If we additionally allow for stock market information, our approach also outperforms leading alternatives that require market data.

Keywords: bankruptcy prediction, negative book equity, mechanical earnings forecasts, financial distress

JEL Classification: G17, G33, M41, C25

Suggested Citation

Hess, Dieter and Huettemann, Martin, Predicting Bankruptcy via Cross-Sectional Earnings Forecasts (February 2019). Available at SSRN: https://ssrn.com/abstract=3136978 or http://dx.doi.org/10.2139/ssrn.3136978

Dieter Hess

University of Cologne - Department of Corporate Finance ( email )

Corporate Finance Seminar
Albertus-Magnus-Platz
D-50923 Cologne
Germany
+49 221 470 7876 (Phone)
+49 221 470 7466 (Fax)

HOME PAGE: http://cf.uni-koeln.de/

University of Cologne - Centre for Financial Research (CFR)

Germany

Martin Huettemann (Contact Author)

University of Cologne - Cologne Graduate School in Management, Economics and Social Sciences ( email )

Albertus-Magnus-Platz
Cologne, 50931
Germany

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