Insolvency Detection Using Publicly-Traded Debt and Equity

Abstract

That solvency testing is difficult is nothing new. Commentators in a 1929 Columbia Law Review article lamented that “courts have not yet developed any clear-cut principles or rules” for solvency testing.Seventy-five years later, Delaware’s Court of Chancery complained that “it is not always easy to determine whether a company even meets the test for solvency.” More than a decade after that, courts still struggle to detect insolvency reliably. This article presents a simple method of detecting balance-sheet insolvency at a publicly traded firm. The method provides guidance for using financial-market evidence, even when it is incomplete in some respects.