Does Audit Report Information Improve Financial Distress Prediction Over Altman's Traditional Z‐Score Model?

33 Pages Posted: 28 May 2020

See all articles by Nora Muñoz-Izquierdo

Nora Muñoz-Izquierdo

Universidad Complutense de Madrid (UCM) - Colegio Universitario de Estudios Financieros (CUNEF)

Erkki K. Laitinen

University of Vaasa - Department of Accounting and Finance

María‐del‐Mar Camacho‐Miñano

affiliation not provided to SSRN

David Pascual‐Ezama

Universidad Complutense de Madrid (UCM)

Date Written: February 2020

Abstract

We analyze empirically the usefulness of combining accounting and auditing data in order to predict corporate financial distress. Concretely, we examine whether audit report information incrementally predicts distress over a traditional accounting model: the Altman's Z‐Score model. Although the audit report seems to play a critical part in financial distress prediction because auditors should warn investors about any default risks, this is the first study that uses audit report disclosures for predicting purposes. From a dataset of 1,821 Spanish distressed private firms, we analyze a sample of distressed and non‐distressed firms and develop logit prediction models. Our results show that while the only accounting model registers a classification accuracy of 77%, combined models of accounting and auditing data exhibit considerably higher accuracy (about 87%). Specifically, our findings indicate that the number of disclosures included in the audit report, as well as disclosures related to a firm's going concern status, firms’ assets, and firms’ recognition of revenues and expenses contribute the most to the prediction. Our empirical evidence has implications for financial distress practice. For managers, our study highlights the importance of audit report disclosures for anticipating a financial distress situation. For regulators and auditors, our study underscores the importance of recent changes in regulation worldwide intended to increase auditor's transparency through a more informative audit report.

Keywords: Altman's Z‐Score, audit report, emphasis of matter sections, financial distress prediction, private companies, qualifications

Suggested Citation

Muñoz-Izquierdo, Nora and Laitinen, Erkki K. and Camacho‐Miñano, María‐del‐Mar and Pascual‐Ezama, David, Does Audit Report Information Improve Financial Distress Prediction Over Altman's Traditional Z‐Score Model? (February 2020). Journal of International Financial Management & Accounting, Vol. 31, Issue 1, pp. 65-97, 2020, Available at SSRN: https://ssrn.com/abstract=3608886 or http://dx.doi.org/10.1111/jifm.12110

Nora Muñoz-Izquierdo (Contact Author)

Universidad Complutense de Madrid (UCM) - Colegio Universitario de Estudios Financieros (CUNEF) ( email )

Leonardo Prieto Castro 2
Madrid, Madrid 28040
Spain
+34650961908 (Phone)

Erkki K. Laitinen

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

P.O. Box 700
FIN-65101 Vaasa, FI-65101
Finland
+358 61 324 8275 (Phone)
+358 61 324 8344 (Fax)

María‐del‐Mar Camacho‐Miñano

affiliation not provided to SSRN

No Address Available

David Pascual‐Ezama

Universidad Complutense de Madrid (UCM) ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain

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