Have financial statements become less informative? Evidence from a new accounting model to predict bankruptcy: A few ratios do not tell the whole story

Abstract

Prior literature has raised concern that increased financial reporting discretion (FRD) over the last decades might have led to a significant decrease of the information content of financial statements for predicting bankruptcy over the last decades. We hypothesize that, while a few ratios prone to FRD have indeed lost their informational content, financial statement information (FSI) taken as whole has not experienced such a decline, since much of the discretion introduced by FRD can be mitigated through appropriate FSI selection. To test our hypothesis, we develop a new accounting model for bankruptcy prediction, whose predictors are purposefully chosen to alleviate the impact of FRD and make a better use of FSI. This model has a significantly higher predicting power than previous models based on FSI, highlighting the fact that previous models were far from extracting all the relevant information from financial statements. More importantly, it does not experience the decline in predictive power observed in past models over time. Overall, our paper shows that increased FRD over the last decades has not meaningfully impaired the ability of FSI to predict bankruptcies.

Keywords: Bankruptcy prediction, financial statements, market information, hazard model JEL Codes: G31, G32, G33, G34

JEL Classification: G31,G32,G33,G34