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Analyzing Insolvency Prediction Models in the Period Before and After the Financial Crisis: A Case Study on the Example of US Firms

Author

Listed:
  • George Giannopoulos
  • Sophia Ali Sardar
  • Rebecca Salti
  • Nicos Sykianakis
Abstract
Purpose: The study aims to assess the most accurate bankruptcy prediction model for US firms. Design/methodology/approach: Validating the accuracy of bankruptcy prediction models can provide management with a handy tool as it can decrease potential damage, and carry out corrective actions by intervening and preventing insolvency. The impetus of this paper is not to create a new prediction model but to validate the practical application of 3 widely accepted models to determine accuracy in predicting corporate insolvency for; Altman’s, Taffler’s and Ohlson’s models. The Logit regression framework is employed to estimate the 3 aforementioned models. Findings: The results revealed that: i) Taffler’s and Ohlson’s models are the most accurate for correctly predicting failed and non-failed firms with an average predictive ability of 75% and 87%, respectively, ii) Altman’s model had a rather lower predicting ability of 57%, iii) Altman’s model predicts high accuracy for only solvent firms, iv) Taffler’s and Ohlson’s models can subsequently, assist lenders, auditors, executives, investors and corporations to evaluate bankruptcy risk. Practical implications: An early warning system can protect a firm from running into insolvency. Furthermore, a country with healthy economic conditions can attract national and international investors. In view of that, a robust bankruptcy predictor reduces the probability of large number of insolvencies occurring. Originality value: This study found that failed US firms had low liquidity, low profitability and high gearing. Therefore, these three aspects should be measured as the primary concern when examining a US firm’s financial condition.

Suggested Citation

  • George Giannopoulos & Sophia Ali Sardar & Rebecca Salti & Nicos Sykianakis, 2022. "Analyzing Insolvency Prediction Models in the Period Before and After the Financial Crisis: A Case Study on the Example of US Firms," International Journal of Finance, Insurance and Risk Management, International Journal of Finance, Insurance and Risk Management, vol. 12(3), pages 23-45.
    • Handle: RePEc:ers:ijfirm:v:12:y:2022:i:3:p:23-45
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    References listed on IDEAS

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    1. Jackson, Richard H.G. & Wood, Anthony, 2013. "The performance of insolvency prediction and credit risk models in the UK: A comparative study," The British Accounting Review, Elsevier, vol. 45(3), pages 183-202.
    2. Almamy, Jeehan & Aston, John & Ngwa, Leonard N., 2016. "An evaluation of Altman's Z-score using cash flow ratio to predict corporate failure amid the recent financial crisis: Evidence from the UK," Journal of Corporate Finance, Elsevier, vol. 36(C), pages 278-285.
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    7. Edward I. Altman, 1968. "The Prediction Of Corporate Bankruptcy: A Discriminant Analysis," Journal of Finance, American Finance Association, vol. 23(1), pages 193-194, March.
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    More about this item

    Keywords

    Insolvency Prediction Models; Bankruptcy; US firms.;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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