Assessing the Probability of Bankruptcy |
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| Authors: | Stephen A. Hillegeist Elizabeth K. Keating Donald P. Cram Kyle G. Lundstedt |
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| Affiliation: | (1) Kellogg School of Management, Northwestern University, 2001 Sheridan Road, Room 6223, Evanston, IL, 60208;(2) Kennedy School of Government, Harvard University, Littauer 115, 79 JFK St., Cambridge, MA, 02138;(3) College of Business and Economics, California State University, Fullerton, 800 N. State College Blvd., LH-360, Fullerton, CA, 92834;(4) VaRisk, Inc., 116 Lyon St., San Francisco, CA, 94117 |
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| Abstract: | We assess whether two popular accounting-based measures, Altman s (1968) Z-Score and Ohlsons (1980) O-Score, effectively summarize publicly-available information about the probability of bankruptcy. We compare the relative information content of these Scores to a market-based measure of the probability of bankruptcy that we develop based on the Black–Scholes–Merton option-pricing model, BSM-Prob. Our tests show that BSM-Prob provides significantly more information than either of the two accounting-based measures. This finding is robust to various modifications of Z-Score and O-Score, including updating the coefficients, making industry adjustments, and decomposing them into their lagged levels and changes. We recommend that researchers use BSM-Prob instead of Z-Score and O-Score in their studies and provide the SAS code to calculate BSM-Prob. |
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| Keywords: | bankruptcy prediction option-pricing models Z-Score O-Score |
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