Predicting the outcome following bankruptcy filing: a three‐state classification using neural networks

This paper uses artificial neural networks (ANNs), multi‐state ordered logit and nonparametric multiple discriminant analysis (NPDA) for predicting the three‐state outcome of bankruptcy filing. The study compares the classification accuracy of these procedures. It differs from previous studies on predicting financial distress by focusing on the firm after the filing of bankruptcy using accounting data, market data, and court‐related information. Following the filing and through court approval the bankruptcy is resolved as firms are either acquired by other firms, emerging as independent operating entities, or liquidated. Distinguishing this three‐state outcome is more complex than discriminating between healthy and financially distressed firms. Models suggested in previous studies for predicting the two‐group financial distress perform poorly for our three‐state scenario. Therefore, we develop models which focus on characteristics relevant for the bankruptcy resolution. We use a sample of 237 publicly traded firms which have complete data. For the entire sample and estimation samples, ANNs provide significantly better three‐state classification than logit and NPDA. However, for some holdout samples the differences in classification accuracies are statistically insignificant. © 1997 John Wiley & Sons, Ltd.