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What is behind the magic of O-Score? An alternative interpretation of Dichev’s (1998) bankruptcy risk anomaly

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  • Sohyung Kim

    (Brock University)

Abstract

Using Ohlson’s (J Account Res 18(1):109–131, 1980) measure of bankruptcy risk (O-Score), Dichev (J Fin 53(3):1131–1147, 1998) documents a bankruptcy risk anomaly in which firms with high bankruptcy risk earn lower than average returns. This study first demonstrates that the negative association between bankruptcy risk and returns does not generalize to an alternative measure of bankruptcy risk. Then, by examining the nine individual components of O-Score, I find that funds from operations (FFO) is the only component that is associated with returns. Furthermore, I show that the return-predictive power of FFO is due to cash flows from operations. Taken as a whole, this study provides evidence that Dichev’s bankruptcy risk anomaly is a manifestation of investors’ under (over)-pricing of cash flows (accrual) component of earnings, i.e., the accrual anomaly documented by Sloan (Account Rev 71(3):289–316, 1996).

Suggested Citation

  • Sohyung Kim, 2013. "What is behind the magic of O-Score? An alternative interpretation of Dichev’s (1998) bankruptcy risk anomaly," Review of Accounting Studies, Springer, vol. 18(2), pages 291-323, June.
    • Handle: RePEc:spr:reaccs:v:18:y:2013:i:2:d:10.1007_s11142-012-9206-7
    DOI: 10.1007/s11142-012-9206-7
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    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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