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Assessing the Probability of Bankruptcy

Author

Listed:
  • Stephen A. Hillegeist

    (Northwestern University)

  • Elizabeth K. Keating

    (Harvard University)

  • Donald P. Cram

    (California State University)

  • Kyle G. Lundstedt

    (VaRisk, Inc.)

Abstract

We assess whether two popular accounting-based measures, Altman’s (1968) Z-Score and Ohlson’s (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.

Suggested Citation

  • Stephen A. Hillegeist & Elizabeth K. Keating & Donald P. Cram & Kyle G. Lundstedt, 2004. "Assessing the Probability of Bankruptcy," Review of Accounting Studies, Springer, vol. 9(1), pages 5-34, March.
    • Handle: RePEc:spr:reaccs:v:9:y:2004:i:1:d:10.1023_b:rast.0000013627.90884.b7
    DOI: 10.1023/B:RAST.0000013627.90884.b7
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    3. Lawrence D. Brown & Artur Hugon, 2009. "Team earnings forecasting," Review of Accounting Studies, Springer, vol. 14(4), pages 587-607, December.
    4. Santhosh Ramalingegowda, 2014. "Evidence from impending bankrupt firms that long horizon institutional investors are informed about future firm value," Review of Accounting Studies, Springer, vol. 19(2), pages 1009-1045, June.
    5. Elena Rond'os-Casas & Germ`a Coenders & Miquel Carreras-Sim'o & N'uria Arimany-Serrat, 2025. "The use of financial and sustainability ratios to map a sector. An approach using compositional data," Papers 2509.06468, arXiv.org.
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    7. William H. Beaver & Maria Correia & Maureen F. McNichols, 2012. "Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy?," Review of Accounting Studies, Springer, vol. 17(4), pages 969-1010, December.
    8. Maria Correia & Scott Richardson & İrem Tuna, 2012. "Value investing in credit markets," Review of Accounting Studies, Springer, vol. 17(3), pages 572-609, September.
    9. Stephen Lok & Scott Richardson, 2011. "Credit markets and financial information," Review of Accounting Studies, Springer, vol. 16(3), pages 487-500, September.
    10. 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.
    11. Mary E. Barth & Leslie D. Hodder & Stephen R. Stubben, 2013. "Financial reporting for employee stock options: liabilities or equity?," Review of Accounting Studies, Springer, vol. 18(3), pages 642-682, September.
    12. Correia, Maria, 2025. "Accounting and corporate failure: the evolving role of accounting information in bankruptcy prediction," LSE Research Online Documents on Economics 128340, London School of Economics and Political Science, LSE Library.
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