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Assessing the Probability of Bankruptcy

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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.

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Authors and Affiliations

  1. Kellogg School of Management, Northwestern University, 2001 Sheridan Road, Room 6223, Evanston, IL, 60208

    Stephen A. Hillegeist

  2. Kennedy School of Government, Harvard University, Littauer 115, 79 JFK St., Cambridge, MA, 02138

    Elizabeth K. Keating

  3. College of Business and Economics, California State University, Fullerton, 800 N. State College Blvd., LH-360, Fullerton, CA, 92834

    Donald P. Cram

  4. VaRisk, Inc., 116 Lyon St., San Francisco, CA, 94117

    Kyle G. Lundstedt

Authors
  1. Stephen A. Hillegeist
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  2. Elizabeth K. Keating
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  3. Donald P. Cram
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  4. Kyle G. Lundstedt
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Correspondence to Stephen A. Hillegeist.

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Hillegeist, S.A., Keating, E.K., Cram, D.P. et al. Assessing the Probability of Bankruptcy. Review of Accounting Studies 9, 5–34 (2004). https://doi.org/10.1023/B:RAST.0000013627.90884.b7

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