Frontiers of Computer Science in China

, Volume 4, Issue 2, pp 220–236 | Cite as

Corporate financial distress diagnosis model and application in credit rating for listing firms in China

Research Article


With the enforcement of the removal system for distressed firms and the new Bankruptcy Law in China’s securities market in June 2007, the development of the bankruptcy process for firms in China is expected to create a huge impact. Therefore, identification of potential corporate distress and offering early warnings to investors, analysts, and regulators has become important. There are very distinct differences, in accounting procedures and quality of financial documents, between firms in China and those in the western world. Therefore, it may not be practical to directly apply those models or methodologies developed elsewhere to support identification of such potential distressed situations. Moreover, localized models are commonly superior to ones imported from other environments.

Based on the Z-score, we have developed a model called ZChina score to support identification of potential distress firms in China. Our four-variable model is similar to the Z-score four-variable version, Emerging Market Scoring Model, developed in 1995. We found that our model was robust with a high accuracy. Our model has forecasting range of up to three years with 80 percent accuracy for those firms categorized as special treatment (ST); ST indicates that they are problematic firms. Applications of our model to determine a Chinese firm’s Credit Rating Equivalent are also demonstrated.


financial distress discriminant analysis credit rating listing firms 


  1. 1.
    Beaver W. Financial ratios as predictors of failure. Journal of Accounting Research, 1966, 4(suppl.): 71–111CrossRefGoogle Scholar
  2. 2.
    Altman E I. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance, 1968, 23(4): 189–209CrossRefGoogle Scholar
  3. 3.
    Wilcox JW. A prediction of business failure using accounting data. Journal of Accounting Research, 1973, 11: 163–179CrossRefGoogle Scholar
  4. 4.
    Merton R. On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 1974, 29(2): 449–470CrossRefGoogle Scholar
  5. 5.
    Corporation KMV. Introducing Credit monitor, Version 4 and the KMV EDF Credit Measure. 2000. San Francisco: KMV CorporationGoogle Scholar
  6. 6.
    Robert J, Lando D, Turnbull S. A Markov model for the term structures of credit spreads. Review of Financial studies, 1997, (10): 481–523Google Scholar
  7. 7.
    Altman E I. Measuring corporate bond mortality and performance. Journal of Finance, 1989, 44(4): 909–922CrossRefGoogle Scholar
  8. 8.
    Asquith P, Mullins D W Jr, Woff E D. Original issue high yield bonds: aging analysis of defaults, exchanges and calls. Journal of Finance, 1989, 44(4): 923–953CrossRefGoogle Scholar
  9. 9.
    Altman E I, Narayanan P. An international survey of business failure classification models. Financial Markets, Institutions and Instruments 2001, 6(2): 1–57CrossRefGoogle Scholar
  10. 10.
    Dewing H S. The Financial Policy of Corporations. New York: Ronald Press, 1952Google Scholar
  11. 11.
    Lau A. A five-state financial distress prediction model. Journal of accounting research. 1987, 25(1): 127–138CrossRefGoogle Scholar
  12. 12.
    Donaldson G. Strategy for Financial Mobility. Boston, Mass.: Harvard University Press, 1969Google Scholar
  13. 13.
    Newton G W. Bankruptcy and Insolvency Accounting. New York: The Ronald Press, 1975Google Scholar
  14. 14.
    Gilbert L R, Menon K, Schwartz K B. Predicting bankruptcy for firms in financial distress. Journal of Business Finance & Accounting, 1990, 17: 161–171CrossRefGoogle Scholar
  15. 15.
    Ross S A, Westerfield RW, Jaffe J. Corporate Finance. 7th edition, McGraw-Hill Companies. 2005Google Scholar
  16. 16.
    Chen Q. Evidence analysis on financial distress of listing companies. Accounting Research, 1999, 4: 31–38 (in Chinese)Google Scholar
  17. 17.
    Chen X. Chen Z H. Corporate financial distress theory, methodology and application. Investment Study, 2000, 125–126 (in Chinese)Google Scholar
  18. 18.
    Zhang L. Financial distress early warning model. Quantitative and Technical Economics, 2000, (3): 49–51 (in Chinese)Google Scholar
  19. 19.
    Wu S, Lu X. Financial distress prediction model for chinese trading firms. Economic Research Journal., 2001, 6: 46–55 (in Chinese)Google Scholar
  20. 20.
    Jiang X H, Sun Z. A forecasting model of financial distress for listed companies. Forecasting, 2002, (3): 56–62Google Scholar
  21. 21.
    Zhang L, Chen S, Zhang X. Financial distress early warning based in MDA and ANN technique. Systems Engineering, 2005, (11): 50–58Google Scholar
  22. 22.
    Yang S E, Xu W G. Financial affairs in early warning model for listed companies-an empirical study on y Market’s model. China Soft Science Magazine, 2003, (1): 56–61Google Scholar
  23. 23.
    Chen J, Marshall B R, Zhang J. Financial distress prediction in China. Review of Pacific Basin Financial Markets and Policies, 2006, 9(2): 317–336CrossRefGoogle Scholar
  24. 24.
    Hua Z, Wang Y, Xu X, Zhang B, Liang L. Predicting corporate financial distress based on integration of support vector machine and logistic regression. Expert Systems with Applications, 2007, 33(2): 434–440CrossRefGoogle Scholar
  25. 25.
    Ailtman E I, Haldeman R G, Narayanan P. Zeta analysis, a new model to identify bankruptcy risk of corporations. Journal of Banking and Finance. June 1977, 29–54Google Scholar
  26. 26.
    Altman E I, Hotchkiss E. Corporate Financial Distress and Bankruptcy, 3rd ed., J. Wiley & Sons, England, 2005Google Scholar
  27. 27.
    Ministry of Finance. State Capital Share Performance Evaluation Standard. June, 1999Google Scholar
  28. 28.
    Shenzhen GuoTaiAn Information Technology and Tinysoft Finance Analysis DatabaseGoogle Scholar
  29. 29.
    Basel II New Economy Accord (2004)Google Scholar

Copyright information

© Higher Education Press and Springer-Verlag Berlin Heidelberg 2010

Authors and Affiliations

  1. 1.College of Business AdministrationHunan UniversityChangshaChina
  2. 2.Salomon CenterNew York UniversityNew YorkUSA
  3. 3.Business SchoolHong Kong University of Science and TechnologyHong KongChina

Personalised recommendations