BUSINESS FAILURE PREDICTION: AN ANALYSIS OF TYPE II PREDICTION ERRORS.
Item
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Title
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BUSINESS FAILURE PREDICTION: AN ANALYSIS OF TYPE II PREDICTION ERRORS.
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Identifier
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AAI8629685
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identifier
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8629685
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Creator
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EL-ZAYATY, AHMED ISMAIL.
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Date
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1986
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Language
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English
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Publisher
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City University of New York.
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Subject
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Business Administration, Accounting
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Abstract
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Earlier research has revealed that when business failure prediction models are used to make predictions, on an ex ante basis, the rate of Type II prediction errors (i.e., firms predicted as going to fail that do not actually fail) is about 97%. This dissertation investigated the reasons behind the observed high rate of Type II prediction errors. The following two aspects were examined: (1) The adequacy of the model to identify financially distressed firms, and (2) Type of actions taken by interested parties to bail out financially distressed firms.;To investigate the first issue, Altman's (1968) Z-score model was used to predict which firms, among those included in the COMPUSTAT file of fiscal year ended 1979, were going to fail. A total of 132 firms were predicted as going to fail. However, upon following-up the financial performance of those 132 firms over a 5-year period, it was found that only two firms went bankrupt, three firms were liquidated, eleven firms were merged, four firms became private and 112 firms still survive. The financial conditions of those 112 survival firms were examined, using bond ratings, Value Line Financial Strength ratings, solvency ratios, and financial press news. Of the 112 firms investigated, 45 firms (40%) were found to be apparently financially healthy, 36 firms (32%) were found to be apparently financially distressed, the remaining 31 firms were classified as "gray area".;These findings indicate that when business failure prediction models are used on an ex ante basis, they are not only a poor predictor of bankruptcy, but also fails to adequately identify firms in financial distress.;To investigate the second issue, an exploratory survey of 45 firms was used to see what actions might have been taken to keep financially troubled firms from bankruptcy.;The survey results showed that financially troubled firms tend to take the following corrective actions to avoid bankruptcy: sell off assets and/or entire divisions or subsidiaries; restructure debt; obtain government guaranteed loans; request relief from labor unions; change the production and/or market strategies; sale-leaseback of property; cut dividends; and follow cost reduction and or strict cash policies. These findings explain why business failure predictions do not materialize.
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Type
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dissertation
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Source
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PQT Legacy CUNY.xlsx
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degree
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Ph.D.
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Program
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Business Administration
