Accounting and corporate failure: the evolving role of accounting information in bankruptcy prediction

Abstract

This paper reviews the extensive literature on the predictive power of accounting information for bankruptcy. Prior research demonstrates that financial statement information effectively predicts bankruptcy out-of-sample, both independently and in combination with market data. I discuss several attributes of accounting information that may enhance or impair its utility in bankruptcy prediction. Using a comprehensive dataset of bankruptcies from 1980 to 2023, I analyse how the role of accounting information in credit risk assessment has evolved over the past four decades. My findings reveal that the predictive power of models based solely on accounting information has remained stable over the most recent decades, whereas the predictive power of equity market information has shown a modest increase. Notably, the performance of accounting and market-based models does not always align. In periods of declining market information efficacy, accounting information often remains robust, mitigating the impact on combined models. Conversely, market information frequently offsets reductions in the predictive power of accounting data, underscoring the complementary strengths of these information sources.