PREDICTING FINANCIAL DISTRESS OF COMPANIES: REVISITING THE Z-SCORE AND ZETA® MODELS
Edward I. Altman*
*Max L. Heine Professor of Finance, Stern School of Business, New York University. This paper is adapted and updated from E. Altman, “Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy,” Journal of Finance, September 1968; and E. Altman, R. Haldeman and P. Narayanan, “Zeta Analysis: A New Model to Identify Bankruptcy Risk of Corporations,” Journal of Banking & Finance, 1, 1977.
Predicting Financial Distress of Companies: Revisiting the Z-Score and ZETA® Models
Background This paper discusses two of the venerable models for assessing ...view middle of the document...
The latter utilizes a version of the Z-Score model called Z”. This paper also updates the predictive tests on defaults and bankruptcies through the year 1999. As I first wrote in 1968, and it seems even truer in the late 1990’s, academicians seem to be moving toward the elimination of ratio analysis as an analytical technique in assessing the performance of the business enterprise. Theorists downgrade arbitrary rules of thumb (such as
company ratio comparisons) widely used by practitioners. Since attacks on the relevance on ratio analysis emanate from many esteemed members of the scholarly world, does this mean that ratio analysis is limited to the world of “nuts and bolts?” Or, has the significance of such an approach been unattractively garbed and therefore unfairly handicapped? Can we bridge the gap, rather than sever the link, between traditional ratio analysis and the more rigorous statistical techniques which have become popular among academicians in recent years? Along with our primary interest, corporate bankruptcy, I am also concerned with an assessment of ratio analysis as an analytical technique. It should be pointed out that the basic research for much of the material in this paper was performed in 1967 and that several subsequent studies have commented upon the Z-Score model and its effectiveness, including an adaptation in 1995 for credit analysis of emerging market corporates. And, this author has co-developed a “second generation” model (ZETA) which was developed in 1976. Traditional Ratio Analysis The detection of company operating and financial difficulties is a subject which has been particularly amenable to analysis with financial ratios. Prior to the development of quantitative measures of company performance, agencies were established to supply a qualitative type of information assessing the credit-worthiness of particular merchants. (For instance, the forerunner of the well-known Dun & Bradstreet, Inc. was organized in 1849 in Cincinnati, Ohio, in order to provide independent credit investigations). Formal aggregate studies concerned with portents of business failure were evident in the 1930’s. One of the classic works in the area of ratio analysis and bankruptcy classification was performed by Beaver (1967). In a real sense, his univariate analysis of a number of bankruptcy
predictors set the stage for the multivariate attempts, by this author and others, which followed. Beaver found that a number of indicators could discriminate between matched samples of failed and nonfailed firms for as long as five years prior to failure. He questioned the use of multivariate analysis, although a discussant recommended attempting this procedure. The ZScore model did just that. A subsequent study by Deakin (1972) utilized the same 14 variables that Beaver analyzed, but he applied them within a series of multivariate discriminant models. The aforementioned studies imply a definite potential of ratios as predictors of bankruptcy....