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

Abstract

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 Z_China 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.

Keywords

financial distress / discriminant analysis / credit rating. listing firms

References

[1] BeaverW. Financial ratios as predictors of failure. Journal of Accounting Research, 1966, 4(suppl.): 71–111

[2] AltmanE I. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance, 1968, 23(4): 189–209

[3] WilcoxJ W. A prediction of business failure using accounting data. Journal of Accounting Research, 1973, 11: 163–179

[4] MertonR. On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 1974, 29(2): 449–470

[5] CorporationKMV. Introducing Credit monitor, Version 4 and the KMV EDF Credit Measure. 2000. San Francisco: KMV Corporation

[6] RobertJ, LandoD, TurnbullS. A Markov model for the term structures of credit spreads. Review of Financial studies, 1997, (10): 481–523

[7] AltmanE I. Measuring corporate bond mortality and performance. Journal of Finance, 1989, 44(4): 909–922

[8] AsquithP, MullinsD W Jr, WoffE D. Original issue high yield bonds: aging analysis of defaults, exchanges and calls. Journal of Finance, 1989, 44(4): 923–953

[9] AltmanE I, NarayananP. An international survey of business failure classification models. Financial Markets, Institutions and Instruments2001, 6(2): 1–57

[10] DewingH S. The Financial Policy of Corporations. New York: Ronald Press, 1952

[11] LauA. A five-state financial distress prediction model. Journal of accounting research. 1987, 25(1): 127–138

[12] DonaldsonG. Strategy for Financial Mobility. Boston, Mass.: Harvard University Press, 1969

[13] NewtonG W. Bankruptcy and Insolvency Accounting. New York: The Ronald Press, 1975

[14] GilbertL R, MenonK, SchwartzK B. Predicting bankruptcy for firms in financial distress. Journal of Business Finance & Accounting, 1990, 17: 161–171

[15] RossS A, WesterfieldR W, JaffeJ. Corporate Finance. 7th edition, McGraw-Hill Companies. 2005

[16] ChenQ. Evidence analysis on financial distress of listing companies. Accounting Research, 1999, 4: 31–38 (in Chinese)

[17] ChenX. ChenZ H. Corporate financial distress theory, methodology and application. Investment Study, 2000, 125–126 (in Chinese)

[18] ZhangL.Financial distress early warning model. Quantitative and Technical Economics, 2000, (3): 49–51 (in Chinese)

[19] WuS, LuX. Financial distress prediction model for chinese trading firms. Economic Research Journal., 2001, 6: 46–55 (in Chinese)

[20] JiangX H, SunZ. A forecasting model of financial distress for listed companies. Forecasting, 2002, (3): 56–62

[21] ZhangL, ChenS, ZhangX. Financial distress early warning based in MDA and ANN technique. Systems Engineering, 2005, (11): 50–58

[22] YangS E, XuW G. Financial affairs in early warning model for listed companies—an empirical study on y Market’s model. China Soft Science Magazine, 2003, (1): 56–61

[23] ChenJ, MarshallB R, ZhangJ. Financial distress prediction in China. Review of Pacific Basin Financial Markets and Policies, 2006, 9(2): 317–336

[24] HuaZ, WangY, XuX, ZhangB, LiangL. Predicting corporate financial distress based on integration of support vector machine and logistic regression. Expert Systems with Applications, 2007, 33(2): 434–440

[25] AiltmanE I, HaldemanR G, NarayananP. Zeta analysis, a new model to identify bankruptcy risk of corporations. Journal of Banking and Finance. <month>June</month>1977, 29–54

[26] AltmanE I, HotchkissE. Corporate Financial Distress and Bankruptcy, 3rd ed., J. Wiley & Sons, England, 2005

[27] Ministry of Finance. State Capital Share Performance Evaluation Standard. <month>June</month>, 1999

[28] ShenzhenGuoTaiAn Information Technology and Tinysoft Finance Analysis Database

[29] Basel II New Economy Accord(2004)

RIGHTS & PERMISSIONS

2014 Higher Education Press and Springer-Verlag Berlin Heidelberg