The Efficacy of Auditors’ Going‐Concern Opinions Compared with a Temporal and an Atemporal Bankruptcy Risk Model: Analysing U.S Trade and Service Industry Failures 1974 ‐ 1988

Abstract

Conflicting results have emerged from several past studies as to whether bankruptcy prediction models are able to forecast corporate failure more accurately than auditors’ going‐concern opinions. Nevertheless, the last decade has seen improved modelling of the path‐to‐failure of financially distressed firms over earlier static models of bankruptcy. In the light of the current crisis facing the auditing profession, this study evaluates the efficacy of auditors’ going‐concern opinions in comparison to two bankruptcy prediction models. Bankrupt firms in the U.S. service and trade industry sectors were used to compare model predictions against the auditors’ going‐concern opinion for two years prior to firm failure. The two models are the well‐known Altman (1968) Multiple Discriminant Analysis (MDA) model that includes only financial ratio variables in its formulation and the newer, temporal logit model of Cybinski (2000, 2003) that includes explicit factors of the business cycles in addition to variables internal to the firm. The results show overall better bankruptcy classification rates for the temporal model than for the Altman model or audit opinion.

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