An Error Component Logit Analysis of Corporate Bankruptcy and Insolvency Risk in Australia

David A. Hensher · Stewart Jones · William H. Greene

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Financial Distress and Bankruptcy Prediction Corporate Finance and Governance Corporate Insolvency and Governance

Abstract

This paper introduces a four‐state failure model to depict a wider range of distress scenarios that public companies typically face in the real world. We use a multinomial error component logit model to analyse firm failure, a major advance on the modelling techniques used in previous research. The error component logit model, being an extension of the more familiar mixed logit model, relaxes several questionable statistical assumptions associated with standard models. Using a sample of Australian firms we provide an interpretative illustration of the error component logit model and contrast its behavioural performance with the standard logit model widely used in previous research.

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References

1968FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY 2001Discrete Choice Methods with Simulation 1980Financial Ratios and the Probabilistic Prediction of Bankruptcy 2003Discrete Choice Methods with Simulation 1984Methodological Issues Related to the Estimation of Financial Distress Prediction Models 2001Forecasting Bankruptcy More Accurately: A Simple Hazard Model 2005Applied choice analysis a primer 2004Default Risk in Equity Returns

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2012Test–Retest Reliability of Choice Experiments in Environmental Valuation 2014Statistics-based wrapper for feature selection: An implementation on financial distress identification with support vector machine 2019Predicting private company failure: A multi-class analysis 2010Empirical research of hybridizing principal component analysis with multivariate discriminant analysis and logistic regression for business failure prediction 2020Financial Distress Prediction and Feature Selection in Multiple Periods by Lassoing Unconstrained Distributed Lag Non-linear Models

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