Corporate Financial Distress Diagnosis in China

Edward I. Altman · Max L. Heine · Ling Zhang · Jerome Yen

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

Abstract

With the enforcement of the removal system for “distress firms” and the 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 the accounting procedures and the quality of financial documents between the 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. And, local models are usually superior to ones imported from other environments. Based on the family of models, we developed a particular model called ZChinaScore to support identification of potential distress firms in China. Our model contains four factors, which include asset liability, working capital, return on total assets, and retained earnings ratios. Our four-variable model is very similar to the Z-Score four-variable version -Emerging Market Scoring Modeldeveloped in 1995. We found that the model was robust with very high accuracy. The model has forecasting power of up to three years with eighty percent accuracy for those firms categorized as Special Treatment (ST) – which indicated that they were problematic firms. Applications of our model to determine a Chinese firm’s Bond Rating Equivalent are also demonstrated.

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References

1968FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY 1966Financial Ratios As Predictors of Failure 1977ZETATM analysis A new model to identify bankruptcy risk of corporations 1997A Markov Model for the Term Structure of Credit Risk Spreads 1972A Discriminant Analysis of Predictors of Business Failure 2007Financial statement analysis 1978Journal of business finance and accounting 1989Measuring Corporate Bond Mortality and Performance

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