Edited by Adrian R. Bell, Chris Brooks and Marcel Prokopczuk
Chapter 17: Predicting financial distress of companies: revisiting the Z-Score and ZETA® models
This chapter discusses two of the venerable models for assessing the distress of industrial corporations. These are the so-called Z-Score model (1968) and the ZETA® (1977) credit risk model. Both models are still being used by practitioners throughout the world. The latter is a proprietary model for subscribers to ZETA Services, Inc. (Hoboken, NJ, USA). The purposes of this summary are twofold. Firstly, those unique characteristics of business failures are examined in order to specify and quantify the variables which are effective indicators and predictors of corporate distress. By doing so, I hope to highlight the analytic as well as the practical value inherent in the use of financial ratios. Specifically, a set of financial and economic ratios will be analyzed in a corporate distress prediction context using a multiple discriminant statistical methodology. Through this exercise, I will explore not only the quantifiable characteristics of potential bankrupts but also the utility of a much-maligned technique of financial analysis: ratio analysis. Although the models that I will discuss were developed in the late 1960s and mid-1970s, I will extend the tests and findings to include applications to firms not traded publicly, to non-manufacturing entities, and also refer to a new bond-rating equivalent model for emerging markets corporate bonds. The latter utilizes a version of the Z-Score model called Z”. This chapter also updates the predictive tests on defaults and bankruptcies through to 1999.
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