Have Financial Statements Become Less Informative: Evidence From the Ability of Financial Ratios to Predict Bankruptcy

Have Financial Statements Become Less Informative: Evidence From the Ability of Financial Ratios to Predict Bankruptcy

Review of Accounting Studies. March
2005, Vol. 10, Issue 1, Pages 93-122

Using a hazard model, we examine secular changes in the ability of financial statement data to predict bankruptcy from 1962 to 2002. We identify three trends in financial reporting that could influence predictive ability with respect to bankruptcy: FASB standards, the perceived increase in discretionary financial reporting behavior, and the increase in unrecognized assets and obligations. A parsimonious three-variable model provides significant explanatory power throughout the time period, with only a slight deterioration in predictive power from the first to the second time period. The striking feature of the results is the robustness of the predictive models over a forty-year period.