Research has documented that forecasts of future earnings made by financial analysts capture aspects of risk and expected return for firms, and reflect information not reflected in firms’ accounting reports. This study investigates the usefulness of measures developed from analysts’ earnings forecasts as indicators of impending bankruptcy. Results indicate that healthy and failing firms differ significantly with respect to four properties of earnings forecasts: forecast level, forecast error, forecast bias, and forecast dispersion. When combined in a model, measures related to these four forecast properties are able to predict bankruptcy in the year prior to failure as accurately as more traditional approaches using accounting ratios.
Get full access to this article
View all access options for this article.
References
1.
AltmanE. “A Further Empirical Investigation of the Bankruptcy Cost Question.” Journal of Finance (September1984), pp. 1067-1089.
2.
AltmanE.BrennerM.. “Information Effects and Stock Market Response to Signs of Firm Deterioration.” Journal of Financial and Quantitative Analysis (March1981), pp. 35-51.
3.
AltmanE.AveryR.EisenbeisR.SinkeyJ.. Application of Classification Techniques in Business, Banking and Finance (JAI Press, 1981).
4.
BarefieldR.ComiskeyE.. “The Accuracy of Analysts’ Forecasts of Earnings Per Share.” Journal of Business Research (July1975), pp. 241-252.
5.
BeaverW. “Financial Ratios as Predictors of Failures.” In Empirical Research in Accounting, selected studies, 1966. Supplement to Journal of Accounting Research.
6.
BeaverW.Financial Reporting: An Accounting Revolution (Prentice-Hall, 1981) Chapter 6.
7.
BrownL.HagermanR.GriffinP.ZmijewskiM.. “Security Analyst Superiority Relative to Univariate Time-Series Models in Forecasting Quarterly Earnings.” Journal of Accounting and Economics (April1987), pp. 61-87.
8.
BrownL.RozeffM.. “Adaptive Expectations, Time-Series Models and Analyst Forecast Revisions.” Journal of Accounting Research (Autumn1979), pp. 341-351.
9.
BrownP.FosterG.NoreenE.. Security Analyst Multi-year Earnings Forecasts and the Capital Market. Sarasota, Florida: American Accounting Association, 1985
10.
CollinsW.HopwoodW.. “A Multivariate Analysis of Annual Earnings Forecasts Generated from Quarterly Forecasts of Financial Analysts and Univariate Time Series Models.” Journal of Accounting Research (Autumn1980), pp. 340-406.
11.
CrichfieldT.DyckmanT.LakonishokJ.. “An Evaluation of Security Analysts’ Forecasts.” Accounting Review (July1978), pp. 651-668.
12.
CukiermanA.GivolyD.. “Heterogeneous Earnings Expectations and Earnings Uncertainty— Theory and Evidence.” Working paper, Tel Aviv University (1982).
13.
EltonE.GruberM.GultekinM.. “Professional Expectations: Accuracy and Diagnosis of Errors.” Journal of Financial and Quantitative Analysis (December1984), pp. 351-363.
14.
FriedD.GivolyD.. “Financial Analysts’ Forecasts of Earnings: A Better Surrogate for Earnings Expectations.” Journal of Accounting and Economics (October1982), pp. 85-107.
15.
FrydmanH.AltmanE.KaoD.. “Introducing Recursive Partitioning for Financial Classification: The Case of Financial Distress.” The Journal of Finance (March1985), pp. 269-291.
16.
GivolyD. “The Formation of Earnings Expectations.” The Accounting Review (July1985), pp. 372-386.
17.
GivolyD.LakonishokJ.. ‘‘The Information Content of Financial Analysts’ Forecasts of Earnings. Journal of Accounting and Economics (Winter1979), pp. 165-185.
18.
-. “Financial Analysts’ Forecasts of Earnings and Their Value to Investors. ” Journal of Banking and Finance (September1980), pp. 221-233.
19.
-. “Divergence of Earnings Expectations: The Effect on Market Response to Earnings Signals.” Working paper 768/83, Faculty of Management, Tel Aviv University (February1983).
20.
-. “Properties of Analysts’ Forecasts of Earnings: A Review and Analysis of the Research.” Journal of Accounting Literature (Spring1984), pp. 117-152.
21.
GrangerC.NewboldP.. Forecasting Economic Time Series (Academic Press, 1977).
22.
MakeeverD. “Predicting Business Failures.” The Journal of Commercial Bank Lending (January1984), pp. 14-18.
23.
MalkielB. “The Valuation of Public Utility Equities.” The Bell Journal of Economics and Management (Spring1970), pp. 143-160.
24.
MalkielB. “Risk and Return: A New Look.” Working paper, Lynch Jones, and Ryan. New York (April1981).
25.
MalkielB.CraggJ.. “Expectations and the Structure of Share Prices.” American Economic Review (1970), pp. 601-617.
26.
MalkielB. “The Valuation of Public Utility Equities.” The Bell Journal of Economics and Management (Spring1970), pp. 143-160.
27.
-. “Risk and Return: A New Look.” Working paper, Lynch, Jones, &Ryan. New York (April1981).
28.
MalkielB.CraggJ.. “Expectations and the Structure of Share Prices.” American Economic Review (1970), pp. 601-617.
29.
MalkielB.CraggJ.. “Expectations and the Valuation of Shares.” Working paper471 (April1980), National Bureau of Economic Research.
30.
MosesD.LiaoS.. “Predicting Bankruptcy of Private Firms: A Simplified Approach.” Proceedings. Decision Sciences Institute 1986 Annual Meeting, pp. 212-214.
31.
-. “On Developing Models for Failure Prediction.” Journal of Commercial Bank Lending (March1987), pp. 27-38.
32.
NeiderhofferV.ReganP.. “Earnings Changes, Analysts’ Forecasts and Stock Prices.” Financial Analysts Journal (May-June1972), pp. 65-71.
33.
PenmanS. “An Empirical Investigation of Voluntary Disclosure of Corporate Earnings Forecasts.” Journal of Accounting Research (Spring1980), pp. 132-160.
34.
WoodD.PiesseJ.. “The Information Value of MDA Based Financial Indicators.” Journal of Business Finance and Accounting (Spring1987), pp. 27-38.
35.
ZavgrenC. “The Prediction of Corporate Failure: The State of the Art.” Journal of Accounting Literature (Spring1983), pp. 1-38.
