Recalibration and improvement of the Altman, Zmijewski, and Prophecy model: Earnings management as a predictor of bankruptcy of Philippine manufacturing firm

• Main Authors: Aguirre, Eugene C., Marcojos, Noel Christian C., Santiago, Leomar T., Valeriano, Alyssa Gale D.
• Format: text
• Language: English
• Published: Animo Repository 2016
• Subjects: Bankruptcy > Philippines > Prevention; Earnings management > Philippines; Accounting
• Online Access: https://animorepository.dlsu.edu.ph/etd_bachelors/6288
• Institution: De La Salle University

Bankruptcy leads to adverse effects to various stakeholders, the industry, and the country it is operating to. It is then important for decision makers to predict a company's bankruptcy as a precaution to prevent such effects. Investors rely on the public information provided by publicly-listed companies in order to evaluate the firm ability to continue as a going concern. One way to assess the predictability of the firm risk of bankruptcy is through bankruptcy prediction models (BPM) which were developed to aid prospective investors in making financial decisions. Previous literature show that poor corporate governance may lead to bankruptcy while the degree of earnings management (EM) increases as the quality of corporate governance decreases. Considering this, a relationship between EM and the risk of bankruptcy may possibly exist. Studies indicate that companies are more likely to employ EM in times of financial distress making it a possible predictor of a firm risk of bankruptcy. Thus, the study seeks to determine ability of earnings management to improve the predictability of bankruptcy by incorporating it in existing bankruptcy prediction models. The study utilized three (3) BPMs that were proven to be the most accurate models as predictor of bankruptcy. The researchers extracted 288 SEC registered companies which comprise of 144 bankrupt firms and 144 non-bankrupt firms. The models were tested and the study proved that bankrupt firms employs EM to a greater extent than their healthy counterparts. The researchers compared the accuracy of the three recalibrated models in predicting the bankruptcy of Philippine manufacturing firms with its EM-induced counterparts. The study accuracy tests reveal that Altman model and Prophecy models accuracy was improved while the accuracy of Zmijewski model decreased as a result of the modification. The researchers deemed that Zmijewski model is already in its optimal form thus adding a variable would only decrease its accuracy. The study concludes that EM is a predictor of bankruptcy.