Inability of Gearing-Ratio as Predictor for Early Warning Systems

• Authors: Mario Situm
• Languages of publication: EN

Abstracts

EN

Background: Research in business failure and insolvency prediction provides numerous potential variables, which are in the position to differentiate between solvent and insolvent firms. Nevertheless, not all of them have the same discriminatory power, and therefore their general applicability as crisis indicators within early warning systems seems questionable. Objectives: The paper aims to demonstrate that gearing-ratio is not an appropriate predictor for firm failures/bankruptcies. Methods/Approach: The first and the second order derivatives for the gearing-ratio formula were computed and mathematically analysed. Based on these results an interpretation was given and the suitability of gearing-ratio as a discriminator within business failure prediction models was discussed. These theoretical findings were then empirically tested using financial figures from financial statements of Austrian companies for the observation period between 2008 and 2010. Results: The theoretical assumptions showed that gearing-ratio is not a suitable predictor for early warning systems. This finding was confirmed with empirical data. Conclusions: The inclusion of gearing-ratio within business failure prediction models is not able to provide early warning signals and should therefore be ignored in future model building attempts.

Keywords

EN

capital structure; gearing-ratio; business failure prediction; crisis indicators; C61; G32; G33

• Publisher: Sciendo
• Journal: Business Systems Research Journal
• Year: 2014
• Volume: 5
• Issue: 2
• Pages: 23-45

Dates

received

2014-02-02

accepted

2014-05-18

online

2014-09-10

Contributors

author

Mario Situm

• Fachhochschule Kufstein Tirol Bildungs GmbH, University of Applies Sciences, Austria

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Identifiers

DOI

10.2478/bsrj-2014-0008