The efficacy of liquidation and bankruptcy prediction models for assessing going concern

Abstract

Although previous research generally finds bankruptcy prediction models to outperformauditors' views on going concern, accuracy in identifying failing companies is lower. Recent research questions whether bankruptcy is the best proxy for assessing going concern, since filing for bankruptcy is not synonymous with the invalidity of the going concern assumption. Furthermore, in contrast to debtor oriented countries such as the US, liquidation is the most likely outcome of corporate insolvency in creditor oriented countries such as the UK, Germany, Australia and New Zealand. This suggests that bankruptcy prediction models have limited use for assessing going concern in creditor oriented countries. Previous research hasnot recognised this distinction between corporate bankruptcy and liquidation in developing statistical models as an audit tool for assessing going concern. This study examines the efficacy of a corporate liquidation model and a benchmark bankruptcy prediction model for assessing company liquidation. It finds that the liquidation model is more accurate in predicting company liquidations in comparison with the benchmark bankruptcy prediction model. Most importantly. Type 1 errors for the liquidation prediction model is significantlylower than for the bankruptcy prediction model, which indicates its greater efficacy as an analytical tool for assessing going concern. The results also suggest that bankruptcy prediction models may not be appropriate for assessing going concern in countries where the insolvency code is creditor oriented.