ELSEVIER Decision Support Systems 18 (1996) 63-72

D m aSu ort
Hybrid neural network models for bankruptcy predictions
Ku n C h a n g L e e a, I n g o o Hart b,* , Y o u n g s i g K w o n c
a Department of Management Information Systems, Center for Artificial Intelligence Research (CAIR), Kyonggi University,
Suwon 791-940, South Korea
u Department of Management Information Systems, Korea Advanced Institute of Science and Technology, Seoul 130-650, South Korea
Department of Industrial Engineering, Dong-Kuk University, Seoul 100-715, South Korea
Abstract
The objective of this paper is to develop the hybrid neural network models for bankruptcy prediction. The proposed
hybrid neural network models are (1) a MDA-assisted neural network, (2) an ID3-assisted neural network, and (3) a
SOFM(self organizing feature map)-assisted neural network. Both the MDA-assisted neural network and the ID3-assisted
neural network are the neural network models operating with the input variables selected by the MDA method and ID3
respectively. The SOFM-assisted neural network combines a backpropagation model (supervised learning) with a SOFM
model (unsupervised learning). The performance of the hybrid neural network model is evaluated using MDA and ID3 as a
benchmark. Empirical results using Korean bankruptcy data show that hybrid neural network models are very promising
neural network models for bankruptcy prediction in terms of predictive accuracy and adaptability.
Keywords: Bankruptcy prediction; Neural network; Hybrid neural network; Unsupervised learning
1. Introducti on
Neural networks have performed well in business
classifications including bankruptcy prediction. A
neural network model has a good ability in modeling
and forecasting. The success of the neural network
model is attributable to its generalization capability
to predict the output for new data after the neural
network was trained. Bankruptcy prediction has been
a major research issue in accounting and finance for
the last thirty years. There exist extensive studies in
this area using statistical approaches [1,2,4,10,
* Corresponding author. Fax: 82-2-958-3604; Email:
ingoohan@msd.kaist.ac.kr.
11,16,20] and AI (artificial intelligence) approaches
[3,8,9,21,24,28]. MDA has been used the most fre-
quent l y among the statistical approaches in
bankruptcy prediction. Previous empirical results
show that neural network models provi de higher
predictive accuracies than statistical methods and
other AI methods such as inductive learning and
genetic algorithm. However, it has not been resolved
yet how to design a neural network model suitable
for a specific problem. It has been proposed that the
hybrid model combining two or more models has a
potential to achieve a high predictive performance
[19]. We propose three kinds of hybrid neural net-
work models: (1) MDA-assisted neural network, (2)
ID3-assisted neural network, and (3) SOFM (sel f
organizing feature map)-assisted neural network
0167-9236/96/$15.00 1996 Elsevier Science B.V. All rights reserved.
Pl l SO 167-9236(96)00018-8
64 K. Chang Lee et aL / Decision Support Systems 18 (1996) 63-72
models. The purpose of this study is then to explore
the possibility of the proposed hybrid neural network
models in bankruptcy prediction.
A MDA-assisted neural network is a neural net-
work model operating with input variables selected
by MDA method. Similarly, an ID3-assisted neural
network indicates a neural network model operating
with input variables selected by the ID3 method. A
SOFM-assisted neural network is a neural network
model combining a supervised neural network model
with an unsupervised neural network model. In this
study, we use a popular backpropagated neural net-
work model as supervised model and a SOFM neural
network model [17] as unsupervised model. We use a
SOFM model as preprocessing mechanism. Then,
the backpropagated neural network model performs a
classification task based on the information given by
the SOFM model. We use MDA and ID3 methods as
benchmarking tools.
The testbed used in this study consists of
bankruptcy cases reported in Korea from 1979
through 1992. We collected a sample of 83 bankrupt
firms. The 57 financial variables were used as input
variables. To simulate a predictive mode, we divided
the bankruptcy data into the training data over one
period and the hold-out data over the next period. In
addition, we organized the sample by the three groups
to investigate the adaptability of classification mod-
els to the changes in the training data.
The rest of the paper is organized as follows. The
classification models used in this study are discussed
in the next section. Research data and modeling is
presented in Section 3. Empirical results are pro-
vided in Section 4. Concluding remarks are pre-
sented in Section 5.
2. Classification model s for bankruptcy prediction
In this section, we briefly discuss the characteris-
tics of classification models used in our empirical
tests: MDA, ID3, MDA-assisted neural network, an
ID3-assisted neural network, and a SOFM-assisted
neural network.
2.1. Multivariate discriminant analysis
The MDA method is based on the Fisher proce-
dure [12] which constructs a discriminant function by
maximizing the ratio of between-groups and within-
groups variances. Li near classifiers derived from the
Fisher procedure are known to be optimal in mini-
mizing the expected cost of misclassifications, pro-
vided the following conditions are satisfied:
1. each group follows a multivariate normal distribu-
tion,
2. the covariance matrices of each group are identi-
cal,
3. mean vectors, covariance matrices, and prior
probabilities of misclassification are known.
MDA yields a linear discriminant function or
hyperplane relating a set of independent variables to
a dependent variable. In bankruptcy prediction, fi-
nancial ratios are used as independent variables while
the state of bankruptcy or non-bankruptcy is used as
dependent variable. The violation of multivariate
normality assumptions for independent variables fre-
quently occurs in the financial data [11]. As an
alternative to overcome this problem, natural loga-
rithm transformations are used to approximate nor-
mal distribution although the transformed variables
may be difficult to interpret.
2.2. ID3
Instead of generating a decision rule in the form
of a discriminant function, the ID3 method yields a
decision tree that classifies the training sample by
using the entropy measure [22,23]. This inductive
learning method has been applied to various business
classification problems including credit scoring [7],
corporate failures prediction [20], stock portfolio
construction [28], stock market behavior prediction
[5], and bankruptcy risk prediction [18]. The ID3
method intends to minimize the entropy by splitting
subsets.
2.3. MDA-assisted neural network
In general, the neural network model does not
impose any kind of assumptions on input variables
while most statistical methods such as MDA impose
strict statistical assumptions on the input variables.
The intention underlying the MDA-assisted neural
network model is that MDA met hod is used as
K. Chang Lee et aL / Decision Support Systems 18 (1996) 63-72 65
preprocessing mechanism for selecting important in-
put variables which will be used in the neural net-
work model.
2. 4. I D3 - a s s i s t e d n e u r a l n e t w o r k
The ID3-assisted neural network intends to incor-
porate ID3 in the form of preprocessing mechanism.
ID3 selects input variables which are to be used later
in the neural network model. The experi ment using
ID3 as preprocessor is to test how well ID3 performs
in selecting input variables based on the entropy
values.
2. 5. S O F M- a s s i s t e d n e u r a l n e t w o r k
Neural network-based learning is the process by
which a neural network model adjusts their connec-
tion weights when presented with external input.
There are two types of neural network-based learn-
ing: supervised and unsupervised. In supervised
learning, the actual output of a neural network is
compared to the desired output. Then, the connection
weights are adjusted to minimize the error between
the actual and desired output. In unsupervised learn-
ing, only the input is given without any information
on what the desired output should be, and then the
neural network is self-organized by its weights ac-
cording to the learning rules such as Kohonen' s,
Hebbian, and Grossberg' s rule.
The unsupervised learning has not been applied
for business classification research though it seems
to have a good potential for improving the predictive
performance. In this paper, we propose the SOFM-
assisted neural network model which integrates un-
supervised and supervised learning in a sequential
manner. The problem solving logic underlying this
hybrid neural network model is that the uncertainty
a nd/ or fuzziness residing in the data may be re-
duced as the unsupervised neural network learning
model is first applied to the input data and generates
a certain number of clusters.
Next, the supervised neural network learning
model is applied to the clusters. The SOFM-assisted
neural network basically combines the SOFM model
with a LVQ (Linear Vector Quantization) model in a
sequential manner so that more refined clusters can
be extracted from the given input data, where a
cluster represents a regularity or a rule describing the
data as a whole.
The SOFM model proposed by Kohonen [17] is
one of the unsupervised neural network models. Its
essential constituents are as follows:
1. An array of neurons receiving coherent inputs and
computing a simple output function,
2. A mechanism for comparing the neuronal outputs
to select the neuron producing maxi mum output,
3. A local interaction between the selected neuron
and its neighbors,
4. An adaptive mechanism that updates the intercon-
nection weights.
The SOFM model is a two-layered neural network
such as an input layer and a competitive layer. All
the neurons in the input layer are fully intercon-
nected to those in the competitive layer. The main
recipe of SOFM learning is that an input pattern is
presented sequentially to the input layer, and then the
best matching neurons are found in the competitive
layer through learning. Afterward, the best matching
neurons activate their neighbors to classify the same
input patterns. In contrast to the random mapping in
competitive learning, the SOFM model transforms
the input data into a topology-preserving map consti-
tuted by the competitive neurons. As a result, the
similarities among the patterns are mapped into the
closeness relationships on the competitive layer.
Each neuron in the competitive layer is called
q u a n f i z a t i o n neuron which comput es how close its
quantization vector is to the input vector. Suppose
that x is the M-dimensional input vect or incident to
the neuron along the connection weight vector (or
called quantization vector) m i. I f the best match
between vectors m i a n d x occurs at neuron c, then
we have
[ I x - moll = mi n l l x - mi l l , i = 0,1 . . . . . N 2
where I I " I I indicates the Euclidean norm. The weight
updating rule is given as
m i ( t + 1)
[ m i ( t ) + c t ( t ) ( x ( t ) - m i ( t ) ) f o r i ~ N c
mi ( l ) otherwise,
where a ( t ) is a positive constant that decays with
time and N~ defines a topological neighborhood
around the maximally responding neuron c, such that
it also decreases with time. Di fferent parts of the
66 K. Chang Lee et aL / Decision Support Systems 18 (1996) 63-72
neural network become selectively sensitized to dif-
ferent inputs in an ordered fashion so as to form a
continuous map of the signal space. After a number
of sweeps through the training data, with weight
updating at each iteration obeying the weight updat-
ing rule above, the asymptotic values of m i cause
the output space to attain proper topological order-
ing. This is basically a variation of unsupervised
learning.
Meanwhile, the structure of learning with the
LVQ model [17] is basically the same as SOFM-based
learning. However, the LVQ model is based on
supervised learning by assigning quantization vec-
tors m i to each class. Each class is labeled with the
corresponding class symbols, and then the class bor-
ders are determined by the nearest-neighbor method
that computes the smallest distance between the in-
put vector x with the quantization vector m; in
terms of Euclidean distance. As a result, the label of
the closest weight vector m c defines the classifica-
tion of input vector x.
Based on the arguments about SOFM and LVQ
models, the SOFM-assisted neural network is com-
posed of two stages: (1) the clustering neural net-
work (CNN) stage and (2) the output neural network
(ONN) stage.
Stage 1: CNN stage
Input data samples are clustered to detect the
regularities hidden in them. The clusters may be
expressed as rules [27]. For the purpose of clustering,
we used two neural network models SOFM and
LVQ proposed by Kohonen [ 17] in a hybrid manner.
Based on these two neural network models, the CNN
stage is composed of the following three steps:
Step 1: Apply SOFM model.
The SOFM neural model, one of the unsupervised
neural network models proposed by Kohonen [17], is
applied to the input data samples. Then we can
obtain a certain number of clusters by separating the
given input data set. Such clusters represent a set of
meaningful rules encompassing the input data. Since
those rules help to find the regularity among the
related output classes more clearly, the neural net-
work model can have a better ability of generaliza-
tion for the unknown data.
Step 2: Refine with LVQ model.
The LVQ model, which is also proposed by Ko-
honen [17], is used to refine the boundaries between
clusters formed by SOFM. In this way, the vague
cases which SOFM cannot correctly classify into an
appropriate cluster are assigned to proper clusters.
As mentioned previously, the LVQ model is a super-
vised neural network model different from the SOFM
model. Hung [ 15] shows the effectiveness of combin-
ing SOFM and LVQ models in building a neuro-fuzzy
learning control system.
Step 3: Train the clusters with backpropagated
neural network.
After the appropriate clusters hidden in the input
data samples are detected by the SOFM model and
refined by the LVQ model in a sequential manner,
backpropagation learning [25] is applied to the input
data samples with cluster outputs given by SOFM
and LVQ models. Therefore, CNN is a backpropa-
gated neural network model which is trained to find
an appropriate cluster for each given sample.
Stage 2: ONN stage
ONN is built by applying the backpropagation
neural network model to each cluster. ONN is a
mapping function between the input sample and
corresponding desired output (i.e., "bankr upt " or
"non-bankrupt "). Once ONN is built, then the sam-
ple can be classified into one of the "bankr upt " or
"non- bankr upt " states.
3. Re s e a r c h d a t a a n d mo d e l i n g
3.1. Research data
The data sample consists of Korean firms that
failed in the period 1979-1992. They were selected
from the bankrupt companies listed in the Korea
Stock Exchange. We define the state of bankruptcy
as follows:
1. The firms which applied for, have started, or are
under the process of corporate clearance.
Table I
The size of sample and the year by group
Group Training dam Testing dam
Group I 66 ( 1979-1984) 100 0985-1992)
Group I! 96 0979-1990) 70 (1991-1992)
Group III 126 (1979-1991) 40 (1992)
K. Chang Lee et a l . / Decision Support Systems 18 (1996) 63- 72 67
Tabl e 2
A list of 57 fi nanci al vari abl es
Section No. Fi nanci al ratio
Growt h 1 Gr owt h
2 Gr owt h
3 Gr owt h
4 Gr owt h
5 Gr owt h
6 Gr owt h
7 Gr owt h
8 Gr owt h
9 Gr owt h
10 Gr owt h
I 1 Gr owt h
Profitability 12
13
14
15
16
17
18
19
20
21
22
23
Stability 24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
Cash fl ow 42
43
44
45
Act i vi t y 46
47
48
49
rate of total asset s
rate of sal es
rate of ordi nary i ncomes
rate of net i ncomes
rate of fi xed asset 1
rate of fixed asset 2
rate of fi xed asset 3
rate of total liabilities 1
rate of total liabilities 2
rate of total liabilities 3
rate of total liabilities 4
Or di nar y i ncome to total asset s
Net i ncome to total asset s
Or di nar y i ncome to bus i nes s capital
Ordi nary i ncome to st ock hol der s' equi t y
Net i ncome to st ock hol der s' equi t y
Net i ncome to capital st ock
Or di nar y i ncome to sal es
Net i ncome to sal es
Gr oss profit to sal es
Operat i ng i ncome to sal es
Fi nanci al expens es to sal es
Di vi dends to capital st ock
Stock hol der s' equi t y to total asset s
Current ratio
Qui ck ratio
Fi xed ratio
Fi xed asset s to st ockhol der s' equi t y and
l ong-t erm liabilities
Debt ratio
Current liabilities ratio
Fi xed liabilities ratio
Total bor r owi ngs and bonds to total asset s l
Tot al borrowi ngs and bonds to total asset s 2
Tot al bor r owi ngs and bonds to total asset s 3
Tot al liability composi t i on
Fi xed asset composi t i on
Invent ory to cur r ent asset s
Change in i nvent ory to current asset s
Net wor ki ng capital to total asset s
Int erest cover age ratio
Int erest ratio
Cash Fl ow to st ockhol der s' equi t y
Cash fl ow to total borrowi ngs and bond
Cash fl ow to total asset s
Cash flow to sal es
Tot al asset s t ur nover
St ockhol der s' equi t y t ur nover
Net worki ng capital t ur nover
Fi xed asset s t ur nover
Table 2 ( cont i nued)
Section No. Fi nanci al ratio
Act i vi t y
Credibility
50
51
52
53
54
55
56
57
Invent ori es t urnover
Change in Invent ori es t ur nover
Change in payabl es to recei vabl es
Payabl es to current liabilities
Change in payabl es to cur r ent liabilities
Change in recei vabl es to current asset s
Payabl es to recei vabl es
Payabl es to i nvent ori es
2. The firms which quit or closed business.
3. The firms which have had losses for the consecu-
tive three years and are currently under legal
control.
4. The firms which reported the withdrawal of list-
ing or terminated to be listed by the Korea Stock
Exchange.
Using the above definition of bankruptcy, 83
bankrupt firms were selected. A failed firm was
matched with a nonfailed firm in terms of (1) asset
size, (2) capital size, (3) number of employees, and
(4) age. Therefore, 166 firms in total were selected
as sample. We grouped the training sample into the
three subsamples by the time period: (1) Group I
(1979-1984), (2) Group II (1979-1990), and (3)
Group III (1979-1991). The motivation of this
grouping is to see the impact of training sample size
on the performance of classification models. Group
I, II, and III contains 66, 96, and 126 training firms
and 100, 70, and 40 hold-out firms respectively, as
shown in Table 1. This grouping will help to find
how the neural network models can perform as the
new training data are added.
Initially 57 financial variables are selected for the
prediction model. The list of financial ratios is shown
in Table 2.
The 57 financial variables are those which were
found significant in predicting bankruptcy by previ-
ous studies or have been used in practice to predict
bankruptcy. The 57 ratios can be grouped into six
categories such as growth, profitability, stability, cash
flow, activity, and credibility.
One of major assumptions of MDA is that inde-
pendent variables are normally distributed. Financial
ratios are usually skewed to the positive side [14].
Buijink and Kegers [6] found that the skewness of
68 K. Chang Lee et al . / Decision Support Systems 18 (1996) 63-72
financial ratios holds for the long term period as well
as for the short term period. The ways to approxi-
mate normal distribution are trimming, truncation,
and log-transformation. Tri mmi ng and truncation are
used to eliminate or adjust outliers. Inappropriate
trimming or truncation may lead to serious errors. In
this sense, Berry and Tregueiros [3] advocate the use
of log-transformation. In this study, the log-transfor-
mation is used to approximate the normal distribu-
tion of financial variables. To verify the normal
approximation of the log-transformed financial ra-
tios, a statistical analysis was performed. The results
show that the log-transformed ratios are normally
distributed at the significance level of 5%. The t-test
was performed for each of the 57 financial variables
in the data sample to test the discriminative power of
input variables.
3.2. MDA
To determine a linear function of input variables
for the MDA, there are two methods; a direct method
and a stepwise method. In this research, we used the
stepwise method using Wi l k' s Lambda to sequen-
tially select important variables from 57 variables.
Table 3, Table 4, and Table 5 show the MDA results
for each group. For Group I, I0 financial variables
were selected as important input variables for pre-
dicting bankruptcy. Similarly, 18 and 17 financial
variables were chosen for Group II and III, respec-
tively.
Tabl e 3
Fi nanci al ratios sel ect ed by MDA in Gr oup I
Selected fi nanci al ratios Wi i k' s A
x4: Gr owt h r a t e of net i ncome 0. 45958
x12: Ordi nary i ncome to total asset s 0. 29407
x18: Or di nar y i ncome to sal es 0. 34206
x23: Di vi dends to capital st ock 0. 48159
x24: St ock hol der s' equi t y to total asset s 0. 36554
x26: Qui ck ratio 0. 43109
x31: Fi xed liabilities ratio 0. 30236
x46: Tot al asset s t urnover 0. 31162
x47: Stock hol der s' equi t y t urnover 0. 35251
x49: Fi xed asset s t urnover 0. 32575
Tabl e 4
Financial ratios selected by MDA in Gr oup Ii
Independent Wi l ks ' s A
variable
x4:
x5:
x9:
x12:
x13:
x16:
x18:
x23:
x24:
Gr owt h rate of net i ncomes 0. 40187
Gr owt h rate of fi xed asset s 1 0.32671
Gr owt h rate of total liabilities 2 0. 34777
Or di nar y i ncome to total asset s 0. 35616
Net i ncome to total asset s 0. 47133
Net i ncome to st ock hol der s' equi t y 0. 38720
Ordi nary i ncome to sal es 0. 29298
Di vi dends to capital st ock 0. 50334
St ock hol der s' equi t y to total asset s 0. 36999
x26: Qui ck ratio 0. 42133
x28: Fi xed asset s to st ock hol der s' 0. 28450
equi t y and l ong-t erm liabilities
x30: Cur r ent liabilities ratio 0. 37989
x35: Tot al liability composi t i on 0. 29298
x41: Fi xed asset composi t i on 0. 28839
x42: Cash fl ow to st ock hol der s' 0. 3197
equi t y ratio
x44: Cas h flow to total asset s 0. 33337
x47: St ock hol der s' equi t y t urnover 0. 27996
x48: Net worki ng capital t ur nover 0.45011
Tabl e 5
Fi nanci al ratios selected by MDA in Gr oup Ill
Independent Wi l k' s A
variable
x3:
x5:
x9:
x12:
x13:
x14:
x19:
x23:
x24:
x26:
x28:
x30:
x33:
x40:
x45:
x47:
x54:
Growth rate of ordi nary incomes 0.38273
Growth rate of f i xed assets 1 0.46688
Gr owt h rate of total liabilities 2 0. 39475
Or di nar y i ncome to capital st ock 0. 29407
Net i ncome to total asset s 0. 41362
Fi nanci al expens es and ordi nary 0. 41915
i ncome to total asset s
Net i ncome to sal es 0.40761
Di vi dends to capital st ock 0.58411
St ock hol der s' equi t y to total asset s 0. 44148
Qui ck ratio 0. 47886
Fi xed asset s to st ock hol der s' 0. 49619
equi t y and l ong-t erm liabilities
Cur r ent liabilities ratio 0. 40202
Tot al borrowi ngs and bonds to 0. 51856
total asset s 2
Int erest coverage ratio 0. 39475
Cash fl ow to sal es 0. 38942
St ock hol der s' equi t y t ur nover 0. 43100
Change in payabl es to current 0. 45836
liabilities
K. Chang Lee et aL / Decision Support Systems 18 (1996) 63- 72 69
< Figure 1 > Decision Tree for Grou;~ 1
H (X23~ 0.25, I X23L25, I L (X23< 0.251
l
,
Ii:t
( - . 6 8 5 1
H L I
Fi g. I . De c i s i on t r ee f or gr oup I . Legend: B: Ba nkr upt c y, NB:
Non- banknJ pt cy.
3.3. ID3
ID3 forms a decision tree that correctly classifies
all the input data on the basis of the entropy measure
of attribute. The ID3 algorithm was coded in Pascal.
The classification tree generated by ID3 for Group I
is illustrated in Fig. 1. The number of financial
variables chosen by ID3 is 7 for Group I in the
process of building a decision tree. Similarly, 7 and
9 financial variables were selected by using ID3 for
Group II and III, respectively.
3.4. Neural network model
We have constructed 3-layer networks. The num-
ber of hidden units are set to be the same as the
number of input units for the neural networks for
Group I, II, and III. The backpropagation learning
algorithm has been frequently used in business clas-
sification studies while SOFM and LVQ have been
hardly used in this area. We used NeuralWorks
Professional V5.0 (Neural Ware Inc., 1994) to im-
plement the neural network models.
4. Empirical results
The prediction accuracies by MDA are 68%,
68.57%, and 70% for Group I, II, and III respec-
tively. The prediction results by ID3 are 74%,
72.86%, and 77.50% for Group I, II, and III respec-
tively. MDA-assisted neural network uses the finan-
cial variables, selected by the stepwise method of
MDA, as input variables. Therefore, the input vari-
ables are the same as those of MDA. There has yet
been a formal method to design or configure a neural
network appropriate for a certain classification task
(for example, the number of neurons and hidden
layers, selection of learning algorithms, and learning
parameters, etc). Exploratory experiments were per-
formed to find an appropriate architecture.
In the experiment for MDA-assisted neural net-
work, 10 input neurons are placed in the input layer
for Group I, 18 input neurons for Group II, and 17
input neurons for Group III. We used one hidden
l ayer containing the same number of hidden neurons
as the input units. Finally, two output neurons are
placed in the output layer.
Therefore, experiments with the MDA-assisted
neural net work were performed with three kinds of
neural network architectures: (1) neural network with
10 input neurons, 10 hidden neurons, and 2 output
neurons (Group I), (2) neural network with 18 input
neurons, 18 hidden neurons, and 2 output neurons
(Group II), and (3) neural network with 17 input
neurons, 17 hidden neurons, and 2 output neurons
(Group III). The prediction accuracies by the MDA-
assisted neural network are 70%, 80%, and 80% for
Group I, II, and III.
The ID3-assisted neural network indicates a neu-
ral network model operating with the input variables
included in the decision tree by ID3. The architecture
of the ID3-assisted neural network is similar to that
of MDA-assisted neural network except for the num-
ber of input neurons. The stepwise method of MDA
selects input variables in terms of geometric distance
measure while ID3 selects input variables in terms of
ent ropy measure. For the experiments of ID3-as-
sisted neural network, the input variables are ob-
tained by ID3. Neural network models for both
Group I and II have 7 input neurons, 7 hidden
neurons, and 2 output neurons. The neural network
for Group Il l has 9 input neurons, 9 hidden neurons,
and 2 output neurons. The prediction accuracies by
the ID3-assisted neural network are 73%, 81.43%,
and 82.5% for Group I, II, and III respectively.
The SOFM-assisted neural network is a sequential
integration of SOFM and supervised network. The
70 K. Chang Lee et aL / Decision Support Systems 18 (1996) 63-72
Table 6
Prediction accuracies of classification models
Group MDA ID3 MDA-assisted NN ID3-assisted NN SOFM(MDA)-
assisted NN
SOFM(ID3)- Total
assisted NN
Group I 68.00% 74.00% 70.00% 73.00% 84.00% 74.00% 73.83%
Group I1 68.57% 72.86% 80.00% 81.43% 74.30% 80.00% 76.19%
Group III 70.00% 77.50% 80.00% 82.50% 82.50% 77.50% 78.33%
Total 68.57% 74.29% 75.24% 77.62% 80.48% 76.67% 75.00%
Legend: NN = Neural Network,
selection of input variables are performed by MDA
and ID3 as before. The SOFM-assisted neural net-
work model using input variables selected by the
stepwise method of MDA is denoted by
SOFM(MDA)-assisted neural network. Similarly, the
SOFM(ID3)-assisted neural network uses input vari-
ables included in the decision tree of ID3. The
prediction accuracies of the SOFM(MDA)-assisted
neural network are 84%, 74.3%, and 82.5%. Those
of the SOFM(ID3)-assisted neural network are 74%,
80%, and 77.5% respectively. The results are sum-
marized in Table 6.
On the average, the SOFM(MDA)-assisted neural
network model performs the best. This model shows
an outstanding prediction accuracy (84%) for Group
I. The addition of more training data does not im-
prove the predictive performance of the
SOFM(MDA)-assisted neural network. The next one
is the ID3-assisted neural network. Although per-
forming poorly for Group I, it provides a strong
performance for Group II and III. The third one is
the SOFM(ID3)-assisted neural network. The MDA-
assisted neural network is the fourth. ID3 is placed in
the fifth place. The MDA performs the worst. There-
fore, our proposed hybrid neural network models
outperform the MDA and ID3 models. It is notewor-
thy that the performances of the hybrid neural net-
work models generally improve as the training data
increase in number. This can be found by comparing
the performance of each group in Table 6. However,
this trend is weak for MDA and ID3. The MDA-as-
sisted neural network and the ID3-assisted neural
network show a big increase in the prediction perfor-
mance between Group I and Group II. The trend is
not clear for the SOFM(MDA)-assisted neural net-
work and the SOFM(ID3)-assisted neural network.
In summary, hybrid neural network models per-
form better than MDA and ID3. The SOFM-assisted
neural network turns out to have a great potential in
bankruptcy prediction. This is attributable to the fact
that it categorizes the input data samples into appro-
priate numbers of clusters and extracts regularities
Table 7
Z values for the pairwise comparison of performance between classification models
ID3 -assisted NN SOFM(ID3)- MDA-assistod NN
assisted NN
ID3 MDA
SOFM(MDA)-assisted NN 0.7201 0.95 i 5 1.2932
ID3-assisted NN - 0.2318 0.5746
SOFM(ID3)-assisted NN - - 0.3429
MDA-assisted NN - - -
ID3 - - -
1.5162 2.8009 c
0.7985 2.0911 t,
0.5669 1.8613 b
0.2241 1.5206
- 1.2974
Significant at 10%.
b Significant at 5%.
c Significant at 1%.
K. Chang Lee et aL / Decision Support Systems 18 (1996) 63- 72 71
from each cluster. Therefore, the SOFM-assisted
neural network can cope with the noise or irregulari-
ties more efficiently than the other models.
We use the Z-tests to examine whether the predic-
tion accuracies of hybrid models are higher than
those of MDA or ID3. Table 7 shows the standard-
ized normalized test statistic, Z values when the
prediction accuracies of the left-vertical methods are
compared with those of the right-horizontal methods.
The SOFM(MDA)-assisted neural network per-
forms significantly better than MDA at a 1% level
and marginally better than the MDA-assisted neural
network or ID3 at a 10% level. The ID3-assisted
neural networi< performs significantly better than
MDA at a 5% level. The SOFM(ID3)-assisted neural
network performs significantly better than MDA at a
5% level. The MDA-assisted neural network per-
forms marginally better than MDA at a 10% level. In
general, the predictive performance is improved by
using the hybrid approach.
5. Concluding remarks
This paper has suggested the hybrid neural net-
work models which perform very well in the
bankruptcy prediction tasks. Our proposed hybrid
neural network models either integrate different kinds
of neural network models (like SOFM-assisted neu-
ral network) or combine neural network model with
other statistical or AI models (like MDA-assisted or
ID3-assisted neural network models). The SOFM-as-
sisted neural network model integrates unsupervised
learning model (SOFM) and supervised learning
(LVQ) to find more refined regularity hidden in the
input data. Meanwhile, a MDA-assisted or an ID3-
assisted neural network model uses MDA or ID3
models as a preprocessor for selecting the appropri-
ate input variables which are to be used by the
supervised neural network model.
This study experimented MDA, ID3, and hybrid
neural network models using Korean bankruptcy data.
Experimental results showed that the SOFM(MDA)-
assisted neural network model performs the best,
which implies the high potential of integrating unsu-
pervised learning with supervised learning. This is an
exploratory study to propose and test hybrid neural
network models. Future studies are expected to pre-
sent improved hybrid neural network models with
superior performances.
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