Journal of Business Research 54 (2001) 53 61

Tests of the generalizability of Altmans bankruptcy prediction model

John Stephen Gricea,*, Robert W. Ingramb
a

Sorrell College of Business, Troy State University, 131 Bibb Graves, Troy, AL 36082, USA
b
The University of Alabama, USA

Abstract
Though developed in 1968 using a small sample of firms from the 1950s and 1960s, Altmans Z-score model remains a commonly used
tool for evaluating the financial health of companies. Because of the age of the model and other attributes, such as its small sample of
manufacturing firms and the use of equal group sizes of bankrupt and non-bankrupt firms, it is likely that model is not as effective in
classifying firms in more recent studies as it was when it was developed by Altman. This study examines three research questions using
recent sample data: (1) Is Altmans original model as useful for predicting bankruptcy in recent periods as it was for the periods in which it
was developed and tested by Altman? (2) Is the model as useful for predicting bankruptcy of non-manufacturing firms as it is for predicting
bankruptcy of manufacturing firms? (3) Is the model as useful for predicting financial stress conditions other than bankruptcy as it is for
predicting bankruptcy? Our results are consistent with negative answers to questions one and two and a positive answer to question three.
D 2001 Elsevier Science Inc. All rights reserved.
Keywords: Generalizability; Bankruptcy; Z-score model

Altman (1968) developed his well-known Z-score

model using a matched sample of 33 bankrupt and 33
non-bankrupt manufacturing firms from 1946 1965.
Though the Z-score model exhibited high accuracy rates
using both estimation and hold-out samples (95% and
84%), the generalizability of this model to industries and
periods outside of those in the original sample has
received little attention. Nevertheless, the original model
has been employed in recent research to evaluate financial
conditions of firms from a variety of industries and
periods (e.g., Chen and Church, 1996; Chen and Wei,
1993; Carcello et al., 1995; Berger et al., 1996; Subramanyan and Wild, 1996). Also, it continues to be used in
a variety of business situations involving the prediction of
bankruptcy and other financial stress conditions. Commercial banks use the model as part of the periodic loan
review process, and investment bankers use the model in
security and portfolio analysis. The model has been
employed as a management decision tool and as an
analysis tool by auditors to assess their clients abilities
to continue as going concerns (AICPA, 1987; Dugan and
Zavgren, 1988).

* Corresponding author. Tel.: +1-334-670-3154; fax: +1-334-670-3154.

E-mail address: sgrice@trojan.troyst.edu (J.S. Grice).

The continued use of Altmans bankruptcy prediction

model by researchers and practitioners leads to three
research questions considered in this paper:1 Is Altmans
original model as useful for predicting bankruptcy in
recent periods as it was for the periods in which it
was developed and tested by Altman? Is the model as
useful for predicting bankruptcy of non-manufacturing
firms as it is for predicting bankruptcy of manufacturing
firms? Is the model as useful for predicting financial
stress conditions other than bankruptcy as it is for
predicting bankruptcy?
Our results lead us to question current uses of Altmans
model. Though our results indicate that the model is
useful for predicting financial distress conditions other
than bankruptcy, they also indicate that the models
accuracy is significantly lower in recent periods than that
reported in Altmans (1968) study across all sample
characteristics considered in this study. Additionally, the
magnitude and significance of the models coefficients
differ from those reported by Altman. Our results suggest
that better accuracy can be achieved by re-estimating
1
Though other models have been proposed and examined in the
literature, Altmans continues to be the one most cited and used. See
Zavgren (1983) and Jones (1987) for detailed discussions of other models
and techniques used in prior bankruptcy prediction studies.

0148-2963/00/$ see front matter D 2001 Elsevier Science Inc. All rights reserved.
PII: S 0 1 4 8 - 2 9 6 3 ( 0 0 ) 0 0 1 2 6 - 0

54

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

model coefficients using estimation samples from periods

close to test periods. Also, the accuracy of the model
decreases significantly when non-manufacturing firms are
included in the sample.
Section 1 discusses Altmans model and prior research
relevant to this study. Section 2 describes the sample and
tests employed to evaluate Altmans model. Section 3
examines findings and Section 4 discusses implications for
users of Altmans model.

1. Contributions to prior research

This section summarizes Altman (1968) and studies that
have examined his bankruptcy prediction model. It explains
the contributions of the present study to solving problems
identified in these earlier studies.
To develop the Z-score model, Altman (1968) compiled
a list of 22 financial ratios and classified each into one of
five categories (liquidity, profitability, leverage, solvency,
and activity). The ratios were not selected on a theoretical
basis, but rather, on the basis of their popularity in the
literature and Altmans belief about their potential relevancy to bankruptcy. He estimated the model using multiple discriminant analysis to derive a linear combination of
variables that discriminated between bankrupt and nonbankrupt firms. After numerous tests, the linear function
that best discriminated between the 33 bankrupt and 33
non-bankrupt manufacturing firms was:
Z 1:2X1 1:4X2 3:3X3 0:6X4 0:999X5

where, X1 is the working capital/total assets, X2 is the

retained earnings/total assets, X3 is the earnings before
interest and taxes/total assets, X4 is the market value equity/
book value of total debt, X5 is the sales/total assets, and Z is
the overall Z-score index. The lower a companys Z-score,
the higher its probability of bankruptcy.
Scott (1981) noted potential search bias in the variable
selection technique used by Altman. The lack of a theory
of bankruptcy invites the researcher to consider a multitude of variables and then to reduce the original set to
the most accurate subset. The resulting subset of variables often proves ineffective when applied to a sample
of firms or periods other than those used in developing
the model.
Hold-out sample accuracy rates in Altmans and other
studies are potentially upwardly biased (Bias here means
that the hold-out sample accuracy rates are higher than the
rates users should expect when they apply the models) for
three reasons: (1) the estimation and hold-out sample
periods are not substantially different, (2) the hold-out
sample consists of firms from the same restricted set of
industries as those in the estimation sample, and (3) the
hold-out samples are small (the largest sample was 111 in
studies we examined) and are not proportional to actual
bankruptcy rates.

Other studies that directly tested the Z-score model

include Moyer (1977), Zmijewski (1983), Holmen (1988),
and Begley et al. (1996). The most relevant of these to our
study is Begley et al. (1996). They applied the Z-score
model to a prediction sample that included 65 bankrupt and
1300 non-bankrupt industrial firms from 1980 1989 and
reported a 78% accuracy rate. They also re-estimated the
Altman (1968) coefficients using a matched sample of 100
bankrupt and 100 non-bankrupt companies. Their re-estimated coefficients exhibited a 78% classification accuracy
using their prediction sample.
The accuracy rates reported in these studies also are
potentially upwardly biased because they suffer from one, or
a combination, of the limitations of the hold-out samples
described above. For example, all prior tests of the Z-score
model used samples that included restricted sets of industries. Also, except for the Begley et al. (1996) study, the
results of prior research are dated because the samples were
primarily for companies from the 1960s and 1970s. Another
limitation of the test samples is that the samples were small
and not proportional to actual bankruptcy rates.2 Though
Begley et al. (1996) used a proportional sample to test the
Z-score model, they imposed a size restriction on firms
included in their sample, limiting the study to larger
firms. Begley et al. (1996) also used matched samples
of bankrupt and non-bankrupt companies to re-estimate
their models, thus ignoring the effects of proportionate
sampling in developing these models.
When a model is applied to periods other than those used
to develop and test the model, researchers assume the model
is stable across economic conditions that change over time,
such as inflation, interest rates, and credit availability.3 The
effect of changing economic factors on the accuracy,
magnitude, and significance of model coefficients was
evaluated by Mensah (1984) who developed four models
using samples from the 1972 1973, 1974 1975, 1976
1977, and 1978 1980 periods, each period representing a
different economic environment. He reported that the accuracy and structure of the models changed over the four time
periods. Accordingly, it is unlikely that Altmans model
performs equally well in all financial periods. Tests in the
current study compare both the accuracy rates and estimated
coefficients of the original Z-score model to those derived
using recent proportional samples.
Another limitation of the hold-out samples of prior
studies is that the samples were small. Altman tested his
2

Zmijewski (1983) used a proportionate sample; however, he did not

report the Z-score models accuracy rate.
3
Begley et al. (1996) also briefly discussed the concerns of using dated
bankruptcy prediction models on recent data. They indicated that the
merger and takeover activity of the 1980s changed the likelihood of
bankruptcy associated with high corporate debt levels. Additionally, they
suggested that the changes in the bankruptcy laws during the 1970s allowed
companies to strategically use bankruptcy. To the extent the reasons for
strategic use are associated with financial variables, models developed prior
to the changes in the law may result in greater classification errors.

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

model on two different independent samples consisting of

91 (25 bankrupt and 66 non-bankrupt) and 111 (53 bankrupt
and 58 non-bankrupt) firms. Also, the hold-out samples
were not proportionately representative of the population of
bankrupt and non-bankrupt firms. The average business
failure rate is less than 1%,4 while the proportion of bankrupt to non-bankrupt firms included in previous hold-out
samples ranges from 24% to 50%.
Results of oversampling bankrupt firms include misstatement of Type I and Type II errors. Altman (1968)
used an equal number of bankrupt and non-bankrupt
companies for his estimation sample. Altman et al.
(1977) reported classification accuracy under assumptions
of equal prior probabilities as well as under different
probabilities.5 The overall accuracy rate (92%) of their
model was not affected when prior probabilities more
representative of the average business failure rate were
incorporated. However, the number of bankrupt (nonbankrupt) firms misclassified increased (decreased) under
the more representative prior probabilities. The Z-score
model understated Type I errors and overstated Type II
errors. Zmijewski (1984) also tested the effect of disproportionate sampling in bankruptcy prediction studies and
reported similar findings.
Hold-out sample tests in prior studies included firms
from the same industries as those in the estimation sample.6
The test samples used in prior studies that directly tested the
Z-score model also included restricted sets of industries.
Platt and Platt (1991) demonstrated that a bankruptcy
prediction model that included industry-relative ratios produced improved prediction accuracy relative to a model that
included only unadjusted ratios. Industry-relative ratios
were adjusted for the average ratio for a specific industry.
Their results suggest that a bankruptcy estimation model
developed using firms from one set of industries may not be
highly accurate in predicting bankruptcies for firms in other
industries. Tests in the current study evaluate results of
applying Altmans model to industries other than manufacturing firms.
Even though the Z-score model was developed to predict
bankruptcy, this event is only one of several indicators (or

55

consequences) of financial distress. It is not clear whether

Altmans model is specifically useful for identifying firms
that are likely to go bankrupt or whether it is more
generally a model for identifying firms experiencing financial distress, though the model is commonly used for this
purpose. While firms that experience financial distress are
more likely to declare bankruptcy than other firms, most
financially distressed firms do not declare bankruptcy.
Gilbert et al. (1990) suggested that financial dimensions
that distinguish bankrupt from healthy firms are different
from those that separate bankrupt from distressed firms.
Bankruptcy is a joint result of financial distress and other
events that precipitate legal action.7
This study considers the Z-score models ability to assess
financial distress conditions other than bankruptcy. If Altmans model is better suited for predicting bankruptcy than
for predicting other financial distress problems, it may not
be appropriate for some of the applications for which it has
been used.

2. Research design
This section describes the sample selection criteria.
Also, it explains the methodology employed to test the
Altman model.
2.1. Sample
The analyses in this study used a 1985 1987 estimation
sample and a 1988 1991 prediction sample from Compustats annual industrial and research files. 1985 was the first
year of the study because certain variables were unavailable
prior to this year. The final year in the prediction sample was
1991 because the number of bankrupt firms identified on
Compustat was minimal in years following 1991 and we
wanted to ensure that sufficient data were available to
determine whether a firm declared bankruptcy subsequent
to the test period. Distressed companies were defined as
those reported by Compustat as meeting one or more of the
following conditions: (1) Chapter 11 bankruptcy, (2) Chapter 7 liquidation, (3) bonds vulnerable to default, or (4) low

The average business failure rate between 1970 and 1991 ranged from
.038% to 1.19% (Gentry et al., 1985).
5
Altman et al. (1977) adjusted the models cutoff score to simulate the
effect of using unequal prior probabilities. The adjustment factor was
calculated as ln( p1/p2) where p1 and p2 represent the prior probabilities of
the bankrupt and non-bankrupt groups. If their sample violated the
assumptions of equal variance covariance matrices between the groups
and multivariate normality, then this adjustment factor may be inappropriate. Though Altman et al. did not report information related to these
assumptions, prior research suggests the assumptions are typically violated
for the estimation samples used to develop bankruptcy prediction models
(Jones, 1987).
6
Altman et al. (1977) used a hold-out sample that included 61
manufacturing and 50 retail firms to test the Z-score model; however, they
did not report the models accuracy by industry classification. The model
exhibited an 84% classification accuracy for the entire hold-out sample.

7
A limitation of the Z-score model is that the variable set does not
incorporate proxies for non-financial events that precipitate bankruptcy. For
example, a banks refusal to extend credit, lawsuits, and union problems are
three factors associated with bankruptcies. Arguably, a banks refusal to
extend credit is typically attributable to firms poor financial performances
or high debt levels. However, union problems and lawsuits could result in
firms filing bankruptcy as a result of strategic management decisions. That
is, management may deem it necessary to file bankruptcy to secure a
favorable outcome in negotiations or court proceedings, even though the
firm is not experiencing serious financial problems. The lack of
homogeneity in the motivation for bankruptcy filings complicates the
modeling effort, and users should recognize that the Z-score model does not
capture all events that may cause, or precede, bankruptcy.

56

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

stock ratings.8 The non-distressed firms were selected

randomly from the population of Compustat firms for which
S&P ratings were available.9
The 1985 1987 estimation sample included 972 companies (148 distressed and 824 non-distressed). This sample
was used to re-estimate coefficients in Eq. (1). The 1988
1991 prediction sample included 1002 companies (148
distressed and 854 non-distressed). This sample was used
to evaluate the predictive accuracies of both Altmans
original and the re-estimated (1985 1987) Z-score models.
These samples included bankrupt and other financially
distressed firms and included non-manufacturing as well
as manufacturing firms. Subsamples were used to address
the various research questions examined in this study.
Table 1 reports descriptive statistics by distressed and
non-distressed groups for the estimation and prediction
samples. A comparison of the 1985 1987 distressed and
non-distressed variable means indicates that working capital/total assets (X1), retained earnings/total assets (X2), and
earnings before interest and taxes/total assets (X3) were
lower in the distressed than in the non-distressed group.
The p-values for the test of mean differences between
distressed and non-distressed companies were significant
for each of these variables. The means for market value of
equity/book value of total debt (X4) and sales/total assets
(X5) were not significantly different between the distressed
and non-distressed groups, however. The descriptive statistics for Altmans variables using the 1985 1987 sample
were similar to those reported by Altman for his estimation
sample except for the market value variable, which was
significantly different between his bankrupt and non-bankrupt groups.
The descriptive statistics for the 1988 1991 prediction sample in Table 1 are similar to those of the
1985 1987 sample except for sales/total assets. The
means for sales/total assets were significantly different
between the distressed and non-distressed firms in the

The Compustat research file contains companies that were deleted

from the annual industrial file because of bankruptcy (liquidation) and
identifies bankrupt (liquidated) firms with a 02 (03) code for footnote 35.
The files report S&P bond and stock ratings (data items 280 and 282).
Companies whose bonds were rated CCC or below or whose stock was
rated lower B or below were included in the distressed sample.
9
Companies that maintained codes for data item 280 (282) that were
less than 19 (18) were included in the non-distressed sample. A random
number generator was used to select the companies for the non-distressed
group. Approximately 25% (18%) of the companies for each year in the
1985 1987 (1988 1991) sample were selected. These proportions were
used to: (1) closely equate the number of non-distressed firms in each
sample, and (2) reduce the opportunity for a firm to be selected in multiple
years. Including firms in the non-distressed population that were not rated
by S&P increased the non-distressed group by approximately 500
companies. These firms were not included in the results reported in this
study because we could not assume firms were non-distressed just because
they were not rated by S&P. The accuracy rates of the re-estimated models
using the larger estimation sample were not significantly different from
those reported in this study, however.

Table 1
Descriptive statistics for 1985 1987 and 1988 1991 samples
1985 1987
sample
Non-distressed
(n=824)

Distresseda
(n=148)

Statistic
a

X1

Mean
0.229
Standard
0.199
deviation
Minimum 0.266
Maximum
0.858
Mean
0.092
Standard
0.389
deviation
Minimum 2.410
Maximum
0.841
p-valueb
0.000

X2

X3
0.283
0.241

0.107
0.081

1.690 0.406
1.384
0.508
0.565 0.176
1.056
0.409

X4

X5
2.264 1.235
3.156 0.812

0.040
28.705
3.166
13.992

0.033
7.283
1.213
0.988

6.203 2.042
0.014 0.000
0.550
0.038 161.918 6.593
0.000
0.000
0.436 0.799

1988 1991 Sample

Non-distresseda Mean
0.200
0.182
0.090
2.267 1.239
(n=854)
Standard
0.208
1.794
0.110
4.058 0.760
deviation
Minimum 0.684 2.427 1.722
0.361 0.002
Maximum
0.843
1.077
0.351 59.890 5.284
Distresseda
Mean
0.061 0.773 0.122
2.268 1.622
(n=148)
Standard
0.500
2.152
0.349
9.158 1.173
deviation
Minimum 3.442 19.023 2.446
0.003 0.001
Maximum
0.861
0.663
0.301 101.802 6.633
p-valueb
0.000
0.000
0.000
0.998 0.000
X1 = working capital/total assets; X2 = retained earnings/total assets;
X3 = earnings before interest and taxes/total assets; X4 = market value of
equity/total assets; X5 = sales/total assets.
a
The distressed group includes companies that experienced bankruptcy
or liquidation as well as those that received low S&P ratings for their bonds
or stock. The non-distressed group includes companies that were rated by
S&P and did not receive low bond or stock ratings.
b
p-Value of t-test of differences in variable means between the
distressed and non-distressed groups.

1988 1991 sample.10 The means for the market value

variable were not significantly different between the
distressed and non-distressed groups for the 1988
1991 prediction sample.
Our sample included firms from all two-digit SIC codes
for which data were available to calculate model variables.
Financial institutions were excluded because Compustat
does not include current asset and liability data for these
firms. The 1985 1987 sample included 79 distressed and
435 non-distressed manufacturing firms (SIC code 2000
3999) and 69 distressed and 389 non-distressed non-manufacturing firms. The 1988 1991 sample included 78 distressed and 452 non-distressed manufacturing firms and 70
distressed and 402 non-distressed non-manufacturing firms.
The 1985 1987 sample included 86 bankrupt companies
and 62 companies that were financially distressed but that
10
Minimum and maximum values for certain variables indicated
outliers in the sample. The results reported in this study did not change
when the outliers were omitted, however. Specifically, the p-value for the
X4 variable was affected by outliers, but the coefficients and explanatory
power of the models were not affected when the outliers were removed.
Details of these results are available from the authors.

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

had not declared bankruptcy. Of the distressed companies,

26 eventually declared bankruptcy after 1987 and prior to
1997. The 1988 1991 sample included 92 bankrupt companies and 56 companies that were financially distressed but
that had not declared bankruptcy. Of the distressed companies, 18 declared bankruptcy subsequent to 1991 and prior
to 1997. The bankrupt firms were unique for the 1985 1987
and 1988 1991 samples. Twenty-two of the firms that were
distressed in the 1985 1987 sample also appeared in the
distressed group in the 1988 1991 sample.
2.2. Test procedures
We evaluated the classification accuracy of Altmans Zscore model using the full 1988 1991 sample, a subset of
the sample containing only bankrupt firms in the distressed
group, and a subset of the sample containing only manufacturing firms in both distressed and non-distressed
groups. The Z-scores were derived for each of these
samples using Altmans coefficients from Eq. (1).11 The
accuracy of the Z-score model was calculated by dividing
the number of firms correctly predicted by the total number
of firms in the sample.
Binomial tests of proportions were used to test the
significance of differences between the accuracies reported
by Altman and those reported in the current study using the
1988 1991 sample. For the binomial test, p1 and p2 are
defined as the proportion of successes (correct predictions)
for two samples, n1 and n2. The test statistic is calculated as
(p1p2)/sp1p2, where s is defined as the standard deviation of the binomial probability distribution. The binomial
test is appropriate if nipi and ni(1pi) are greater than 5.
The classification accuracy of Altmans model using a
subset of the 1988 1991 sample containing only bankrupt
firms was used to evaluate the models ability to assess
financial distress other than bankruptcy. Binomial tests
compared the models classification accuracy using the
full 1988 1991 sample to the accuracy using the bankruptcy subset.
The Z-score models classification accuracy using a
subset of the 1988 1991 sample containing only manufacturing firms was used to evaluate the sensitivity of the
model to non-manufacturing industries. Binomial tests
compared the models classification accuracy using the full
1988 1991 sample to the accuracy using the manufacturing
subset of the sample.
To compare results from Altmans original model with
those from a more recent period, the Z-score models
coefficients were re-estimated using the 1985 1987 estimation sample. The coefficients were re-estimated using
the methodology Altman originally employed to derive

11
Firms were classified as distressed if their Z-scores were < 2.675
(Altman, 1968). Firms with a 2.675 Z-score had approximately a 50%
chance of being classified as distressed in Altmans study.

57

his model, discriminant analysis (DA). Arguably, DA is

no longer the prevalent statistical methodology used by
bankruptcy prediction researchers to develop prediction
models.12 The use of DA was necessary in this study so
direct comparisons could be made between the coefficients in the original and re-estimated Z-score score
models.13
We compared the coefficients of the 1985 1987 model
to those shown in Eq. (1) to test the stationarity of the
model. Also, we compared the magnitude and significance
of the coefficients for the manufacturing-only and bankruptcy-only models to those for the 1985 1987 model to
evaluate whether re-estimations of Altmans model were
sensitive to industry classifications or financial conditions.
Binomial tests compared the accuracies of the re-estimated
models to those using Altmans original model.

3. Results
This section reports test results used to evaluate the
generalizability of Altmans model. These results are divided into two primary categories. The first are those using
coefficients from Altmans 1968 model. The second are
those using our 1985 1987 estimation sample to recompute
model coefficients.
3.1. Classification accuracy of Altmans (1968) model
Table 2 reports results of tests of Altmans (1968)
model. The table contains four panels. Panel A contains
the classification results from Altmans study. Panel B
contains the classification results using Altmans model
to predict outcomes for our 1988 1991 sample. The
overall correct classification rate dropped from 83.5% in
Panel A to 57.8% in Panel B, a significant difference at the
0.05 level using the binomial test. Classification rates for
both the distressed and non-distressed groups were significantly lower in the 1988 1991 sample than in the
original sample. These results indicate that Altmans model
is not as useful for predicting financial distress in recent
periods as it was in the 1960s.

12

See Jones (1987) for detailed discussions of DA and other statistical

methodologies used in bankruptcy prediction research.
13
Linear models, such as Eq. (1) derived using DA, assume the
variance covariance matrices of the distressed and non-distressed groups
are equal. Unequal variance covariance matrices for the groups suggest
that a quadratic discriminant function may be more suitable for the sample.
Altmans (1968) study does not report information related to this
assumption. However, prior research suggests that the samples used to
derived bankruptcy prediction models typically violate the equal variance
covariance matrix assumption (Jones, 1987). The estimation sample used in
this study violated the equal variance covariance assumption based on
Bartletts test of homogeneity. Further analysis indicated no significant
differences between the accuracy rates of the quadratic and linear
discriminant models, however.

58

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

Table 2
Comparisons of classification accuracies using coefficients from Altmans
(1968) model
Sample

Statistic

Panel A
Altmans (1968)
sample

Accuracya
n

Panel B
1988 1991
sample

Panel C
Bankruptcy
samplec

Panel D
Manufacturing
samplec

Overall

Distressed
group

Non-distressed
group

83.5%
91

96.0%
25

78.8%
66

Accuracya
n
Test statisticb

57.8%
979
4.748*

70.9%
148
2.552*

55.5%
831
3.668*

Accuracya
n
Test statisticd
Test statisticb

56.1%
972
0.779
5.045*

68.2%
85
0.439
2.621*

54.9%
887
0.238
3.762*

Accuracya
n
Test statisticd
Test statisticb

69.1%
547
4.283*
2.755*

69.2%
78
0.270
2.524*

69.1%
469
4.741*
1.597

a
Accuracy rates represent correct classifications using Altmans (1968)
model coefficients.
b
Test statistic for binomial tests comparing the accuracy rates to those
in Panel A.
c
The manufacturing and bankruptcy samples are subsets of the 1988
1991 sample.
d
Test statistic for binomial tests comparing the accuracy rates to those
in Panel B.
* Significant at the 0.05 level.

The sample used in Panel B includes both bankrupt and

other financially distressed firms, perhaps explaining the
lower classification rates. Panel C includes only bankrupt
firms in the distressed group for the 1988 1991 sample. A
comparison of these results with those in Panel A and Panel
B reveals that the classification rates for the bankrupt firms
were significantly lower in the 1988 1991 sample than in
the original sample. Further, the classification rates for the
bankrupt firm sample were approximately the same as that
for the Panel B sample. These results indicate that Altmans
model predicts financial distress other than bankruptcy with
the same accuracy as it predicts bankruptcy. Consequently,
the lower accuracy of Altmans model for the 1988 1991
sample was not due to the inclusion of non-bankrupt firms
in the distressed group.
Panel D of Table 2 reports results for the 1988 1991
sample when the sample is limited to manufacturing firms.
A comparison of these results with those in Panel A reveals
that the prediction accuracy was significantly lower for the
1988 1991 sample than for the original sample. The overall
accuracy for the 1988 1991 sample was 69.1%, compared
to the rate of 83.5% for Altmans sample. Classification
results for the distressed group were significantly lower for
the 1988 1991 sample. Those for the non-distressed group

were lower for the 1988 1991 sample, but the difference
was not significant at the 0.05 level.
A comparison of Panel D results with those for Panel B
indicates that classification results for the manufacturing
sample were significantly higher than those for the total
1988 1991 sample. These results suggest that Altmans
model is more useful for predicting financial distress of
manufacturing firms than for predicting financial distress of
non-manufacturing firms.
3.2. Classification accuracy of a re-estimated model
Additional evidence of the stationarity of the Z-score
model was obtained by re-estimating the models coefficients using our 1985 1987 sample. Table 3 reports results
for the re-estimated model. Data are reported for four
models. The first column of coefficients contains those for
Altmans (1968) model. The second column contains those
for the re-estimation sample from 1985 to 1987. A comparison of these columns reveals several differences in the
coefficients. Most of the coefficients for the 1985 1987
model are lower than those for Altmans original model, and
most of these changes are quite large, suggesting the model
is not stationary. Differences between the univariate F
statistic for Altmans original and the 1985 1987 models
reported in Table 3 provide further indication of a stationarity problem. The retained earnings/total assets and earnings before interest and taxes/total assets variables exhibit
higher significance levels in the 1985 1987 model than in
Altmans original model. The market value of equity/book
value of total debt variable has a higher significance level in
the original model, and the working capital/total assets and
sales/total assets variables maintained about the same level
of significance.
Multivariate significance tests of the coefficients for the
1985 1987 sample revealed that only the retained earnings/
total assets and earnings before interest and taxes/total assets
coefficients were significant at the 0.05 level. Altman did
not report the multivariate significance of his tests; however,
he indicated that each ratio provided significant information
in the original Z-score model.
Limiting the 1985 1987 sample to bankrupt firms for
the distressed group or to manufacturing firms for both
distressed and non-distressed groups had relatively little
effect on model coefficients or significance tests. The third
column of numbers in Table 3 reports results for the bankruptcy sample, and the fourth column reports results for the
manufacturing sample. A comparison of these numbers with
the second column reveals the results are similar for most
variables. Coefficients for the working capital/total assets
variable were lower for the bankruptcy and manufacturing
samples than for the total sample of 1985 1987 firms. A
comparison of columns three and four with column one
again indicates that the original model is not stationary, even
if only bankrupt or only manufacturing firms are included in
the sample.

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

59

Table 3
Coefficients for Altmans (1968) and 1985 1987 re-estimated models
Altmans (1968) modela

Variables and statistics

Working capital/total assets
p-Value
Univariate F
Retained earnings/total assets
p-Value
Univariate F
Earnings before interest and taxes/total assets
p-Value
Univariate F
Market value equity/book value debt
p-Value
Univariate F
Sales/total assets
p-Value
Univariate F

1.200
32.66*
1.400
58.86*
3.300
26.56*
0.600
33.26*
0.990
2.840

1985 1987 modelb

Bankruptcy-only modelc

Manufacturing-only modeld

0.058
0.831
39.67*
1.504
0.000
387.37*
2.073
0.000
289.23*
0.014
0.129
3.025
0.058
0.396
0.261

0.301
0.307
19.573*
1.599
0.000
369.01*
2.627
0.000
309.12*
0.033
0.001
11.41*
0.157
0.033
1.050

0.386
0.345
9.67*
2.067
0.000
278.84*
1.385
0.019
185.33*
0.005
0.607
2.815
0.069
0.557
0.249

p-Value: multivariate significance of the coefficient in the full model. Altman did not report the multivariate significance of his coefficients.
Univariate F: individual discriminating ability of each ratio.
a
Coefficients and significance levels reported in Altmans (1968) study (N = 66, 33 bankrupt and 33 non-bankrupt firms).
b
Coefficients estimated using the full 1985 1987 sample (N = 972, 824 non-distressed and 148 distressed companies).
c
Coefficients estimated using a subset of the 1985 1987 sample that included only bankrupt companies in the distressed group (N = 910, 824 nondistressed and 86 distressed firms).
d
Coefficients estimated using a subset of the 1985 1987 sample that included only manufacturing companies (N = 555, 476 non-distressed and 79
distressed firms).
* Significant at the 0.05 level.

Table 4 reports predictive accuracies using coefficients

estimated from the 1985 1987 model. These coefficients
were used to predict outcomes for the 1988 1991 sample
and can be compared to results in Table 2. The four panels
in Table 4 parallel those in Table 2. Panel A reports the
classification accuracies of Altmans 1968 model when

used to predict outcomes for the 1988 1991 sample. Panel

B reports the classification accuracies using the 1985
1987 reestimation model to predict outcomes for the
1988 1991 sample. Classification results for the reestimation sample were significantly higher for the reestimation
model than for Altmans original model. Binomial test

Table 4
Comparisons of the classification accuracy of Altmans (1968) model and the 1985 1987 re-estimation model
Model

Statistic

Overall

Distressed group

Non-distressed group

Panel A
Altmans (1968)

Accuracya

57.8%

70.9%

55.5%

Accuracya
Test statisticc

88.1%
13.657*

54.7%
3.702*

93.8%
15.871*

Accuracya
Test statisticc

87.6%
13.243*

48.6%
4.225*

94.9%
15.989*

Accuracya
Test statisticc

86.4%
12.681*

55.4%
2.945*

92.1%
14.871*

Panel B
1985 1987 Re-estimationb

Panel C
Bankrupt firmsd

Panel D
Manufacturing firmse
a

Accuracy rates represent the correct classifications for each model using the 1988 1991 sample.
Model coefficients are reported in Table 3.
c
Test statistic comparing the re-estimated models accuracy rates to those of Altmans (1968) model.
d
Model estimated using a subset of the 1985 1987 sample that included only bankrupt firms from the distressed group. Model coefficients are reported
in Table 3.
e
Model estimated using a subset of the 1985 1987 sample that included only manufacturing firms. Model coefficients are reported in Table 3.
* Significant at the 0.05 level.
b

60

J.S. Grice, R.W. Ingram / Journal of Business Research 54 (2001) 5361

results were significant at the 0.05 level. These results also

hold for Panel C that includes only bankrupt firms in the
nondistressed group and for Panel D that includes only
manufacturing firms in the distressed and nondistressed
groups. The overall classification results for Panel B, C,
and D are similar to those reported by Altman in his 1968
study (see Panel A of Table 2).
A comparison of results for the distressed and nondistressed groups in the re-estimation model in Panel B of
Table 4 with those of Altmans original model in Panel A
indicates that the Type I and Type II error rates differ
between the models. Accuracy rates for the distressed group
were higher for Altmans model than for the re-estimation
model, while accuracy rates for the non-distressed group
were lower for Altmans model. These results demonstrate
the effect of using proportionate samples of distressed and
non-distressed companies in the re-estimation model. Altman used a matched sample of 33 bankrupt and 33 nonbankrupt firms and, accordingly, ignored the prior probabilities of group membership. The 1985 1987 models
were developed using proportionate samples of distressed
and non-distressed companies. As a result, the Type I (Type
II) errors for the Altman (1968) model were lower (higher)
than those for the re-estimated models.14 These results hold
for the bankrupt only and manufacturing only samples as
well as for the total sample.

4. Summary
This study evaluated the generalizability of Altmans
(1968) Z-score model using a proportionate sample of
distressed and non-distressed companies from time periods,
industries, and financial conditions other than those used by
Altman to developed his model. The findings indicated that
the accuracy of Altmans model declined when applied to
our samples. Altman reported an 83.5% overall accuracy for
his model using a sample from 1958 to 1961. The overall
accuracy for the 1988 1991 sample used in this study was
57.8%. Additionally, the coefficients of Altmans (1968)
model changed dramatically when re-estimated using a
1985 1987 sample. Thus, it appears the relation between
financial ratios and financial distress changes over time.
Altmans model was sensitive to industry classifications
in the sample used in this study. The overall accuracy of
the model was significantly higher for manufacturing firms
(69.1%) than for the entire sample (57.8%) that included
non-manufacturing firms. Altmans model was not sensitive to type of financial distress. The overall accuracy of
14
Begley et al. (1996) also ignored the prior probabilities of group
membership when they re-estimated Altmans (1968) coefficients using
a matched sample of 100 bankrupt and 100 non-bankrupt firms.
Binomial tests indicated that their re-estimated model was significantly
more (less) accurate at predicting bankrupt (non-bankrupt) firms than
the 1985 1987 model.

the model for bankrupt companies (56.1%) in the 1988

1991 sample was not significantly different from that of
the entire sample (57.8%) that included other financial
distress situations.
Other results of this study indicate that those who employ
Altmans Z-score model should re-estimate the models
coefficients rather than relying on those reported by Altman
(1968). Because the coefficients are not stable, significantly
better classification results were achieved when the models
coefficients were re-estimated using 1985 1987 data than
when the original coefficients were used.
Finally, care should be used in applying Altmans model
because of the potential underestimation of Type I and
overestimation of Type II errors that result from using
non-proportional samples of bankrupt and non-bankrupt
firms. This problem can be overcome by re-estimating
Altmans model coefficients using a sample of firms that
approximates the proportions of distressed and non-distressed firms in the population.
In conclusion, our findings suggest that results of recent
studies that have used Altmans model to estimate financial
distress of sample firms should be interpreted cautiously.
The ability of the model to accurately classify firms as being
financially distressed is likely to differ considerably from
that assumed by those employing the model.

Acknowledgments
We gratefully acknowledge comments from Mike
Dugan, Rich Houston, Mary Stone, Gary Taylor, and an
anonymous reviewer.

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