<abstract xmlns="http://www.w3.org/1999/xhtml"><p><bold>Background:</bold> 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. <bold>Objectives:</bold> The paper aims to demonstrate that gearing-ratio is not an appropriate predictor for firm failures/bankruptcies. <bold>Methods/Approach:</bold> 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. <bold>Results:</bold> The theoretical assumptions showed that gearing-ratio is not a suitable predictor for early warning systems. This finding was confirmed with empirical data. <bold>Conclusions:</bold> 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.</p></abstract>

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.

Inability of Gearing-Ratio as Predictor for Early Warning Systems

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

Business Systems Research Journal

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

{"article-title":"Inability of Gearing-Ratio as Predictor for Early Warning Systems"}

Background: Research in business failure and insolvency prediction provides numerous potential variables, which are in the position to differentiate between...

Inability of Gearing-Ratio as Predictor for Early Warning Systems

Published Online: Sep 10, 2014

Page range: 23 - 45

Received: Feb 02, 2014

Accepted: May 18, 2014

DOI: https://doi.org/10.2478/bsrj-2014-0008

Keywords
capital structure, gearing-ratio, business failure prediction, crisis indicators

© 2014 Mario Situm

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

Inability of Gearing-Ratio as Predictor for Early Warning Systems

Published Online: Sep 10, 2014

Page range: 23 - 45

Received: Feb 02, 2014

Accepted: May 18, 2014

DOI: https://doi.org/10.2478/bsrj-2014-0008

Keywordscapital structure, gearing-ratio, business failure prediction, crisis indicators

© 2014 Mario Situm

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

Keywords
capital structure, gearing-ratio, business failure prediction, crisis indicators