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Using a cross-section data set of manufacturing firms in Korea and the U.S., this paper explores the most significant factors that determine firm default during the periods of 1991-2001 and 1991-2003, respectively. Based on the findings, a probit default model is constructed to perform better than two default prediction models such as Altman’s z-score model and the new Altman z-score model. To improve the predictive power, z-score is incorporated into the model as one of the explanatory variables with other significant default factors, which can provide additional information in predicting bankruptcy. It is found that z-score, leverage, and short-term debt ratios are the most important determinants of default for firms in both Korea and the U.S. However, soft budget constraint (SBC), defined as the ability of a firm with a low z-score to obtain short-term bank loans, and ownership concentration (ownership by the largest shareholders) are identified as strong indicators of the likelihood of bankruptcy only for Korean firms. Moreover, based on these and other significant default factors of age of a firm, export ratio, and inventory ratio, the probit default model for both Korean firms and US firms is found to perform better than the two Altman models. This suggests that the additional information gained from the z-score and the non-financial default factors in the default regression model can help improve the predictive power of a default prediction model.

Determinants and Predictive Powers of Bankruptcy Models for Firms in Korea and the U.S.