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Earnings Retention as a Specification Mechanism in Logistic Bankruptcy Models: A Test of the Free Cash Flow Theory
Author(s) -
Dhumale Rahul
Publication year - 1998
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/1468-5957.00223
Subject(s) - bankruptcy , free cash flow , cash flow , bankruptcy prediction , earnings , econometrics , mechanism (biology) , economics , investment (military) , operating cash flow , business , actuarial science , accounting , finance , philosophy , epistemology , politics , political science , law
This paper explores the applicability of as a specification mechanism to improve forecasting methods in corporate bankruptcy. The study combines lessons from Jensen's Free Cash Flow Theory with a logisitic model of bankruptcy to improve forecasting accuracy. The model uses data from the Indian textile industry to show that data classification based on investment opportunities is yet another way of improving precision. The study also re‐examines the Free Cash Flow Theory and concludes that in applying it to a bankruptcy scenario, its initial findings regarding retention policy hold true; that is, low growth firms should retain less of their earnings than their high growth counterparts.