International Finance and Accounting Handbook

in the nonfailed groups. The investigation was based on 135 bad companies and 25
good companies and consisted of (1) an examination of the functional areas of the
companies leading to their weak points and (2) partly standardized interviews of
bank lending personnel most familiar with the history and behavioral characteristics
of the owner/managers.
The qualities found to set the failed company management apart were the following:

• Being out of touch with reality


• Large technical knowledge but poor commercial control


• Great talents in salesmanship


• Strong-willed


• Sumptuous living and unreasonable withdrawals


• Excessive risk-taking

The management of the solvent companies was found to be more homogeneous
than the failed companies and seldom showed a lack of consciousness of reality. The
authors recommend all three components of analysis (balance sheet, account behav-
ior, and management) be pursued to assess a company.

(f ) Baetge, Huss, and Niehaus (1988). This study reports the results of a multiple
discriminant analysis model whose aim is to identify at least 80% of the endangered
corporate borrowers three years before they become distressed.
The bad borrowers were defined as those that resulted in a final credit loss to the
bank or wherever a temporal delay occurred or was feared in the payment of the ob-
ligations of the borrower as stipulated by contract. Good borrowers were those that
did not possess the above characteristics. Samples were drawn from both bad and
good enterprises representative of the line of business, legal form, and size. Principal
component analysis was used to reduce the initial universe of 42 financial ratios to
seven factors. These factors in turn led to a three variable MDA model consisting of
the following ratios:

1.Capital structure: Net worth/(total assets – quick assets – property and plant

[without equipment])

10 • 12 BUSINESS FAILURE CLASSIFICATION MODELS

Correct

Classification

Semiannual Period Correct of Good

before Fixed Date Classification Cases

8 73.3% 89.2%

7 66.7 83.8

6 75.6 81.1

5 80.0 89.2

4 82.2 78.4

3 91.1 78.4

2 88.9 83.8

1 88.9 83.8

Exhibit 10.3. Classification Results on the Development Sample.