An Analysis of the Usefulness of Debt Defaults and Going Concern Opinions in Bankruptcy Risk Assessment

Abstract

This study extends the research of Hopwood et al. (1994) and Mutchler et al. (1997) by empirically investigating the relationships between loan defaults, violation of loan covenants, going-concern opinions, and bankruptcy in bankruptcy prediction models. One objective of this study is to empirically test the ability of loan defaults/accommodations and loan covenant violations to assess the risk of bankruptcy. Another objective of this study is to investigate the impact of failing to control for these two distress events on results from tests of the usefulness of going-concern opinions in assessing bankruptcy risk. Results suggest that loan default/accommodation and loan covenant violation are both significant explanatory variables of bankruptcy at the time of the last annual report before the event. While a going-concern opinion variable appears to significantly explain bankruptcy, it is not significant when included in a model with loan default/accommodation and covenant violation variables. Consequently, our results suggest that researchers should include both loan default/accommodation and covenant violation as control variables when using bankruptcy to test the usefulness of going-concern opinions.