Predicting financial distress of companies: revisiting the Z-Score and ZETA® models

This paper discusses two of the venerable models for assessing the distress of industrial corporations.These are the so-called Z-Score model (1968) and ZETA ® 1977) credit risk model.Both models are still being used by practitioners throughout the world.The latter is a proprietary model for subscribers to ZETA Services, Inc. (Hoboken, NJ).The purpose of this summary are two-fold.First, those unique characteristics of business failures are examined in order to specify and quantify the variables which are effective indicators and predictors of corporate distress.By doing so, I hope to highlight the analytic as well as the practical value inherent in the use of financial ratios.Specifically, a set of financial and economic ratios will be analyzed in a corporate distress prediction context using a multiple discriminant statistical methodology.Through this exercise, I will explore not only the quantifiable characteristics of potential bankrupts but also the utility of a much-maligned technique of financial analysis: ratio analysis.Although the models that we will discuss were developed in the late 1960's and mid-1970's, I will extend our tests and findings to include application to firms not traded publicly, to non-manufacturing entities, and also refer to a new bond-rating equivalent model for emerging markets corporate bonds.The latter utilizes a version of the Z-Score model called Z".This paper also updates the predictive tests on defaults and bankruptcies through the year 1999.As I first wrote in 1968, and it seems even truer in the late 1990's, academicians seem to be moving toward the elimination of ratio analysis as an analytical technique in assessing the performance of the business enterprise.Theorists downgrade arbitrary rules of thumb (such as