Bankruptcy Prediction Using Only the Face Value of Debt and Stock Market Capitalization in a Single Ratio

Abstract

I show that a single ratio requiring only a public company's face value of debt and stock market capitalization is a robust bankruptcy predictor. I develop this ratio from a simple theory of the bankruptcy decision and denote it Ps, since it is the minimum price at which a firm's debt must trade if the firm is solvent. Used alone or in combination with other variables, Ps provides a useful tool for credit analysts, bankers, public accountants and others, and will be of considerable value in academic research on financial distress. I present bankruptcy frequencies for a range of Ps values to facilitate bankruptcy prediction by the reader.