Corporate Failure Risk Assessment for Knowledge-Intensive Services Using the Evidential Reasoning Approach

Jian-Bo Yang,Meng-Meng Tan,Dong-Ling Xu

doi:10.3390/jrfm15030131

Jian-Bo Yang, Meng-Meng Tan + Show 1 more

Open Access

https://doi.org/10.3390/jrfm15030131

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Abstract

In this study, a new risk assessment model is developed and the evidence reasoning (ER) approach is applied to assess failure risk of knowledge-intensive services (KIS) corporates in the UK. General quantitative financial indicators alone (e.g., operational capability or profitability) cannot comprehensively evaluate the probability of company bankruptcy in the KIS sector. This new model combines quantitative financial indicators with macroeconomic variables, industrial factors and company non-financial criteria for robust and balanced risk analysis. It is based on the theory of enterprise risk management (ERM) and can be used to analyze company failure possibility as an important aspect of risk management. This study provides new insight into the selection of macro and industry factors based on statistical analysis. Another innovation is related to how marginal utility functions of variables are constructed and imperfect data can be handled in a distributed assessment framework. It is the first study to convert observed data into probability distributions using the likelihood analysis method instead of subjective judgement for data-driven risk analysis of company bankruptcy in the KIS sector within the ER framework, which makes the model more interpretable and informative. The model can be used to provide an early warning mechanism to assist stakeholders to make investment and other decisions.

Highlights

The issue of company failure prediction has received considerable critical attention since many firms have been bankrupt due to their suffering from financial risks, which has brought adverse impacts on their investors, creditors, governments and other stakeholders.The narrow definition of financial risk is the possibility that a company may default on its debts, and its essence is the evaluation of companies’ debt control capabilities or financial leverage management (Valaskova et al 2018)
From the perspective of the enterprise risk management (ERM) theory, the survival and prosperity of a company depends on its abilities to deal with risks in internal operations and properly handle possible losses caused by uncertainties in external environments (Da Silva Etges and Cortimiglia 2019)
The failure assessment model for private limited knowledge-intensive services (KIS) companies can help stakeholders better understand the performances of companies and reduce the possibility of missed opportunities and the risk of investment failure caused by information asymmetry

Summary

Introduction

The narrow definition of financial risk is the possibility that a company may default on its debts, and its essence is the evaluation of companies’ debt control capabilities or financial leverage management (Valaskova et al 2018) This may be the reason why there has been plenty of bankruptcy research in the field of debt default. From the perspective of the ERM theory, the survival and prosperity of a company depends on its abilities to deal with risks in internal operations and properly handle possible losses caused by uncertainties in external environments (Da Silva Etges and Cortimiglia 2019). These risks come from various aspects, such as finance, operation, natural disasters, policies and technology innovation

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