Abstract
This study attempts to clarify whether using a hybrid model based on non-financial variables and financial variables is able to provide a more accurate company financial distress prediction model than using a model based on financial variables only. The relationship between the model test results and the De la Rey K-Score for the subject companies is tested, employing Cramer’s V statistical test. A movement towards a Cramer’s V value of one indicates a strengthening relationship, and a movement towards zero is an indication of a weakening relationship. Against this background, further empirical research is proposed to prove that a model combining financial variables with true non-financial variables provides a more accurate company distress prediction than a financial variable-only model. The limited evidence of a strengthening relationship found is insufficient to establish the superiority of the proposed model beyond reasonable doubt.
Highlights
When companies fail, the consequences for stakeholders are far-reaching
There is no generally accepted listing of non-financial variables that can be used in forecasting company distress, a limited number of studies have identified a unique set of nonfinancial variables
Scenario 2 uses a model based on non-financial variables only; and Scenario 3 uses a model based on a combination of financial and non-financial variables
Summary
The consequences for stakeholders are far-reaching. Shareholders stand to lose most, because the value of their investment deteriorates significantly or is lost completely. Continuously changing market dynamics that affect company performance could potentially have a detrimental effect on the validity of these models It is doubtful whether a model based purely on historical financial variables would be able to predict company financial distress with reasonable accuracy (Agarwal & Taffler, 2008:1542). This study is important to stakeholders and will benefit them because it combines non-financial variables with an existing South African-based financial distress prediction model This hybrid model has the potential to enhance the ability of a particular stakeholder to identify financial distress timeously, and, where applicable, to take appropriate remedial action to avoid failure.
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