Company failure prediction with limited information: newly incorporated companies

Abstract

Developing ‘Internal Rating Systems’ (IRB) for corporate risk management requires building risk (PD) models geared to the specific characteristics of corporate sub-populations (eg small and medium-sized enterprises (SMEs), private companies, listed companies, sector specific models), tuned to changes in the macro environment, and, of course, tailored to the available data. Tracking the risk of ‘newly incorporated companies’ provides a particular challenge since there is very limited publically available data in the time period from incorporation date until the submission of the first accounts. Yet a large number of these companies fail (via bankruptcy). We employ a substantial database to estimate discrete time hazard models (DHM) over the period 2000–2008 (4 427 896 firm-year observations and 34 903 incidences of insolvency), inclusive of macro and regional economic conditions, that capture early indicators of financial stress and measure aspects of the characteristics of board of directors in order to assess the utility of this type of non-financial information in failure prediction models.