Decomposition Measures and the Prediction of Financial Failure

Lev has indicated that the decomposition measures of failed firms are larger than those of non‐failed firms and concludes that decomposition measures may be usefully included in financial failure prediction models. This paper extends the use of decomposition measure concepts for financial failure prediction. Firstly, on a univariate basis, attributes of decomposition measures are tested for discriminating ability between failed and non‐failed companies. Secondly, all decomposition measures tested are used to derive a discriminant analysis model for failure prediction. The paper concludes that (1) the stability and size of some balance sheet derived decomposition measures discriminate between failed and non‐failed companies as far as four years before failure, and (2) a discriminant analysis model of balance sheet derived decomposition measures is not successful at predicting financial failure.