Predicting financial distress: evidence from Italian troubled debt restructuring agreements

This paper focuses on the ability of accounting ratios to predict the financial distress status of a firm as defined by the Italian Insolvency Law of 2006, which introduced the Troubled Debt Restructuring (TDR) procedure in Italian law. Based on a linear discriminant analysis, we formulate the probability of a firm to file for TDR in one year, as well as other quantitative tools that are intended to measure financial health status. We begin with a test of Altman’s Z, Z’ and Z’’ scores for bankruptcy (1968, 1993, 2000) on the listed Italian companies that filed for TDR. The test results are not satisfying for the TDR prediction. Therefore, we introduce a new score formula based on seven accounting ratios and specific coefficients. A confirmative analysis has also been conducted to validate the predictive accuracy of our score formula.