Misclassification in bankruptcy prediction in Finland: human information processing approach

In this study the factors behind the decision‐makers’ erroneous judgements regarding failure prediction (classification of firms as bankrupt and non‐bankrupt) are analysed. The purpose is to find out the factors causing incorrect responses, i.e. the cases in which the decision‐maker is for some reason incapable of using the given information to arrive at the correct classification. The following five possible sources of disturbance in this decision‐making were hypothesized: firm‐specific factors, data, decision‐maker‐specific factors, external factors, and failure process. In further analysis these factors were empirically operationalized and their significance was tested applying logistic (logit) analysis separately for the Type I and Type II classification errors identified in an HIP study. The results indicated that the effect of all of the five hypothesized factors on misclassifications is statistically significant. The inconsistency of the cues (firm‐specific factors) may be the main factor causing errors in evaluation. Moreover, the failure process is another important factor (Type I error). Thus, human bankruptcy prediction can be improved mainly by checking the consistency of financial statements (that they give a true view of the firm’s economic status) and by paying special attention to timely identification of the possible failure process. Future HIP studies on bankruptcy prediction and also other economic events should pay attention to control the kinds of sources of disturbance identified in this study, to maintain validity.