Audit Integrity Launches New Bankruptcy Risk Model


New York – One of the more nuanced areas of investment research is that of bankruptcy investment. When a firm crosses the line between solvency and bankruptcy protection, traditional investors back off. This raises the opportunity for some brave souls to take bets as to whether the firm will reemerge from bankruptcy. Statistical studies indicate that these firms are vastly undervalued when in bankruptcy protection and therefore have a large upside potential when they reemerge.

 There are of course a handful of research providers in the Integrity database that do the deep dive analysis on the probability of a firm’s reemergence. We classify this approach as distressed/bankruptcy analysis.

 The counterpart to the reemergence from bankruptcy long play is the short play associated with the entry of a firm into bankruptcy protection. Because the event tends to create an undervalued asset scenario, taking advantage of both side of this play can be highly profitable.  There are a number of research approaches that give an indication of the probability of bankruptcy (or more generally a credit event). These are credit analysis firms, such as the rating agencies, credit default models and risk arbitrage research providers.

 One new firm in the space is Audit Integrity. Audit Integrity utilizes forensic approaches to finding troubled firms or firms that are squeaky clean, utilizing a quantitative analytical process.  Last week, they announced a new model which is specifically designed for sniffing out firms that have a high probability of bankruptcy.  As one might expect, they call this model the bankruptcy model.

 Knowing that there was already a well know indicator to signal the bankruptcy event—namely the Altman Z-score—Audit Integrity used this as the bogey for its model and found that the Audit Integrity model had 20 percentage points of greater predictability than the Altman Z-score system. 

 So what is the special sauce? Audit Integrity indicates that they use not only the standard liquidity, leverage, cash flow and profitability factors, but also include measures of corporate governance and fraudulent accounting indicators in their bankruptcy risk model.


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