Are, Therefore, Not Possible. Please Note

Dear Author,
Here are the proofs of your article.
• You can submit your corrections online, via e-mail or by fax.
• For online submission please insert your corrections in the online correction form. Always
indicate the line number to which the correction refers.
• You can also insert your corrections in the proof PDF and email the annotated PDF.
• For fax submission, please ensure that your corrections are clearly legible. Use a fine black
pen and write the correction in the margin, not too close to the edge of the page.
• Remember to note the journal title, article number, and your name when sending your
response via e-mail or fax.
• Check the metadata sheet to make sure that the header information, especially author names
and the corresponding affiliations are correctly shown.
• Check the questions that may have arisen during copy editing and insert your answers/
corrections.
• Check that the text is complete and that all figures, tables and their legends are included. Also
check the accuracy of special characters, equations, and electronic supplementary material if
applicable. If necessary refer to the Edited manuscript.
• The publication of inaccurate data such as dosages and units can have serious consequences.
Please take particular care that all such details are correct.
• Please do not make changes that involve only matters of style. We have generally introduced
forms that follow the journal’s style.
Substantial changes in content, e.g., new results, corrected values, title and authorship are not
allowed without the approval of the responsible editor. In such a case, please contact the
Editorial Office and return his/her consent together with the proof.
• If we do not receive your corrections within 48 hours, we will send you a reminder.
• Your article will be published Online First approximately one week after receipt of your
corrected proofs. This is the official first publication citable with the DOI. Further changes
are, therefore, not possible.
• The printed version will follow in a forthcoming issue.
Please note
After online publication, subscribers (personal/institutional) to this journal will have access to the
complete article via the DOI using the URL: http://dx.doi.org/[DOI].
If you would like to know when your article has been published online, take advantage of our free
alert service. For registration and further information go to: http://www.link.springer.com.
Due to the electronic nature of the procedure, the manuscript and the original figures will only be
returned to you on special request. When you return your corrections, please inform us if you would
like to have these documents returned.
Metadata of the article that will be visualized in
OnlineFirst
ArticleTitle Can earnings management information improve bankruptcy prediction models?
Article Sub-Title
Article CopyRight The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature
(This will be the copyright line in the final PDF)
Journal Name Annals of Operations Research
Corresponding Author Family Name Veganzones
Particle
Given Name David
Suffix
Division
Organization ESCE International Business School
Address Paris, France
Phone
Fax
Email david.veganzones@gmail.com
URL
ORCID http://orcid.org/0000-0002-6456-3393
Author Family Name Séverin

Particle
Given Name Eric
Suffix
Division
Organization Institut D’Administration Des Entreprises de Lille (IAE)
Address Lille, France
Phone
Fax
Email
URL
ORCID
Received
Schedule Revised
Accepted 24 June 2021
Abstract This study investigates whether earnings management in its two forms (accruals and real activities
manipulation) can improve bankruptcy prediction models. In particular, it examines whether special
information extracted from earnings management, including potential manipulations of the reported
earnings found in financial statements, might improve the accuracy of bankruptcy prediction models. It
applies earnings management–based models, based on financial ratios and earnings management variables,
to a sample of 6,000 French small and medium-size enterprises, then compares the classification rates
obtained by these models with a model based solely on financial ratios. This study thus makes several
contributions by (1) investigating novel predictors, accruals, and real activities manipulation variables, in
the context of bankruptcy prediction modeling; (2) enabling analyses of the contribution of earnings
management–based variables, in the form of static and dynamic indicators, to model performance; (3)
revealing the influence of these variables on the forecasting horizon of bankruptcy prediction models (one-
to three-year horizon); and (4) establishing that earnings management information provides a
complementary explanatory variable for enhancing model performance.
Keywords (separated by '-') Earnings management - Bankruptcy prediction models - Corporate finance
JEL Classification (separated G33 - C53
by '-')
Footnote Information
Journal : SmallCondensed 10479 Article No : 4183 Pages : 26 MS Code : 4183 Dispatch : 3-7-2021
Annals of Operations Research

https://doi.org/10.1007/s10479-021-04183-0
1 S.I. : REGRESSION METHODS BASED ON OR TECHNIQUES
2 Can earnings management information improve bankruptcy

Author Proof
3 prediction models?
4 Eric Séverin1 · David Veganzones2
5 Accepted: 24 June 2021

6 © The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature 2021
7 Abstract
8 This study investigates whether earnings management in its two forms (accruals and real
9 activities manipulation) can improve bankruptcy prediction models. In particular, it exam-
10 ines whether special information extracted from earnings management, including potential
F
11 manipulations of the reported earnings found in inancial statements, might improve the
O
12 accuracy of bankruptcy prediction models. It applies earnings management–based models,
13 based on inancial ratios and earnings management variables, to a sample of 6,000 French
O
14 small and medium-size enterprises, then compares the classiication rates obtained by these
15 models with a model based solely on inancial ratios. This study thus makes several con- AQ2
PR
16 tributions by (1) investigating novel predictors, accruals, and real activities manipulation
17 variables, in the context of bankruptcy prediction modeling; (2) enabling analyses of the
18 contribution of earnings management–based variables, in the form of static and dynamic
19 indicators, to model performance; (3) revealing the inluence of these variables on the
D
20 forecasting horizon of bankruptcy prediction models (one- to three-year horizon); and (4)
establishing that earnings management information provides a complementary explanatory
TE
21
22 variable for enhancing model performance. AQ1
23 Keywords Earnings management · Bankruptcy prediction models · Corporate inance

EC
24 JEL Classification G33 · C53

R
R
O
NC
U
A1 * David Veganzones
A2 david.veganzones@gmail.com
1
A3 Institut D’Administration Des Entreprises de Lille (IAE), Lille, France
2
A4 ESCE International Business School, Paris, France
13
Vol.:(0123456789)
25 1 Introduction
26 Earnings constitute an important entry in inancial statements, because they provide a

27 measure of irm performance. They also arguably drive irms’ future prospects and value
Author Proof
28 (Richardson et al., 2005). When irm executives manipulate earnings, or engage in earn-
29 ings management, they seek to specify desired irm inancial performance (Burgstahler
30 & Dichev, 1997).1 Although questions regarding earnings management, inancial perfor-
31 mance, and irm bankruptcy are frequently studied topics (Campa & Camacho-Miñano,
32 2015), few investigation—even in the aftermath of the global inancial crisis—focus on the
33 relationship between earnings management and irm bankruptcy models. In their recent
34 contribution, du Jardin et al. (2019) note the inluence of inancial manipulation as a com-
35 plementary variable and show that unique information extracted from analyses of inancial
36 manipulations can provide explanatory variables that enhance the accuracy of bankruptcy
37 prediction models. They attest that by considering earnings management, it is possible
to capture inancial information that is not included in inancial statements but that still
F
38
39 might afect irm inancial performance. Thus, inancial manipulation might be considered
O
40 a means to forecast irm bankruptcy. However, the authors account only for the predictive
41 power of accruals-based earnings management. Empirical studies of earnings management
O
42 mainly have focused on accruals; their results indicate the presence of discretionary earn-
43 ings through accrual alterations (Dechow & Skinner, 2000). Yet other studies document
PR
44 that accruals are not the only tool available for manipulating earnings; irms also conduct
45 earnings management through real activities (Hribar et al., 2006; Roychowdhury, 2006).
46 Managers’ actions in the course of normal business practices can produce deviations, espe-
D
47 cially in cash lows, that relate directly to earnings and thus can produce certain earnings
48 values. In this sense, du Jardin et al.’s (2019) study does not address whether earnings
TE
49 management information can predict bankruptcy, because it accounts only for accruals-
50 based earnings management.
51 Accordingly, we investigate the efect of earnings management information (accruals
EC
52 and real activities) on predictions of irm bankruptcy, to determine whether it provides

53 additional predictive power. We seek to extend failure forecasting models by considering
54 earnings management information that is assimilated with the intended manipulation of
R
55 inancial statements. More technically, if accruals and real activities represent the main
56 tools available to conduct earnings management, both types of manipulation should be
R
57 explored simultaneously to understand the impact of earnings management in bankruptcy

58 prediction.
O
59 We also comparatively evaluate the forecasting ability of various prediction models,

relying on inancial ratios in prediction models augmented by earnings management infor-
NC
60
61 mation. With this approach, we extend du Jardin et al.’s (2019) work in three ways.
62 • First, we analyze the independent impact of both types of earnings management–

U
63 based variables (accruals and real activities) on the performance of bankruptcy pre-
64 diction models. We adopt Kothari et al.’s (2005) accrual model, together with Roy-
65 chowdhury’s (2006) real activities model. Each form of earnings management might
1
1FL01 Earnings management occurs when managers use their judgment to develop inancial reports and struc-
1FL02 ture transactions, but they also may alter inancial reports to mislead some stakeholders about their irms’
1FL03
underlying economic performance or inluence contractual outcomes that depend on reported accounting
1FL04
numbers (Healy and Wahlen, 1999).
13
66 stem from diferent motivations, and its impact on bankruptcy model might vary
67 with the irm’s inancial conditions (bankrupt versus non-bankrupt). Our indings
68 reveal the discriminatory power of earnings management tools for difering predic-
69 tion horizons (i.e., one to three years prior to the moment of bankruptcy). Accord-
Author Proof
70 ingly, our paper contributes to literature that considers the importance of predic-
71 tor variables on the performance of bankruptcy prediction models by adding new
72 insights on how earnings management–based variables serve as predictors of bank-
73 ruptcy.
74 • Second, earnings management–based variables have been computed in two forms, as
75 static (calculated in one particular year) or dynamic (variation over two years) indica-
76 tors. On the one hand, a static vision assumes that inancial manipulation may be a sud-
77 den action, independent of the previous practices, and take only one form. On the other
78 hand, a dynamic vision implies a phase of the manipulation process in which the irm
79 inds itself, which leads to diferent manipulation practices over time. Accordingly, we
F
80 shed light on which form better encapsulates the information extracted from earnings
management to serve as explanatory variables in bankruptcy models.
O
81
82 • Third, we analyze the combined impact of accruals and real activities measures on
O
83 the contributions of earnings management models. For this purpose, we estimate a
84 bankruptcy model in which we consider the simultaneity of accruals and real activi-
85
86
PR
ties manipulation, because these manipulations are interdependent and not mutually
exclusive (Liu et al., 2014). That is, accruals and real activities–based variables may
provide complementary information, such that a model that considers both variables
87
88 together may lead to more accurate predictions. Accordingly, we further contribute
D
89 to the body of knowledge by proposing a novel class model that, to our knowledge,
90 has never been applied to bankruptcy prediction literature.
TE
91 In summary, our article provides deinitive indings about the capacity of earnings
92 management–based variables to improve bankruptcy prediction models. These ind-
EC
93 ings ofer evidence of improvements to forecasting models that include both inancial
94 ratios and earnings management information. Although the capacity for improvement
95 achieved with the use of accruals and real activities–based variables is similar, accruals-
R
96 based models better forecast failed irms, whereas real activities models provide spe-
97 ciic information for identifying non-failed irms. Moreover, our results indicate that
R
98 both forms of earnings management variables—static and dynamic—possess signiicant

99 discriminatory power, but in diferent ways. Finally, we ind evidence that the model
O
100 that includes both indicators of earnings management leads to more accurate and robust
results, especially with static variables.
NC
101
102 The remainder of this article consists of four sections. Section 2 presents a literature
103 review; Sect. 3 discusses methodology; Sect. 4 provides an empirical evaluation; and
104 Sect. 5 concludes.
U
105 2 Literature review
106 In this section, after reviewing the evolution of literature devoted to bankruptcy predic-
107 tion models and the variables used for prediction, we focus on studies that investigate
108 the relationship between corporate bankruptcy and earnings management.
13
109 2.1 Bankruptcy prediction models
110 Since Beaver (1966) and Altman (1968) conducted their pioneering studies, the ability to
111 forecast corporate failure has been a subject of increasing importance for corporate inance
Author Proof
112 because of its signiicant inancial and economic impacts on many segments of society.
113 Diverse perspectives, prediction methods, and determinants of failure have been proposed,
114 such that it is possible to divide the evolution of corporate failure research into three main
115 periods.
116 In the mid-1960s and 1970s (the “foundational era”), studies generated initial corporate
117 failure models, which included inancial information based on statistics (Meyer & Pifer,
118 1970; Norton & Smith, 1979). Financial information extracted from annual statements
119 served to create explanatory variables, and well-known concepts from statistical decision
120 theory established discriminatory boundaries between two irm classes: failed irms and
121 non-failed irms.
122 A second remarkable period arrived in 1990s, when the evolution of computers and
F
123 computational science allowed more complex modeling of corporate failure (Charalam-
O
124 bous et al., 2000; Leshno & Spector, 1996; Wilson & Sharda, 1994). These new artiicial
125 intelligence techniques immediately replaced the former statistical methods, because they
O
126 did not require any data-speciic assumptions; they learned directly from the data, and by
127 relying on nonlinear approaches, they ofered extended possibilities for testing complex
PR
128 data, such as those pertaining to corporate failure.
129 Finally, a new perspective emerged as a critique of the classical paradigms of previous
130 bankruptcy prediction studies; it focuses mostly on developing an innovation prediction
D
131 method, according to advanced statistics or machine learning, to enhance model perfor-
132 mance. This trend proposes that the performance of corporate failure models depends not
TE
133 only on the complexity of the prediction method but also on explanatory variables. Noting
134 the relevance of paying attention to the predictive power of data sources, our studies seek
135 to enrich the strand of literature that investigates the role of explanatory variables in bank-
EC
136 ruptcy prediction models.

R
137 2.2 Variables to predict bankruptcy

R
138 Not surprisingly, inancial ratios—which represent the relationship between two igures
O
139 extracted from inancial information—are the dominant indicators of bankruptcy, because
140 numerous causes that lead to bankruptcy can be observed in inancial ratios. Moreover,
NC
141 they are objective measures drawn from publicly available information (Micha, 1984), so
142 many studies build their bankruptcy prediction models using solely inancial ratios. In this
143 regard, Liang et al. (2016), in line with Altman et al. (2010), claim that any model con-
taining only inancial information cannot predict failure with certainty, because it encap-
U
144
145 sulates only that part of bankruptcy contained in the inancial information. These authors
146 also express doubt about the capacity of models to predict failure with evidence only from
147 inancial ratios, noting the many possible causes of bankruptcy. Some subsequent stud-
148 ies have investigated complementary factors, such as market (Doumpos et al., 2017; Tian
149 et al., 2015), corporate governance (Ciampi, 2015; Liang et al., 2016), DEA eiciency
150 (Ouenniche & Tone, 2017; Tsolas, 2015), and economic (Fabling & Grimes, 2005; Mare,
151 2015) variables. The inclusion of such variables provides greater discriminatory power
152 and improves model accuracy, but they tend to be diicult to gather or are available only
13
153 for speciic irms. As a result, inancial information still represents the core of bankruptcy
154 models.
155 If accounting-based models dominate eforts to predict corporate bankruptcy, the qual-
156 ity of the inancial information becomes a key question. Although the use of inancial
Author Proof
157 information implies inancial statements provide fair and true views of irms’ inancial situ-
158 ations, inancial igures can be altered but still accord with lexible accounting rules (Libby
159 et al., 2015). Thus, inancial statements might not relect irms’ real, underlying situations.
160 Accounting loopholes allow managers to use their judgment, thereby displaying their dis-
161 cretionary objectives. In particular, managers tend to alter the level of earnings in inancial
162 accounts (known as earnings management), because earnings are the main indicators of
163 management performance (Richardson et al., 2005).
164 Garcia-Lara et al. (2009) argue that because irms may exhibit diferent forms of earn-
165 ings management behavior, according to their inancial health, a variable that encapsulates
166 potential earnings management should provide signiicant information to distinguish failed
F
167 from non-failed irms. Earnings management information may be an ideal complementary
indicator to inancial ratios for two reasons: First, it is available for all irms that publish
O
168
169 their inancial accounts, and second, it accounts for the part of inancial information not
O
170 relected in annual accounts (when irms manipulate their igures) but that may be relevant
171 for identifying irms’ good faith. In this line, Beaver et al. (2012) claimed that authors ana-
172
173
PR
lyzing corporate bankruptcy should take into consideration the inclusion of indicators to
detect earnings management and not assume that inancial information always relects a
true view of irms’ inancial situation. Thus, the inclusion of this information may be espe-
174
175 cially useful to overcome the loss of model performance due to irms altering their inan-
D
176 cial igures.
TE
177 2.3 Studies related to earnings management and corporate bankruptcy

EC
178 When analyzing corporate bankruptcy, researchers routinely examine earnings manage-
179 ment, because irms can alter their inancial accounts to hide their critical inancial situa-
180 tions. Table 1 contains a list of recent studies that analyze earnings management by bank-
R
181 rupt irms. We highlight several general themes that emerge from this table.
182 The irst category of themes focuses on earnings management behavior before bank-
R
183 ruptcy procedures begin. Most studies in Table 1 fall into this category. Our seek to empha-
184 size the incentives or factors that lead irms to engage in earnings management prior to
O
185 iling for bankruptcy and to analyze which tools managers prefer to use to alter earnings.
In this regard, studies conirm the existence of extensive earnings management practices
NC
186
187 by irms before they ile for bankruptcy. Nonetheless, the studies provide heterogeneous
188 results with regard to the direction of earnings management; in critical inancial situations,
189 there are incentives for both upward (Etemadi et al., 2013; Hassanpour & Ardakani, 2017)
U
190 and downward (Franceschetti & Koschtial, 2013; Habib et al., 2013) earnings management.
191 Empirical evidence also reveals signiicant diferences between failed and non-failed
192 irms with regard to their earnings management indicators (Campa & Camacho-Miñano,
193 2015; Garcia-Lara et al., 2008). They relate the choice towards one earnings manage-
194 ment tool over the other in relation to the inancial health. Bearing this is mind, as Table 1
195 indicates, recent studies have started to evaluate whether earnings management has pre-
196 dictive power in corporate failure prediction models. In particular, du Jardin et al. (2019)
197 investigate the impact of accruals-based earnings management variables on bankruptcy
198 prediction models and ind that using an accruals-based model that embeds a irm’s
13
Author Proof
13
NC
Table 1 Recent studies devoted to the relationship between earnings management and bankruptcy
Journal : SmallCondensed 10479
Study Data Sample size Time period Key results

O
Garcia-Lara et al. (2008) UK irms R 352 1998–2004 Accruals manipulation is more pronounced in ex post bankrupt irms
Biddle et al. (2011) USA listed irms 4 621 1989–2007 Bankruptcy risk is positively associated with earnings management
Li et al. (2011) Chinese listed irms
R 987 2003–2007 The levels of earnings management are diferent depending on whether a irm expe-
Article No : 4183
rience distress or not prior bankruptcy

Etemadi et al. (2013) Iranian listed irms 136 2006–2009 Under pressure of audit opinion, irms are compelled to employ earnings manipula-
tion
EC
Franceschetti and Koschtial (2013) Italian SMEs 60 2011–2012 Income decreasing earning management prior bankruptcy
Habib et al. (2013) New Zealand irms 767 2000–2011 Managers of distressed irms engage more in income-decreasing earnings practices
Pages : 26
Bisogno and de Luca (2015) Italian SMEs 200 2006–2011 Securing outside inancing in an incentive to engage in earnings management
TE
Campa and Camacho (2015) Spanish SMEs 724 2006–2010 Upward earnings manipulation of bankrupt irms with respect to non-bankrupt
D irms
Hassanpour and Ardakani (2017) Iranian listed irms 133 2010–2014 Positive relation between pre-bankruptcy inancial distress and earning management
MS Code : 4183
practices
du Jardin et al. (2019) French non-listed irms 14 040 2006–2012 Accruals-based variables enhance the performance of corporate failure prediction
models
PR
Agustia et al. (2020) Indonesian listed irms 1 068 2014–2016 The efect of earnings management to bankruptcy risk is mitigated with business
strategies
O
O
Dispatch : 3-7-2021
F
199 earnings management enhances the performance of bankruptcy models. Their study merely
200 “scratches the surface” of the ability of earnings management variables to predict bank-
201 ruptcy, such that aspects of earnings management that may contribute to the performance
202 of bankruptcy prediction models remain unknown.
Author Proof
203 We explore the predictive power of a new form of data: real activities manipulation,
204 which provide a cornerstone for recent studies. In accounting literature, these data have
205 shifted the discussion about earnings management, which previously focused almost exclu-
206 sively on accruals manipulation. Despite being one of the two main tools (along with
207 accruals) available to managers to manipulate earnings, and despite substantial documenta-
208 tion of real activities–based earnings management in failed irms, the efectiveness of this
209 information to predict corporate bankruptcy has not yet been evaluated. To ill this gap, we
210 study real activities–based bankruptcy prediction models and compare their performance
211 with accruals-based and accounting-based models. We also propose a new earnings man-
212 agement–based corporate failure prediction model that simultaneously considers accruals
F
213 and real activities manipulations. The model attempts to incorporate all earnings manage-
ment information to support its predictions, as output.
O
214
215 Unlike du Jardin et al. (2019), who irst to apply earnings management information in
O
216 bankruptcy prediction models and encapsulate this indicator as a static variable, we cal-
217 culate earnings management indicators as dynamic variables and thereby account for the
218
219
PR
possibility that the level of current earnings management practices depends on previous-
year practices. Therefore, we evaluate which form of variable (static or dynamic) better
enhances model performance and in turn can identify the optimal method for encapsulating
220
221 earnings management information. With this deep analysis to address the capacity of earn-
D
222 ings management information to predict bankruptcy, our study adds to extant literature; it
223 comprehensively accounts for all aspect of earnings management that signiicantly improve
TE
224 the performance of bankruptcy prediction models.

EC
225 3 Methodological approach
226 We extend bankruptcy prediction models by proposing the novel explanatory variable of
R
227 earnings management. In this section, we detail the methodological approach we use to
228 design our proposed prediction model. Figure 1 displays this design procedure.
R
O
229 3.1 Data set

NC
230 We drew our data from a French database (Diane) managed by bureau Van Dijk. This data-
231 base includes balance sheet and income statement information from French irms, which
232 are required by law to ile annual reports with the French commercial courts. We built the
U
233 data set by collecting both a training set that estimates model parameters and a test set that
234 evaluates the models’ accuracy. We collected training and test sets that have a lag of one
235 year. We estimated an out-of-sample and out-of-time error with an intertemporal validation
236 and did not include any the irms in the training set in the test set. This procedure increases
237 conidence in our bankruptcy prediction models, because we tested them on subsequent
238 data, by construction (Balcaen & Ooghe, 2006). We selected irms in the training set from
239 2016 and irms in the test set from 2017, thereby establishing the time t, such that irms
240 continue their activities at time t + 1 (non-failed), or irms proceed to be liquidated or reor-
241 ganized at t + 1 (failed). To be selected, irms had to have at least three years of inancial
13
2. Generate earnings
1. Identify Training
management-based
financial ratios sample
variables
Author Proof
Financial Accrual-based Real act.-based

ratios (F.R) variable (Acc) variable (R.A)
Model 1 Model 2 Model 3 Model 4 (F.R +

(F.R) (F.R + Acc) (F.R + R.A) Acc + R.A)
F
O
O
PR
3. Set up the hyperparameters of prediction
methods by model
D
TE
Prediction
Test sample
Evaluation
EC
Fig.1 Snapshot of the methodological approach employed to design earnings management-based models
R
R
242 data available, such that we could test the prediction models on short-term (one-year) and
O
243 mid-term (two- and three-year) bankruptcy horizons.

244 The training and testing sets consist of 4000 and 2000 irms, respectively, each with
NC
245 the same number of bankrupt and non-bankrupt irms.2 We selected small- and medium-
246 sized enterprises, which are known to manage their earnings (Ball & Shivakumar, 2005)
U
2
2FL01 Although failed irms are clearly outnumbered by non-failed irms in general, most studies use equal
2FL02 numbers (Yu et al., 2014), because predicting bankruptcy using a representation of the whole population
2FL03
(imbalanced data set, in which failed irms only represent 5%) can produce a suboptimal classiication
2FL04
2FL05
model that provides unfavorable predictions across data classes, concentrated on predicting the majority
2FL06 class (non-failed irms) and ignoring the minority class (failed irms). We use a popular paired-sample tech-
2FL07 nique, such that we pair data about irms that have failed with irms that have not, according to their indus-
2FL08 try sector (Gordini, 2014). In turn, we can evaluate the impact of earnings management in the bankruptcy
prediction model without the distortion that imbalanced data sets can cause.
13
Table 2 Descriptive analysis of Failed irms (%) Non-failed

sample irms irms (%)
Industry sector
Author Proof
Trade 36.5 36.5

Manufacturing 32.4 32.4
Services 31.1 31.1
Size (turnover in euros)
Size (below 0.5 million) 40.2 37.5
Size (0.5–1 million) 38.4 37.7
Size (over 1million) 21.4 24.
Nº employees
Nº employees (1–5) 55.2 52.4
Nº employees (6–10) 33.5 36.9
F
Nº employees (over 10) 12.3 10.7
O
The service sector includes personal services and transport; the manu-
facturing sector includes agriculture, manufacturing, and construction;
O
the trade sector includes retail, wholesale, and restaurants
247
248
PR
and to represent the majority of irms in industrialized countries.3 As Table 2 reveals,
because both bankrupt and non-bankrupt irms have similar characteristics in terms of size
249 and number of employees, this comparison appears acceptable. In addition, models from
such data should be applicable to a broad range of irms, in terms of size and industry
D
250
251 representation.4
TE
252 3.2 Identifying inancial ratios

EC
253 We used inancial ratios extracted from annual accounts and inancial statements as explan-
254 atory variables to build bankruptcy prediction models. In particular, we computed 50
255 inancial ratios, used in du Jardin’s (2015) study, that measure relevant inancial charac-
R
256 teristics, including liquidity, solvency, proitability, inancial structure, turnover, and activ-
257 ity. However, the use of all 50 inancial ratios would have led to a very high-dimensional
R
258 feature space that could have reduced the model’s predictive ability. Thus, we selected a
259 subset of the most relevant inancial ratios using a three-step prodecure. First, we evalu-
O
260 ated which variables relect signiicant diferences in irms’ classes, according to t-tests and
261 Kruskal–Wallis tests, then excluded variables that did not reveal signiicant discrimination
NC
262 between failed and non-failed irms.

263 Second, we analyzed the correlation values between each variable to measure the redun-
264 dancy of information among them. Removal of highly correlated variables reduces poten-
U
265 tial instabilities, such as the need to solve poorly conditioned inverse matrices (Mensah,
3
3FL01 Small- to medium-sized enterprises employ between 10 and 250 people, earn turnover between €2 and
3FL02 €50 million, and have total assets between €2 and €43 million (http://ec.europa.eu). They represent 99.6%
3FL03
of irms in Europe, employ 69.5% of workers, and contribute to the 60.1% of the gross valued added gener-
3FL04
ated in the EU-28 in 2017 (Source: Annual Report on European SMEs 2017/2018).
4
4FL01 Firms in inancial intermediation or insurance, real estate irms, and foreign activities irms are excluded
4FL02 because their inancial accounts have diferent characteristics than those of other irms, which would make
4FL03
comparisons based on earnings manipulation and inancial information problematic.
13
Table 3 Descriptive statistics of the inancial variables

Financial variables Failed irms Non-failed irms
Mean SD Median Mean SD Median t-test K-W test
Author Proof
Cash/Total Assets 0.01 0.03 0.077 0.032 0.136 0.161 *** ***
Current Liabilities/Total Assets 0.283 0.480 0.561 0.11 0.218 0.357 *** ***
Quick Assets/Current Liabilities 0.018 0.051 0.124 0.048 0.16 0.248 *** ***
Financial Expenses/Total Assets 0.008 0.012 0.018 0.001 0.003 0.007 *** **
Shareholder Funds/Permanent Equity 0.06 0.513 0.963 0.909 1.172 1.947 *** ***
Net Income/Total Sales 0.311 0.805 0.905 0.431 0.934 1.22 *** ***
Total Sales/Total Assets 0.67 1.24 1.93 0.977 1.594 2.496 *** ***
SD , standard deviation. The t-test refers to the t-ratio test for the diference in mean. K-W test denotes the
Kruskal–Wallis test for the diference in medians
***Signiicant at 1% level; **signiicant at 5% level
F
O
266 1984). However, because there is no theory that indicates the value at which a variable
267 should be considered highly correlated, we empirically selected variables with correlation
O
268 values lower than 0.6; Atiya (2001) uses 0.7, and du Jardin and Severin (2012) use 0.65, in
269 similar study contexts. By being even more conservative, we can better avoid redundancy.5
PR
270 Third, among the many variable selection methods available in prior literature, it is
271 unclear which method will enable a prediction method to provide the best performance
272 (Tsai, 2009). Variable selection methods may inluence prediction models by including
D
273 unnecessary variables while eliminating signiicant ones (du Jardin, 2010). To reduce this
274 possible impact of the choice of variable selection methods, we employed an intuitive, wis-
TE
275 dom-of-the-crowd idea, as proposed by du Jardin and Séverin (2012) and used by Ciampi
276 et al. (2018). If several diverse, independent feature selection methods select a variable, it
277 likely is more representative. Thus, we retained variables selected by at least three of the
EC
278 ive methods used.

279 These variable selection methods represent two categories, ilter or wrapper. Filter
280 methods are based on statistical concepts and are computationally eicient and statistically
R
281 diferentiable, particularly when the variables under consideration are numerous (Guyon &
282 Elisseef, 2003). Stepwise search procedures with the Fisher F-test and the X2 test establish
R
283 the stopping criteria. In contrast, wrapper methods depend on the classiier, which eventu-
ally is used to predict bankruptcy, to assess the set of variables. Both methods rely on a
O
284
285 heuristic technique that selects variables according to their usefulness for a given classiier.
NC
286 In our case, the three-wrapper variable selection methods relied on backward search pro-
287 cedures. In each case, we performed the evaluation out-of-sample. We divided the training
288 set into two parts, using 70% during the learning phase and the remaining 30% to evaluate
289 performance. We searched for subsets of variables that led to best performance.
U
5
5FL01 When the correlation between two variables is greater than 0.6, we remove one of them. That is, to bal-
5FL02 ance the inancial dimensions included in the initial set of variables, we remove one of the two variables
5FL03
that gives too much weight to a given inancial dimension among those represented in the initial set of
5FL04
5FL05
variables. Although neither variable is likely to overweight a given dimension, we rely on a factor analysis
5FL06 to remove the least relevant variable. Following this procedure, we ensure diversity among inancial dimen-
5FL07 sions and avoid concentration of the most representative ones, such as proitability, liquidity, and inancial
structure (Kirkos, 2015).
13
290 Table 3 lists the selected variables and their descriptive statistics. In line with our expec-
291 tations, it shows failed irms display lower solvency, liquidity, and proitability values and
292 weaker inancial structures than non-failed irms. The inancial variables also exhibit sig-
293 niicant diferences in their mean and median values across failed and non-failed irms.
Author Proof
294 3.3 Earnings management proxy-based variables
295 The measure of earnings management by a irm captures manipulations of its accounts,
296 which naturally is a complex task. Therefore, we need a proxy or model that uses compo-
297 nents directly related to earnings. Two metrics eiciently identify earnings management
298 that relies on accruals or real activities-based models. These proxies are regression mod-
299 els that attempt to explain the amount of accruals/real activities through some explana-
tory variables. The use of these regression models has become the accepted methodology
F
300
301 in accounting to capture discretion, because they isolate the managed component of earn-
O
302 ings (Dechow et al., 2010). We use models that account for accruals and real activities,
303 because prior literature shows both components can be leveraged for earnings management
O
304 activities.
305 In our regressions, the estimated parameters assess the normal values of a component,
306
307
PR
and the residual represents a discretionary value of the parameters for each irm. Thus, with
the estimated residuals 𝜀it , we can capture potential earnings management, which we use
308 in conjunction with inancial ratios to enhance the contribution of earnings management
information to irms’ bankruptcy models. We focus on the absolute value of discretion-
D
309
310 ary accruals/real activities, which ofers the most common unsigned measure of earnings
TE
311 management (Chowdhury et al., 2018; Mouselli et al., 2012; Sun & Liu, 2016; Yu, 2008).
312 According to Cohen et al. (2008), a more meaningful measure of earnings management
313 is the absolute value, because its magnitude measures a irm’s capacity to manage earn-
ings upward or downward, depending on its speciic situation. That is, we isolate irms that
EC
314
315 manage earnings either upward or downward, and we account for whether irms opt for one
316 of the two earnings management tools, according to their inancial situations.
R
R
317 3.3.1 Accruals-based model

O
318 Accruals models seek to distinguish “normal” accruals, which measure changes related
319 to irms’ fundamental performance, from “abnormal” accruals, which capture alterations
NC
320 due to earnings management. Dechow et al. (1995) and Kothari et al. (2005) extend the
321 well-known Jones (1991) accruals-based model, such that Dechow et al. (1995) propose
322 an adjustment on sales by trade receivables, with the assumption that credit sales often
U
323 are manipulated when administrators fail to recognize credit sales immediately. However,
324 this modiied model still underestimates the efect of earnings management. Kothari et al.
325 (2005) incorporate return on assets (ROA) to overcome this problem, arguing that perfor-
326 mance might play a signiicant role in explaining the earnings manipulation (Dechow et al.,
327 2010). Because du Jardin et al.’s (2017) benchmark indicates the superiority of Kothari
328 et al.’s (2005) accruals-based model to estimate the earnings management behavior of
329 irms and provide discriminatory power for bankruptcy prediction, we adopt it to build an
330 accruals-based earnings management indicator. Formally, the accruals model proposed by
331 Kothari et al. (2005) is:
13
332 TAccit 1 ΔSalesit PPEit ROAit−1

=𝛼 +𝛽 +𝛾 +𝛿 + 𝜀 it (1)
TAit−1 TAit−1 TAit−1 TAit−1 TAit−1
333
334 where “TAcc” (total accruals) is the change in non-cash working capital before income
Author Proof
335 taxes payable, less total expense depreciation. The change in non-cash working capital
336 before taxes equals the change in current assets other than cash and short-term investments,
337 less current liabilities other than current maturities of long-term liabilities and income
338 taxes payable. In addition, for irm i, TAit-1 denotes total assets in year t–1; ΔSalesit is sales
339 in year t less sales in year t–1; PPEit refers to gross property, plant, and equipment in year t;
340 ROAit-1 denotes net income in year t–16; and 𝜀it is discretionary accruals in year t.
341 3.3.2 Real activities-based model
342 Real activities manipulation refers to actions conducted by managers to produce devia-
343 tions, especially in cash lows, to achieve certain earnings values. The relationship between
F
344 real activities and earnings management has been highlighted by Roychowdhury (2006),
O
345 who proposes novel proxies to analyze three types of real activities manipulation: sales
346 manipulation, overproduction, and reductions of discretionary expenditures. Earnings man-
O
347 agement through sales manipulation accelerates sales for the year by issuing price reduc-
348 tions or assigning incomplete sales on credit to the current year. An overproduction model
PR
349 focuses on production costs, which can be manipulated through an unconventional applica-
350 tion of scale economies. Finally, reductions of discretionary expenditures apply to certain
351 items, such as research and development. Following Cohen and Zarowin (2010) and Luo
D
352 et al. (2017), we estimate an aggregate measure based on abnormal levels of cash lows
353 operations and production costs.7 For every irm, we measure real activities–based earn-
TE
354 ings management as the diference between actual values and the normal levels calculated
355 using the estimated coeicients. Therefore, these three discretionary earnings aggregately
356 measure the extent of real activities–based earnings management. Speciically, the sales
EC
357 manipulation model is

358 CFit 1 Salesit ΔSalesit
=𝛼 +𝛽 +𝛾 + 𝜀 it (2)
TAit−1 TAit−1 TAit−1 TAit−1
R
359
and the overproduction model corresponds to
R
360
361 Prodit 1 Salesit ΔSalesit ΔSalesit−1

O
=𝛼 +𝛽 +𝛾 +𝛿 + 𝜀 it (3)
TAit−1 TAit−1 TAit−1 TAit−1 TAit−1
362
NC
363 where, for irm i, CFit deines cash low in year t; Prodit deines the cost of goods sold plus
364 the change in inventory in year t; TAit−1 denotes total assets in year t − 1; Salesit refers to
365 sales in year t; Salesit−1 refers to sales in year t − 1; ΔSalesit refers to the change in net sales
U
366 between years t and t − 1; ΔSalesit−1 refers to the change in net sales between years t − 1 and
367 t − 2; and 𝜀it denotes discretionary earnings in year t.
6
6FL01 When we estimate ROA, we use net income rather than net income plus net-of-tax interest expense (a tra-
6FL02 ditional measure), to avoid potential problems associated with estimating the tax rate.
7
7FL01 The reduction of discretionary expenditures model implies reducing expenditures in certain items, such as
7FL02 research and development, which can be found among listed irms, whereas our data set features by small
7FL03
and medium-sized irms. Thus, we have excluded it from the aggregated real activities measure.
13
Table 4 Accuracy rates achieved with inancial ratios and earnings management models
Models Accuracy rate (%) Diferences(1) Signiicance levels(1)
F.R Acc R.A E.M Acc R.A E.M Acc R.A E.M
Author Proof
LDA 78.1 79.9 80.1 80.5 + 1.9 + 2.1 + 2.5 * * **

LR 78.0 80.0 80.4 80.6 + 2.0 + 2.4 + 2.6 * ** **
NN 78.4 80.5 80.8 81.5 + 2.1 + 2.4 + 3.1 * ** ***
ELM 78.4 80.1 80.6 80.4 + 1.7 + 2.2 + 2.0 – ** *
SVM 78.9 80.9 80.8 81.1 + 2.0 + 1.9 + 2.2 * * **
(1)
Diferences and signiicance levels between the model based on inancial ratios and models based on
earnings management variables
F.R. ,model based on inancial ratios; Acc. , accruals-based model; R.A., real activities-based model;
E.M. = earnings management–based model (accruals and real activities)
F
Not signiicant; *signiicant at 10% level; **signiicant at 5% level; ***signiicant at 1% level
O
368 3.4 Prediction methods
O
369 Prior literature cites diverse methods for predicting bankruptcy, though none signiicantly
370
371
outperforms the others (Balcaen & Ooghe, 2004). Generally, the choice of prediction PR
method depends on its unique pros and cons, as well as the task at hand. For our study,
372 we selected ive prediction methods with diferent characteristics to evaluate whether the
373 methods were particularly sensitive to earnings management-based variables. The irst two
D
374 methods, linear discriminant analysis (LDA) and logistic regression (LR), provide robust
TE
375 results according to well-known statistical decision theory. The other three methods, neu-
376 ral networks (NN), extreme learning machine (ELM), and support vector machine (SVM),
377 make predictions by directly learning from the data and rely on nonlinear approaches. We
used Matlab16 to implement the prediction methods.
EC
378
379 Although statistical methods (LDA and LR) require no speciic settings, for the other
380 methods, we conducted parameter optimization by using only the training data (cross-vali-
381 dated trials) and retaining the test set as a true holdout sample. We divide the training data
R
382 into two parts, using 70% of them to model the parameters and the remaining 30% to assess
383 performance. For each model employed, we uploaded the hyper-parameters using the same
R
384 procedure.
O
385 With regard to the neural network, we chose a single hidden layer and one output neu-
386 ron neural network with the Levenberg–Marquardt algorithm as the optimization technique
NC
387 and the hyperbolic tangent as an activation function. In this case, the cross-validated trials
388 select the best performing number of hidden neurons, in a range of 5 to 25 neurons, with
389 50 learning epochs. We selected the architecture that led to the lowest error. For ELM, we
390 used the same optimization procedure that we applied to NN, such that only the size of
U
391 the hidden layer needed to be set. The radial-basis kernel SVM requires two parameters
392 to optimize: the regularization parameter, C, set as a value between 10 and 100, and the
393 parameter of the radial basis function, p, set as a value between 1 and 25. We chose the
394 combination of parameters that led to the lowest error.
395 Finally, the probabilistic methods needed to be turned according to a classiication to
396 compute the performance metrics. We had to determine the cut-of a priori (delimiting
397 the separation between classes) so that it could be compared with the score estimated, to
398 assign a determined class (bankrupt or non-bankrupt). For this study, we set the cut-of to
13
399 maximize the overall correct classiication, as is common in prior bankruptcy prediction
400 literature (Charalambous et al., 2000; du Jardin, 2019).
Author Proof
401 4 Empirical evaluation
402 4.1 Estimating the contribution of earnings management to predict irm

403 bankruptcy
404 We analyze the contribution of earnings management to predict bankruptcy. Table 4 con-
405 tains the accuracy results achieved using only inancial ratios with those obtained using
406 inancial ratios in combination with the novel variables that encapsulate earnings manipu-
407 lation. More precisely, we irst estimate a model that includes only inancial ratios, then
408 add the earnings management variables to the inancial ratios–based models to create three
F
409 new models. Two of those models relect accruals- and real activities–based earnings man-
O
410 agement, respectively, such that we could evaluate the independent contribution of each
411 form to predicting bankruptcy. In the inal model, we analyze their combined impact on the
O
412 global contributions of earnings management information.
413 The inclusion of earnings management variables into traditional prediction models is
PR
414 signiicant and relevant for forecasting irm bankruptcy, because earnings management
415 information contributes signiicantly to the predictive power of irm bankruptcy models.
416 Nonetheless, the range of accuracy improvement depends on the measure used to encapsu-
late the earnings management variables. In terms of accuracy rates by the type of model,
D
417
418 we observe that on average, the traditional model achieves an accuracy rate of 78.3%,
TE
419 whereas the models that include earnings management variables measured using accru-
420 als and real activities reach 80.3 and 80.5%, respectively. Thus, models that incorporate
421 earnings management variables associated with accruals or real activities measures sig-
EC
422 niicantly improve the correct classiication rate (at 10 and 5% signiicance levels, respec-
423 tively). This result attests to the predictive power of accruals-based models to anticipate
424 bankruptcy, as well as that of real activities–based models. Moreover, the earnings man-
agement model (with both accruals and real activities) leads to the best results, at an 80.8%
R
425
426 accuracy rate (signiicant at 5%); this inding is not surprising, because literature devoted
R
427 to earnings management identiies them as complementary actions (Alhadab et al., 2015;
428 Campa & Camacho-Miñano, 2015). Thus, the information extracted from both types of
O
429 manipulation creates a prediction synergy that leads to the highest classiication rate.
430 To obtain more conclusive results about the contributions of earnings management
NC
431 measures to bankruptcy prediction models, we analyze the impact of earnings management
432 for predictions of both types of irms, failed and non-failed, separately. For this efort, we
433 use type-I and type-II errors. A type-I error implies that a failed irm has been misclassi-
U
434 ied, and a type-II error is a misclassiication of non-failed irms. The lower the type-I and
435 type-II errors, the more accurately the models predict correctly failed and non-failed irms,
436 respectively.
437 Table 5 reveals some discrepancies regarding the reduction of type-I error when we
438 include earnings management variables (Panel A). That is, the reduction clearly depends
439 on the type of earnings manipulation measure employed, whether accruals or real activi-
440 ties. If we analyze the average values of type-I errors, traditional models reveal an
441 error rate of 23.8%; the accruals model achieves an average reduction of 3.8 percentage
442 points, or a type-I error value of 20.0% on average (signiicant at 1% level); and the real
13
Table 5 Type-I and type-II errors achieved with inancial ratios and earnings management models
Models Type-I error (%) Diferences(1) Signiicance levels(1)
Author Proof
Panel A: Type-I error

LDA 23.9 20.7 22.6 20.9 − 3.4 − 1.3 − 3.0 *** – **
LR 24.8 19.9 22.9 21.5 − 4.9 − 1.9 − 3.3 *** * ***
NN 24.1 20.5 22.9 20.7 − 3.6 − 1.2 − 3.4 *** – ***
ELM 23.5 20.4 22.1 21.5 − 3.1 − 1.4 − 2.0 *** – *
SVM 22.9 18.8 22.2 20.5 − 4.1 − 0.7 − 2.4 *** – **
Panel B: Type-II error
LDA 20.0 19.8 17.3 18.0 − 0.2 − 2.7 − 2.0 – ** *
LR 19.2 20.0 16.2 17.3 + 0.8 − 3.0 − 1.9 – ** *
NN 19.1 18.9 15.4 16.4 − 0.2 − 3.7 − 2.7 – *** **
F
ELM 19.7 19.5 16.7 17.7 − 0.2 − 3.0 − 2.0 – ** *
O
SVM 19.4 19.6 16.3 17.3 + 0.2 − 3.1 − 2.1 – ** *
O
(1)

PR
F.R. = model based on inancial ratios; Acc. = accruals-based model; R.A. = real activities-based model;
Not signiicant; *signiicant at 10% level; **signiicant at 5% level; ***signiicant at 1% level

D
443 activities–based model slightly reduces the error, obtaining an average type-I error of
TE
444 22.5%. In terms of their relevance for designing accurate earnings management–based
445 models, the accruals measure clearly surpasses the real activities measure. Moreover, their
446 synergy does not improve the earnings management model; the error reduction achieved
EC
447 by this latter model is less than that of the accruals-based model (average type-I error of
448 21.0%), though all diferences remain signiicant at conventional levels.
449 Table 5 shows that in contrast with type-I error results, the model based on real activi-
R
450 ties outperforms the accruals-based measure for reducing type-II error (Panel B). With the
451 real activities–based measure, all diferences are statistically signiicant at least at the 5%
R
452 level. The accruals-based model does not display any signiicant diferences. All difer-
453 ences remain signiicant with the earnings management–based model but only at 10% sig-
O
454 niicance. Thus, speciic information extracted from earnings manipulation has predictive
455 power and can better identify non-failed irms, especially using the real activities measure.
NC
456 The inluences of both type of earnings management variables thus are relevant but
457 opposite. Including accruals-based earnings management variables in bankruptcy pre-
458 diction models signiicantly and positively afects the capacity to predict failed irms,
U
459 and earnings management models based on real activities measures better predict non-
460 failed irms. This result is somewhat unexpected, considering that even if irms engage
461 in both manipulation actions, those actions are so costly they might choose to trade of
462 the types of earnings management, depending on costliness and irm constraints (Zang,
463 2012). In this regard, failed irms might perceive accruals as less costly and more con-
464 venient, because they involve the use of accounting choices without future, persistent
465 consequences, whereas real activities exert negative efects on cash low and proitabil-
466 ity (Bhojraj et al., 2009; Chen et al., 2009). In contrast, healthy irms are in good inan-
467 cial situations that mitigate the potentially negative efect of engaging in real activities
13
Table 6 AUC values achieved Models AUC values Signiicance levels(1)

with inancial ratios and earnings
management models F.R Acc R.A E.M Acc R.A E.M
LDA 0.814 0.833 0.837 0.840 * * **

Author Proof
LR 0.818 0.837 0.839 0.846 * * **

NN 0.825 0.848 0.852 0.854 ** ** ***
ELM 0.822 0.834 0.842 0.845 – * **
SVM 0.827 0.844 0.849 0.851 * ** **
(1)
Signiicance levels between the model based on inancial ratios and
models based on earnings management variables
F.R. = model based on inancial ratios; Acc. = accruals-based model;
R.A. = real activities-based model; E.M. = earnings management–based
model (accruals and real activities)
Not signiicant; *signiicant at 10% level; **signiicant at 5% level;
F
***signiicant at 1% level
O
O
468 manipulations. Because real activities have greater eicacy and are more diicult to
469
470
PR
detect, healthy irms might consider these actions more convenient for manipulating
earnings. Moreover, because information extracted from accruals and real activities
471 is relevant in relation to irms’ inancial health, it is crucial to note that the comple-
472 mentary use of both forms of earnings management information leads to signiicant
D
473 reductions in both types of errors. That is, the earnings management–based model sta-
474 bilizes the correct classiication of each class by complementing the predictive ability
TE
475 of accruals and real activities measures for failed and non-failed irms, respectively.
476 Finally, we compute the area under the curve (AUC), a measure used widely to eval-
477 uate global model performance, because it is independent of misclassiication costs.
EC
478 The AUC represents the trade-of between a true positive (failed irms, correctly clas-
479 siied) and a false positive (failed irms, incorrectly classiied). This measure is more
480 comprehensive than accuracy, because it evaluates the true positive rate against a false
R
481 positive rate at various thresholds (He and Garcia, 2009). It also provides an easy com-
482 parison of models, given that diferent AUC values indicate model performance. The
R
483 AUC value should be as close as possible to 1, which would imply 100% true positive
O
484 and 0% false positive instances.

485 These results are in line with our previous indings and conirm the superiority of
NC
486 an aggregate earnings management–based model for predicting bankruptcy (Table 6).

487 Its dominance is clear, in that all diferences between the AUC estimated using this
488 earnings management–based model and those of traditional models are signiicant (4
of 5 are signiicant at the 5% level, the other at 1%). Moreover, accruals and real activi-
U
489
490 ties–based models display similar improvements, such that both forms of earnings
491 management appear to possess similar power for predicting bankruptcy. Finally, these
492 initial results indicate that artiicial intelligence methods perform slightly better than
493 statistical methods, though without signiicant diferences; all methods obtain similar
494 performance for predicting bankruptcy. The predictive power of earnings management
495 variables is steady, regardless of the methods’ characteristics.
13
Table 7 Accuracy rates achieved for diferent forecasting horizons by type of model
Horizon Accuracy rate (%) Diferences(1) Signiicance levels(1)
Author Proof
1 year 78.3 80.3 80.6 80.8 + 2.0 + 2.3 + 2.5 * ** **

2 years 75.6 77.5 77.6 78.0 + 1.9 + 2.0 + 2.4 * * **
3 years 70.0 70.9 71.2 71.9 + 0.9 + 1.2 + 1.9 – – *
(1)
Not signiicant; * signiicant at 10% level; **signiicant at 5% level; ***signiicant at 1% level
F
Table 8 Type-I and type-II errors achieved for diferent forecasting horizons by type of model
O
Horizon Type-I error (%) Diferences(1) Signiicance levels(1)
O
1 year
2 years
23.8
25.7
20.0
22.8
22.5
24.7
20.9
23.2
− 3.8
− 2.9
− 1.3
− 1.0
PR − 2.9
− 2.4
***
**
–
–
**
**
3 years 32.0 30.2 31.4 30.0 − 1.9 − 0.6 − 2.0 * – *
D
1 year 19.5 19.6 16.4 17.3 + 0.1 − 3.1 − 2.2 – *** **
TE
2 years 23.1 22.0 20.1 20.7 -1.1 − 3.0 − 2.4 – ** **

3 years 27.9 27.8 26.2 26.2 -0.1 − 1.7 − 1.7 – - -
(1)
EC

R
Not signiicant
*Signiicant at 10% level; **Signiicant at 5% level; ***Signiicant at 1% level
R
O
496 4.2 Earnings management variables and bankruptcy prediction horizon

NC
497 We thus have documented the viability of including earnings management variables in
498 bankruptcy models to improve their predictive power. However, we have considered
499 only a short prediction horizon, one year prior to bankruptcy. In this regard, du Jardin
U
500 and Severin (2012) criticize models with such short forecasting horizons, because pre-
501 diction rates often are good one year before a failure, but less so as the horizon extends
502 to three years or more. Thus, we also investigate the predictive power of earnings man-
503 agement variables in the estimated bankruptcy model across one, two, and three years
504 before failure; that is, we analyze their contributions to model performance, along with
505 the forecasting horizon. Tables 7, 8, 9 display the estimated results.
13
Table 9 AUC values achieved for Horizon AUC values Signiicance

diferent forecasting horizons by levels(1)
type of model
F.R Acc R.A E.M Acc R.A E.M
Author Proof
1 year 0.821 0.839 0.845 0.847 * ** **

2 years 0.784 0.804 0.806 0.810 * * **
3 years 0.712 0.719 0.723 0.733 – – *
(1)
Signiicance levels between the model based on inancial ratios and
Not signiicant
*Signiicant at 10% level; **Signiicant at 5% level; ***Signiicant at
1% level
F
O
506 Together, the tables indicate that the capacity of bankruptcy prediction models tends to
O
507 decrease as the prediction horizon extends.8 The boundary that makes it possible to distin-
508
509
PR
guish failed and non-failed irms moves slightly as the horizon extends (Pompe & Bilderbeek,
2005). Thus, the distribution of explanatory variables no longer is identical, which inluences
510 the accuracy of the bankruptcy models. We also observe this phenomenon with regard to the
511 earnings management variables. The improved accuracy of accruals-based models relative to
D
512 models that rely solely on inancial ratios is signiicant and rather similar for the one- and two-
513 year prediction horizons (+ 2.0 and + 1.9 percentage points), but its relevance disappears in the
TE
514 longest horizon (+ 0.9 percentage points for the three-year horizon). These results stem from
515 the inability to reduce type-I error signiicantly as the prediction horizon extends (− 3.8, − 2.9,
516 and − 1.9 percentage points for one-, two-, and three-year horizons, respectively), though the
EC
517 type-II error remains stable. The real activities–based model reveals similar results; the mag-
518 nitude of its efect in mid-term horizons is smaller than that of earnings abnormalities infor-
519 mation measured at the moment of imminent failure. The efect of this measure can signii-
R
520 cantly reduce type-II error (− 3.1 and − 3.0 percentage points for one- and two-year horizons,
521 respectively), and the diference in accuracy between this model and the inancial ratios–based
R
522 model is signiicant at conventional levels (5% for the one-year horizon, 10% for the two-year
horizon). Thus, earnings management variables present statistically signiicant predictive
O
523
524 power for discriminating between failed and non-failed irms in short prediction horizons, but
NC
525 they lack such power over longer time horizons. In contrast, a model that incorporates both
526 measures (accruals and real activities variables together) is more stable over time. Because
527 each earnings management–based variable provides signiicant and complementary informa-
528 tion, the aggregate model proits from their combined efects and achieves more relevant, sta-
U
529 ble results. This result is particularly interesting, because it provides a means to discern failed
530 irms more accurately, together with good predictions of non-failed irms. Finally, the AUC
531 values complement these indings by showing that aggregate earnings management–based
8
8FL01 We developed and tested all models on the same test set, to ensure comparisons among them are valid. To
8FL02 achieve conciseness, and noting that 60 results for each evaluation metric (3 prediction horizons 4 models
8FL03
5 prediction methods) would not be readable, we present the results using average values.
13
Table 10 Accuracy rates Horizon Accuracy rate (%) Diferences(1) Signiicance

achieved with earnings levels(1)
management models (dynamic
variables) Acc R.A E.M Acc R.A E.M Acc R.A E.M
Author Proof
1 year 81.5 81.4 81.8 + 3.2 + 3.1 + 3.5 *** *** ***
2 years 76.9 77.1 78.0 + 0.8 + 1.0 + 1.9 – – *
3 years 70.8 70.5 71.2 + 0.8 + 0.5 + 1.2 – – –
(1)
Diferences and signiicance levels between the model based on
inancial ratios (estimated in Table 6) and models based on earnings
management variables
Not signiicant; * signiicant at 10% level; **signiicant at 5% level;
F
O
Table 11 Type-I and type-II errors achieved with earnings management models (dynamic variables)
O
Horizon Type-I error (%) Diferences(1) Signiicance
levels(1)
Acc R.A E.M Acc R.A PR E.M Acc R.A E.M

1 year 18.2 19.9 18.9 − 5.6 − 3.9 − 4.9 *** *** ***
D
2 years 24.2 25.3 23.8 − 1.5 − 0.4 − 1.9 – – *
3 years 30.1 32.1 31.5 − 0.5 + 0.1 − 0.5 – – –
TE

1 year 18.9 17.1 17.4 − 0.6 − 2.4 − 2.1 – ** *
2 years 21.9 20.6 20.3 − 0.2 − 1.5 − 1.8 – – –
EC
3 years 28.3 26.9 26.1 + 0.4 − 1.0 − 0.8 – – –

(1)
Diferences and signiicance levels between the model based on inancial ratios (estimated in Table 7) and
R
R
Not signiicant; * signiicant at 10% level; **signiicant at 5% level; ***signiicant at 1% level

O
NC
532 models provide signiicantly better results than those achieved by traditional bankruptcy
533 models for all time horizons, though its inluence also decreases at the longest horizon (three
534 years). These results are consistent with our previous indings, reiterating the relevance of
U
535 earnings management information for improving the performance of bankruptcy prediction
536 models. In particular, if we include two proxies of earnings management simultaneously, their
537 contributions to forecasting bankruptcy increase.
538 4.3 Contribution of dynamic earnings management variables
539 Earnings management variables thus present speciic information that make them
540 particularly useful for improving forecasts of bankruptcy, because they provide
13
Table 12 AUC values achieved Models AUC values Signiicance levels(1)

with earnings management
models (dynamic variables) Acc R.A E.M Acc R.A E.M
1 year 0.850 0.852 0.856 *** *** ***

Author Proof
2 years 0.787 0.790 0.794 – – –

3 years 0.715 0.710 0.724 – – –
(1)
Signiicance levels between the model based on inancial ratios
(estimated in Table 8) and models based on earnings management
variables
Not signiicant; * signiicant at 10% level; **signiicant at 5% level;
F
O
541 complementary power to discriminate between failed and non-failed irms. However,
O
542 the idea that underlies the design of these variables is that earnings management prac-
543 tices represent a sudden accounting act, performed by managers to achieve a prede-
PR
544 ined objective. Accordingly, they have been built as static variables, providing a sin-
545 gle measure of earnings management actions at a given time. In reality, however, this
546 action can be conducted repeatedly for years, as a long-term strategic decision, such
D
547 that earnings management practices from one period may inluence subsequent choices
548 of manipulation practices (Charitou et al., 2007; Dutzi & Rausch, 2016). If earnings
TE
549 manipulation information were encapsulated in dynamic earnings management vari-

550 ables, making it possible to assess variations and measure the evolution of earnings
551 management over multiple periods, they might be even more relevant for improving
EC
552 the predictive power of bankruptcy models. We therefore evaluate the forecasting abil-
553 ity of dynamic earnings management–based variables to determine the best way to pre-
554 sent and integrate earnings management information.
R
555 Tables 10, 11, 12 present the performance results for the various prediction hori-
556 zons. The earnings management–based variables feature variations in discretionary
R
557 earnings between the previous and current periods, along with inancial information.
558 All the results clearly indicate a signiicant decrease of the inluence of dynamic earn-
O
559 ings management variables as the horizon extends. That is, models enhance their
prediction performance only at the one-year horizon, and the improvements are all
NC
560
561 signiicant at a 1% threshold. In the comparison with results obtained by static earn-
562 ings management variables (Tables 7, 8, 9), the discrepant outcomes do not allow us
563 to establish the superiority of one type of variables over the other. That is, dynamic
U
564 variables improve predictive power in the short horizon (one year; average accuracy
565 rate 81.5%, AUC 0.853; cf. static variables that achieve 80.5 and 0.835, respectively).
566 However, they are surpassed by static earnings management variables in the mid-term
567 horizon (dynamic accuracy rate 74.1%, AUC 0.753; static accuracy rate 74.5%, AUC
568 0.766). These important results indicate that the use of earnings management variables
569 to enhance the discriminatory power of bankruptcy models must be considered accord-
570 ing to the forecasting period.
13
571 4.4 Discussion
572 In summary, these results are consistent with prior analyses of inancial manipulation, and
573 they establish the contributions of earnings management variables to bankruptcy model
Author Proof
574 performance. We show that accruals-based and real activities–based variables both pos-
575 sess predictive power to discriminate between failed and non-failed irms. Both indicators
576 achieve similar, statistically signiicant improvements in bankruptcy model performance.
577 However, the information gained from these two earnings management tools exerts oppo-
578 site inluences on the ability to predict failed and non-failed irms. In particular, accru-
579 als-based models efectively forecast failed irms, whereas real activities more efectively
580 identify non-failed irms. Firms may engage in both type of earnings management, but our
581 results suggest they are more prone to adopting one type more intensely, according to their
582 inancial health.9
583 Thus, we can explain the inding that accruals measures and real activities measures
F
584 characterize failed and non-failed irms, respectively. The usefulness of earnings manage-
ment information difers across failed and non-failed irms, because irms prefer manipula-
O
585
586 tions that are costless. Distressed irms perceive accrual-based manipulation as more con-
O
587 venient and less expensive, but real activities manipulation negatively afects their future
588 performance (Gunny, 2010) by exerting negative efects on future cash lows (Chen et al.,
589
590
PR
2009) and proitability (Bhojraj et al., 2009). It also deviates from optimal business strate-
gies, with potentially high marginal costs, especially for failed irms (Zang, 2012). Thus,
591 managers of distressed irms likely prefer accruals, a less costly action that can be altered
592 without afecting the real conduct of business. Because such accruals management can take
D
593 place after the iscal year, when managers acknowledge their irms’ extreme distress, it pro-
594 vides irms with a means to hide their weaknesses. Moreover, because distressed irms rely
TE
595 more on accruals manipulation, a model that detects these irregularities can provide sig-
596 niicant information and improve predictions of failed irms.
597 In contrast, non-failed irms regard real activities earnings management as less costly,
EC
598 because the practice attracts less negative attention and can be hidden within optimal busi-
599 ness decisions (Gunny, 2010). Such actions usually involve ofering larger discounts or
600 unusually favorable credit terms to customers, so it might easily be presented as a strategic
R
601 decision in pursuit of market share. As a result, a measure intended to encapsulate real
602 activities manipulation can strongly characterize failed irms. In addition, we conirm that
R
603 the complementary use of both forms of earnings management information (accruals and
604 real activities) produces the most accurate bankruptcy prediction model. This predictive
O
605 synergy seems logical, considering that accruals and real activities measures ofer better
predictions of failed and non-failed irms, respectively; the complementary information
NC
606
607 supports predictions of failed and non-failed irms simultaneously and thus leads to the
608 best results.
U
9
9FL01 We processed diferent segments of the sample in the training sets, according to size, to test whether
9FL02 model performance might depend on the training set size. Across training sets of diferent sizes (6000,
9FL03
8000, and 12,000), the test generates results that match those from the main study, including signiicant dif-
9FL04
9FL05
ferences between a model based solely on inancial ratios and models based on earnings management vari-
9FL06 ables (static and dynamic). As a further check, we consider the proposed models’ prediction capacity when
9FL07 the training set features a realistic proportion. Therefore, we built a training set with 2,000 failed irms and
9FL08 38,000 non-failed irms (5/95 proportion). Although the earnings management–based models perform well
9FL09 in this scenario, prediction performance with regard to the failed class sufers. The results are available
from the authors upon request.
13
609 The predictive power of both dynamic and static forms of variables associated with
610 earnings management also is signiicant, though no single form better relects earnings
611 manipulation information than the other. On the one hand, dynamic variables ofer the best
612 discriminatory power in terms of improving bankruptcy models in a short time horizon
Author Proof
613 (one year). This inding also is reasonable; the highest variations in earnings management
614 practices, as encapsulated by dynamic variables, occur in proximity to the actual failure.
615 That is, failed irms likely engage intensively in earnings management practices in the last
616 moments before their failure, compared with previous years, in their attempts to avoid fail-
617 ure. Etemedi et al. (2012), in line with Charitou et al. (2007), show that failed irms alter
618 their earnings more signiicantly prior to their bankruptcy iling, but in preceding periods,
619 their earnings management was not signiicantly diferent from that of other, non-failed
620 irms. Thus, variations in earnings management are noticeable mostly as failure becomes
621 imminent, and dynamic variables signiicantly improve bankruptcy model predictions in
622 the short term by identifying failed irms more accurately. On the other hand, static vari-
623 ables provide signiicant, steady results over time. Garcia-Lara et al. (2009), who com-
F
624 pare the earnings management of failed irms several years before bankruptcy with that of
O
625 non-failed irms, attest that failed irms manage earnings diferently, in terms of the form
626 (accruals or real activities). Thus, it is not surprising that static variables, which measure
O
627 these manipulations, favor better prediction over time, even if the magnitude of the efect
628 diminishes as the prediction horizon extends. PR
5 Conclusion
D
629
TE
630 We investigate the extent to which variables intended to encapsulate earnings manipula-
631 tion improve the predictions of bankruptcy models, by analyzing three key elements: two
632 earnings management–based variables (accruals and real activities), two forms of these
EC
633 variables (static and dynamic), and the inclusion of both variables together in bankruptcy
634 models. We rely on diferent model speciications of irm failure and conduct an empirical
635 investigation with an original data set. The inclusion of earnings management variables to
complement traditional bankruptcy models, according to inancial ratios, signiicantly ben-
R
636
637 eits prediction performance. Furthermore, we show that two impact factors related to earn-
R
638 ings management–based variables need to be considered before incorporating them into
639 bankruptcy models. First, a model based on earnings management through accruals has
O
640 signiicant predictive power for failed irms, but earnings management information based
641 on real activities manipulations is more relevant for predicting non-failed irms. The inclu-
NC
642 sion of both earnings management measures in bankruptcy models leads to the best perfor-
643 mance by equalizing the predictive power for failed and non-failed irms. Second, the use of
644 static or dynamic earnings management variables may lead to distinct models. A dynamic
U
645 version of earnings management information reveals discriminatory power and produces a
646 more accurate bankruptcy model for the one-year prediction horizon, whereas static indica-
647 tors achieve better performance over time. In practice, inancial institutions make eicient
648 economic decisions according to the expected cost of misclassiication. Misclassiication
649 of failed irms leads to loss of capital and commercial performance, with greater risk over
650 time. These fundamental aspects of earnings management information thus are crucial for
651 developing a viable, practical bankruptcy model to assess the risk of default.
652 Our study also outlines how incorporating earnings management information into a
653 model signiicantly improves the results obtained from bankruptcy models. With this
13
654 broader perspective, we make two main contributions to bankruptcy prediction literature.
655 First, we show that speciic information extracted from earnings management can improve
656 model accuracy. Bankruptcy models are designed to encompass accounting and inancial
657 information, in the form of inancial ratios, such that managers can use accounting manipu-
Author Proof
658 lation to alter these inancial variables and indirectly inluence the predictions produced by
659 bankruptcy models. However, our results show such manipulations may not be detrimental
660 to bankruptcy models, because incorporating earnings management variables can improve
661 the models’ performance. With this contribution, we ofer an option for dealing with poor
662 bankruptcy model performance resulting from alterations of inancial igures. Second, our
663 study proposes a notable break from traditional practices by showing the beneits of com-
664 plementary variables. We thus reinforce the need for a broader modeling approach that
665 includes explanatory variables to complement inancial information, because doing so
666 enhances bankruptcy models’ performance.
667 Furthermore, our results extend indings by du Jardin et al. (2019), with implications
F
668 that are pertinent for both inancial institutions and academicians; they also suggest the
need for ongoing investigations. Recent studies identify the limits of accounting-based
O
669
670 bankruptcy models. We hope our study inspires other researchers to investigate other var-
O
671 iables that might account for irms’ failure dynamics. One option would be to integrate
672 other inancial variables to improve failure predictions; information quality variables seem
673
674
PR
likely to improve the performance of bankruptcy prediction models. Moreover, corporate
bankruptcy is a protracted process over time, and diferent irms exhibit unique patterns of
decline (d’Aveni, 1989). The forms and magnitudes of earnings management thus might
675
676 vary with irms’ patterns of failure. In addition, earnings management practices across
D
677 large, medium-sized, and small enterprises might not be entirely homogeneous. Research-
678 ers could investigate whether earnings management–based models better predict bank-
TE
679 ruptcy for large irms. Finally, proiles of irms according to their histories of earnings
680 management arguably might establish their propensity to manipulate, as a irm characteris-
681 tic. Investigating these inluences represent next research directions.
EC
682 Acknowledgements We are very grateful to the anonymous reviewers for their substantial contributions to
683 improving this article.
R
R
684 References
O
685 Agustia, D., Muhammad, N. P. A., & Permatasari, Y. (2020). Earnings management, business strategy, and
686 bankruptcy risk: Evidence from Indonesia. Heliyon, 6(2), e03317.
NC
687 Alhadab, M., Clacher, I., & Keasey, K. (2015). Real and accrual earnings management and IPO failure risk.
688 Accounting and Business Research, 45(1), 55–92.
689 Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy.
690 Journal of Finance, 23(4), 589–609.
U
691 Altman, E. I., Sabato, G., & Wilson, N. (2010). The value of non-inancial information in small and
692 medium-sized enterprise risk management. Journal of Credit Risk, 6(2), 95.
693 Atiya, A. F. (2001). Bankruptcy prediction for credit risk using neural networks: A survey and new results.
694 IEEE Transactions on Neural Networks, 12(4), 929–935.
695 Balcaen, S., & Ooghe, H. (2004). Alternative methodologies in studies on business failure: Do they produce
696 better results than the classical statistical methods. Vlerick Leuven Gent Management School Working
697 Paper Series, 16, 1–44.
698 Balcaen, S., & Ooghe, H. (2006). 35 years of studies on business failure: An overview of the classic statisti-
699 cal methodologies and their related problems. British Accounting Review, 38(1), 63–93.
700 Ball, R., & Shivakumar, L. (2005). Earnings quality in UK private irms: Comparative loss recognition
701 timeliness. Journal of Accounting and Economics, 39(1), 83–128.
13
702 Beaver, W. H. (1966). Financial ratios as predictors of failure. Journal of Accounting Research, 4,
703 71–111.
704 Bhojraj, S., Hribar, P., Picconi, M., & McInnis, J. (2009). Making sense of cents: An examination of
705 irms that marginally miss or beat analyst forecasts. Journal of Finance, 64(5), 2361–2388.
706 Biddle, G. C., Ma, M. L., & Song, F. M. (2011). Accounting conservatism and bankruptcy risk. Journal
Author Proof
707 of Accounting, Auditing & Finance, 0148558X20934244.

708 Bisogno, M., & De Luca, R. (2015). Financial distress and earnings manipulation: Evidence from Italian
709 SMEs. Journal of Accounting and Finance, 4(1), 42–51.
710 Burgstahler, D., & Dichev, I. (1997). Earnings management to avoid earnings decreases and losses.
711 Journal of Accounting and Economics, 21(1), 99–126.
712 Campa, D., & Camacho-Miñano, M. M. (2015). The impact of SME’s pre-bankruptcy inancial distress
713 on earnings management tools. International Review of Financial Analysis, 42, 222–234.
714 Charalambous, C., Charitou, A., & Kaourou, F. (2000). Comparative analysis of artiicial neural network
715 models: Application in bankruptcy prediction. Annals of Operations Research, 99(1–4), 403–425.
716 Charitou, A., Lambertides, N., & Trigeorgis, L. (2007). Earnings behavior of inancially distressed
717 irms: The role of institutional ownership. Abacus, 43(3), 271–296.
718 Chen, C. L., Yen, G., & Chang, F. H. (2009). Strategic auditor switch and inancial distress prediction–
719 empirical indings from the TSE-listed irms. Applied Financial Economics, 19(1), 59–72.
F
720 Chowdhury, A., Mollah, S., & Al Farooque, O. (2018). Insider-trading, discretionary accruals and infor-
721 mation asymmetry. The British Accounting Review, 50(4), 341–363.
O
722 Ciampi, F. (2015). Corporate governance characteristics and default prediction modeling for small enter-
723 prises. An empirical analysis of Italian irms. Journal of Business Research, 68(5), 1012–1025.
O
724 Ciampi, F., Cillo, V., & Fiano, F. (2018). Combining Kohonen maps and prior payment behavior for
725 small enterprise default prediction. Small Business Economics, 54(4), 1007–1039.
726 Cohen, D. A., Dey, A., & Lys, T. Z. (2008). Real and accrual-based earnings management in the pre-and
PR
727 post-Sarbanes-Oxley periods. The Accounting Review, 83(3), 757–787.
728 Cohen, D. A., & Zarowin, P. (2010). Accrual-based and real earnings management activities around sea-
729 soned equity oferings. Journal of Accounting and Economics, 50(1), 2–19.
730 d’Aveni, R. A. (1989). The aftermath of organizational decline: A longitudinal study of the strategic and
D
731 managerial characteristics of declining irms. Academy of Management Journal, 32(3), 577–605.
732 Dechow, P. M., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies,
TE
733 their determinants and their consequences. Journal of Accounting and Economics, 50, 344–401.
734 Dechow, P. M., & Skinner, D. J. (2000). Earnings management: Reconciling the views of accounting
735 academics, practitioners and regulators. Accounting Horizons, 14(2), 235–250.
736 Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. Accounting
EC
737 Review, 70(2), 193–225.

738 Doumpos, M., Andriosopoulos, K., Galariotis, E., Makridou, G., & Zopounidis, C. (2017). Corporate
739 failure prediction in the European energy sector: A multicriteria approach and the efect of country
740 characteristics. European Journal of Operational Research, 262(1), 347–360.
R
741 du Jardin, P. (2010). Predicting bankruptcy using neural networks and other classiication methods: The
742 inluence of variable selection techniques on model accuracy. Neurocomputing, 73(10–12), 2047–2060.
R
743 du Jardin, P. (2015). Bankruptcy prediction using terminal failure processes. European Journal of Oper-
744 ational Research, 242(1), 286–303.
O
745 du Jardin, P. (2019). Forecasting bankruptcy using biclustering and neural network-based ensembles.
746 Annals of Operations Research, 299(1), 531–566.
du Jardin, P., & Séverin, E. (2012). Forecasting inancial failure using a Kohonen map: A comparative study
NC
747
748 to improve model stability over time. European Journal of Operational Research, 221(2), 378–396.
749 du Jardin, P., Veganzones, D., & Séverin, E. (2019). Forecasting corporate bankruptcy using accrual-
750 based models. Computational Economics, 54(1), 7–43.
Dutzi, A., & Rausch, B. (2016). Earnings management before bankruptcy: A review of the literature.
U
751
752 Journal of Accounting and Auditing Research & Practice, 2016(2016), 1–21.
753 Etemadi, H., Dastgir, M., Momeni, M., & Dehkordi, H. F. (2012). Discretionary accruals behavior of
754 Iranian distressed irms. African Journal of Business Management, 7(20), 1956–1965.
755 Etemadi, H., Dehkordi, H. F., & Amirkhani, K. (2013). Efect of auditor opinion on discretionary accru-
756 als behavior of distressed irms: Empirical evidences from Iran. African Journal of Business Man-
757 agement, 7(20), 1956–1965.
758 Fabling, R., & Grimes, A. (2005). Insolvency and economic development: Regional variation and adjust-
759 ment. Journal of Economics and Business, 57(4), 339–359.
760 Franceschetti, B. M., & Koschtial, C. (2013). Do bankrupt companies manipulate earnings more than the
761 non-bankrupt ones? Journal of Finance and Accountancy, 12, 1.
13
762 García Lara, J. M., Osma, B. G., & Neophytou, E. (2009). Earnings quality in ex-post failed irms. Account-
763 ing and Business Research, 39(2), 119–138.
764 Gordini, N. (2014). A genetic algorithm approach for SMEs bankruptcy prediction: Empirical evidence
765 from Italy. Expert Systems with Applications, 41(14), 6433–6445.
766 Gunny, K. A. (2010). The relation between earnings management using real activities manipulation and
Author Proof
767 future performance: Evidence from meeting earnings benchmarks. Contemporary Accounting
768 Research, 27(3), 855–888.
769 Guyon, I., & Elisseef, A. (2003). An introduction to variable and feature selection. Journal of Machine
770 Learning Research, 3, 1157–1182.
771 Habib, A., Bhuiyan, B. U., & Islam, A. (2013). Financial distress, earnings management and market pricing
772 of accruals during the global inancial crisis. Managerial Finance, 39(2), 155–180.
773 Hassanpour, S., & Ardakani, M. N. (2017). The efect of pre-bankruptcy inancial distress on earnings man-
774 agement tools. International Review of Management and Marketing, 7(3), 213–219.
775 He, H., & Garcia, E. A. (2008). Learning from imbalanced data. IEEE Transactions on Knowledge & Data
776 Engineering, 21(9), 1263–1284.
777 Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its applications
778 for standard settings. Accounting Horizon, 13(4), 365–383.
F
779 Hribar, P., Jenkins, N. T., & Johnson, W. B. (2006). Stock repurchases as an earnings management device.
O
781 Kirkos, E. (2015). Assessing methodologies for intelligent bankruptcy prediction. Artificial Intelligence
782 Review, 43(1), 83–123.
Kothari, S. P., Leone, A. J., & Wasley, C. E. (2005). Performance matched discretionary accrual measures.
O
783
785 Jones, J. (1991). Earnings management during import relief investigations. Journal of Accounting Research,
786
787
788
29(2), 193–228. PR
Leshno, M., & Spector, Y. (1996). Neural network prediction analysis: The bankruptcy case. Neurocomput-
ing, 10(2), 125–147.
789 Li, F., Abeysekera, I., & Ma, S. (2011). Earnings management and the efect of earnings quality in relation
to stress level and bankruptcy level of Chinese listed irms. Corporate Ownership and Control, 9(1),
D
790
791 366–391.
Liang, D., Lu, C. C., Tsai, C. F., & Shih, G. A. (2016). Financial ratios and corporate governance indicators
TE
792
793 in bankruptcy prediction: A comprehensive study. European Journal of Operational Research, 252(2),
794 561–572.
795 Libby, R., Rennekamp, K. M., & Seybert, N. (2015). Regulation and the interdependent roles of managers,
auditors, and directors in earnings management and accounting choice. Accounting, Organizations and
EC
796
797 Society, 47, 25–42.
798 Liu, X., Hodgkinson, I. R., & Chuang, F. M. (2014). Foreign competition, domestic knowledge base and
799 innovation activities: Evidence from Chinese high-tech industries. Research Policy, 43(2), 414–422.
800 Luo, J. H., Xiang, Y., & Huang, Z. (2017). Female directors and real activities manipulation: Evidence from
R
801 China. China Journal of Accounting Research, 10(2), 141–166.

802 Mare, D. S. (2015). Contribution of macroeconomic factors to the prediction of small bank failures. Journal
R
803 of International Financial Markets, Institutions and Money, 39, 25–39.

804 Mensah, Y. M. (1984). An examination of the stationarity of multivariate bankruptcy prediction models: A
O
805 methodological study. Journal of Accounting Research, 22, 380–395.

806 Meyer, P. A., & Pifer, H. W. (1970). Prediction of bank failures. The Journal of Finance, 25(4), 853–868.
NC
807 Micha, B. (1984). Analysis of business failures in France. Journal of Banking and Finance, 8(2), 281–291.
808 Mouselli, S., Jaafar, A., & Hussainey, K. (2012). Accruals quality vis-à-vis disclosure quality: Substitutes or
809 complements? The British Accounting Review, 44(1), 36–46.
810 Norton, C. L., & Smith, R. E. (1979). A comparison of general price level and historical cost inancial state-
ments in the prediction of bankruptcy. Accounting Review, 55(3), 72–87.
U
811
812 Ouenniche, J., & Tone, K. (2017). An out-of-sample evaluation framework for DEA with application in
813 bankruptcy prediction. Annals of Operations Research, 254(1–2), 235–250.
814 Pompe, P. P., & Bilderbeek, J. (2005). The prediction of bankruptcy of small-and-medium- sized industrial
815 irms. Journal of Business Venturing, 20(6), 847–868.
816 Richardson, S. A., Sloan, R. G., Soliman, M. T., & Tuna, I. (2005). Accrual reliability, earnings persistence
817 and stock prices. Journal of Accounting and Economics, 39(3), 437–485.
818 Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Account-
819 ing and Economics, 42(3), 335–370.
820 Sun, J., & Liu, G. (2016). Does analyst coverage constrain real earnings management? The Quarterly
821 Review of Economics and Finance, 59, 131–140.
13
822 Tian, S., Yu, Y., & Guo, H. (2015). Variable selection and corporate bankruptcy forecasts. Journal of Bank-
823 ing & Finance, 52, 89–100.
824 Tsai, C. F. (2009). Feature selection in bankruptcy prediction. Knowledge-Based Systems, 22(2), 120–127.
825 Tsolas, I. E. (2015). Firm credit risk evaluation: A series two-stage DEA modeling framework. Annals of
826 Operations Research, 233(1), 483–500.
Author Proof
827 Wilson, R. L., & Sharda, R. (1994). Bankruptcy prediction using neural networks. Decision Support Sys-
828 tems, 11(5), 545–557.
829 Yu, F. F. (2008). Analyst coverage and earnings management. Journal of Financial Economics, 88(2),
830 245–271.
831 Yu, Q., Miche, Y., Séverin, E., & Lendasse, A. (2014). Bankruptcy prediction using extreme learning
832 machine and inancial expertise. Neurocomputing, 128, 296–302.
833 Zang, A. Y. (2012). Evidence on the trade-of between real activities manipulation and accrual-based earn-
834 ings management. The Accounting Review, 87(2), 675–703.
835 Publisher’s Note Springer Nature remains neutral with regard to jurisdictional claims in published maps and
836 institutional ailiations.
837
F
O
O
PR
D
TE
EC
R
R
O
NC
U
13
Journal: 10479
Article: 4183
Author Proof
Author Query Form

Please ensure you fill out your response to the queries raised below
and return this form along with your corrections
Dear Author
During the process of typesetting your article, the following queries have arisen.
Please check your typeset proof carefully against the queries listed below and mark
the necessary changes either directly on the proof/online grid or in the ‘Author’s
response’ area provided below
Query Details Required Author’s

Response
AQ2 Kindly check and conirm ailiations are correctly
identiied.
AQ1 References Garcia-Lara et al., (2008), Beaver et al.
(2012),du Jardin et al.’s (2017) are cited in text,but not
provided in reference list. Please provide the reference in
the list or delete the citations.

Are, Therefore, Not Possible. Please Note

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Are, Therefore, Not Possible. Please Note

Uploaded by

Copyright:

Available Formats

Dear Author,

Here are the proofs of your article.

• You can submit your corrections online, via e-mail or by fax.

• The printed version will follow in a forthcoming issue.

Author Family Name Séverin

Annals of Operations Research

1 S.I. : REGRESSION METHODS BASED ON OR TECHNIQUES

2 Can earnings management information improve bankruptcy

5 Accepted: 24 June 2021

23 Keywords Earnings management · Bankruptcy prediction models · Corporate inance

24 JEL Classification G33 · C53

Annals of Operations Research

26 Earnings constitute an important entry in inancial statements, because they provide a

52 and real activities) on predictions of irm bankruptcy, to determine whether it provides

57 explored simultaneously to understand the impact of earnings management in bankruptcy

59 We also comparatively evaluate the forecasting ability of various prediction models,

62 • First, we analyze the independent impact of both types of earnings management–

Annals of Operations Research

98 both forms of earnings management variables—static and dynamic—possess signiicant

105 2 Literature review

Annals of Operations Research

109 2.1 Bankruptcy prediction models

136 ruptcy prediction models.

137 2.2 Variables to predict bankruptcy

Annals of Operations Research

177 2.3 Studies related to earnings management and corporate bankruptcy

Study Data Sample size Time period Key results

rience distress or not prior bankruptcy

Annals of Operations Research

224 the performance of bankruptcy prediction models.

225 3 Methodological approach

229 3.1 Data set

Annals of Operations Research

Financial Accrual-based Real act.-based

Model 1 Model 2 Model 3 Model 4 (F.R +

243 mid-term (two- and three-year) bankruptcy horizons.

Annals of Operations Research

Table 2 Descriptive analysis of Failed irms (%) Non-failed

Trade 36.5 36.5

252 3.2 Identifying inancial ratios

262 between failed and non-failed irms.

Annals of Operations Research

Table 3 Descriptive statistics of the inancial variables

278 ive methods used.

Annals of Operations Research

294 3.3 Earnings management proxy-based variables

317 3.3.1 Accruals-based model

Annals of Operations Research

332 TAccit 1 ΔSalesit PPEit ROAit−1

341 3.3.2 Real activities-based model

357 manipulation model is

361 Prodit 1 Salesit ΔSalesit ΔSalesit−1

Annals of Operations Research

LDA 78.1 79.9 80.1 80.5 + 1.9 + 2.1 + 2.5 * * **

Annals of Operations Research

401 4 Empirical evaluation

402 4.1 Estimating the contribution of earnings management to predict irm

Annals of Operations Research

Panel A: Type-I error

E.M. = earnings management–based model (accruals and real activities)

Not signiicant; *signiicant at 10% level; **signiicant at 5% level; ***signiicant at 1% level

Annals of Operations Research

Table 6 AUC values achieved Models AUC values Signiicance levels(1)

Not signiicant; signiicant at 10% level; signiicant at 5% level; signiicant at 1% level

1 year 78.3 80.3 80.6 80.8 + 2.0 + 2.3 + 2.5 *

2 years 23.1 22.0 20.1 20.7 -1.1 − 3.0 − 2.4 –

1 year 0.821 0.839 0.845 0.847 *

Not signiicant; * signiicant at 10% level; signiicant at 5% level; *signiicant at 1% level

1 year 0.850 0.852 0.856 * * ***