The Role of Corporate Governance in Forecasting Bankruptcy: Pre- and Post- SOX Enactment.

Abstract

This paper contributes to the literature by documenting the improved performance of bankruptcy prediction models after including corporate governance variables. The empirical results demonstrate better predictive power for financial bankruptcy than previous bankruptcy prediction models, particularly in the post-SOX period. Our theoretical argument emphasizes the urgent need for such improvements to the bankruptcy prediction model following the introduction of the SOX Act, with the empirical results providing intuitive economic meaning for all relevant market participants. Policymakers may consider enacting laws to include designs for corporate governance monitoring mechanisms, entrepreneurs may use this model to improve their own governance structures and compensation mechanisms to avoid financial bankruptcy, and investors may refer to it to ensure that ‘losers’ are excluded from their investment portfolios.