Business Failure Prediction: A Comparison of Discriminant Analysis, Logit Regression, and PLS Regression

Abstract

Corporate failure prediction represents a major challenge for lenders, investors, and managers in a context characterized by increasing bankruptcy rates and growing economic uncertainty. Although discriminant analysis and logistic regression models have been extensively employed in the bankruptcy prediction literature, comparative studies incorporating the Partial Least Squares (PLS) method remain relatively limited, particularly in contexts characterized by high multicollinearity among financial variables. This study aims to compare the predictive performance of Linear Discriminant Analysis (LDA), Logistic Regression (Logit), and the PLS method in forecasting corporate failure.

The study is based on a balanced sample of 200 Moroccan firms, including 100 failed companies and 100 non-failed companies. Thirty-three financial ratios covering financial structure, liquidity, solvency, profitability, activity, and growth were analyzed over three forecasting horizons prior to failure (T-1, T-2, and T-3). Discriminating variables were selected using Wilks’ Lambda and Fisher’s statistic before being incorporated into the different prediction models.

The results suggest that the Logit model provides the best short-term predictive performance, achieving a classification accuracy of 93.4% at T-1, compared with 91.2% for discriminant analysis and 90.8% for the PLS method. At longer forecasting horizons, the PLS approach appears to be the most robust, with a classification accuracy of 83.2% at T-3, outperforming both discriminant analysis (78.4%) and Logistic Regression (81.3%). Ratios related to working capital, working capital requirements, solvency, and profitability emerge as the most relevant indicators for the early detection of financial distress.

These findings highlight the relevance of Logit and PLS approaches for the development of early warning systems and credit risk scoring models used by financial institutions and decision-makers.

JEL Classification : G32, C38, C51, M41

Paper type : Empirical research.