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One criticism of failure prediction models is the bias resulting from pooling failure data over years when economic conditions might influence the failure of a firm. This research incorporates both macroeconomic variables and firm specific variables in explaining corporate failure. The results suggest that including economic variables improve the explanation of failure by ten percent. The economic variables included in the analysis were one-year lag in change in GDP, a two-year lag in interest rates, a one-year lag in the share price index, and a one-year lag in corporate profits. Economic variables were identified using a principal component analysis of key economic variables.
This document has been peer reviewed.