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For the Love of Money

University of Cincinnati researchers find common cause for bankruptcy in world's leading economies.

"Small businesses are the heart of the American economy. They're responsible for half of all private sector jobs," President Obama remarked to a selection of small business owners in March 2009. "And small businesses don't just provide jobs — they provide the innovations that help us lead in the global economy."

Yet a research project out of the University of Cincinnati begs to point out one problem with small businesses -- they fail a lot.* Associate professor of quantitative analysis and operations management, Yan Yu, and doctoral student Shaonan Tian announced 23 country-specific variables projected to lead to bankruptcy in the United States, United Kingdom, and Japan at the Joint Statistical Meeting — the largest gathering of statisticians in North America — in Vancouver this week. Among their findings, the researchers determined that in United States, alone, company size is the most prevalent risk variable in determining a company's propensity for bankruptcy — the smaller the company, the greater the risk.

The project, titled "Forecasting Corporate Bankruptcy: International Evidence," mined information from an international financial database, CompuState Global, for financial variables that led to bankruptcy between 1995 and 2009. Combining findings with model-selection techniques, Yu determined which corporate financial variables were likely to lead to bankruptcy in which country and in what period of time. For the purposes of her study, Yu defined bankruptcy as both liquidation of assets (equivalent to Chapter 7 in the United States) and reorganization (Chapter 11). Data was compiled from both companies that went bankrupt and those that did not.

Searching for a marker that predicts a company's failure is a popular pursuit (see here, here and here for examples), especially since an accurate test would be tonic for financial markets and regulators.

On an international scale, Yu found a 97 percent correlation rate between corporate bankruptcies and waning revenue from the sale of a good or service — making sales turnover the most common cause of bankruptcy in a one-year time span within the world's leading economies.

Yu's research rings especially significant with a 40 percent rise in corporate bankruptcies in the United States between 2008 and 2009 — notably General Motor's declaration in June 2009. "In 2002, corporate bankruptcies in the U.S. represented an estimated loss of $100 billion to the economy," explained Yu. "Now, economic losses due to corporate bankruptcy defaults have increased to trillions of dollars."

In June 2010, the House of Representatives passed the Small Business Jobs and Credit Act, a bill that promises to shore up the economy through increased loan limits, additional tax breaks, and lending assistance to small businesses. The bill is now being discussed in the Senate.

* This line originally read, "Yet a research project out of the University of Cincinnati begs to differ."