In his 1968 paper, Altman found that sales volume (i.e., sales divided by total assets) is a useful predictor not by itself, but as a suppressor variable to improve the predictive power of EBIT/TA.

Suppressor variables are such that they do not or not significantly correlate with the dependent variable, but they do have a high (positive or negative) correlation with another independent variable.

In this case, Altman found a high negative correlation between sales volume and EBIT in the bankrupt sample. All other things being equal, this would imply that companies go bankrupt when they sell their wares at a higher profit margin?

I've been racking my brain as to why that is.

Altman's 1968 paper: https://pdfs.semanticscholar.org/cab5/059bfc5bf4b70b106434e0cb665f3183fd4a.pdf

  • $\begingroup$ I call attention to this statement (which I don't fully understand) page 597: " The logic behind the high negative correlation in the bankrupt group is that as firms suffer losses and deteriorate toward failure, their assets are not replaced as much as in healthier times, and also the cumulative losses have further reduced the asset size through debits to Retained Earnings. The asset size reduction apparently dominates any sales movements. " Apparently failing firms have negative EBIT/Assets but large Sales/Assets because of low assets. $\endgroup$ – Alex C Jun 9 at 13:36

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