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Archives of Business Research – Vol. 11, No. 12
Publication Date: December 25, 2023
DOI:10.14738/abr.1112.16059.
Willey, T., Edwards, S., & Bhagwat, Y. (2023). An Investigation of the Altman Z-Score Measure and Return on Equity (ROE) of Firms
in the Airline Industry. Archives of Business Research, 11(12). 96-102.
Services for Science and Education – United Kingdom
An Investigation of the Altman Z-Score Measure and Return on
Equity (ROE) of Firms in the Airline Industry
Thomas Willey
Grand Valley State University
Susan Edwards
Grand Valley State University
Yatin Bhagwat
Grand Valley State University
ABSTRACT
This research measures the relationship between the Altman Z-Score, a measure of
a firm’s financial health, and the Return on Equity (ROE), a measure of a firm’s
profitability for a sample of airline companies. The period of the study covers 2014
to 2022 and uses linear regression to examine the relationship between ROE
(dependent variable) and the Z-Score (independent variable). Our data set contains
sixty-five (65) airline firms traded on twenty-eight (28) stock exchanges. Our initial
hypothesis is that a positive and statistically significant relationship exists between
the two variables over the examined period. Further research will look at the
relationship in other sectors of the markets.
Keywords: Altman Z-Score, Corporate Performance, Return on Equity, Airlines, Financial
Distress Prediction
INTRODUCTION
This research measures the relationship between the Altman Z-Score, a measure of a firm’s
current financial health and future financial distress and the Return on Equity (ROE), a measure
of a firm’s profitability for a sample of companies in the worldwide airline industry. The period
of the study covers 2014 to 2022 and uses linear regression to examine the relationship
between ROE (dependent variable) and the Z-Score (independent variable). Our initial data set
contains sixty-five (65) airlines traded on twenty-eight (28) stock exchanges.
MOTIVATION AND CONTRIBUTION
Literature Review
The Altman Z-Score (Altman, 1968 and 1974) is the most cited measure of financial health of
firms in previous studies. The Z-Score is a unique indicator of financial success due to the
combination of financial ratios that are combined into a single value which indicated the
likelihood a firm would go into financial distress and/or bankruptcy using multiple
discriminant analysis (MDA). Beaver (1968) examined the roles financial ratios played
separately on future outcomes of companies. Examples of previous research using the Altman
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Willey, T., Edwards, S., & Bhagwat, Y. (2023). An Investigation of the Altman Z-Score Measure and Return on Equity (ROE) of Firms in the Airline
Industry. Archives of Business Research, 11(12). 96-102.
URL: http://doi.org/10.14738/abr.1112.16059
method include firms in China (Wang and Campbell, 2010A and 2010B), India (Pradhan, 2014),
Sri Lanka (Gunathilaka, 2014) and Australia (Thai, et al., (2014).
The literature on using the Altman Z-Score and the associated predictive power of the method
is quite prevalent. Previous studies include Deakin (1977), Beynon and Peel (2001), Neophytou
et al. (2001) and Chung et al. (2008). Ohlson (1980) used logit regression methods, while
Frydman et al., (1985) recursive partitioning to measure financial distress. Agarwal and Taffler
(2007) found that MDA remains as the most frequently cited method for bankruptcy prediction.
Additionally, Tandiontong and Mathius (2017), found the existence of a partial correlation
between stock market returns in Indonesia and the Altman Z-Score, the beta of a stock and
inflation.
Aziz and Dar (2006) reviewed eighty-nine articles on bankruptcy prediction between 1968 and
2003 and reported multi-variable models were the most prevalent. The reliability of the Z-Score
model was tested by Altman and McGough (1974), Altman (1982), Levitan and Knoblett (1985)
and Koh and Killough (1990). Finally, Sherbo and Smith (1990) proposed that the Z-Score
model has endured and continues to be relevant in today’s business economy. Considering the
previous and current literature, this study uses the Altman Z-Score as our indicator of financial
health. The components of the model are Figure 1.
The dependent variable and the measure of a firm’s profitability and financial success, the
return on equity (ROE), is used in our study. Studies that used this ratio include Chen and Dodd
(1997), Chen et al, (2005) and Damodaran (2007). Stowe et al., (2002) stated that the ROE is a
widely used metric by companies to make corporate investment decisions.
Research Question and Hypothesis
Our research question: does the ROE of higher (lower) performing firms in the Airline Sector
also coincide with higher (lower) Z-Scores?
Our null hypothesis is there is no statistically significant relationship between the two
variables. Our alternative hypothesis is that there is a significant statistical relationship
between ROE and the Altman Z-Score.
METHODOLOGY AND DATA
The study uses the Altman Z-Score Model as a predictor of financial distress and bankruptcy.
The Altman Z-Score (1968) is shown in Figure 1.
Figure 1: Altman Z − Score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
Where:
X1 = Net Working Capital/Total Assets (TA)
X2 = Retained Earnings/TA
X3 = Earnings Before Interest and Taxes (EBIT)/TA
X4 = Market Value of Equity/Total Liabilities (TL)
X5 = Sales/TA
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Descriptive Analysis
Table 1: Mean, Median, Standard Deviation and Coefficient of Variation of Z- Scores
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022
Mean 2.70 3.12 3.08 3.10 2.85 2.25 1.00 1.39 1.56
Median 1.54 1.94 2.07 2.30 1.82 1.53 0.63 0.92 1.16
Std. Dev. 4.62 3.79 4.23 3.70 3.96 2.67 6.17 1.82 1.65
Coefficient of Variation (CV) 1.71 1.21 1.37 1.20 1.39 1.19 6.17 1.31 1.06
Table 1 shows the mean, median, standard deviation and a measure of relative variability (CV;
defined as the Sample Standard Deviation/Sample Mean) for the Z-Scores for the nine-year
period from 2014 to 2022. Z-Scores greater than 2.99 indicate strong financial health and low
possibility for financial distress and/or bankruptcy (Altman, (1968)). Additionally, Altman
(1968) states that Z-Scores less than 1.81 indicate poor financial health and a strong likelihood
for bankruptcy. The so-called “zone of ignorance” with scores from 1.81 to 2.99, indicates an
undetermined future financial success of the firm. Seventeen percent (17%) of the average and
median Z-Scores are greater than 2.99 (pre-Covid = 3 and Covid = 0) for the entire period
examined and thirty-three percent (33%) of the scores fall in the “’zone of ignorance” between
1.81 and 2.99 (pre-Covid = 6 and Covid = 0). All of the nine of the remaining scores are less than
the lower limit of 1.81 (pre-Covid = 3 and Covid = 6). Our results indicate a significant decrease
in the mean (median) Z-scores during the pandemic years of 2020 through 2022. The relative
variability of the scores, measured by the CV, increased by 418% from 2019 to 2020.
Table 2: Mean, Median, Standard Deviation and Coefficient of Variation of Return on
Equity (ROE)
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022
Mean 10.65% 14.59% 18.51% 16.90% 17.87% 19.28% -33.99% -33.67% -14.13%
Median 9.60% 13.60% 14.70% 14.50% 13.60% 12.45% -8.15% -2.42% 1.22%
Std. Dev. 28.79% 29.17% 29.80% 16.11% 37.78% 80.78% 101.15% 145.11% 52.54%
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
2014 2015 2016 2017 2018 2019 2020 2021 2022
Figure 2: Mean and Median Z-Scores-Airlines
Mean
Median
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Willey, T., Edwards, S., & Bhagwat, Y. (2023). An Investigation of the Altman Z-Score Measure and Return on Equity (ROE) of Firms in the Airline
Industry. Archives of Business Research, 11(12). 96-102.
URL: http://doi.org/10.14738/abr.1112.16059
Coefficient
of Variation
(CV)
2.70 2.00 1.61 0.95 2.11 4.19 -2.98 -4.31 -3.72
Table 2 shows the mean, median, standard deviation and the CV for the ROE for the nine-year
period from 2014 to 2022. The measure of profitability, specifically, the average and median
return to the common stockholders of the firm, varies from a minimum median value of 9.60%
to a maximum average value of 19.28% for the first six years of the sample period. As shown in
Figure 3, firms in the airline industry, as well as the world-wide economy, suffered a dramatic
decrease in this measure of profitability. For the last three years of our study (2020 to 2022),
the average (median) ROE was negative (-27.26%; -3.12%). The minimum value for the ROE
for this period was an average of -33.99%. The maximum median return was 1.22%, the only
positive return result for this period.
Regression Analysis
Table 3: Regression Analysis
Coefficients Std. Error T-Stat P-value Lower 95% Upper 95%
Z-Scores 2.2715 0.7705 2.9482 0.0033 0.7583 3.7847
A linear regression was run over the period of 2014 to 2022 using this formula: ROE (dependent
variable) = Constant + B*Altman Z-Score (independent variable), where B is the regression
coefficient. The source of the financial data was S&P Global Market Intelligence. The industry
classification was the Airline sector, which included sixty-five firms with complete data
available, for the period of our study. The top and bottom one percent of the outliers were
removed for the analysis.
A total of 584 observations were used for the linear estimation of airline sector firms. The
results show a positive coefficient (+2.27 rounded) and statistically significant results (T- Statistic is 2.95, p-value = 0.0033) for the impact of the Altman-Z score on the ROE of the firms.
The standard error is low (0.77), as well.
-40.00
-30.00
-20.00
-10.00
0.00
10.00
20.00
30.00
2014 2015 2016 2017 2018 2019 2020 2021 2022
Figure 3: Mean and Median ROE - Airlines
Mean
Median
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Archives of Business Research (ABR) Vol. 11, Issue 12, December-2023
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Our results indicate a statistically significant and positive relationship between the Altman Z- Score and the ROE of firms in the Airline Sector. As a result, many groups, (management,
investors, lenders and other interested parties), may view the measure of financial success as a
positive signal for profitability in this sector.
DISCUSSION
Limitations and Future Research
The study is limited to firms solely in the Airline Sector and no other economic sectors. Our
focus is to measure the relationship between a measure of financial solvency and profitability
in airline firms. Plans are to extend our analysis to other industries and additional time periods
to expand the coverage of this relationship. For example, the impact of the world-wide
pandemic on the profitability of companies.
Conclusions
The purpose of our research is to investigate and empirically test the relationship between the
Altman Z-Score (a measure of financial health or success) and financial performance and
profitability, measured by Return on Equity (ROE), for firms in the Airline Sector. Our findings
show a positive and statistically significant relationship between the dependent variable (ROE)
and the independent variable (Z-Score).
Seventeen percent (17%) of the average and median Z-Scores are greater than 2.99 (pre-Covid
= 3 and Covid = 0) for the entire period examined and thirty-three percent (33%) of the scores
fall in the “’zone of ignorance” between 1.81 and 2.99 (pre-Covid = 6 and Covid = 0). All of the
nine of the remaining scores are less than the lower limit of 1.81 (pre-Covid = 3 and Covid = 6).
Our results indicate a significant decrease in the mean (median) Z-scores during the pandemic
years of 2020 through 2022.
For the indicator of financial performance, for the first six of the nine years analyzed, the
average (median) ROE was 16.3% (13.08%), respectively. For the pandemic years of 2020 to
2022, the average ROE was -27.26% (the median ROE was -3.12%). This dramatic decrease in
profitability is evidence of the crippling impact of the worldwide pandemic had on the airline
sector, specifically, and the global economy, in general.
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Willey, T., Edwards, S., & Bhagwat, Y. (2023). An Investigation of the Altman Z-Score Measure and Return on Equity (ROE) of Firms in the Airline
Industry. Archives of Business Research, 11(12). 96-102.
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