THE INCREMENTAL PREDICTIVE ABILITY OF GENERAL PRICE LEVEL ADJUSTED ACCOUNTING NUMBERS FOR DOWNWARD BOND RATING CHANGES

The accounting profession has made several attempts to deal with the problems caused by the instability in the purchasing power of the dollar. FASB 33 recommended General Price Level adjustment of accounting numbers as one of two alternatives to deal with the problem of changing price levels. This study is an attempt to determine the increased usefulness, if any, of GPL adjusted (GPLA) numbers in predicting downward bond rating changes.;The selected ratios were composed of financial statement items. Each ratio for every sample firm was computed twice, once using NHC numbers and once using GPLA numbers. The GPLA numbers were obtained by restating NHC numbers using a restatement procedure similar to Parker (1977).;The sample consisted of 81 industrial firms that experienced a downward change in bond ratings during 1977 through 1981, and 267 firms that did not. The selected firms were limited to those that are included in the COMPUSTAT tapes.;The discriminant model employed achieved a predictive accuracy ranging from seventy to eighty percent for each data set (GPLA and NHC). The results did not reveal that GPLA numbers contained information that is not present in NHC accounting numbers. Further tests were made on separate subsets of firms whose bond ratings were downgraded by Moody's compared to those downgraded by S&P. These tests failed to reveal that GPLA numbers had superior predictive ability, in relation to downward change in bond rating decisions of a particular rating agency, given the model employed and the restated GPL number used in this study.;A multiple discriminant analysis model was employed. The variables of this model were five different combinations of twenty financial ratios which were selected on the basis of recommendations of previous research and which, on an a priori basis, were expected to highlight the differences between GPLA and NHC accounting numbers. Five of the twenty ratios were trend ratios.