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This study aims to shed light on the debate concerning the choice between discrete-time and continuous-time hazard models in making bankruptcy or any binary prediction using interval censored data. Building on the theoretical suggestions from various disciplines, we empirically compare widely used discrete-time hazard models (with logit and clog-log links) and continuous-time Cox Proportional Hazards (CPH) model in predicting bankruptcy and financial distress of the United States Small and Medium-Sized Enterprises (SMEs). Consistent with the theoretical arguments, we report that discrete-time hazard models are superior to continuous-time CPH model in making binary predictions using interval censored data. Moreover, hazard models developed using failure definition based jointly on bankruptcy laws and firms’ financial health exhibit superior goodness of fit and classification measures, in comparison to models that employ failure definition based either on bankruptcy laws or firms’ financial health

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This study acknowledges the diversity between micro, small, and medium‐sized firms while predicting bankruptcy and financial distress of the United States small and medium‐sized enterprises. Empirical findings suggest that survival (failure) probability increases (decreases) with increasing firm size and firms in different size categories have varying determinants of bankruptcy, whereas factors affecting their financial distress are mostly invariant. Magnitude of significant covariates changes across the size categories of both bankrupt and financially distressed firms. Further, operating cash flow information does not add any marginal increment in prediction performance of multivariate hazard models above baseline models developed using information from income statements and balance sheets. This result holds for failure likelihood of small and medium‐sized enterprises and their respective size categories.

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In this study we hypothesise that more frequent extreme negative daily equity returns result in higher tail risk, and this subsequently increases firms' likelihood of entering financial distress. Specifically, we investigate the role of Value-at-risk and Expected Shortfall in aggravating firms' likelihood of experiencing financial distress. Our results show that longer horizon (three-and five-year) tail risk measures contributes positively toward firms' likelihood of experiencing financial distress. Additionally, considering the declining number of bankruptcy filings, and increasing out-of-court negotiations and debt reorganisations, we argue in favour of penalising firms for becoming sufficiently close to bankruptcy that they have questionable going-concern status. Thus, we propose a definition of financial distress contingent upon firms' earnings, financial expenses, market value and operating cash flow.

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