Corporate credit-risk evaluation system: Integrating explicit and implicit financial performances

Traditional credit-risk evaluation methods focus mainly on static credit evaluation and rarely consider incentive factors. This paper proposes a comprehensive method of credit-risk evaluation based on dynamic incentives. First, an “explicit incentive” model is constructed based on the firm's current financial standing, and an “implicit incentive” model is subsequently developed focusing on the trend of the firm's past performance. Geometric (or arithmetic) procedures are applied to integrate the two models. To validate the proposed approach, we apply it to 12 publicly traded companies, each with 24 quarters and 20 indicators. We find the proposed integrated evaluation model outperforms the conventional models by better reflecting the key credit-risk management concept of “motivation and guidance”.