Bankruptcy Prediction: The Case of the CLECS

The Telecommunications Act of 1996 led to the creation of the competitive local exchange carriers, known as CLECS (pronounced sea‐lecks). Despite a strong beginning and great optimism, between January 2000 and September 2002, almost half of the publicly held CLECS filed for bankruptcy. Though their path to bankruptcy was typical, the atmosphere surrounding the CLECS was not. They enjoyed the strong support of Wall Street analysts in the form of positive reports and buy ratings, as well as support from institutional investors in the form of investments, for much of their lives. This support may have been the consequence of the telecommunications mania that marked the late 1990s and part of 2000, or, it has been alleged, the result of unethical and possibly illegal behavior on the part of some of Wall Street analysts. Though this situation will no doubt generate a great deal of research in the coming years, this paper examines one of the most important issues that is prompted by the question: Using metrics that are readily available, could investors, analysts and other interested parties have predicted which CLECS would file for bankruptcy prior to the filings? This study attempts to respond to this question by envisioning a scenario in which an investor, analyst, or other observer learns in 2001 that three of the CLECS filed for bankruptcy in 2000. In response, the interested party reads some of the literature on predicting bankruptcy, and then uses certain of the methods described to determine which of the remaining CLECS are likely to become insolvent in 2001 and 2002.