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This study examines whether the evaluation of a bankruptcy prediction model should take into account the total cost of misclassification. For this purpose, we introduce and apply a validity measure in credit scoring that is based on the total cost of misclassification. Specifically, we use comprehensive data from the annual financial statements of a sample of German companies and analyze the total cost of misclassification by comparing a generalized linear model and a generalized additive model with regard to their ability to predict a company's probability of default. On the basis of these data, the validity measure we introduce shows that, compared to generalized linear models, generalized additive models can reduce substantially the extent of misclassification and the total cost that this entails. The validity measure we introduce is informative and justifies the argument that generalized additive models should be preferred, although such models are more complex than generalized linear models. We conclude that to balance a model's validity and complexity, it is necessary to take into account the total cost of misclassification.

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This study analyzes the nonlinear relationships between accounting‐based key performance indicators and the probability that the firm in question will become bankrupt or not. The analysis focuses particularly on young firms and examines whether these nonlinear relationships are affected by a firm's age. The analysis of nonlinear relationships between various predictors of bankruptcy and their interaction effects is based on a structured additive regression model and on a comprehensive data set on German firms. The results of this analysis provide empirical evidence that a firm's age has a considerable effect on how accounting‐based key performance indicators can be used to predict the likelihood that a firm will go bankrupt. More specifically, the results show that there are differences between older firms and young firms with respect to the nonlinear effects of the equity ratio, the return on assets, and the sales growth on their probability of bankruptcy.