Management Decision

Emerald Article: Failure processes and causes of company bankruptcy: a

typology
Hubert Ooghe, Sofie De Prijcker
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Hubert Ooghe, Sofie De Prijcker, (2008),"Failure processes and causes of company bankruptcy: a typology", Management Decision,
Vol. 46 Iss: 2 pp. 223 - 242
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Failure processes and causes of
company bankruptcy: a typology
Hubert Ooghe and Soe De Prijcker
Ghent University, Ghent, Belgium
Abstract
Purpose The purpose of this paper is to show that previous research about nancial and
non-nancial causes of bankruptcy has neglected the time dimension of failure. The paper seeks to
gain deeper insight into the failure process of a company, giving it a more grounded understanding of
the relationship between the characteristics of a company, the underlying causes of failure and the
nancial effects.
Design/methodology/approach The ndings are based on a literature overview and in-depth
case study research.
Findings Four types of failure processes were observed: the failure process of unsuccessful start-
ups, the failure process of ambitious growth companies, the failure process of dazzled growth
companies, and the failure process of apathetic established companies. Between these four failure
processes, there exist major distinctions in terms of the presence and the importance of specic causes
of bankruptcy, i.e. errors made by management, errors in the corporate policy and the importance of
external factors.
Research limitations/implications The results of the study are based on qualitative, case study
research. No attempt is made to quantify the existence and the importance of the ndings. The major
constructs that emerged as important in the research are well-known concepts in the management
literature. As a consequence, they should be further developed in order to quantify their effect in
large-scale studies.
Practical implications Based on the ndings, stakeholders of a company can have a clearer view
of both the time dimension inherent in corporate failure and the impact of their own actions on
bankruptcy.
Originality/value The paper lays the ground for understanding the process of company failure.
Company failure does not happen overnight and therefore a longitudinal and holistic perspective is
needed.
Keywords Bankruptcy, Financial management, Companies, Corporate strategy
Paper type Research paper
Introduction
Happy companies are all alike, every unhappy company is unhappy in its own way (adapted
from Anna Karenina, Tolstoy)
The bankruptcy literature reveals a high number of bankruptcy prediction models.
They are generally based on nancial symptoms (e.g. Beynon and Peel, 2001; Dimitras
et al., 1999, Ooghe et al., 1995), but not on the more fundamental causes of failure.
Publications concerning these causes, on the other hand, generally examine only a
limited number of nonnancial causes or focus on specic types of enterprises (e.g.
Everett and Watson, 1998; Charan and Useem, 2002; Hambrick and DAveni, 1992).
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0025-1747.htm
This study was sponsored by the Research Foundation for Entrepreneurship and Innovation of
the Flemish Government.
Causes of
company
bankruptcy
223
Received March 2007
Revised November 2007
Accepted November 2007
Management Decision
Vol. 46 No. 2, 2008
pp. 223-242
qEmerald Group Publishing Limited
0025-1747
DOI 10.1108/00251740810854131
To our knowledge, an all-embracing approach that relates the causes of bankruptcy to
the characteristics of the company and to the nancial symptoms of distress has never
been applied, despite its relevance for researchers and practitioners (Balcaen and
Ooghe, 2006; Thornhill and Amit, 2003).
Our researchattempts to ll the gapdescribed above. The contributionof this studyis
two-fold. First, we will examine bankruptcy within different industries taking size and
age into account. We will reveal four different failure processes that connect the
fundamental causes of bankruptcy to the nancial and nonnancial consequences.
Second, we will study the presence of nonnancial errors within different failure
processes.
The paper is organized as follows. In the next section, we give an overview of the
previous literature. This is followed by a description of the applied methodology and
case selection. Then, the case study ndings are discussed: we give a detailed
description of the four types of failure processes, and expound the relation between a
companys failure process and its underlying causes of bankruptcy. The paper ends
with our conclusion and suggestions for further research.
Causes of bankruptcy
Considerable attention has been given to bankruptcy prediction models, using
nancial information (e.g. Ooghe et al., 1995; Pompe and Bilderbeek, 2005). These
studies ignore however the time dimension of failure and the inuence of underlying
nonnancial factors. Research that underlines these factors is very fragmented (e.g.
Baum and Mezias, 1992; Daily and Dalton, 1995; Greening and Johnson, 1996;
Swaminathan, 1996). Despite this fragmentation, most studies relate corporate
bankruptcy to managerial errors.
In preparation of this research, an extensive literature review was executed,
resulting in a conceptual failure model (Ooghe and Waeyaert, 2004). Figure 1
expounds the different causes of failure and stresses the mutual relations between
them.
First, general environment clusters several external causes. They affect managers
motivation, the usefulness of their skills and hence corporate policy, next to the
relationship with stakeholders in their immediate environment.
The immediate environment forms a second group of causes. The interactions
between a company and its stakeholders determine corporate development. Ruinous
competition, but also mutual projects with stakeholders are well-known examples of
these interactions.
Third, the characteristics of management or the entrepreneur and fourth, the
companys corporate policy have a more important impact on performance (Boeker,
1997; McGahan and Porter, 1997) and are therefore displayed in the centre of the
model.
Management, the thirdfactor, are recognizedas amajor cause of bankruptcy(DAveni
and MacMillan, 1990; Greening andJohnson, 1996). Inappropriate management qualities
andskills are athreat to rmsurvival andare therefore oftenlinkedto failure of start-ups.
If these managers are in addition reluctant to accept advice from other parties, they
signicantly reduce companys long term survival chances (Newton, 1985). It is
furthermore remarkable to whichextent personal characteristics affect performance. We
describe the two characteristics, which are, in our opinion, most noteworthy. First of all,
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inertia leads to ignorance of opportunities and threats instead of exploring changes in
strategy and the decision making processes (DAveni and MacMillan, 1990; Gilbert,
2005). Second, optimism and risk seeking behaviour may also precede distress. There
exists, however, a difference between entrepreneurs and managers with respect to this
behaviour. Where entrepreneurs threatentheir ownwealthdue toriskseekingbehaviour,
managers on the other hand often ignore stakeholders interests as their utility function
often favours very risky projects, although they may be more risk averse than
entrepreneurs (Parrino et al., 2005).
Management sets up corporate policy that involves several aspects, such as strategy
and nancial management. As errors can quickly lead to bankruptcy, all aspects have
to be taken into account. Unfortunately, a lack of skills and personal characteristics
may precede unanticipated problems in corporate policy.
Figure 1.
Conceptual failure model
of possible causes of
bankruptcy (Ooghe and
Waeyaert, 2004)
Causes of
company
bankruptcy
225
Finally, company characteristics: size, maturity, industry and exibility also have
to be taken into account. Previous research focuses on age and size. First, liability of
newness is an important research topic: young rms have to build up external
legitimacy and stable relationships with stakeholders. They are therefore very
vulnerable (Fichman and Levinthal, 1991). Second, size may also affect survival
chances, but the impact of liability of smallness is normally minor than liability of
newness (Halliday et al., 1987). We nally emphasize that companies in different
industries, even with a similar nancial prole, have a different probability of failure
(Platt et al., 1994). There exists in addition a contagion effect between rms in the same
industry, especially for highly leveraged rms (Lang and Stulz, 1992). More than other
researchers, we stress the strong link between the characteristics of a company, its
management and its policy.
Failure as a process
Few researchers have explicitly analysed failure as a process. The oldest and most
well-known exception is Argenti (1976), relating nonnancial failure causes with
nancial indicators within three different failure processes.
The rst trajectory of failing companies (Argenti, 1976) reveals the typical failure
path of a start-up company with inappropriate management in terms of skills or
personality.
The second trajectory (Argenti, 1976) explains the bankruptcy of young companies
after a very precipitous growth and an even steeper decline. Their collapse is also
caused by management deciencies, but there is an important difference with the rst
path: managers outstanding personality that ensures a swift take-off. The company
goes bankrupt when operational and nancial management are ignored during the
growth phase.
The last trajectory, type 3 (Argenti, 1976), is applicable for mature and inert
companies that refrain adaptation of management structure and lose touch with their
customers. The company goes bankrupt because they do not respond adequately to
environmental changes.
Argentis failure paths contain two major deciencies. First, the concept of
nancial health of a company is not based on nancial indicators. It is therefore
vague and equivocal. Second, although Argenti (1976) emphasizes the importance of
management errors, the existence of specic errors in different failure paths and within
distinctive phases is not clear. The subtleties of the failure paths are therefore not
apparent.
Other failure processes (Laitinen, 1993; Newton, 1985; Ooghe and Van Wymeersch,
2006) ignore the relationship between nonnancial causes and specic nancial effects,
such as liquidity, protability and solvency.
Methodology and data
Methodology
We will use a multicase study research. Case study research is appropriate as we focus
on the evolution of a phenomenon when the borders between the phenomenon and its
context are not very clear (Yin, 1994). More than just measurable data are analysed and
it reveals this topic through multiple perspectives, essential within corporate
bankruptcy (Thornhill and Amit, 2003). This information converges through
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triangulation (accuracy increases by support from several sources) which provides
valuable insights and which facilitates a richer understanding of the complexity of a
failure process. This approach is also very useful for sensitive topics with condential
information.
Case selection and description
The goal of the used sample method, theoretical sampling, is to choose cases, which
can replicate or extend the emergent theory (Eisenhardt, 1989). The necessary steps are
taken to ensure appropriate sampling. 12 Belgian companies are selected, based on
size, age and industry. The selection frame is displayed in Table I. For reasons of
condentiality, each case is denoted by a letter. For each category, we select all
bankruptcies in Flanders and Brussels during the previous three years. We select
companies under the condition that necessary information can be obtained. For all
cases, we gather nancial and nonnancial information: we analyse rst the annual
accounts of the company. Second, we obtain the ndings of the court. Third, related
parties such as management, trustees, banks and employees are interviewed, based on
a questionnaire that was designed after the literature review and revised after some
test interviews. The semi-structured process allows us a free expression of the
entrepreneurs ideas and to compare ndings with other related parties. We conducted
our interviews from Spring 2004 till Fall 2005.
The results of each of the 12 case studies are written out in a standard report
including the following items: the companys history, a nancial statement analysis for
the 3 most recent accounting years and a description of failure causes. This within-case
analysis helps to gain full insight and to cope with the volume of data received
(Eisenhardt, 1989). We select different categories and look for within-group similarities
coupled with intergroup differences. Finally, the emerging concepts were tied to the
existing literature in order to enhance internal validity.
Case study ndings: a typology of four types of failure processes and their
causes of bankruptcy
Four types of failure processes to explain a companys deterioration and bankruptcy
Based on the companys maturity and the causes of bankruptcy, we discover four
different types of failure processes: the failure process of an unsuccessful start-up
(cases C, E, G, I and K), the failure process of an ambitious growth company (cases A, D
and L), the failure process of a dazzled growth company (cases B and F) and the failure
process of an apathetic established company (cases H and J). There is no uniform
relationship between the type of failure process and size or industry. Only age or
maturity of the (young) company is linked with the type 1 failure process.
Large (. 100 employees) Small (, 100 employees)
Type of industry , ve years . ve years , ve years . ve years
Manufacturing A B C D
Service E F G H
Trade I J K L
Table I.
Selection of the 12 cases
based on size, age and
industry
Causes of
company
bankruptcy
227
Within this section, we draw attention to the dynamics and interactions between
nonnancial and nancial factors in the different phases of the four failure processes.
We also aim to expound the relations between the internal and external environment of
failing companies. Furthermore, each failure path has three phases. First, initial
shortcomings form the foundation of a latter failure. The second phase indicates
problems in terms of capital expenditures, sales or expenses. These are symptoms of a
corporate policy that falls short due to those initial shortcomings. The last phase gives
an overview of nancial problems and is very much interrelated to the previous
phases. We emphasize the similarities in terms of the occurrence of nancial signals of
distress between the four failure processes. However, the speed at which the signals
succeed each other and managements reaction towards these signals differs
signicantly. The most considerable difference is the presence of very distinctive initial
shortcomings.
The failure process of an unsuccessful start-up company (type 1: cases C, E, G, I and K)
Many companies fail within ve years after their founding. Most of these companies
have very limited growth, are unprotable and have no survival chances. An overview
of their failure process is displayed in Figure 2. We draw attention to the specic
characteristics of management in our description below.
A typical initial shortcoming concerns the lack of managerial or industry-related
experience. The necessities within a companys business plan are unknown and many
companies (E, G, K) have no strategic advantage. Inappropriate management may also
lead to insufcient control mechanisms and all cases are characterized by severe
operational inefciencies. As a consequence, the companys long term survival seems
very unlikely as from its start-up.
Errors in the companys policy are the visible result of errors made by management.
Depending on the experience, three negative signals can be observed: heavy capital
expenditures, low sales levels and underestimated expenses.
These negative signals are rapidly followed by nancial indicators of distress. Low
cash ow and protability inevitably leads to liquidity problems, often increased by
unadjusted investments. The fall of the company appears likely shortly after its
foundation.
All stakeholders are well aware of the companys problems and stable relationships
cannot be established. The lack of external legitimacy (Kale and Arditi, 1998) and
stakeholders mistrust accelerate the failure process.
Management gradually realize the necessity of a restructuring, but banks refuse
cooperation. Therefore, start-ups without signicant starting capital have scant
possibilities to survive and even with sufcient starting capital, they are still very
likely to fail as management does not assess the underlying issues. As a consequence,
these companies cannot escape the downward spiral.
The failure process of an ambitious growth company (type 2: cases A, D and L)
From the start, management or the entrepreneur leading an ambitious growth
company are risk lovers with industry-related experience and ambitious objectives.
Some are moreover over-optimistic. An expansion plan is launched which implies a
major increase of the rms debt/equity ratio. Note that some of these companies have
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already existed for several years when they did not have the opportunity or the means
to execute the intended strategy. The growth scenario implies a new start.
The initial shortcoming is the large overestimation of demand despite the
experience and capabilities of management. This overestimation is due to
over-optimism or to an overestimation of either market size or customers switching
behaviour. The latter reects its liability of newness. Consequently, turnover is
insufcient to cover expenses and overcapacity is large. These negative signals lead to
insufcient prots and cash ow. Due to the high debt/equity ratio, all nancial
consequences including liquidity and solvency are very harmful.
Figure 2.
The failure process of an
unsuccessful start-up
company (type 1)
Causes of
company
bankruptcy
229
Fortunately, as a result of their expertise, management normally have a clear view
of the issues. A successful recovery is nevertheless very difcult without internal
means and banks mostly refuse additional debt.
Management are therefore unable to reorganize in the most efcient way. Despite
these issues, protability improves steadily, but the companys liquidity and solvency
remain very weak. Due to its nancial structure, the company is vulnerable to changes
in the environment. If changes in the companys environment do occur, then the
company will face a dramatic loss of strategic advantage and this inevitably leads to
its bankruptcy within a short period.
This failure process contrasts with Argenti (1976), which relates failing high growth
companies to insufcient skills in terms of nancial, administrative or operational
policy. Our ndings indicate that managements overestimation of turnover combined
with vulnerability towards changes in the environment is another possible cause for
bankruptcy after failed growth.
The failure process of a dazzled growth company (type 3: cases B and F)
Failure process 2 (Figure 3) and failure process 3 (Figure 4) expound the deterioration
and bankruptcy of a company after a failing growth. As a consequence, there are some
similarities between both failure processes, but there exist two critical distinctions. First,
companies that fail according to the type 3, failure process (Figure 4) have a higher
nancial strength at the start of their growth because these companies are more mature.
Second, management characteristics vary signicantly between these failure processes.
Initially, internal or external growth is desired: a new strategy is developed, often
combined with an innovative product or process. This strategy is successful and the
company gains legitimacy as one of the most promising companies in the industry.
The initial shortcoming is managements reaction to this success: dangerously dazzled
over-optimism. Later on, growth and capital expenditures increase together with
leverage, pitfalls are ignored and the organizational structure remains almost
unchanged. This inevitably leads to a loss of control and to unawareness of possible
issues that could affect operational efciency or turnover. This results in a variety of
negative signals: overestimated sales, large overcapacity and high expenses.
As a consequence, protability and nancial strength decline swiftly. Because of
extreme optimism and unrealistic perceptions, negative signals are ignored or
attributed to external and temporary factors. In reality, the need for internal
restructuring is urgent.
Managements dazzle and the companys unbalanced growth will continue until
they face critical difculties, such as very weak solvency and payment delays. From
that moment on, most companies have little chance of survival, as many stakeholders
feel deceived and lose condence. The length of this last phase depends on
management efforts to recover and on the cooperation with stakeholders, but nally,
the negative spiral cannot be reversed.
The differences between types 2 and 3 have important implications. Type 3
companies have, as a consequence of their nancial reserves, more possibilities of
outliving a disastrous investment plan. Their bankruptcy is due to dazzle and
overcondence. Therefore, this failure process is an illustration of the perils of a risk
seeking behaviour for healthy companies without an adapted management structure
that can draw a stop at decline. Type 2 companies are much more vulnerable after a
failed investment even if management have a clear view of the situation. Bankruptcies
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Figure 3.
The failure process of an
ambitious growth
company (type 2)
Causes of
company
bankruptcy
231
Figure 4.
The failure process of a
dazzled growth company
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of dazzled growth companies are more unusual than bankruptcies of ambitious growth
companies, but the latter receive more media attention.
The failure process of an apathetic established company (type 4: cases H and J)
Finally, we describe the failure process of an apathetic established company that
existed more or less successfully for several years. The failure process is displayed in
Figure 5. Management of these companies are characterized by a lack of motivation
and commitment. Due to apathy, they still believe in strategies that were successful in
the past, unaware of the gradual changes in the environment. When the companys
closest competitors do react to these changes, it loses its strategic advantage.
Inevitably, customers switch over to competitors and turnover decreases signicantly,
but management ignore the fundamental causes. Instead, they look at temporary
inuences to explain decreasing prots.
Figure 5.
The failure process of an
apathetic established
company (type 4)
Causes of
company
bankruptcy
233
Management will not reorganize until they suffer from a signicant lack of internal
nance. Unfortunately, the recovery plan contains major deciencies, as management,
because of their rigidity and limited commitment, cannot estimate opportunities and
threats correctly. This results in inappropriate capital expenditures, and low sales are
insufcient to cover the companys increased expenses.
Because of the failing restructuring, liquidity and solvency problems arise.
Customers and creditors lose condence in the company. Management are now fully
aware of the situation, but the company fails after several years of apathetic
management and a desperate nancial situation.
This failure process illustrates the threats of routine inertia (Gilbert, 2005). In
addition to Wiseman and Bromiley (1996), we furthermore do not fully agree with the
threat rigidity response (declining organizations reduce their risk taking). We state,
in addition to Wiseman and Bromiley (1996), that a high potential slack (e.g. less debt
compared to equity) of companies in crisis often induces management to take higher
risks and to change business signicantly. However, due to inertia, they are unaware of
the most suited opportunities and fail to expound an appropriate recovery plan.
Specic causes of bankruptcy for each type of failure process
In this section, we discuss the causes of bankruptcy for each type of failure process. We
will stress the interdependence between the causes during the failure path instead of
focussing on a limited number of causes.
Management: the origin of most problems
Similarly to most authors, we stress managements responsibility in corporate
bankruptcy. There are, however, signicant differences in terms of the errors made by
management between the different failure processes. An overview is given in Table II.
Type 1 Type 2 Type 3 Type 4
Failure process of
an unsuccessful
start-up
Failure process of
an ambitious
growth company
Failure process of
a dazzled growth
company
Failure process of an
apathetic established
company
Competences
and skills
Insufcient
competences and
skills in many areas
Wrong estimation
turnover
Lack of nancial
background (some
cases)
Motivation Enduring
motivation
Very motivated Insufcient
motivation and
commitment
Personal
characteristics
Rashness Persuasiveness Over-optimism Inertia
Authoritarian
leadership (some
cases)
Risk lovers Dazzled
Over-optimism
(some cases)
Table II.
Causes of bankruptcy for
each type of failure
process: management
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The major shortcoming of management of unsuccessful start-up companies is, given
their insufcient competences and skills, their rashness in establishing a company
without taking advice and without anticipating possible threats. Additionally, a
minority of managers are too authoritarian.
The overestimation of turnover that initiates the deterioration of ambitious growth
companies is caused by either a lack of skills or by personal characteristics
(over-optimism) that affect the leaders ability to select and assimilate information
correctly. The decision to expand is furthermore affected by personal characteristics
and their motivation to succeed is necessary for the gradual but insufcient recovery
after the failed investment plan.
Leaders of dazzled growth companies do not lack management or industry-related
experience, competencies or skills. This is illustrated by the success of their rst
expansion. The main reason for bankruptcy is managements dazzled over-optimism
after these successes. Finally, their motivation is only critical in the expansion phase,
not in subsequent phases.
Finally, management of apathetic established companies are inert and lack
motivation and commitment.
Corporate policy: where they got lost
As management set out corporate policy, the differences between failure processes in
terms of management errors lead to distinctive problems in terms of corporate policy.
This is summarized in Table III.
Type 1
Failure process
of an
unsuccessful
start-up
Type 2
Failure process of
an ambitious
growth company
Type 3
Failure process of an
ambitious growth
company
Type 4
Failure process of an
apathetic established
company
Strategy No strategic
advantage
No adjustments to
environment
Capital
expenditures
Inappropriate Exaggerated Exaggerated Unadjusted
Commercial
policy
Lack of
customers
Overestimated sales Loss of customers
Customer
dissatisfaction
Customer
dissatisfaction
Finance and
administration
Insufcient
nancial
planning
Lack of expertise
(some cases)
Extreme gearing
Operational
policy
Severe
operational
errors
Unadjusted
management and
operational
structure
Operational
inefciencies
Human
resources
management
Insufcient
training
Minor inuence
Corporate
governance
Moderate
inuence
Table III.
Causes of bankruptcy for
each type of failure
process: corporate policy
Causes of
company
bankruptcy
235
The issues in terms of corporate policy of start-up companies are diverse and depend
upon managements lacking expertise: a low commercial insight results in low sales
and high capital expenditures (E, G and K), while a decient operational organization
leads to high expenses (and capital expenditures) or low customer satisfaction (C, E
and I). All companies however lack a clear nancial planning and control system.
As we have mentioned in the previous section, the expansion of ambitious growth
companies fails to a major extent because of the overestimation of turnover. A lack of
nancial expertise is also common, but it never has a signicant inuence on the
failure of the intended growth, as this business plan was executed under serious
consideration and after professional advice. These errors only possibly inuence the
survival chances of the company in a subsequent phase, as they affect assessment and
amelioration of the nancial situation during the recovery process.
The exaggerated investment plan of dazzled growth companies fails as a
consequence of extreme gearing, combined with an unadjusted managerial and
operational structure. Possible errors in the companys commercial policy do not have a
critical inuence.
The lack of commitment and motivation of apathetic established companies
restrains them not only from adapting to external changes but also from restructuring
successfully later on. This results in an unadjusted strategy, inappropriate
investments and a strategic disadvantage, often combined with an inefcient
operational structure.
The inuence of human resources management did not differ between the failure
paths and was never the basis of deterioration. The existence and inuence of
corporate governance (or mismanagement) on bankruptcy did not depend on the type
of failure path. This issue is however rather complex. For ve companies in our sample
(cases F, G, I, J and K), the dramatic effects of some investments or expenditures were
obvious and must be considered as mismanagement. The likelihood of
mismanagement is greater at the end when condence in survival is low.
The immediate environment of the company: a domino-effect dwindling a companys
survival chances
Constant interaction with the immediate environment is inevitable to survive (Ooghe
and Waeyaert, 2004). In this section, we mention the different issues, noted during our
research, starting with the most critical ones: customers and competition. The ndings
are summarized in Table IV.
Most unsuccessful starters face problems with attracting or maintaining customers,
caused by the lack of a unique selling proposition or low customer satisfaction. The
failing expansion of ambitious growth companies is caused by overestimated demand.
In the nal stages of the failure path, they also suffer from competition as they cannot
adapt to the changing environment unlike their competitors. In contrast to other
processes, the bankruptcy of a dazzled growth company has little connection with a
lack of strategic advantage or with competition. Lastly, the problems of apathetic
established companies in retaining customers are caused by the loss of competitive
advantage.
Overall, liquidity problems increase companies difculties in retaining customers.
The effect of customers mistrust however, does not only depend on the specicities of
the failure process, but also on the operational cycle. Companies that operate in
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industries that work on the basis of long-term agreements or advances, or those in
which after-sales service is very important, face the most difculties.
Other factors in the immediate environment banks, suppliers, stockholders,
misadventure and trade unions were never the basis of deterioration. No substantial
differences existed between the distinctive failure processes. First, suppliers,
stockholders (if applicable) and credit institutions react in a similar way to nancial
problems by refusing further cooperation. This accelerates the failure process. Second,
the impact of misadventure can be compared with the impact of stakeholders: it does
not affect competing companies in the same industry. These circumstances are
exceptional but extremely damaging for distressed rms. Finally, personnel and trade
unions are very unlikely to initiate the companys deterioration.
The general environment of a company: the excuse most often used by management
As a company is an open system, one has to regard the general environment, which is
similar for all companies in the sector (Ooghe and Waeyaert, 2004). Its impact is
discussed hereunder.
With respect to unsuccessful start-ups, we did not nd any threat within the general
environment, except from a recession in the industry. Companies, making the
ill-considered decision to start-up at that moment are destined to fail. These companies
do not exist long enough to face gradual changes in the general environment. If we
analyse the impact of the general environment on the failure of an ambitious growth
company, we nd that these factors normally do not affect the initial problems.
Type 1 Type 2 Type 3 Type 4
Failure process of
an unsuccessful
start-up
Failure process of an
ambitious growth
company
Failure process of
a dazzled growth
company
Failure process of an
apathetic established
company
Customers Shortage of
customers
Shortage of
customers
Mistrust Shortage of
customers
Customer
dissatisfaction
Mistrust Customer
dissatisfaction
Mistrust Mistrust
Competition Because of lack of
strategic
advantage
Competition of
foreign companies
Strategic advantage
competitors
Consequence of
inexibility
Suppliers Increasing mistrust
Banks Mistrust
Stockholders Only applicable for
listed companies
Misadventure Exceptional, but very
damaging (if already
in distress)
Personnel
and trade
unions
Possible consequence
of nancial problems
Table IV.
Causes of bankruptcy for
each type of failure
process: immediate
environment
Causes of
company
bankruptcy
237
Company A is an exception, though, because an unexpected recession accelerated the
effects of an overestimated demand. However, in the nal phase, changes in the general
environment can have a critical inuence on these rms bankruptcy because they lack
the nancial means necessary for restructuring. Issues in the general environment,
such as a bear market or a recession, do not affect the survival chances of dazzled
growth companies. It only affects the duration of their failure process. Lastly, apathetic
established companies have the possibility to adapt to the changing general
environment, such as political changes (H) or changes in foreign countries (J), but are
too rigid to do so.
No company in our case study research failed due to an industry-effect. We did
observe contagion in our sample. However, contagion only inuenced the duration of
the failure process, not the underlying causes of failure. Table V summarizes our
ndings.
Conclusions
This paper reveals four different types of failure processes, based on the companys
maturity and management characteristics: the bankruptcy of unsuccessful start-up
companies, the failure process of ambitious growth companies, the failure process of
dazzled growth companies and lastly, the bankruptcy of apathetic established
companies. For each process, a detailed overview of the direct and indirect effects of
nonnancial and nancial causes is given. Our typology is developed by case study
research of 12 Belgian companies of different industries, sizes and ages.
Start-up companies that went bankrupt (type 1 failure process) are characterized by
a management with a serious deciency in managerial and industry-related
experience. These companies lack a strategic advantage or have a poor operational
Type 1
Failure process of
an unsuccessful
start-up
Type 2
Failure process of
an ambitious
growth company
Type 3
Failure process of
a dazzled growth
company
Type 4
Failure process of
an apathetic
established
company
Economic factors Recession in the
industry (some
cases)
Weak stock
markets (some
cases)
Weak stock
markets (some
cases)
Price increase of
raw materials
(some cases)
Recession of the
industry (some
cases)
Technology
Foreign countries Economic changes
in foreign
countries (some
cases)
Political inuences Stricter legislation
(some cases)
Society
Table V.
Causes of bankruptcy for
each type of failure
process: general
environment
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structure. These errors, combined with a weak nancial and administrative structure,
inevitably lead to a lack of internal nance from the beginning. They do not have the
qualities to solve their nancial problems. External factors have no inuence on the
short failure path of these companies.
The second failure process reveals the deterioration of ambitious growth companies
leaded by risk seeking managers (or entrepreneurs) with industry-related experience
and persuasiveness. Thanks to cooperation of banks, an ambitious expansion strategy
is developed, but due to over-optimism or misinformation, turnover is greatly
overestimated and the company becomes very vulnerable to bankruptcy. As these
companies have a motivated and experienced management, they intervene as soon as
possible by developing a recovery plan, and as a consequence, they have a realistic
probability of outliving this crisis. Unfortunately, these companies lack the necessary
nancial means to implement the most cost-effective recovery plan. As a result, they
only slightly improve their nancial situation and lack the exibility to react to threats
in the environment. A lot of these companies go bankrupt in the end, if changes in the
environment do occur.
The third type of failure process (type 3: the failure process of a dazzled growth
company) is initiated by managements dazzle. They take exaggerated risks and ignore
the companys managerial and operational structure. This leads to a severe increase in
expenses and deterioration in protability. Weak protability is however attributed to
external and temporary factors. By the time they develop their recovery plan, the
company has lost both its nancial strength and its trust from its immediate
environment. As a result, the company goes bankrupt after a steep rise and an ever
steeper fall.
In the last type of failure process (type 4: the failure of apathetic established
companies) management have the ability to manage a protable organization, but they
lack commitment and motivation. Management do not notice sales to be gradually
decreasing. They only react after a signicant decrease of internal nance. Moreover,
managements restructuring plan is not adjusted to the changing reality, and errors in
the companys policy decrease its operational efciency. When liquidity problems
occur, they start realizing the severity of the situation. There is no chance to survive
because stakeholders become mistrustful and all nancial means are wasted.
The typology of the four different failure processes gives new insight into the
evolution of nancial performance ratios during the years preceding bankruptcy. First
of all, there are many similarities within the evolution of nancial performance ratios
for distressed companies. There exist however signicant differences in the duration
by which these ratios affect each other. For unsuccessful start-up companies (type 1) all
nancial ratios have an equal predictive power, as solvency and liquidity deteriorate
very shortly after the protability problems. They are visible from the companys rst
annual accounts onward. Ambitious growth companies (type 2) have a very specic
nancial prole after the unsuccessful investment plan. While the companys solvency
and liquidity remain weak, its protability increases slowly due to restructuring. The
company remains however very vulnerable. Third, extreme gearing is a signal that
dazzled growth companies (type 3) are taking exaggerated risks. A low nancial
independence (equity/balance total) is the rst indicator of possible distress. Later on,
alarming protability will inevitably lead to insufcient liquidity and solvency. Last,
apathetic established companies (type 4) have a gradual decrease in nancial
Causes of
company
bankruptcy
239
performance before bankruptcy: protability decreases long before solvency and
liquidity.
Furthermore, there appears to be an interaction between the failure process of the
company and the direct and interactive importance of specic causes of bankruptcy:
management errors, errors in company policy, and the inuence of the immediate and
general environments of the company.
The results of our study are based on qualitative, case study research. No attempt is
made to quantify the existence and the importance of our ndings. The major
constructs that emerged as important in our research, are well-known concepts in the
management literature. As a consequence, they should be further developed in order to
quantify their effect in large scale studies. These studies could give a more ne-grained
insight in its effect on other non nancial and nancial symptoms of distress and on
the length of the failure path.
Furthermore, this paper reveals that the presence and the inuence of specic
management errors on the nancial situation largely depend on the companys
characteristics. Maturity and nancial strength are the two most notable
characteristics, but other features, such as the operational cycle, cannot be
neglected. One has to take them into account when analysing possible threats of
specic management actions to the company in both the short and long term.
Lastly, the general and immediate environment of a failing company normally play
a subordinate role. They only have an effect if apathetic management do not anticipate
and respond to these changes or if management, because of previous errors, lack the
nancial means to adjust their way of doing business to a changing environment.
Therefore, future research should carefully take into account both nancial and non
nancial characteristics of a company and its management when they study the impact
of macro-economic changes (e.g. exchange rates) on corporate bankruptcy.
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Corresponding author
Hubert Ooghe can be contacted at: hubert.ooghe@vlerick.be
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