Causes of Corporate Failure:
(i) Technological causes
Traditional methods of doing work have been turned upside down by the development of new technology. If within an industry, there is failure to exploit information technology and new production technology, the firms can face serious problems and ultimately fail. By using new technology, cost of production can be reduced and if an organization continues to use the old technology and its competitors start using the new technology; this can be detrimental to that organization. Due to high cost of production, it will have to sell its products at higher prices than its competitors and this will consequently reduced its sales and the organization can serious problems.
This situation was seen in the case of Mittal Steel Company taking over Arcelor Steel Company. Arcelor Steel Company was using its old technology to make steel while Mittal Steel Company was using the new technology and as a result, Mittal Steel Company was able to sell steel at lower price than Arcelor Steel Company due to its low cost of production. Arcelor Steel Company was approaching corporate failure and luckily, Mittal Steel Company
merged with Arcelor Steel Company and became Arcelor Mittal Steel Company, thus preventing Arcelor from failure.
(ii) Working capital problems Organizations also face liquidity problems when they are in financial distress. Poor liquidity becomes apparent through the changes in the working capital of the organization as they have insufficient funds to manage their daily expenses. Businesses, which rely only on one large customer or a few major customers, can face severe problems and this can be detrimental to the businesses. Losing such a customer can cause big problems and have negative impact on the cash flows of the businesses. Besides, if such a customer becomes bankrupt, the situation can even become worst, as the firms will not be able to recover these debts.
(iii) Economic Distress A turndown in an economy can lead to corporate failures across a number of businesses. The level of activity will be reduced, thus affecting negatively the performance of firms in several industries. This cannot be avoided by businesses. The recent economic crisis in the USA led to many cases of corporate failures. One of them is the insurance AIG insurance company. It is facing serious problems and it might close its door in the near future.
(iv) Mismanagement Inadequate internal management control or lack of managerial skills and experience is the cause of the majority of company failures. Some managers may lack strategic capability that is to recognize strengths, weaknesses, opportunities and threats of a given business environment. These managers tend to take poor decisions, which may have bad consequences afterwards. Furthermore, managers of different department may not have the ability to work closely together. There are dispersed department objectives, each department will work for their own benefits not towards the goal of the company. This will bring failure in the company. One example can be WorldCom, where the finance and legal functions were scattered over several states and communication between these departments were poor.
(v) Over-expansion and diversification Research has shown that dominant CEO is driven by the ultimate need to succeed for their own personal benefits. They neglect the objective set for the company and work for their self-interest. They want to achieve rapid growth of the company to increase their status and pay level. They may do so by acquisition and expansion. The situation of over expansion may arise to the point that little focus is given to the core business and this can be harmful as the business may become fragment and unfocused. In addition, the companies may not understand the new business field. Enron and WorldCom can be an example for this situation where the managers did not understand how growing overcapacity would influence its investment and therefore did not comprehend the risks associated with it.
(vi) Fraud by management
Management fraud is another factor responsible for corporate collapse. Ambitious managers may be influenced by personal greed. They manipulate financial statements and accounting reports. Managers are only interested in their pay checks and would make large increase in executive pay despite the fact that the company is facing poor financial situation. Dishonest managers will attempt to tamper and falsify business records in order to fool shareholders about the true financial situation of the company. These fraudulent acts or misconduct could indicate a serious lack of control. These frauds can lead to serious consequences: loss of revenue, damage to credibility of the company, increased in operating expenses and decrease in operational efficiency.
(vii) Poorly Structured Board Board of Directors is handpicked by CEO to be docile and they are encouraged by executive pay and generous benefits. These directors often lack the necessary competence and may not control business matters properly. These directors are often intimated by dominant CEO and do not have any say in decision making. Example Enron and WorldCom where poorly structured board was a contributor towards their failure.
(viii) Financial distress Firms that become financially distressed are found to be under- performing relative to the other companies in their industry. Corporate failure is a process rooted in the management defects, resulting in poor decisions, leading to financial deterioration and finally corporate collapse. Financial distresses include the following reasons also low and declining profitability, investment Appraisal, Research and Development and technical insolvency amongst others. A firm may fail, as its returns are negative or low. A firm that consistently reports operating losses probably experiences a decline in market value. If the firm fails to earn are turn greater than its cost of capital, it can be viewed as having failed. Falling profits have an obvious link with both financial and bankruptcy as the firm finds it is not generating enough money to meet its obligations as they fall due. Another cause that will lead the company to fail is the investment appraisal. Many organizations run into difficulties as they fail to appraise investment projects carefully. The long-term nature of many projects means that outcomes are difficult to forecast and probabilities are usually subjective. ―Big project gone wrong‖ is a common cause of decline. For example, the acquisition of a loser company, this has happen in the case for the failure of Parmalat Co Ltd of Italy, which made the acquisition of several losses making company where Inappropriate evaluation of the acquired company, its strengths and weaknesses.
(i) Technological causes
Traditional methods of doing work have been turned upside down by the development of new technology. If within an industry, there is failure to exploit information technology and new production technology, the firms can face serious problems and ultimately fail. By using new technology, cost of production can be reduced and if an organization continues to use the old technology and its competitors start using the new technology; this can be detrimental to that organization. Due to high cost of production, it will have to sell its products at higher prices than its competitors and this will consequently reduced its sales and the organization can serious problems.
This situation was seen in the case of Mittal Steel Company taking over Arcelor Steel Company. Arcelor Steel Company was using its old technology to make steel while Mittal Steel Company was using the new technology and as a result, Mittal Steel Company was able to sell steel at lower price than Arcelor Steel Company due to its low cost of production. Arcelor Steel Company was approaching corporate failure and luckily, Mittal Steel Company
merged with Arcelor Steel Company and became Arcelor Mittal Steel Company, thus preventing Arcelor from failure.
(ii) Working capital problems Organizations also face liquidity problems when they are in financial distress. Poor liquidity becomes apparent through the changes in the working capital of the organization as they have insufficient funds to manage their daily expenses. Businesses, which rely only on one large customer or a few major customers, can face severe problems and this can be detrimental to the businesses. Losing such a customer can cause big problems and have negative impact on the cash flows of the businesses. Besides, if such a customer becomes bankrupt, the situation can even become worst, as the firms will not be able to recover these debts.
(iii) Economic Distress A turndown in an economy can lead to corporate failures across a number of businesses. The level of activity will be reduced, thus affecting negatively the performance of firms in several industries. This cannot be avoided by businesses. The recent economic crisis in the USA led to many cases of corporate failures. One of them is the insurance AIG insurance company. It is facing serious problems and it might close its door in the near future.
(iv) Mismanagement Inadequate internal management control or lack of managerial skills and experience is the cause of the majority of company failures. Some managers may lack strategic capability that is to recognize strengths, weaknesses, opportunities and threats of a given business environment. These managers tend to take poor decisions, which may have bad consequences afterwards. Furthermore, managers of different department may not have the ability to work closely together. There are dispersed department objectives, each department will work for their own benefits not towards the goal of the company. This will bring failure in the company. One example can be WorldCom, where the finance and legal functions were scattered over several states and communication between these departments were poor.
(v) Over-expansion and diversification Research has shown that dominant CEO is driven by the ultimate need to succeed for their own personal benefits. They neglect the objective set for the company and work for their self-interest. They want to achieve rapid growth of the company to increase their status and pay level. They may do so by acquisition and expansion. The situation of over expansion may arise to the point that little focus is given to the core business and this can be harmful as the business may become fragment and unfocused. In addition, the companies may not understand the new business field. Enron and WorldCom can be an example for this situation where the managers did not understand how growing overcapacity would influence its investment and therefore did not comprehend the risks associated with it.
(vi) Fraud by management
Management fraud is another factor responsible for corporate collapse. Ambitious managers may be influenced by personal greed. They manipulate financial statements and accounting reports. Managers are only interested in their pay checks and would make large increase in executive pay despite the fact that the company is facing poor financial situation. Dishonest managers will attempt to tamper and falsify business records in order to fool shareholders about the true financial situation of the company. These fraudulent acts or misconduct could indicate a serious lack of control. These frauds can lead to serious consequences: loss of revenue, damage to credibility of the company, increased in operating expenses and decrease in operational efficiency.
(vii) Poorly Structured Board Board of Directors is handpicked by CEO to be docile and they are encouraged by executive pay and generous benefits. These directors often lack the necessary competence and may not control business matters properly. These directors are often intimated by dominant CEO and do not have any say in decision making. Example Enron and WorldCom where poorly structured board was a contributor towards their failure.
(viii) Financial distress Firms that become financially distressed are found to be under- performing relative to the other companies in their industry. Corporate failure is a process rooted in the management defects, resulting in poor decisions, leading to financial deterioration and finally corporate collapse. Financial distresses include the following reasons also low and declining profitability, investment Appraisal, Research and Development and technical insolvency amongst others. A firm may fail, as its returns are negative or low. A firm that consistently reports operating losses probably experiences a decline in market value. If the firm fails to earn are turn greater than its cost of capital, it can be viewed as having failed. Falling profits have an obvious link with both financial and bankruptcy as the firm finds it is not generating enough money to meet its obligations as they fall due. Another cause that will lead the company to fail is the investment appraisal. Many organizations run into difficulties as they fail to appraise investment projects carefully. The long-term nature of many projects means that outcomes are difficult to forecast and probabilities are usually subjective. ―Big project gone wrong‖ is a common cause of decline. For example, the acquisition of a loser company, this has happen in the case for the failure of Parmalat Co Ltd of Italy, which made the acquisition of several losses making company where Inappropriate evaluation of the acquired company, its strengths and weaknesses.
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