External factors

External pressures routinely place companies under stress. Astute managerial teams tend to cope with such stresses and their companies usually survive. Such pressures, however, can lead lesser managers to fail. In the extreme, some external shocks may be so severe that even the most skilled managers cannot save the company.

Changing markets and economic conditions are factors that almost invariably impinge on corporate activities.73 A business may fail because a demand swing is too severe for it to respond successfully: where, for example, consumers change a preference rapidly from one fashion design to another. The prices of raw materials may escalate in an unpredictable manner and to a degree that makes a company’s product or price unattractive to consumers. A major competitor may attack the company’s market with a level of commitment and aggression that pulls the financial carpet from beneath the company’s feet, and economic cycles (often compounded by drops in investor confidence) may produce slumps that are so severe and sustained that the company fails. Since 1970 the economy has been subjected to a series of shocks which have caused problems for many companies. These shocks have included the oil price rises of 1973–4 and 1979–81, the wage explosions of 1973–4 and 1978–80,74 and the credit squeeze of the early 1990s and the credit crisis of 2007–8.

Some trade sectors (notably manufacturing and construction)75 are more prone to failure and insolvency than others and the seasonality encountered in some sectors can place severe stresses on corporate solvency. The seasonality of the toy industry, with its focus on Christmas sales and discounting at other times of the year, has been said to explain the sector’s long history of corporate failures.76

73 On instability of the global financial system, international market shifts, macroeconomic factors and recessions as causes of corporate failure see Bank of England, Financial Stability Review, 2008 (Issue 24) Summary (Bank of England, London, 2008);

Financial Stability Review, 2007, ch. 1 and Financial Stability Review, 2005; K. Dyson and S. Wilks, ‘The Character and Economic Content of Industrial Crisis’ in Dyson and Wilks (eds.), Industrial Crisis: A Comparative Study of the State and Industry (Blackwell, Oxford, 1985).

74Pratten, Company Failure, p. 4.

75The R3 Twelfth Survey suggested that the service sector is the most prone to insolvency and accounts for 49 per cent of cases.

76SPI, Eighth Survey, Company Insolvency in the United Kingdom (SPI, London, 1999) p. 9.

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Overseas producers can provide severe price competition and this has been identified as the probable cause of decline in UK manufacturing industries in such sectors as cars, motor cycles, machine tools, paper and textiles.77 Nor do pressures come only from markets. Governments and regulatory bodies may take actions that precipitate failures. The British Government’s high interest rate policy produced a surge of company failures in the second half of 1990, so that the number of companies entering receivership during those six months matched the figure for the whole of the preceding year. Companies also suffered shocks from high sterling exchange rates in 1980–1 and 1990–1, as well as from credit explosions in 1972–3 and 1986–9, and from the credit crisis in 2008.78 Rapid inflation made matters worse for companies during the 1970s, early 1980s and in 1990. Recessions resulted in 1974–5, 1980–1 and 1990–1.79 Adapting to such changes is particularly difficult for companies when the shocks cannot be predicted. Firms that relied on long-term fixed price contracts during the early 1970s were especially hard pressed by inflation.

Where companies operate with high levels of gearing and tight repayment schedules they will be particularly vulnerable to changes in overdraft costs when, as at the start and end of the 1980s, there are dramatic increases in the minimum lending rate.80 If governments impose squeezes on credit, lenders will tend to ration credit and give priority to those firms that are considered the best risks. These are unlikely to be new or small firms or those with existing problems, and, accordingly, the proportion of loans going to established large firms will tend to rise when money is tight. Small firms tend to be less capable of surviving such credit shortages than large firms. So, overall, the result tends to be a rise in the number of small firm failures.81 Governments may even precipitate

77See Campbell and Underdown, Corporate Insolvency, p. 19.

78On the credit crisis and financial instability of 2007/8 see further Bank of England,

Financial Stability Report – Issue 24 (2008); Bank of England News Release, Financial Stability Report: Rebuilding Confidence in the Financial System (28 October 2008); Bank of England and HM Treasury, Financial Stability and Depositor Protection: Further Consultation (Cm 7436) (July 2008), pp. 7–9; Technical Committee of the International Organization of Securities Commissions (IOSCO), Report on the Subprime Crisis – Final Report (May 2008) (www.iosco.org).

79Pratten, Company Failure, p. 4. In 2008 the Bank of England stated that a ‘global economic turndown’ was underway: see Bank of England News Release, Financial Stability Report: Rebuilding Confidence in the Financial System.

80See Campbell and Underdown, Corporate Insolvency, p. 19.

81See R3 Twelfth Survey, p. 5. In September 2008, Richard Roberts, head of small/mediumsized enterprise analysis at Barclays, forecast that ‘We will probably see the [business]

corporate failures more directly when, for example, they withdraw or decline further financial aid, as occurred in January 1971 when the Government decided not to support Rolls Royce further in the RB211 engine affair82 and, in October 2001, when anticipated state subsidies were not forthcoming and Railtrack was put into administration.

Regulators, be they agencies, government departments or European bodies, may impose critical stresses on companies by a number of routes. It is commonly complained by industry that the costs of complying with regulations are a burden (particularly for small businesses)83 and, on occasion, such costs can break the camel’s back.84 In response, however, it can be said that competent managers will generally be able to cope with regulatory burdens, and that if regulation kills firms because the managers of those firms are incompetent, or because regulation outlaws a product central to the company’s output, those firms should go to the wall because they are either uncompetitive or Parliament’s voice demands that they cease business.85 If regulators, for instance, enforce statutory rules prohibiting, say, the production of eggs in battery cages, and if battery producers fail to adapt by employing other processes, the

stock fall by up to 150,000 in the course of the downswing. Growth has already stopped – closures have been higher than start-ups for some time.’ See J. Guthrie, ‘Barclays Signals End of an Era for Entrepreneurs’, Financial Times, 2 September 2008. See also Grant, ‘Insolvency Rate to Rise 41% by End of 2009’.

82On 4 February 1971 a receiver was appointed: see Argenti, Corporate Collapse, p. 90.

83See Bank of England, Finance for Small Firms, Eighth Report (March 2001) p. 7 and CBI,

Cutting Through the Red Tape: The Impact of Employment Legislation (November 2000). The CBI argues that the direct costs to companies of new employment rights introduced since May 1997 could be over £12 billion. A Federation of Small Businesses Report,

Barriers to Survival and Growth in UK Small Firms (London, 2000), suggests that small

firms’ concerns rest on regulation. In 2005 the CBI warned again that excessive red tape was making it difficult for many small companies to overcome the effects of a challenging economic environment in the UK: see D. Prosser, ‘Tough Trading and Red Tape Hitting Small Manufacturers, says CBI’, Financial Times, 15 August 2005; and in 2006 a Federation of Small Business and Foreign Policy Centre report stated that EU legislation is implemented more stringently than necessary in the UK, imposing higher costs on small businesses and deterring them from taking on new staff: see J. Willman, ‘Small Business Hit by Overuse of EU Rules’, Financial Times, 7 September 2006.

84On compliance costs and governmental responses see, for example, Better Regulation Task Force, Regulation – Less is More (Cabinet Office, London, 2005); P. Hampton,

Reducing Administrative Burdens (HM Treasury, London, 2005).

85Some surveys suggest that although red tape is often seen as a problem by small businesses, this does not stop such firms from taking an optimistic view of the UK climate for business start-ups. See e.g. J. Guthrie et al., ‘FT–Harris Poll: UK Holds Mixed View on Start-Ups’, Financial Times, 19 November 2007 (86 per cent of respondents were unhappy with red tape in the UK but 57 per cent of those offering an opinion saw the UK as a good place to set up a new company).

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effect will be to drive those producers out of business in accordance with the legislative will.

Regulators, however, may produce unjustifiable failures where they regulate badly. They may, for example, vacillate in their demands, delay licensing approvals unnecessarily and impose excessive costs on businesses. A failure to regulate may also produce insolvencies where, for instance, effective regulation is necessary to sustain consumer confidence in a product. The BSE crisis of 1996–9 demonstrated that regulatory deficiencies relating to animal foodstuffs can produce dramatic levels of corporate failure in the farming industry. Deregulation can also precipitate failure by breaking down the entry barriers that have protected enterprises and allowed relatively inefficient operators to survive. Where, moreover, there is a rush of new entrants into a competitive industry there may naturally follow a period in which the less efficient are weeded out. Rates of failure can be expected to rise where the costs of entry and exit to a newly deregulated sector are high.

Government taxation policies can also bring marginal companies to the point of failure and industrial relations problems can break companies. If production is stopped by a prolonged strike the consequences for a firm may be severe. Where the company’s own workforce is involved in an industrial dispute the firm’s managers may have some control over events and may have to shoulder some blame for mismanagement. If, however, the dispute is between employers and workers at a key supplier or customer, there may be little that even the most competent managers can do.86

Unexpected calamities may also threaten companies. These may range from natural disasters, such as earthquakes that destroy essential firm assets, to the illegal acts of humans, for example the criminal behaviour of a financial fraudster or an arsonist who burns down a firm’s premises. Devastating losses may also result from new legal liabilities: thus a court decision rendering tobacco companies liable to governmental bodies for the cost of treating lung cancer sufferers might precipitate a series of corporate failures. Penalty clauses in contracts may produce similar effects where companies fail to deliver finished products on time.87

86See J. R. Lingard, Corporate Rescues and Insolvencies (2nd edn, Butterworths, London, 1989) p. 3.

87See Argenti, Corporate Collapse, p. 91 on the role of penalty clauses in the Rolls Royce failure of 1971; Cork, Cork on Cork.