Modelling Business Duration and Business Failure (CBR project)

Overview

Aims and objectives

This research programme, supported by the Leverhulme Trust, examined the legal, accounting and economic background to company exit either into bankruptcy or acquisition. The grant supported 4 projects which are reported together here. They were:

1. Macroeconomic Stability and Business Failure
2. Concepts of Insolvency
3. Insolvency and Stakeholding
4. Modelling Business Duration and Business Failure.

We sought to determine how macroeconomic instability impacted on firms and changed the probability that exit into bankruptcy or acquisition would take place. We also examined the factors that determine small business failure and acquisition with a particular emphasis on managerial aspects of the firm obtained from sample surveys. We examined the role that accounting information played in securing the economically efficient exit of firms during the process of insolvency.

Results and dissemination

We find clear evidence that instability in the macroeconomic environment is detrimental to companies. Newly listed companies were more likely to go bankrupt when the pound depreciates sharply. Uncertainty in the form of sharp increases in inflation also makes new firms more prone to go bankrupt. Acquisition activity at this time is often subdued and so firms that might have otherwise been taken over go bankrupt. Moreover, from our analysis of small and medium sized firms we are able to identify a much more important role for the age and experience of the chief executive than has been found previously. Once a firm is bankrupt and becomes insolvent, our research also shows that, when looking at the type of accounting information that is available, the relevant measures of insolvency are not independent of beliefs of groups such as creditors and customers, about the probability that a company will survive. As a result, firm value deteriorates rapidly simply in response to changing perceptions of its survival prospects. English insolvency law has allowed much of the decision-making power to be allocated to a bank through the grant of a floating charge, a framework which has been much-criticised in the academic literature and which has recently been altered by legislation in significant respects (the Enterprise Act 2002). Our work suggests that notwithstanding this criticism, there might be efficiencies to the concentration of decision-making power which bank-led processes involve. In particular, the concentration of rights often facilitates pre-insolvency decision making by interested parties.

Project leader

Andy Cosh

Other principal investigators

Alan Hughes
Melvyn Weeks

Research fellows

Cathryn Law (1999-2000)
Natalia Isachencova (2000-)

Project status

Completed