Keeping zombie companies alive is a scary policy
COMPANY insolvencies are a sign of a healthy economy and preventing companies from failing stifles the innovation this country needs to grow.
Insolvencies, together with mergers and acquisitions, new company registrations, recruitment, and redundancies are, strange though it may seem to some, a sign of a healthy economy.
Analysis of the number of new companies created versus the number of company insolvencies over the last ten years shows a pattern. After a lag of two years, more new registered companies resulted in more insolvencies. The rate of growth, or indeed fall, in the UK GDP followed the same pattern as new company registrations. A period of relatively high growth in GDP (and in this time of low growth the term “high” is definitely relative) was accompanied by a surge in new company registrations, followed by an increase in the number of corporate insolvencies. Equally telling is that 2010 and 2011, a period of virtually no net growth in GDP, has initially seen a drop of 21 per cent in company registrations, followed by a period of virtually no change in the number of corporate insolvencies.
There are, of course, some major corporate insolvencies that indicate fundamental problems in the economy and in particular a lack of consumer confidence – as can be seen in the recent spate of large high street retailers going to the wall – but for many years it has been evident that the single biggest cause of business failure is bad management.
Low interest rates for corporate loans or overdrafts enable poorly performing companies to struggle on, covering their relatively low financing charges, while not creating reserves that will be required when business picks up again and they will need to finance growth. We will see, therefore, when the rate of growth in GDP starts to rise again, an increasing number of company insolvencies, not resulting from a recent increase in new company registrations, but from a lack of the resources needed to fund an increase in demand for their products.
Similarly, the lack of resources available now to fund research and development and innovation will restrict growth when the opportunities to develop come around again. Also, that banks are allowing poorly performing managers to remain in business so long as they are merely servicing their debts is failing to force those that who have the talent to be innovative and imaginative. Even good managers, in these circumstances, have to spend too long fire-fighting, micro-managing costs or simply treading water. This is curbing their entrepreneurial tendencies.
Companies that take risks grow and sometimes fail. In the current environment there is too little growth, risk-taking and innovation – thus relatively few companies are going bust. By propping up companies that may be in difficulties we may actually be stifling the innovation the country needs for us to grow and trade our way out of the current mire.
John Alexander heads Carter Backer Winter’s corporate recovery and insolvency department.