Management DecisionEmerald Article: Failure processes and causes of company bankruptcy: a typologyHubert Ooghe, Sofie De Prijcker

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Failure processes and causes ofcompany bankruptcy: a typology

Hubert Ooghe and Sofie De PrijckerGhent University, Ghent, Belgium

AbstractPurpose The purpose of this paper is to show that previous research about financial andnon-financial causes of bankruptcy has neglected the time dimension of failure. The paper seeks togain deeper insight into the failure process of a company, giving it a more grounded understanding ofthe relationship between the characteristics of a company, the underlying causes of failure and thefinancial effects.

Design/methodology/approach The findings are based on a literature overview and in-depthcase 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 growthcompanies, and the failure process of apathetic established companies. Between these four failureprocesses, there exist major distinctions in terms of the presence and the importance of specific causesof bankruptcy, i.e. errors made by management, errors in the corporate policy and the importance ofexternal factors.

Research limitations/implications The results of the study are based on qualitative, case studyresearch. No attempt is made to quantify the existence and the importance of the findings. The majorconstructs that emerged as important in the research are well-known concepts in the managementliterature. As a consequence, they should be further developed in order to quantify their effect inlarge-scale studies.

Practical implications Based on the findings, stakeholders of a company can have a clearer viewof both the time dimension inherent in corporate failure and the impact of their own actions onbankruptcy.

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 isneeded.

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 (adaptedfrom Anna Karenina, Tolstoy)

The bankruptcy literature reveals a high number of bankruptcy prediction models.They are generally based on financial symptoms (e.g. Beynon and Peel, 2001; Dimitraset 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 alimited number of nonfinancial causes or focus on specific 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 ofthe Flemish Government.

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Received March 2007Revised November 2007

Accepted November 2007

Management DecisionVol. 46 No. 2, 2008

pp. 223-242q Emerald Group Publishing Limited

0025-1747DOI 10.1108/00251740810854131

To our knowledge, an all-embracing approach that relates the causes of bankruptcy tothe characteristics of the company and to the financial symptoms of distress has neverbeen applied, despite its relevance for researchers and practitioners (Balcaen andOoghe, 2006; Thornhill and Amit, 2003).

Our research attempts tofill the gap described above. The contribution of this study istwo-fold. First, we will examine bankruptcy within different industries taking size andage into account. We will reveal four different failure processes that connect thefundamental causes of bankruptcy to the financial and nonfinancial consequences.Second, we will study the presence of nonfinancial errors within different failureprocesses.

The paper is organized as follows. In the next section, we give an overview of theprevious literature. This is followed by a description of the applied methodology andcase selection. Then, the case study findings are discussed: we give a detaileddescription of the four types of failure processes, and expound the relation between acompanys failure process and its underlying causes of bankruptcy. The paper endswith our conclusion and suggestions for further research.

Causes of bankruptcyConsiderable attention has been given to bankruptcy prediction models, usingfinancial information (e.g. Ooghe et al., 1995; Pompe and Bilderbeek, 2005). Thesestudies ignore however the time dimension of failure and the influence of underlyingnonfinancial 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 corporatebankruptcy 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 1expounds the different causes of failure and stresses the mutual relations betweenthem.

First, general environment clusters several external causes. They affect managersmotivation, the usefulness of their skills and hence corporate policy, next to therelationship with stakeholders in their immediate environment.

The immediate environment forms a second group of causes. The interactionsbetween a company and its stakeholders determine corporate development. Ruinouscompetition, but also mutual projects with stakeholders are well-known examples ofthese interactions.

Third, the characteristics of management or the entrepreneur and fourth, thecompanys corporate policy have a more important impact on performance (Boeker,1997; McGahan and Porter, 1997) and are therefore displayed in the centre of themodel.

Management, the third factor, are recognized as amajor cause of bankruptcy (DAveniandMacMillan, 1990; Greening and Johnson, 1996). Inappropriatemanagement qualitiesand skills are a threat tofirmsurvival andare therefore often linked to failure of start-ups.If these managers are in addition reluctant to accept advice from other parties, theysignificantly reduce companys long term survival chances (Newton, 1985). It isfurthermore remarkable towhich extent personal characteristics affect performance.Wedescribe 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 instrategy and the decision making processes (DAveni and MacMillan, 1990; Gilbert,2005). Second, optimism and risk seeking behaviour may also precede distress. Thereexists, however, a difference between entrepreneurs and managers with respect to thisbehaviour.Where entrepreneurs threaten their ownwealthdue to risk seekingbehaviour,managers on the other hand often ignore stakeholders interests as their utility functionoften favours very risky projects, although they may be more risk averse thanentrepreneurs (Parrino et al., 2005).

Management sets up corporate policy that involves several aspects, such as strategyand financial management. As errors can quickly lead to bankruptcy, all aspects haveto be taken into account. Unfortunately, a lack of skills and personal characteristicsmay precede unanticipated problems in corporate policy.

Figure 1.Conceptual failure model

of possible causes ofbankruptcy (Ooghe and

Waeyaert, 2004)

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Finally, company characteristics: size, maturity, industry and flexibility also haveto be taken into account. Previous research focuses on age and size. First, liability ofnewness is an important research topic: young firms have to build up externallegitimacy and stable relationships with stakeholders. They are therefore veryvulnerable (Fichman and Levinthal, 1991). Second, size may also affect survivalchances, but the impact of liability of smallness is normally minor than liability ofnewness (Halliday et al., 1987). We finally emphasize that companies in differentindustries, even with a similar financial profile, have a different probability of failure(Platt et al., 1994). There exists in addition a contagion effect between firms in the sameindustry, especially for highly leveraged firms (Lang and Stulz, 1992). More than otherresearchers, we stress the strong link between the characteristics of a company, itsmanagement and its policy.

Failure as a processFew researchers have explicitly analysed failure as a process. The oldest and mostwell-known exception is Argenti (1976), relating nonfinancial failure causes withfinancial indicators within three different failure processes.

The first trajectory of failing companies (Argenti, 1976) reveals the typical failurepath of a start-up company with inappropriate management in terms of skills orpersonality.

The second trajectory (Argenti, 1976) explains the bankruptcy of young companiesafter a very precipitous growth and an even steeper decline. Their collapse is alsocaused by management deficiencies, but there is an important difference with the firstpath: managers outstanding personality that ensures a swift take-off. The companygoes bankrupt when operational and financial management are ignored during thegrowth phase.

The last trajectory, type 3 (Argenti, 1976), is applicable for mature and inertcompanies that refrain adaptation of management structure and lose touch with theircustomers. The company goes bankrupt because they do not respond adequately toenvironmental changes.

Argentis failure paths contain two major deficiencies. First, the concept offinancial health of a company is not based on financial indicators. It is thereforevague and equivocal. Second, although Argenti (1976) emphasizes the importance ofmanagement errors, the existence of specific errors in different failure paths and withindistinctive phases is not clear. The subtleties of the failure paths are therefore notapparent.

Other failure processes (Laitinen, 1993; Newton, 1985; Ooghe and Van Wymeersch,2006) ignore the relationship between nonfinancial causes and specific financial effects,such as liquidity, profitability and solvency.

Methodology and dataMethodologyWe will use a multicase study research. Case study research is appropriate as we focuson the evolution of a phenomenon when the borders between the phenomenon and itscontext are not very clear (Yin, 1994). More than just measurable data are analysed andit reveals this topic through multiple perspectives, essential within corporatebankruptcy (Thornhill and Amit, 2003). This information converges through

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triangulation (accuracy increases by support from several sources) which providesvaluable insights and which facilitates a richer understanding of the complexity of afailure process. This approach is also very useful for sensitive topics with confidentialinformation.

Case selection and descriptionThe goal of the used sample method, theoretical sampling, is to choose cases, whichcan replicate or extend the emergent theory (Eisenhardt, 1989). The necessary steps aretaken to ensure appropriate sampling. 12 Belgian companies are selected, based onsize, age and industry. The selection frame is displayed in Table I. For reasons ofconfidentiality, each case is denoted by a letter. For each category, we select allbankruptcies in Flanders and Brussels during the previous three years. We selectcompanies under the condition that necessary information can be obtained. For allcases, we gather financial and nonfinancial information: we analyse first the annualaccounts of the company. Second, we obtain the findings of the court. Third, relatedparties such as management, trustees, banks and employees are interviewed, based ona questionnaire that was designed after the literature review and revised after sometest interviews. The semi-structured process allows us a free expression of theentrepreneurs ideas and to compare findings with other related parties. We conductedour interviews from Spring 2004 till Fall 2005.

The results of each of the 12 case studies are written out in a standard reportincluding the following items: the companys history, a financial statement analysis forthe 3 most recent accounting years and a description of failure causes. This within-caseanalysis 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 similaritiescoupled with intergroup differences. Finally, the emerging concepts were tied to theexisting literature in order to enhance internal validity.

Case study findings: a typology of four types of failure processes and theircauses of bankruptcyFour types of failure processes to explain a companys deterioration and bankruptcyBased on the companys maturity and the causes of bankruptcy, we discover fourdifferent 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, Dand L), the failure process of a dazzled growth company (cases B and F) and the failureprocess of an apathetic established company (cases H and J). There is no uniformrelationship between the type of failure process and size or industry. Only age ormaturity of the (young) company is linked with the type 1 failure process.

Large (. 100 employees) Small (, 100 employees)Type of industry , five years . five years , five years . five years

Manufacturing A B C DService E F G HTrade I J K L

Table I.Selection of the 12 casesbased on size, age and

industry

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Within this section, we draw attention to the dynamics and interactions betweennonfinancial and financial factors in the different phases of the four failure processes.We also aim to expound the relations between the internal and external environment offailing companies. Furthermore, each failure path has three phases. First, initialshortcomings form the foundation of a latter failure. The second phase indicatesproblems in terms of capital expenditures, sales or expenses. These are symptoms of acorporate policy that falls short due to those initial shortcomings. The last phase givesan overview of financial problems and is very much interrelated to the previousphases. We emphasize the similarities in terms of the occurrence of financial signals ofdistress between the four failure processes. However, the speed at which the signalssucceed each other and managements reaction towards these signals differssignificantly. The most considerable difference is the presence of very distinctive initialshortcomings.

The failure process of an unsuccessful start-up company (type 1: cases C, E, G, I and K)Many companies fail within five years after their founding. Most of these companieshave very limited growth, are unprofitable and have no survival chances. An overviewof their failure process is displayed in Figure 2. We draw attention to the specificcharacteristics of management in our description below.

A typical initial shortcoming concerns the lack of managerial or industry-relatedexperience. The necessities within a companys business plan are unknown and manycompanies (E, G, K) have no strategic advantage. Inappropriate management may alsolead to insufficient control mechanisms and all cases are characterized by severeoperational inefficiencies. As a consequence, the companys long term survival seemsvery 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 capitalexpenditures, low sales levels and underestimated expenses.

These negative signals are rapidly followed by financial indicators of distress. Lowcash flow and profitability inevitably leads to liquidity problems, often increased byunadjusted investments. The fall of the company appears likely shortly after itsfoundation.

All stakeholders are well aware of the companys problems and stable relationshipscannot be established. The lack of external legitimacy (Kale and Arditi, 1998) andstakeholders mistrust accelerate the failure process.

Management gradually realize the necessity of a restructuring, but banks refusecooperation. Therefore, start-ups without significant starting capital have scantpossibilities to survive and even with sufficient starting capital, they are still verylikely 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 growthcompany are risk lovers with industry-related experience and ambitious objectives.Some are moreover over-optimistic. An expansion plan is launched which implies amajor increase of the firms 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 meansto execute the intended strategy. The growth scenario implies a new start.

The initial shortcoming is the large overestimation of demand despite theexperience and capabilities of management. This overestimation is due toover-optimism or to an overestimation of either market size or customers switchingbehaviour. The latter reflects its liability of newness. Consequently, turnover isinsufficient to cover expenses and overcapacity is large. These negative signals lead toinsufficient profits and cash flow. Due to the high debt/equity ratio, all financialconsequences including liquidity and solvency are very harmful.

Figure 2.The failure process of an

unsuccessful start-upcompany (type 1)

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Fortunately, as a result of their expertise, management normally have a clear viewof the issues. A successful recovery is nevertheless very difficult without internalmeans and banks mostly refuse additional debt.

Management are therefore unable to reorganize in the most efficient way. Despitethese issues, profitability improves steadily, but the companys liquidity and solvencyremain very weak. Due to its financial structure, the company is vulnerable to changesin the environment. If changes in the companys environment do occur, then thecompany will face a dramatic loss of strategic advantage and this inevitably leads toits bankruptcy within a short period.

This failure process contrasts with Argenti (1976), which relates failing high growthcompanies to insufficient skills in terms of financial, administrative or operationalpolicy. Our findings indicate that managements overestimation of turnover combinedwith vulnerability towards changes in the environment is another possible cause forbankruptcy 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 deteriorationand bankruptcy of a company after a failing growth. As a consequence, there are somesimilarities 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 higherfinancial strength at the start of their growth because these companies are more mature.Second, management characteristics vary significantly between these failure processes.

Initially, internal or external growth is desired: a new strategy is developed, oftencombined with an innovative product or process. This strategy is successful and thecompany gains legitimacy as one of the most promising companies in the industry.The initial shortcoming is managements reaction to this success: dangerously dazzledover-optimism. Later on, growth and capital expenditures increase together withleverage, pitfalls are ignored and the organizational structure remains almostunchanged. This inevitably leads to a loss of control and to unawareness of possibleissues that could affect operational efficiency or turnover. This results in a variety ofnegative signals: overestimated sales, large overcapacity and high expenses.

As a consequence, profitability and financial strength decline swiftly. Because ofextreme optimism and unrealistic perceptions, negative signals are ignored orattributed to external and temporary factors. In reality, the need for internalrestructuring is urgent.

Managements dazzle and the companys unbalanced growth will continue untilthey face critical difficulties, such as very weak solvency and payment delays. Fromthat moment on, most companies have little chance of survival, as many stakeholdersfeel deceived and lose confidence. The length of this last phase depends onmanagement efforts to recover and on the cooperation with stakeholders, but finally,the negative spiral cannot be reversed.

The differences between types 2 and 3 have important implications. Type 3companies have, as a consequence of their financial reserves, more possibilities ofoutliving a disastrous investment plan. Their bankruptcy is due to dazzle andoverconfidence. Therefore, this failure process is an illustration of the perils of a riskseeking behaviour for healthy companies without an adapted management structurethat can draw a stop at decline. Type 2 companies are much more vulnerable after afailed investment even if management have a clear view of the situation. Bankruptcies

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Figure 3.The failure process of an

ambitious growthcompany (type 2)

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Figure 4.The failure process of adazzled growth company

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of dazzled growth companies are more unusual than bankruptcies of ambitious growthcompanies, 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 thatexisted more or less successfully for several years. The failure process is displayed inFigure 5. Management of these companies are characterized by a lack of motivationand commitment. Due to apathy, they still believe in strategies that were successful inthe past, unaware of the gradual changes in the environment. When the companysclosest competitors do react to these changes, it loses its strategic advantage.Inevitably, customers switch over to competitors and turnover decreases significantly,but management ignore the fundamental causes. Instead, they look at temporaryinfluences to explain decreasing profits.

Figure 5.The failure process of an

apathetic establishedcompany (type 4)

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Management will not reorganize until they suffer from a significant lack of internalfinance. Unfortunately, the recovery plan contains major deficiencies, as management,because of their rigidity and limited commitment, cannot estimate opportunities andthreats correctly. This results in inappropriate capital expenditures, and low sales areinsufficient to cover the companys increased expenses.

Because of the failing restructuring, liquidity and solvency problems arise.Customers and creditors lose confidence in the company. Management are now fullyaware of the situation, but the company fails after several years of apatheticmanagement and a desperate financial situation.

This failure process illustrates the threats of routine inertia (Gilbert, 2005). Inaddition to Wiseman and Bromiley (1996), we furthermore do not fully agree with thethreat 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 debtcompared to equity) of companies in crisis often induces management to take higherrisks and to change business significantly. However, due to inertia, they are unaware ofthe most suited opportunities and fail to expound an appropriate recovery plan.

Specific causes of bankruptcy for each type of failure processIn this section, we discuss the causes of bankruptcy for each type of failure process. Wewill stress the interdependence between the causes during the failure path instead offocussing on a limited number of causes.

Management: the origin of most problemsSimilarly to most authors, we stress managements responsibility in corporatebankruptcy. There are, however, significant differences in terms of the errors made bymanagement between the different failure processes. An overview is given in Table II.

Type 1 Type 2 Type 3 Type 4Failure process ofan unsuccessfulstart-up

Failure process ofan ambitiousgrowth company

Failure process ofa dazzled growthcompany

Failure process of anapathetic establishedcompany

Competencesand skills

Insufficientcompetences andskills in many areas

Wrong estimationturnover

Lack of financialbackground (somecases)

Motivation Enduringmotivation

Very motivated Insufficientmotivation andcommitment

Personalcharacteristics

Rashness Persuasiveness Over-optimism Inertia

Authoritarianleadership (somecases)

Risk lovers Dazzled

Over-optimism(some cases)

Table II.Causes of bankruptcy foreach type of failureprocess: management

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The major shortcoming of management of unsuccessful start-up companies is, giventheir insufficient competences and skills, their rashness in establishing a companywithout taking advice and without anticipating possible threats. Additionally, aminority of managers are too authoritarian.

The overestimation of turnover that initiates the deterioration of ambitious growthcompanies is caused by either a lack of skills or by personal characteristics(over-optimism) that affect the leaders ability to select and assimilate informationcorrectly. The decision to expand is furthermore affected by personal characteristicsand their motivation to succeed is necessary for the gradual but insufficient recoveryafter the failed investment plan.

Leaders of dazzled growth companies do not lack management or industry-relatedexperience, competencies or skills. This is illustrated by the success of their firstexpansion. The main reason for bankruptcy is managements dazzled over-optimismafter 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 lackmotivation and commitment.

Corporate policy: where they got lostAs management set out corporate policy, the differences between failure processes interms of management errors lead to distinctive problems in terms of corporate policy.This is summarized in Table III.

Type 1Failure processof anunsuccessfulstart-up

Type 2Failure process ofan ambitiousgrowth company

Type 3Failure process of anambitious growthcompany

Type 4Failure process of anapathetic establishedcompany

Strategy No strategicadvantage

No adjustments toenvironment

Capitalexpenditures

Inappropriate Exaggerated Exaggerated Unadjusted

Commercialpolicy

Lack ofcustomers

Overestimated sales Loss of customers

Customerdissatisfaction

Customerdissatisfaction

Finance andadministration

Insufficientfinancialplanning

Lack of expertise(some cases)

Extreme gearing

Operationalpolicy

Severeoperationalerrors

Unadjustedmanagement andoperationalstructure

Operationalinefficiencies

Humanresourcesmanagement

Insufficienttraining

Minor influenceCorporategovernance

Moderateinfluence

Table III.Causes of bankruptcy for

each type of failureprocess: corporate policy

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The issues in terms of corporate policy of start-up companies are diverse and dependupon managements lacking expertise: a low commercial insight results in low salesand high capital expenditures (E, G and K), while a deficient operational organizationleads to high expenses (and capital expenditures) or low customer satisfaction (C, Eand I). All companies however lack a clear financial planning and control system.

As we have mentioned in the previous section, the expansion of ambitious growthcompanies fails to a major extent because of the overestimation of turnover. A lack offinancial expertise is also common, but it never has a significant influence on thefailure of the intended growth, as this business plan was executed under seriousconsideration and after professional advice. These errors only possibly influence thesurvival chances of the company in a subsequent phase, as they affect assessment andamelioration of the financial situation during the recovery process.

The exaggerated investment plan of dazzled growth companies fails as aconsequence of extreme gearing, combined with an unadjusted managerial andoperational structure. Possible errors in the companys commercial policy do not have acritical influence.

The lack of commitment and motivation of apathetic established companiesrestrains them not only from adapting to external changes but also from restructuringsuccessfully later on. This results in an unadjusted strategy, inappropriateinvestments and a strategic disadvantage, often combined with an inefficientoperational structure.

The influence of human resources management did not differ between the failurepaths and was never the basis of deterioration. The existence and influence ofcorporate governance (or mismanagement) on bankruptcy did not depend on the typeof failure path. This issue is however rather complex. For five companies in our sample(cases F, G, I, J and K), the dramatic effects of some investments or expenditures wereobvious and must be considered as mismanagement. The likelihood ofmismanagement is greater at the end when confidence in survival is low.

The immediate environment of the company: a domino-effect dwindling a companyssurvival chancesConstant interaction with the immediate environment is inevitable to survive (Oogheand Waeyaert, 2004). In this section, we mention the different issues, noted during ourresearch, starting with the most critical ones: customers and competition. The findingsare 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. Thefailing expansion of ambitious growth companies is caused by overestimated demand.In the final stages of the failure path, they also suffer from competition as they cannotadapt to the changing environment unlike their competitors. In contrast to otherprocesses, the bankruptcy of a dazzled growth company has little connection with alack of strategic advantage or with competition. Lastly, the problems of apatheticestablished companies in retaining customers are caused by the loss of competitiveadvantage.

Overall, liquidity problems increase companies difficulties in retaining customers.The effect of customers mistrust however, does not only depend on the specificities ofthe 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 inwhich after-sales service is very important, face the most difficulties.

Other factors in the immediate environment banks, suppliers, stockholders,misadventure and trade unions were never the basis of deterioration. No substantialdifferences existed between the distinctive failure processes. First, suppliers,stockholders (if applicable) and credit institutions react in a similar way to financialproblems by refusing further cooperation. This accelerates the failure process. Second,the impact of misadventure can be compared with the impact of stakeholders: it doesnot affect competing companies in the same industry. These circumstances areexceptional but extremely damaging for distressed firms. Finally, personnel and tradeunions are very unlikely to initiate the companys deterioration.

The general environment of a company: the excuse most often used by managementAs a company is an open system, one has to regard the general environment, which issimilar for all companies in the sector (Ooghe and Waeyaert, 2004). Its impact isdiscussed hereunder.

With respect to unsuccessful start-ups, we did not find any threat within the generalenvironment, except from a recession in the industry. Companies, making theill-considered decision to start-up at that moment are destined to fail. These companiesdo not exist long enough to face gradual changes in the general environment. If weanalyse the impact of the general environment on the failure of an ambitious growthcompany, we find that these factors normally do not affect the initial problems.

Type 1 Type 2 Type 3 Type 4Failure process ofan unsuccessfulstart-up

Failure process of anambitious growthcompany

Failure process ofa dazzled growthcompany

Failure process of anapathetic establishedcompany

Customers Shortage ofcustomers

Shortage ofcustomers

Mistrust Shortage ofcustomers

Customerdissatisfaction

Mistrust Customerdissatisfaction

Mistrust MistrustCompetition Because of lack of

strategicadvantage

Competition offoreign companies

Strategic advantagecompetitors

Consequence ofinflexibility

Suppliers Increasing mistrustBanks MistrustStockholders Only applicable for

listed companiesMisadventure Exceptional, but very

damaging (if alreadyin distress)

Personneland tradeunions

Possible consequenceof financial problems

Table IV.Causes of bankruptcy for

each type of failureprocess: immediate

environment

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Company A is an exception, though, because an unexpected recession accelerated theeffects of an overestimated demand. However, in the final phase, changes in the generalenvironment can have a critical influence on these firms bankruptcy because they lackthe financial means necessary for restructuring. Issues in the general environment,such as a bear market or a recession, do not affect the survival chances of dazzledgrowth companies. It only affects the duration of their failure process. Lastly, apatheticestablished companies have the possibility to adapt to the changing generalenvironment, such as political changes (H) or changes in foreign countries (J), but aretoo rigid to do so.

No company in our case study research failed due to an industry-effect. We didobserve contagion in our sample. However, contagion only influenced the duration ofthe failure process, not the underlying causes of failure. Table V summarizes ourfindings.

ConclusionsThis paper reveals four different types of failure processes, based on the companysmaturity and management characteristics: the bankruptcy of unsuccessful start-upcompanies, the failure process of ambitious growth companies, the failure process ofdazzled growth companies and lastly, the bankruptcy of apathetic establishedcompanies. For each process, a detailed overview of the direct and indirect effects ofnonfinancial and financial causes is given. Our typology is developed by case studyresearch of 12 Belgian companies of different industries, sizes and ages.

Start-up companies that went bankrupt (type 1 failure process) are characterized bya management with a serious deficiency in managerial and industry-relatedexperience. These companies lack a strategic advantage or have a poor operational

Type 1Failure process ofan unsuccessfulstart-up

Type 2Failure process ofan ambitiousgrowth company

Type 3Failure process ofa dazzled growthcompany

Type 4Failure process ofan apatheticestablishedcompany

Economic factors Recession in theindustry (somecases)

Weak stockmarkets (somecases)

Weak stockmarkets (somecases)

Price increase ofraw materials(some cases)

Recession of theindustry (somecases)

TechnologyForeign countries Economic changes

in foreigncountries (somecases)

Political influences Stricter legislation(some cases)

Society

Table V.Causes of bankruptcy foreach type of failureprocess: generalenvironment

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structure. These errors, combined with a weak financial and administrative structure,inevitably lead to a lack of internal finance from the beginning. They do not have thequalities to solve their financial problems. External factors have no influence on theshort failure path of these companies.

The second failure process reveals the deterioration of ambitious growth companiesleaded by risk seeking managers (or entrepreneurs) with industry-related experienceand persuasiveness. Thanks to cooperation of banks, an ambitious expansion strategyis developed, but due to over-optimism or misinformation, turnover is greatlyoverestimated and the company becomes very vulnerable to bankruptcy. As thesecompanies have a motivated and experienced management, they intervene as soon aspossible by developing a recovery plan, and as a consequence, they have a realisticprobability of outliving this crisis. Unfortunately, these companies lack the necessaryfinancial means to implement the most cost-effective recovery plan. As a result, theyonly slightly improve their financial situation and lack the flexibility to react to threatsin the environment. A lot of these companies go bankrupt in the end, if changes in theenvironment do occur.

The third type of failure process (type 3: the failure process of a dazzled growthcompany) is initiated by managements dazzle. They take exaggerated risks and ignorethe companys managerial and operational structure. This leads to a severe increase inexpenses and deterioration in profitability. Weak profitability is however attributed toexternal and temporary factors. By the time they develop their recovery plan, thecompany has lost both its financial strength and its trust from its immediateenvironment. As a result, the company goes bankrupt after a steep rise and an eversteeper fall.

In the last type of failure process (type 4: the failure of apathetic establishedcompanies) management have the ability to manage a profitable organization, but theylack commitment and motivation. Management do not notice sales to be graduallydecreasing. They only react after a significant decrease of internal finance. Moreover,managements restructuring plan is not adjusted to the changing reality, and errors inthe companys policy decrease its operational efficiency. When liquidity problemsoccur, they start realizing the severity of the situation. There is no chance to survivebecause stakeholders become mistrustful and all financial means are wasted.

The typology of the four different failure processes gives new insight into theevolution of financial performance ratios during the years preceding bankruptcy. Firstof all, there are many similarities within the evolution of financial performance ratiosfor distressed companies. There exist however significant differences in the durationby which these ratios affect each other. For unsuccessful start-up companies (type 1) allfinancial ratios have an equal predictive power, as solvency and liquidity deterioratevery shortly after the profitability problems. They are visible from the companys firstannual accounts onward. Ambitious growth companies (type 2) have a very specificfinancial profile after the unsuccessful investment plan. While the companys solvencyand liquidity remain weak, its profitability increases slowly due to restructuring. Thecompany remains however very vulnerable. Third, extreme gearing is a signal thatdazzled growth companies (type 3) are taking exaggerated risks. A low financialindependence (equity/balance total) is the first indicator of possible distress. Later on,alarming profitability will inevitably lead to insufficient liquidity and solvency. Last,apathetic established companies (type 4) have a gradual decrease in financial

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performance before bankruptcy: profitability decreases long before solvency andliquidity.

Furthermore, there appears to be an interaction between the failure process of thecompany and the direct and interactive importance of specific causes of bankruptcy:management errors, errors in company policy, and the influence of the immediate andgeneral environments of the company.

The results of our study are based on qualitative, case study research. No attempt ismade to quantify the existence and the importance of our findings. The majorconstructs that emerged as important in our research, are well-known concepts in themanagement literature. As a consequence, they should be further developed in order toquantify their effect in large scale studies. These studies could give a more fine-grainedinsight in its effect on other non financial and financial symptoms of distress and onthe length of the failure path.

Furthermore, this paper reveals that the presence and the influence of specificmanagement errors on the financial situation largely depend on the companyscharacteristics. Maturity and financial strength are the two most notablecharacteristics, but other features, such as the operational cycle, cannot beneglected. One has to take them into account when analysing possible threats ofspecific management actions to the company in both the short and long term.

Lastly, the general and immediate environment of a failing company normally playa subordinate role. They only have an effect if apathetic management do not anticipateand respond to these changes or if management, because of previous errors, lack thefinancial means to adjust their way of doing business to a changing environment.Therefore, future research should carefully take into account both financial and nonfinancial characteristics of a company and its management when they study the impactof macro-economic changes (e.g. exchange rates) on corporate bankruptcy.

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Corresponding authorHubert Ooghe can be contacted at: hubert.ooghe@vlerick.be

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