Question

a) Identify FIVE (5) factors investors should look for to assess the likelihood of corporate failure. Explain how each factor might be related to the likelihood of corporate failure. b) Discuss TWO (2) corporate governance principles that can help prevent failure. Explain THREE (3) ways in which each principle can be applied to reduce the risk of corporate failure.

Answer 1

The term corporate failure entails discontinuation of company’s operations leading to inability to reap sufficient profit or revenue to pay the business expenses. It happens due to poor management, incompetence, and bad marketing strategies.

The basic symptoms of corporate failure are:

1. Low profitability
2. High Gearing
3. Low Liquidity

Causes of Corporate Failure

• Economic Distress: Economic downturn is one of the major causes of corporate failures, across many businesses. The decline in the economy may lead to the reduction in the activities, which adversely affects the performance of many firms in the economy.
• Mismanagement: Mismanagement implies improper management control over the working of the employees and other business activities. It refers to lack of managerial skills and experience, in terms of strategic capability, leadership, teamwork, coordination, foresightedness, etc. resulting in the failure of the enterprise.
• Technological Causes: With the advancement in the technology, new modes of doing business has been introduced, which is better than the traditional ones. If an industry fails to employ the latest information and production technology, then the chance of failure of the firm may increase.
• Working Capital Problems: When the company is going through financial distress, it may face liquidity shortages. Due to the insufficiency of funds the organisation fails to carry out the day to day operations of the organisation properly and weak liquidity becomes evident.
• Fraudulent Management: Corporate collapse is also mainly caused by the fraud of the management. There are instances when managers are influenced by personal greed, due to which they use unfair means such as falsification in the financial statements and accounting reports of the company.

Principles of Corporate Governance

• Shareholder recognition is key to maintaining a company's stock price. More often than not, however, small shareholders with little impact on the stock price are brushed aside to make way for the interests of majority shareholders and the executive board. Good corporate governance seeks to make sure that all shareholders get a voice at general meetings and are allowed to participate.
• Stakeholder interests should also be recognized by corporate governance. In particular, taking the time to address non-shareholder stakeholders can help your company establish a positive relationship with the community and the press.
• Board responsibilities must be clearly outlined to majority shareholders. All board members must be on the same page and share a similar vision for the future of the company.
• Ethical behavior violations in favor of higher profits can cause massive civil and legal problems down the road. Underpaying and abusing outsourced employees or skirting around lax environmental regulations can come back and bite the company hard if ignored. A code of conduct regarding ethical decisions should be established for all members of the board.
• Business transparency is the key to promoting shareholder trust. Financial records, earnings reports and forward guidance should all be clearly stated without exaggeration or "creative" accounting. Falsified financial records can cause your company to become a Ponzi scheme, and will be dealt with accordingly.