Decades of emerging technologies, regulatory convergence and multinationalism have totally redefined the global business space – enabling businesses to scale, cross borders and evolve to become integral cogs within their respective industries. Yet the bigger these organisations become, the harder they fall. That’s why the last two decades have been marred by a flurry of corporate failings and catastrophic collapses.
From Enron and WorldCom in the early 2000s, to AIG and Royal Bank of Scotland, Société Générale, BP, Kodak and dozens in between, markets have been hit repeatedly by huge corporate failings – and while many of those failures appear starkly different in nature, they actually contain a worrying number of shared symptoms. To help financial leaders learn from these failures and avoid repeating them, we’ll delve into 10 of the most common reasons behind corporate failure.
One of most obvious reasons for corporate failure is the lack of an effective board – and there are plenty of warning signs to indicate when boards are in over their heads. Clear skills limitations, an absence of experience in core business areas and the inability of non-executive directors (NEDs) to hold senior executives to account have repeatedly paved the way for collapse.
The cataclysmic fall of Enron in 2001 poses a chilling example. According to the US Senate’s investigation into the role of Enron’s board in the energy conglomerate’s collapse, directors were inexperienced and the board was riddled with conflicts of interest. The board committed repeated fiduciary failures by knowingly allowing Enron to engage in high-risk accounting, interest transactions and extensive undisclosed and off-the-books activities.
Toss excessive executive compensation and a complete lack of independence through the presence of NEDs, and US lawmakers ultimately ruled it was Enron’s ineffective board that was responsible for running America’s seventh-largest public company into the ground.
So, what makes for an effective board?
“Really effective boards are open and honest with each other and appreciate that their task is to scrutinise and ask hard questions,” explains entrepreneur, CEO and author Margaret Heffernan.
“The cozy, golf club boards where everyone is chummy and see eye to eye tend to be disastrous. Harmony matters more than the work. Equally, boards are at their best when they do not feel so beholden to the CEO that they can’t challenge. This is frequent, in my experience.”
“An ineffective board is full of men who all went to school together, studied the same subjects and broadly see eye to eye on everything.”
Intricate processes are certainly necessary at times – but the truth is, excessive complexity is often a root cause of corporate failure. When flaws begin to appear in even the most well-oiled complex system, it can be incredibly difficult to correct, often initiating a domino effect that impacts all aspects of a project or company.
For lessons on how, it’s worth taking a look at Airbus and its ill-fated A380 project. Billed as the world’s largest super jumbo jet, the Airbus A380 was meant to be a phenomenal feat of human engineering – but everything about the project was complicated, from the intricate design, to the IT, procurement process and cross-border supply chain, manufacturing, assembly and political balance between duelling CEOs in France and Germany.
The A380’s innovative wiring system was too challenging for engineers to deploy, and the plane’s development was spread across 16 sites and four different countries. German, Spanish, French and British design teams were using incompatible software – delaying completion by over two years and ballooning the project budget to more than $16bn.
The requirement for an organisation to maintain clear lines of communication should be relatively obvious to most FDs. Yet time and time again, corporate collapse has been spearheaded by communication lapses. After all, even the most effective board cannot lead an organisation if it’s not kept in the loop.
Again, Airbus and its colossal A380 failure offer insight into the ways in which poor communication can cause disaster. As part of the company’s complex supply chain, engineers realised there were nonmatching aircraft sections that didn’t actually adhere to the project specifications six months before they alerted senior management.
For a project that spiralled over budget by $1m per day, Airbus could have saved itself a whole lot of time, money and, potentially the entire project, had the organisation integrated better lines of communication.
“The most frequent challenge corporations face is finding out about things too late—whether it’s the data breach, product quality failures or ethical issues,” says Simon Barker, a managing partner at Blue Moon Consulting Group.
“Having a supportive culture is key, but so is having the right process to escalate issues appropriately, to assess the risk in the context of other events, and to quickly get the leadership team to understand the potential impact and consequences of the issue or event.”
A crucial reason boards often fail is their inability to engage with risk in the same way they engage with opportunity and reward. According to author Margaret Heffernan, this so-called risk blindness perpetuates a wide range of problems for companies.
“Risk blindness means that problems are ignored – which gives them time to grow and to fester,” she says.
“Blindness is insidious because it bestows a sense of comfort (‘if I ignore it, it will go away’), whereas in fact it makes everything worse. Most problems are a great deal easier to tackle when they’re small.”
Risk blindness was a huge reason behind the collapse and subsequent bailout of the AAA-rated AIG in 2008.
AIG didn’t experience rapid growth until the early 2000s – but after a series of ambitious mergers and acquisitions rose to become the globe’s biggest insurance group. By the third quarter of 2007, AIG boasted shareholders’ equity of more than $104bn and consolidated assets of over $1trn. Fast-forward to 2008, and AIG had racked up annual losses of almost $100bn and was effectively nationalised as part of a government rescue deal.
What happened? AIG’s leadership was blind to risk, and was compelled by an overambitious strategy to increase profits by 15% per annum in an impossibly competitive industry space. The company ended up producing misleading accounts and used false reinsurance policies to inflate its profits.
It cost AIG $1.6bn to make things right after it was held to account – and while the board’s eye was fixed on one problem, issues posting collateral destroyed AIG’s derivatives business and the subprime crisis obliterated AIG’s credit swap portfolio.
Unhealthy company culture
Poor company culture is another major culprit in terms of corporate failure. Businesses that place a hyper-intensive focus on driving profits often foster cultures of double standards – which go on to facilitate questionable risk-taking.
The terrifying losses sustained by Société Générale in 2008 pose the ultimate cautionary tale. When junior French trader Jérôme Kerviel was promoted to a spot on Société Générale’s trading desk, he was disappointed to find his remit was limited to arbitrating price differences between derivatives swaps.
That’s when Kerviel got bored and started taking bets on market decisions. After winning big gambling, Kerviel’s supervisors apparently forgot what the junior trader’s true remit was – and using that praise that as his cue, Kerviel then disarming the bank’s safeguards so he could take huge positions betting against the market.
He ended up hiding the positions by filing loads of tiny, fake hedge trades elsewhere – and while the bank claims it had no idea what was going on, Kerviel says managers were aware of the situation and turned a blind eye because he was generating so much profit.
The way Kerviel tells it, Société Générale’s poor company culture was to blame for his rogue trades – and after the trader’s luck finally ran out, a single miscalculated bet ended up costing the bank €4.9bn in losses, its CEO and forced an emergency rights issue.
Technological innovation has been fantastic in advancing industry and simplifying supply chains – but it’s also posing huge challenges for market incumbents. Company leaders who fail to leverage new tech to remain competitive often live to see their entire organisation crumble because of complacency.
The 2012 bankruptcy of iconic brand Kodak offers a textbook example. Founded in the 1880s, Kodak held a monopoly over the global photography industry for almost a century. But when the sector went digital in the 1980s, Kodak refused to acknowledge the disruptive technology. The company was eventually (and grudgingly) a late adopter, but even then tried to repurpose digital as a channel to drive sales for analogue products.
Sales continued to wither with the rise of smartphones – and desperate, eleventh-hour acquisitions like Kodak’s purchase of photo-sharing site Ofoto were too little, too. The film pioneer filed for Chapter 11 at the start of 2012 with $6.8bn worth of debts.
Not enough working capital
If an organisation is undercapitalised, it’s probably going to fail. Periods of financial distress often mean boards struggle to source liquidity and maintain high enough levels of working capital to continue operations. Undercapitalised firms can’t buy relevant fixed assets or invest income in generating assets, leading to underutilisation of capacity and ultimately failure.
Undercapitalisation is one of several core reasons behind last year’s collapse of cake shop chain Patisserie Valerie, which was forced into a major selloff and borrowing spree in a desperate bid to raise capital after a £20m blackhole emerged in the company’s finances.
The rescue deal ultimately fell flat – and at the start of 2019, Patisserie Valerie fell into administration.
Information glass ceiling
Corporate failure is often facilitated by the presence of a so-called ‘information glass ceiling’, in which internal audit teams or those responsible for risk management fail to report on risks that are coming from above in terms of an organisation’s hierarchy. When an information glass ceiling is present, executives tend to overrule red flags generated through audit processes, or information is heavily sanitised by the time it reaches board-level.
The refusal of managers to report and act upon internal compliance red flags raised at Société Générale during Jérôme Kerviel’s wild ride clearly demonstrate how an information glass ceiling can lead to corporate failure. Yet this same issue is also woven into the fabric of Enron’s inevitable collapse. Because the board opted to use its own consultancy firm to audit financial results, Enron’s auditors had an obvious incentive to avoid issuing unfavourable reports.
At best, this was a conflict of interest – at worst, it prevented the board from developing a true understanding of the organisation’s absolutely dire position.
Systematic failures also present a huge external barrier for corporates. After all, when government policy is stacked against the interests of a company or existing regulation facilitates reckless decision-making, those systematic failures pave the way for disaster.
The meteoric rise and fall of Royal Bank of Scotland (RBS) offers a harrowing case study. It can’t be denied much of RBS’s failure came from an ineffective board that repeatedly demonstrated risk blindness. That said, the real nail in the coffin for RBS was systemic.
Inadequate global frameworks for the capital regulation of financial institutions alongside a flawed supervisory approach from regulators like the Financial Services Authority (FSA) effectively facilitated RBS’s collapse. The FSA’s supervision didn’t place enough emphasis on the core prudential issues of capital, liquidity and asset quality. Likewise, regulators weren’t obligated to challenge management judgements or risk assessments.
Finally, even the shrewdest board cannot control every element of business success – and economic downturn is one of the elements beyond a company’s control. Environmental economic instability can decimate sales and adversely affect the activities and performance of organisations, often facilitating failure or even collapse.
At the start of 2016, a 70% tumble in oil prices and economic slowdown in China led to a 17% spike in the number of UK businesses suffering significant financial distress. According to Begbies Traynor’s Red Flag Alert, a perfect storm of bad economic conditions pushed more than 268,000 UK companies into distress – with many of the hardest hit sectors also being those most influential to the UK’s overall economic growth.