The shorter lifetime of the firm in the age of the corporate rescue culture
Something strange is going on. Insolvency regulators and policymakers want to rescue more firms. At the same time, the expected lifetime of businesses is declining.
It is widely accepted that businesses are important drivers of growth, innovation, novelty, change, knowledge and wealth. Companies arise to fill or create economic niches, although their existence may be short lived. The number of business opportunities is fundamentally bullish in the aggregate, even if individual companies come and go (Mauboussin, 1998). So the question is if these important consequences of business activities should or can be achieved by the same companies. The answer is of course no, all these positive effects from entrepreneurship can only be reached by companies that succeed (for a while) and fail. Is this the case empirically?
Let’s look at business history figures. Do companies last forever? Foster and Kaplan questioned this in their famous book ‘Creative Destruction’. In 1917 Bertie Forbes, published the Forbes 100. In 1987 61 of these firms had ceased to exist, 21 had dropped out of the top 100. Only 18 were still in the elite group. These firms survived but they did not perform well: only two of them performed better than the long term US average return: General Electric and Eastman Kodak. We know what happened with the last company; it filed for chapter 11 bankruptcy protection in the US in 2012. The same conclusion can be drawn from the 500 companies that were originally making up the S&P 500 in 1957, only 74 remained on the list in 1997. Also these companies underperformed compared with shareholders return in the same period. The reason for that is that management philosophies are based on the assumption of continuity, whereas the capital markets acts on the assumption of discontinuity. Investors are more flexible to reallocate their capital into more promising alternatives.
As Schumpeter once remarked: the problem that is usually visualized in economics is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them. That slogan not only applies to products, services and technologies, but also extends to the local islands of order that create them: the firm. Foster and Kaplan show that the average lifetime of S&P 500 companies is declining. The continuity of a firm is not given, guaranteed and should not (indirectly) be subsidized with more debtor-friendly insolvency proceedings. It should be earned.
According to Popper failure is the norm of science: failure means progress. Economics is too preoccupied with existence and success, not with fall and failure. Business failure is highly certain, business success is highly uncertain. Ormerod wrote about this asymmetry in his book “Why most things fail”. The reason for business failure is that the world is too complex and unpredictable; it is like playing chess when the rules of the game change continuously. A business can be considered as an interactor and integrator (or pooler). Designs or business plans are made real by pooling resources and bringing them into action, so that they can be tested in the market. Companies have a disadvantage because the portfolio and diversity of their business plans can never be so large as contained in the market. Due to globalization, specialization, technology and digitalization, ideas can be more easily created and combined. This increased number of business plans intensifies competition and accelerates innovation. Beinhocker (2005) calls this evolution’s simple recipe of “differentiate, select and amplify”.
The firm is a “connected temporary coalition” (Taylor, 2004) because business opportunities are time and place specific, it is a temporary shelter as long as it creates value. The rescue culture does not correspond to the symptoms of the new economy, in which firms are a more temporary phenomenon. That leaves the question why the corporate rescue thought is so popular at a time when the existence of a firm seems more fragile and temporary than in the past? Do insolvency regulators want to fight against the consequences of the new economy?