Accounting Financial ACC701
In recent years a number of companies have gone into liquidation (been ‘wound up’) because they have not been able to meet their liabilities when they fell due. In Australia, there are some well-publicised examples such as ABC Learning, HIH Insurance and One. Tel phone company
Use the companies above and find (via electronic journals) the events that led up to the liquidation. Discuss the ethics and governance in explaining the company’s financial stress. Were liabilities a major factor contributing to the liquidation of the company?
Students need to support their analysis with reference to relevant material from the text and a minimum of eight (8) suitable, reliable, current and academically acceptable sources – this should include at least 2 peer-reviewed academic journal articles.
2000 + 10%-word short report format. Title page, executive summary, table of contents, appropriate headings and sub-headings, recommendations/findings/conclusions, in-text referencing and reference list (Harvard – Anglia style), attachments if relevant. Single spaced, font Times New Roman 12pt, Calibri 11pt or Arial 10pt.
Factors Contributing to the Liquidation of Companies
The corporate status provides immunity to the shareholders from unlimited liability and hence limits their risks. But the corporate also results in separation of ownership and management and hence exposes the stakeholders to the risk of being managed by on owners. When the corporate are unable to serve their debt, they are liquidated in order to release the funds struck in the non- performing and idle assets. The biggest reason for liquidation of companies is assumed to be the high debt portion in the balance sheet.
The paper researches the liquidation and failure of three leading companies of Australia viz. ABC Learning, HIH Insurance and One. Tel phone company. All the three companies belong to different industry. ABC learning is from childcare industry, HIH is insurance sector and One.Tel is from telecommunications industry. The review and analysis of the causes of the failure of these companies reveals that it’s not the high portion of debt or the inability to repay the debt that always leads to insolvency but it’s the lack of business ethics and lack of good corporate governance practices that leads to cash shortage in the company and ultimately to winding up of the company.
Lack of business ethics results in keeping person interest before the interest of the stakeholders. Thus the management ends up making decisions to increase the personal wealth that of the stakeholders. On the other hand poor corporate governance practices leads to misrepresentation in the financial statements of the company and lacks transparency of the operations of the company.
Thus ethics and governance are observed to be the biggest factors that lead to bankruptcy of the company and its liquidation.
In the economy when a company becomes insolvent and is unable to pay for its debts and short term liabilities, its winding up is the only best alternative left with the creditors. The legal process of winding up of a corporation results in liquidation of the company. Liquidation results in disposing of the assets of the company and paying the liabilities from them. This way the creditors get some portion of their debt and the assets thus disposed can be used effectively and efficiently by other players in the market. The company is forced into liquidation when it is not able to pay its liabilities (Kotorman, A., n.d.). There could be various reasons for this inability to pay the liabilities, it could be excess of debt as compared to the capacity of the assets and operations of the company, or it could be lack of ethics or good governance practices by the management. The reasons for liquidation may vary slightly from industry to industry but the main causes of liquidations are same across the industries. The paper studies liquidation of some major companies like ABC Learning, HIH Insurance and One.Tel Phone Company in Australia and report the findings on the main causes of liquidation across the various industries.
Research Findings on Corporate Liquidation
The major factor leading to insolvency and hence liquidation is the result of financial failure of the company. The financial failure could be because of unfavorable market conditions, low profit ratios or high debt/equity ratios (Kotorman, n.d.).
The collapse of HIH insurance sent shock waves among the authorities as well as the policy holders. Although the liquidation was because the company was not able to honor the insurance policies, the review into the causes revealed that the failure was because the company expanded very rapidly and lacked proper management. HIH group had many separate government- licensed entities like HIH causality and General insurance Limited, FAI, CIC insurance Limited and WMG (World Marine and General Insurances Limited). It also wrote insurance internationally making its presence in USA and UK along with Australia. A report carried out by the committee in US that investigated insolvency cases (1990 cited in Kehl, 2001) claims that in order to expand too soon, the company entered into complex reinsurance arrangements, offered low prices for the contracts and lacked good governance. The management fell to personal profits and did not follow business ethics. The company reduced its safety margin by purchasing the re-insurance covers from other insurance companies and hence ran out of funds to pay its claims (Kehl, 2001). Cheng and Seeger (2012) also claimed in their study that fall of HIH was as quick as was its growth. The management did not follow ethical and governance protocols necessary for expansion of business. The Directors and executive managers put their personal interest before the interest of the shareholders. The accounts were under provisioned to show good financial results and hide the upcoming financial crisis. The company did not communicate properly on the financial health of the company to the stakeholders and hence lacked transparency; giving a blow to good governance principles.
The collapse of ABC learning is termed as the worst collapse in the childcare industry in Australia even after 10 years of its insolvency. ABC learning was founded in 1988 by Edmund Groves and his wife Le Neve Groves as a chain of Child Care centers in Australia. The company soon expanded by purchasing child care centers in prime location all over the country and by 1999 had owned 30 centers in Australia. The company was listed on ASX in 2001 and by the end of 2008 it owned as many as 2,238 centers in Australia, New Zealand, USA and UK. The growth was phenomenal and the company reported high after tax profits in 2007. However suddenly the company had to sell its share in foreign countries to pay off its debt and was delisted and went for liquidation in 2018 (Teen, 2012). The liquidators and councilors observed that the business model of ABC learning was faulty. The business model was named as “a black box” due to lack of transparency (Teen, 2012). Most of the assets acquired by the company were intangibles and hence the valuation of these assets was complex. The assets included a high value of goodwill and licenses which were not impaired as per the applicable accounting standards. The assets of the company were not real assets. The profits reported were high because the intangible assets were not impaired and valued on the basis of future cash flows. Thus when the company had to pay its debts, it had no real cash to pay them. The assets had practically no market value and liquidation was the only resort. The founder and the chief executive of the company were charged for criminal charges for cheating the stakeholders. The business lacked transparency and was governed irresponsibly (Parker, 2016). Even though the profit after tax was reported high, the company did not have enough cash flows from operations to pay the operating cost and interest cost. Poor corporate governance practices and lack of transparency was the major cause of collapse of ABC learning (Walsh, 2010).
One.Tel was the fourth largest telecommunications Company in Australia when it collapsed in 2001. Avison and Wilson (n.d.) in their research over One.Tel company failure argues that the sudden growth and expansion of the company led to its collapse. The research states that the operating technologies and IT of the company was not adequate to meet the expansion demands of the company. The company was expanding its operations at the cost of incurring operating losses. The revenue and customer base of the company increased many fold but the operating profits dropped significantly. The cost of growth of the company exceeded the revenue growth significantly. The growth at fast pace blurred the financial health of the company and was ignored by the management of the company. The company expanded to wireless and internet services to long distances at very competitive prices however the technologies available with the company were not ready to support the business (Avison & Wilson, n.d.). In addition the company purchased telecommunication licensees by paying very huge amount in order to satisfy the appetite for expansion. This gradually led to cash shortage in the company and ended with liquidation in May 2001. The analysts explained that the high revenue growth of the company did not translate in high cash profits. Corporate governance of the company was held responsible for the collapse (Reza, 2011). The company lacked quality governance as the investment was made without measuring the return on investments. There was no proper flow of information in the top management. The company had faulty financial reporting practices which lacked transparency. The composition of board of the company ensured that CEO of the company was not changed for a long time and only resigned when the company was on the verge of collapse. Thus the influence of the CEO was very high and hence the quality of decisions made by the board was affected. The management remuneration policy of the company was also defective as they were paid, many times more than the after tax profits of the company. Thus the corporate governance was for a toss in the company (Reza 2011, pg. 18).
The review of the cause of liquidation of the three leading companies in Australia from entirely different industries has almost the similar observations. It is obvious that the companies went into liquidation because they fell short of cash either to pay the interest or the debt or to meet their operating costs. While ABC learning could not meet the interest cost and debt repayments, HIH was liquidated as it could not honor the insurance claims. One.Tel on the other hand could not manage the growth and expansion as the management did not plan the growth strategy and lacked management strategies
Thus it can be concluded from the above research and analysis that liabilities and debt can be one of the reasons which leads to liquidation of the company but the primary causes of liquidation are lack of business ethics and good corporate governance practices. The good corporate governance is believed to rely on four pillars of accountability, independence, fairness and transparency (Festus and Temitope, 2016). Fairness and transparency is observed to be lacking in all the above cases. In all the above corporate collapse, the business ethics were put aside and conflict of interests were resolved by keeping personal interest ahead to the stakeholders. The poor governance practices led to failure of the financial statements to disclose the true financial health of the company and were misrepresented to show high profits.
Thus it’s not the debts and liabilities that lead to the liquidation of the company but the lack of business ethics and poor governance policies that leads to the collapse of the corporations.
The collapse of the large companies which at some time seems invincible leaves some important lessons to be learned. In light of the above research and analysis it is recommended that the management of the companies should ensure that business ethics are always maintained and good corporate governance policies are followed throughout.
Business ethics require that the conflict of interest should be avoided as far as possible and if it is unavoidable the interest of the stakeholders should always be preferred over personal interests. The management should refrain from known misrepresentation of the financial facts of the company and take well informed decisions.
Good Corporate governance requires that the four principles of accountability, independence, fairness and transparency should always be held high. The communication between the management and stakeholders should be complete and on a timely basis. Lack of transparency is viewed as the biggest bock in good governance practices. It is important that high transparency is maintained by the management in decision making, disclosing the financial health of the organization, devising the business models and operations of the company. Good corporate governance and fair business ethics can avoid winding up of a large number of corporations.