Factors and causes of business failure

Business Failure

The first and perhaps the most obvious cause for business failure is fraud. Indeed, fraud is quintessential to business failure, mainly because it takes different forms and appearances, from intentional bad management to accounting frauds that lead to legal issues.

The most important example of how fraud brought down a bank that had been financing many important operations for the last three hundred of years is the Barings Bank. Unfortunately, Barings was also a perfect example of how one single employee can actually bankrupt a company.

Indeed, Nick Leeson began his activities with Barings after a short period spent with Morgan Stanley and he was soon sent to Singapore to clear the back office mess and futures trading that was on the way there. Initially operating only as general manager, Leeson soon began to trade on the Singapore Exchange (the SIMEX), especially in financial derivates, such as futures and options.

The fist signs of alarm should have already appeared when Leeson cumulated several functions. Besides general manager and back office manager, he was also authorized, together with his brokers and traders, to "transact futures and options orders for clients or for other firms within the Barings organization" and "to arbitrage price differences between Nikkei futures traded on the SIMEX and Japan's Osaka exchange." If we look only at these two dimensions, we can already notice that Leeson's activity was quite risky indeed.

Leeson began speculating on the futures market in Singapore and on the Nikkei futures market. Accounts clearly state that he lost money from the very beginning and that he used the 88888 account to hide all his losses from the Barings head management in London.

By the end of 1992, the 88888 account already accounted for close to 2 million pounds losses, but, by 1995, the sum was already close to 827 million pounds. The amazing thing was that, while accumulating huge losses in the 88888 account, he was presenting to the bank's management a series of profits in arbitrage trading accounts, such as 92000 or 98008.

We all know the results of Leeson's speculations in the Far East. Barings, one of the oldest banks in the world, went into bankruptcy because of one man's misdoings and speculations.

Another cause for business failure which has often happened in the last years is related to inherent economic risks. Whether business risks, market risks or operational risks, companies are affected by such things as a rise in the price of petrol (which increases transport cost and, hereafter, the general cost of the product), a sudden decrease of the price of the product the company commercializes, etc. Mannesmann lost a large amount of money because of market risks and this was a cause of its later failure and acquisition by Vodafone.