Corporate sickness

CORPORATE
SICKNESS
Maica Jimena Batiancela
BSBA Financial Management
Saint Louise de Marillac College of Sorsogon

Corporate sickness is of considerable significance today. In the U.K., U.S.A.
and other developed countries, there are a large number of companies
suffering from this. In India there are more than 1000 large and medium sized
units and more than hundred thousand small units, which are sick, with millions
of rupees provided by the financial institution / banks locked up in these units.
In India, the problem of sickness especially in large units is getting worse. The
number of new businesses falling sick seems to be growing exponentially
especially because of competition and the new technologies which have
entered into the market. Several of these units which had become sick, have
been safely nurtured back and are today doing extremely well while a few of
these units have deteriorated severely.

Several of these sick organizations have risen back from
their sickness and today are flourishing, while some of these
organizations have not been able to achieve their past
glory.
Strategic Management practices should lead the
organization in the ultimate analysis to a path of growth --
to be recognized as one of the top companies in India and
finally in the globe.

What is Sickness?
The Reserve Bank of India considers a unit sick if it has
incurred a cash loss for a year and is likely to incur a cash loss
in the current and coming years, along with a poor financial
structure, that is, current ratio less than 1:1, worsening debt-
equity ratio (Bidani & Mitra, 1981, p 26). The term lending
institutions consider a unit as sick if it has consecutively
defaulted on four half-yearly loans and interest
instalments, has made cash losses for two consecutive years or
has lost 50 per cent of its net worth, and has mounting arrears
of statutory and other liabilities (Bidani and Mitra, 1981, p 26).

What leads to sickness?
Most studies agree that sickness can be caused by a
wide variety of factors (Argenti, 1976). Broadly speaking,
sickness can be caused by factors internal to the
organization, such as inadequate management, wrong
technology, or a sub-optimal plant, and/or by factors
external to the organization, like increased competitive
pressure, recession, input shortages, changes in government
policies, or disturbed industrial relations.

External Vs. Internal Factors
Even in America, external factors—slumps, exchange rate
changes, credit squeezes, and inflation —were considered
responsible for only about 10 percent of corporate declines.
On the other hand, internal causes of decline, such as one
man rule, lack of management depth, succession
problems, inbred bureaucratic management, weak financial
control, an unbalanced top management, and a weak
board, accounted for about 70 per cent of declines. The
remaining 20 per cent declines were caused by a mix of
external and internal factors (Bibeault, 1982, Ch 5).

Concentration of Corporate Sickness
There is evidence that corporate sickness is
concentrated in some:
 Regions,
 Industries, and
 Sectors

1.Regional Concentration
A 1983 Reserve Bank of India survey indicated that
corporate sickness is in part a regional phenomenon. For
instance, West Bengal accounted for 23 per cent of the 463
large sick units and 19 per cent of the small sick units. Other
states with many large and small sick units were
Maharashtra* U P, Tamil Nadu, and Karnataka. The two
states of West Bengal and Maharashtra accounted for
about half the large sick units in the country.

2.Industry-Specific Concentration
Sickness may also be partly an industry phenomenon
(Dixit, 1984). For instance, up to 1982, just four industries—
textiles, rubber products, transport equipment, and metal
products accounted for 72 per cent of the assistance
sanctioned by the Industrial Reconstruction Corporation of
India, an institution devoted entirely to rehabilitating sick
units..

3.Sectoral Concentration
Sickness may in part be a sectoral phenomenon. A study
in the mid-seventies indicated that the profitability of large
private sector companies was generally far higher than that
of central public sector enterprises in the same industries (Sri
Ram et al, 1976). Also, while less than 15 per cent of large
private sector companies were sick, over 20 per cent of
central public sector units in any year were loss making.

Major Causes of Sickness
The major causes of corporate sickness are:
• Poor Quality of Top Management
• Poor Project Management
• Organizational Transition
• Bureaucratization

1.Poor Quality of Top Management
The poor quality of top management may show in one
of several forms: excessive conservatism, excessive
complacency, growth mania, poor financial
control, excessive centralization and authoritarianism, weak
board and a weak watchdog 'function, excessive
commitment to policies that worked well once but are no
longer appropriate, poor financial or marketing
management (Hegde, 1982).

2.Poor Project Management
Project cost escalation may be a significant promoter
of sickness in India (Bidani and Mitra, 1981, pp 59-60). In
many industries, project costs have doubled or tripled over
a decade. The problem is aggravated by cost overruns.
Thus, delays in commissioning projects may seriously inflate
costs and render a unit nonviable. Besides, cost per ton of
capacity can vary widely—by factors ranging from two to
four— depending on the size of the plant. Wrong choices of
plant size and technology can lead to sickness

3.Organizational Transition
Many declines tend to take place during organizational
transitions (Bibeault, 1982, p 18). Some 40 percent of the 81
turnaround cases studied by Bibeault were in transition during the
decline phase. For instance, once an entrepreneurial venture has
been established, the failure to induct a professional manager to set
up systems such as financial control and production planning may
lead to sickness; if a professional manager is hired, and the
organization grows, excessive centralization may lead to sickness. If
decentralization takes place, and a management control system is in
operation, the depersonalization that follows may cause
sickness, unless management infuses core values in the rank and file
that can act as a binding force.

4.Organizational Size and Bureaucratization
Organizational size often leads to
bureaucratization, which may be an important cause of
sickness. Large size implies growing reliance on rules and
regulations, hierarchy, and specialization of functions.
These, in turn, can lead to alienation of staff, distorted
communications, administrative rigidity, interdepartmental
conflicts, and sub-optimization, leading to sickness
(Blau, 1980; Crazier, 1964; Gouldner, 1954;
Khandwalla, 1977, Ch 13).

Lead Indicators of Corporate Sickness
What are the lead or predictive indicators of corporate sickness? An Indian study
has identified the lead indicators of sickness, applying discriminate analysis to
financial indicators over the 13-year period, 1962-74, to a sample of 40 cotton textile
companies (Gupta, 1983). Certain earnings ratios gave the best results. They were:
• earnings before interest, taxes, and depreciation to sales
• earnings after interest and taxes, but before depreciation, to gross assets.
The study also found that ratios related to net worth and liquidity were not as
reliable. Although balance sheet ratios were not as good a set of predictors as
profitability ratios, the two ratios that were found to be useable were:
• net worth to short- and long-term debt
• all outside liabilities to tangible assets.

Corporate sickness

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