Research Discussion Paper – RDP 2016-09 Why Do Companies Fail?

We explore the determinants of corporate failure in Australia using a large panel of public and private non-financial companies. A novel finding of our research is that corporate failure depends on ‘structural’ company-level characteristics. For instance, public companies are more likely to fail than comparable private companies; perhaps because the greater separation of ownership and control within public companies allows their managers to take greater risks.

Consistent with overseas research, we find that cyclical company-specific factors are important determinants of failure; a corporation is more likely to fail if it has low liquidity, low profitability or high leverage. Cyclical and structural company-level characteristics are the key determinants of the relative risk of a company failing, while aggregate (macroeconomic) conditions appear to be an important determinant of annual changes in the rate of corporate failure.

We quantify the potential contribution of corporate failure to financial stability risks using a ‘debt-at-risk’ framework. By our estimates, less than 1 per cent of aggregate corporate debt is currently at risk, with debt at risk concentrated in some very large companies. Our estimates suggest that trade credit (or business-to-business lending) is an important component of the relationship between corporate failure and financial stability.