Abstract
Background: Delay in cognition by management is likely to see a firm’s distress worsening and the turnaround potential of a firm eroded. This inertia and resistance to change are further likely to result in antecedents absent in the required cognition of distress to trigger turnaround actions. Aim: To explore firstly the Zone of Insolvency (ZOI), and the boundary of financial distress, secondly, agency theory, boards, directors and the ZOI and finally, how these constructs may influence cognition of distress and the firm turnaround boundary value. Setting: The sample studied was drawn from the population of all privately owned firms that had filed for Business Rescue in South Africa between 01 May 2011 and 30 June 2016. Methods: A quantitative research approach consistent with an objective position was utilised. The approach included descriptive statistical analysis and the measurement of strength of relationship between variables. Results: We identified two boundaries that exist as triggers in respect of the required turnaround action: firstly, the boundary of the zone of insolvency (ZOI), and secondly, the turnaround boundary that occurs at some time after the onset of distress and once management has recognised and accepted the distressed position. The period between the two boundaries is a period that may see the turnaround potential of the distressed firm further eroded even beyond the point of no return, making a turnaround impossible. Conclusion: Quantification of the difference in value of the firm between the onset of financial distress and evidence of direct action to turn around the distressed firm may be termed ‘the cost of cognition delay’. Understanding the cost of cognition delay contributes to practice and academic interests and for firms that rely on the legal protection of formal turnaround processes, it may be argued that the act of formal filing is a signal that cognition has occurred.
Highlights
Arresting decline and preventing financial distress of a firm are dependent on the crucial first step of management, recognising and admitting that the firm is distressed (Gopinath 1991)
Arguments put forward by Schulze, Lubatkin and Dino (2003) may provide two reasons as to why this does not happen. They suggest that based on agency theory, owners with a controlling interest define the value of the firm that they control in terms of personal utility, which may translate to their making choices in favour of their personal wealth and not necessarily in the interests of the firm (Schulze et al 2003)
The role performed by boards and directors is recognised as the principal mechanism for corporate governance (Cadbury 2000), and a key consideration during times of financial distress is the shifting fiduciary duty of the board (Ayotte et al 2013)
Summary
Arresting decline and preventing financial distress of a firm are dependent on the crucial first step of management, recognising and admitting that the firm is distressed (Gopinath 1991). Arguments put forward by Schulze, Lubatkin and Dino (2003) may provide two reasons as to why this does not happen They suggest that based on agency theory, owners with a controlling interest define the value of the firm that they control in terms of personal utility, which may translate to their making choices in favour of their personal wealth and not necessarily in the interests of the firm (Schulze et al 2003). They agree with the view that the equity owned by management and the board influences the board’s thinking and decisions (Morck, Shleifer & Vishny 1988; Schulze et al 2003). This inertia and resistance to change are further likely to result in antecedents absent in the required cognition of distress to trigger turnaround actions
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