Recovering and Restructuring of Sick Economies - Are Business Restructuring and Management Models and Experts Relevant?

 


When business managers take over high profile posts in the government, they always refer to the application of management principles for reforming or restructuring of the government institutions or affairs in models popularly practiced by business management experts/consultants for restructuring and resolution of bankrupt business corporates. 

Such experts generally consist of a team of accountants, auditors, HR specialists, investment bankers and lawyers. They normally undertake a due diligence study on ailing companies and implement a cut-and-paste report with new numbers for restructuring of the companies to make them profitable and show their balance sheets healthy in terms of leading accounting ratios. Therefore, the company restructuring is necessarily a numbers-based exercise.

Corporate/Strategic Planning

Further, a report called “Strategic Plan” or “Corporate Plan” is also prepared to reorganize the business and operational lines including finance/budgetary operations to facilitate the restructuring exercise. Statements of vision, mission, values/principles, objectives, goals/targets, leadership, team spirit, job descriptions and deliverables, budgeting, performance evaluation, performance-based incentives, etc., are key ingredients in such strategic plans.

These reports are full of visionary words and colorful diagrams. In some cases, staff retreats at star resorts are conducted for days to gather information in tabular forms and numbers for the compilation of corporate plans. Providing information required for the plan as requested by the planning expert will be a rush exercise to relevant line managers and staff members. In the end, only few will read and understand what are in the plan and the plan invariably ends up in the cabinets of the HR Manager and Finance Manager.

Company Restructuring Models

The core of the restructuring plan/model in terms of due diligence study is the financial reform on the company’s income statement and balance sheet as prescribed by accountants/auditors to revive the company. Fundamental problems detected by management experts in ailing business accompanies are bad or non-performing assets, excessive leverage, costly debt profile, high operating cost, losses or poor earnings and negative capital/net worth. 

Such companies are known as zombie companies that live on costly debt and confront the risk of bankruptcy at any movement if debt rollovers become difficult. Therefore, restructuring or problem resolution plans invariably include balance sheet restructuring to boost profitability, reduce debt and augment net worth. Examples for typical restructuring actions are highlighted below. 

  • Removing bad assets from the balance sheet by selling them at discounts to external parties or transferring them to an Asset Management Companies (AMC) at a market value to resolve them and provide a future cash flow to the restructuring company. This will help write back financial provisions made in the past as risk cover for such bad assets into the income statement and reduce present loss and provisioning. Therefore, this is an exercise to create a cash inflow from non-earning assets and improve income capacity and quality of assets in the balance sheet.
  • In some cases, loss-making or unproductive business lines also will be sold to earn some income while reducing future operational costs.
  • Prime assets such as land and buildings will be revalued and such revaluation reserves will boost the asset value and capital of the company.
  • Costly long-term debt will be converted to company shares at nominal values. Accordingly, cash outflow on the repayment of such debt and interest will disappear and improve the income statement. The increase in share volume will boost the capital base or net worth and make the bankrupt company viable. Through this, creditors/lenders will avoid a default and have the opportunity to recover their funds by selling new shares in the market when the restructured company becomes profitable in the near future.
  • High-cost short-term debt will be converted to long-term debentures at a low or floating interest rate so that debt burden will be reprofiled and eased.
  • A cost reduction/rationalization program including voluntary retirement schemes for old employees will be implemented to improve the profitability of the company.
  • Arrange new shareholders with controlling interest to infuse fresh capital if necessary to fill the capital shortfall.
  • A new board of directors will be appointed while an external management company will be hired to run the company and implement the restructuring plan. This is a key part of management restructuring of the company.
  • A rights share issue or a new public share issue of the restructured company will be made to infuse fresh capital for further business expansion.

Business Management Principles

Such restructuring plans are implemented on the basis of business management principles and literature to improve the profitability, asset quality, price and sustainability of companies in terms of targets set from numbers taken from the set of standard financial statements and accounting ratios. Boards of directors and CEOs are driven by a set of such numbers to assess the progress and strength of the company.

Asset growth, profit growth, return on assets, return on equity, cost-income ratio, liquidity ratio, leverage ratio, net asset value per share and market price of shares are some of them. Also, public announcements will be made periodically on the progress to drive share prices in the market. These are purely financial ratios that depend on numbers in financial statements prepared in terms of relevant accounting standards and principles. 

Creative accounting techniques adopted to boost the numbers by hiding true business and financial conditions of companies are well known in the literature of corporate governance and fair market regulation. Such accounting is behind almost all ailing and bankrupt companies reflecting the past mismanagement (principles and practices) that has taken place in various forms. A set of insider dealers also will boost share prices by creating speculations.

Recovery of Sick Economies - A Macroeconomic Exercise

Economies getting sick from time to time due to various demand-side and supply-side shocks has been seen throughout the past. A good example is the present pandemic-hit economies whereas some countries struggle on life oxygen with hospital/healthcare capacity being excessively stressed. Policymakers of some of these countries are trying to accelerate treatments with fiscal prescriptions with the hope of fast recovery. 

In this regard, services of business management experts also are obtained by appointing them to high-profile state posts under the impression that they can do wonders to speed up the recovery of the economy through the application of business management techniques. Therefore, such experts often tend to adopt accounting-based business revival models and principles for the economies too.

As a result, they tend to target the economic recovery in terms of selected numbers in the sovereign income statement and balance sheet as well as national income statement which are cited erroneously as macroeconomic fundamentals. These target numbers in developing countries invariably include real GDP growth, inflation, budget deficit-GDP ratio, public debt-GDP ratio, BOP current account deficit, exchange rate and official foreign exchange reserve. These numbers are fixed from the top of their heads in business type quick economic plans, similar to company restructuring numbers cited above.

However, restructuring of a sick economy, especially at the time of global pandemic recession caused by disruptions in global supply and demand chains,  is a long-term exercise primarily followed under macroeconomic principles, public trust principles and relevant statutory provisions including fundamental rights under the Constitution which may not be well understood by business management experts, given their profit-motivated, inward-looking exposures. This requires an intertemporal blend of socio-economic and environmental facets of countries in a global economy context.

To be continued.

(This article provides some thoughts of the author based on his hands-on experience in relevant subjects.)


P. Samarsiri
Former Deputy Governor, Central Bank of Sri Lanka

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