Academic journal article Entrepreneurial Executive

Rate of Business Failures: An Analysis of the Determinants

Academic journal article Entrepreneurial Executive

Rate of Business Failures: An Analysis of the Determinants

Article excerpt

ABSTRACT

The prospect of business failure is of significant concern to the entrepreneur as a number of findings suggest that many new businesses end in failure. While there has been speculation about how and which factors are related to business failure, little systematic work has been done to tease apart the various factors which potentially impact business failure. Based on annual data compiled from 1959 to 1996, we use regression analysis to relate business failures to the unemployment rate of experienced wage and salary workers, the gross domestic product, the Federal funds interest rate, and the ratio of profits after Federal income taxes to stockholders' equity for all manufacturing corporations. Moreover, we examine the long-run, as well as the short-run, impact of the determinants of business failures and suggest that many business ventures end in failure because of "outside" economic factors rather than problems specific to the manager.

INTRODUCTION

Business failure has long been recognized as among the most serious issues confronting small business. A prospective entrepreneur faces daunting odds--the typical new business ends in failure (Lane & Schary, 1991). In fact, widespread discussion recently has evolved into a robust advice and analytical industry devoted to defining and describing the characteristics and expertise required of small businesses. Specifically, entrepreneurs are advised to undertake prescribed procedures to decrease the likelihood of failure (Gerber, 1998; 1999).

Why do so many small business failures occur and what can be done to prevent them? Indeed, can business failures be prevented? Much of the discussion in the entrepreneurship literature focuses upon the individual entrepreneur and factors such as managerial inexperience, poor planning, inadequate cash reserves, and the like (see Dun & Bradstreet, April 21, 1999; U.S. Small Business Administration, 1998). To the extent that such factors are the primary determinant of business failure, better preparation of the prospective entrepreneur could do a great deal to prevent these closings (Lussier, 1996). Supporting this argument are situations where an increase in business failures follows from an increase in the number of new firm start-ups. For example, the rate of business failures increased dramatically in the mid-1980s, a time which marks the longest continuous expansion in the United States' economy since World War II and a period of exceptionally heavy new business expansion.

However, there is an equally compelling argument that business failures may result from economic factors which are operating at much more macro levels and which may be completely out of the hands of the entrepreneur. The general public, and many entrepreneurs as well, have come to associate the rate of business failures with the overall strength of our economy. Stemming from experiences such as the heavy rate of failures accompanying the Great Depression, there has been a widespread belief that an increase in business failures is indicative of a weakness in the economy. If this is the case, the connection between business failures and recessions is probably causal, with a poor economy causing failures, for example, and increasing failures fueling further economic problems. Where economic factors are primary contributors, the entrepreneur may have much less control of the issues leading to failure.

In this study, we look specifically at economic factors and attempt to determine how closely they relate to business failure. Specifically, we develop regression models which use economic factors to explain the rate of business failure. To the extent that economic factors account for a large proportion of the variance in the failure rate, we maintain that it is these factors, and not primarily managerial factors, which account for the high rate of small business failure. We next consider how the literature has considered these factors. …

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