Academic journal article Journal of Business and Entrepreneurship

Economic Factors: Examining Why Small Businesses Fail

Academic journal article Journal of Business and Entrepreneurship

Economic Factors: Examining Why Small Businesses Fail

Article excerpt

ABSTRACT

It has been typical in much of the business literature to assume that business failures are problems stemming from managerial failures, especially where the manager is an entrepreneur. Failures are treated as resulting from managerial shortcomings such as poor planning, being too much a "one-person show " and the like. In this research, we take a somewhat different approach and examine a group of "outside" factors which can 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. Our findings suggest that many business ventures end in failure because of "outside" economic factors rather than problems specific to the manager.

INTRODUCTION

It has been typical in much of the business literature to treat business failure as a problem stemming from the manager and the manager's characteristics, especially where the manager is an entrepreneur. What are business failures and what causes them? These issues are central to this research. How are we to define business failures? Dun and Bradstreet (1998) (which is considered the primary source of data on the business failure rate) defines business failures as those businesses that ceased operation following assignment or bankruptcy. Similarly, Archibald and Baker (1988) define business failures as "firms that cease to exist and leave unpaid debts" (p. 221). Lane & Schary (1991) report that "business failures are either the exit of businesses involved in court proceedings or the exit of business by voluntary actions involving losses to creditors" (p. 95).

Failures are said to result from managerial shortcomings such as poor planning, especially in such areas as determining how much start-up capital is needed. Entrepreneurs are accused of being too much a "one-person show," creative, and individualistic, but lacking in day-to-day managerial skills. In terms of personality, when compared to traditional managers, entrepreneurs are said to be far more oriented toward independence, achievement of long term goals, and direct involvement rather than delegation. Moreover, they appear to be more risk seeking and more able to accept failure (Hisrich, 1990; Port, 1997). Stevenson and Gumpert (1985) point out that managers and entrepreneurs ask different strategic questions, with entrepreneurs seeking out opportunities and resources, looking for ways to control resources, and developing structures, while managers emphasize working within the system.

Generally, the literature has regarded these differences as a sort of "good news - bad news" scenario, with the good news being that the entrepreneurial characteristics propel the prospective entrepreneur into action, but the bad news being that those same characteristics may lead to the poor managerial performance which results in failure. And, indeed, a prospective entrepreneur faces daunting odds - the typical new business ends in failure (Lane & Schary, 1991). Furthermore, among those businesses that survive the critical startup period, about 42 percent cease to exist after five years. (Friedman, 1997). Thus, we have recently seen the evolution of a robust advice and analytical industry devoted to defining and describing the characteristics and expertise required of small businesses (Gerber, 1998,1999).

Note, however, that the above discussion has, in effect, taken for granted that the entrepreneur's characteristics bring about failure. But is this the case? Even if bureaucratic managers and entrepreneurs do, in fact, differ, those differences may have little to do with business failure if forces outside the organization are driving the failures. …

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