Else_IBM-ABA_pRELIMS.qxd 8/23/2006 1:43 PM Page CORPORATE CRISIS AND RISK MANAGEMENT i Else_IBM-ABA_pRELIMS.qxd 8/23/2006 1:43 PM Page INTERNATIONAL BUSINESS AND MANAGEMENT Series Editor: Pervez N Ghauri Published: Managing Networks in Transition Economics Johanson Development in Work and Organizational Psychology Jackson & Shams Network Dynamics in International Marketing Naude & Turnbull Corporation and Institutional Transparency for Economic Growth in Europe Oxelheim The Global Challenge for Multinational Enterprises Buckley & Ghauri Managing Customer Relationships on the Internet Lindstrand, Johanson & Sharma Business Network Learning Hakansson & Johanson Managing International Business Ventures in China Li The Common Glue Morosini Non-Business Actors in a Business Network Hadjikhani & Thilenius Other titles of interest: International Trade in the 21st Century Fatemi European Union and the Race for Foreign Direct Investment in Europe Oxelheim & Ghauri Globalization, Trade and Foreign Direct Investment Dunning Strategic Alliances in Eastern and Central Europe Hyder & Abraha International Trade and the New Economic Order Moncarz Intellectual Property and Doing Business in China Yang Contemporary Issues in Commercial Policy Kreinin Co-operative Strategies and Alliances Contractor & Lorange Related journals — sample copies available on request: Relationships and Networks in International Markets Gemünden, Ritter & Walter European Management Journal International Business Review International Journal of Research in Marketing Long Range Planning Scandinavian Journal of Management International Business Negotiations Ghauri & Usunier Critical Perspectives on Internationalisation Havila, Forsgren & Håkansson For full details of all IBM titles published under the Elsevier imprint please go to: http://www.elsevier.com/locate/series/ibm Managing Cultural Differences Morosini ii Else_IBM-ABA_pRELIMS.qxd 8/23/2006 1:43 PM Page INTERNATIONAL BUSINESS AND MANAGEMENT VOLUME 21 CORPORATE CRISIS AND RISK MANAGEMENT: MODELLING, STRATEGIES AND SME APPLICATION BY M ABA-BULGU Centre for Strategic Economic Studies, Victoria University, Melbourne, Australia SARDAR M N ISLAM Centre for Strategic Economic Studies, Victoria University, Melbourne, Australia Series Editor: Pervez N Ghauri Amsterdam ● Boston ● Heidelberg ● London ● New York ● Oxford Paris ● San Diego ● San Francisco ● Singapore ● Sydney ● Tokyo iii Else_IBM-ABA_pRELIMS.qxd 8/23/2006 1:43 PM Page Elsevier The Boulevard, Langford Lane, Kidlington, Oxford OX5 1GB, UK Radarweg 29, PO Box 211, 1000 AE Amsterdam, The Netherlands First edition 2007 Copyright © 2007 Elsevier Ltd All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone (+44) (0) 1865 843830; fax (+44) (0) 1865 853333; email: permissions@elsevier.com Alternatively you can submit your request online by visiting the Elsevier web site at http://elsevier.com/locate/permissions, and selecting Obtaining permission to use Elsevier material Notice No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions or ideas contained in the material herein Because of rapid advances in the medical sciences, in particular, independent verification of diagnoses and drug dosages should be made British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record for this book is available from the Library of Congress ISBN-13: 978-0-08-045102-2 ISBN-10: 0-08-045102-0 For information on all Elsevier publications visit our website at books.elsevier.com Printed and bound in The Netherlands 07 08 09 10 11 10 iv Else_IBM-ABA_pREFACE.qxd 8/2/2006 12:51 PM Page v Preface, Abstract and Acknowledgement The small- and medium-sized enterprises (SMEs) sector plays a significant economic and social role in Australia A large number of these businesses suffer from abrupt financial crises resulting from man-made or natural disasters such as fire, flood, storm, etc, which affect all business sectors in the Australian economy Abrupt financial crises involve a partial or full destruction of productive assets, and manifest themselves in the form of deterioration in cash flows, loss of market share, loss of key personnel and, in extreme cases, a collapse of business organisation built over several years on the back of hard work and lifetime savings There are numerous theoretical and empirical models that have been applied in relation to corporate crisis management with great emphasis on smouldering crises, large companies and strategic crisis management principles and practices Application of these models and techniques to SMEs in Australia in the event of abrupt financial crises is problematic and less effective due to the elements, design and approach of these models The approach employed in this book is developed using a new theoretical framework based on the elements of (i) financial management theories and policies such as risk management, financial engineering, portfolio theory, CAPM, capital budgeting and optimal capital structure; (ii) accounting theories and practices including corporate financial distress and financial ratio analyses; and (iii) corporate management theories and principles with major emphasis on corporate governance, marketing management, business ethics and stakeholders analysis The book also applies systems approach to crisis management at two levels, i.e organisational level and financial crisis management level A corporate planning format involving targets, instruments and policies is adopted Qualitative and quantitative data were collected from 12 SMEs in Australia that experienced business interruptions as a direct result of damage to their physical assets, in order to identify the key activities performed during this period and to establish the best financial crisis management processes to be followed The case studies and analyses of the data based on the new approach developed in this research show that these businesses passed through different crisis phases and v Else_IBM-ABA_pREFACE.qxd vi 8/2/2006 12:51 PM Page vi Preface, Abstract and Acknowledgement required the application of different financial and managerial instruments including cash flows optimisation model, optimal post-loss investment model, EOQ, optimal capital structure, project management techniques, business impact analysis (“BIA”), target-orientated advertising and promotion, and appropriate communication policies with internal and external stakeholders The findings indicate that an integrated approach is required to effectively manage crisis and return SMEs to their normal trading position at a minimum cost and within the shortest possible time The various financial and other models applied in this book are found to be valid and plausible in that they adopt an integrated and comprehensive approach to financial activities of SMEs in crisis mode, can be applied consistently under different scenarios and to data extracted from different entities, and produce results that are consistent with the findings of other studies, the underlying theories and principles In general, the models are appropriate for application by SMEs in the event of a financial crisis resulting from a disastrous situation The designs used to formulate the optimisation problems in Microsoft Excel appeal to small businesses, as they not appear to be overly complicated nor too difficult to understand As a result, the approach developed in this book is robust and superior in its design, application and outcome This book has also extended the existing financial and business management theories and models of SMEs (which are well documented in Schaper et al., 2004 and Holmes et al., 2003) by providing an integrated approach to crisis management of SMEs using optimisation models This study therefore offers some significant contributions in making a systematic study of financial activities of small- and medium-sized business organisations in financial crises mode by developing and adopting a new framework, by identifying, modifying and applying various financial management tools and techniques suitable to SMEs, and by adopting systems approach both at organisational and crisis management levels The development and application of this new approach to an abrupt financial crisis management is particularly important due to the frequency and severity of man-made or natural disasters in Australia and its potential application to SMEs in other economies beyond our border The authors thank Ms Margarita Kumnick and Mr Kashif Rashid for their editorial and research assistance throughout the preparation of this book M Aba-Bulgu and Sardar M N Islam Else_IBM-ABA_foreword.qxd 8/19/2006 4:27 PM Page vii Foreword Book entitled Corporate Crisis and Risk Management: Issues, Mathematical Modelling, Strategies, and Small and Medium Size Enterprise Applications by M Aba-Bulgu and Sardar M N Islam There are only a limited number of research-based books dealing with such an important topic as crisis management This is one of those books Its strength is derived from the theoretical underpinnings and support from empirical academic research findings Furthermore, the authors expand their critical reasoning into key managerial implications stemming from research work There are also a number of challenging topics such as “customer focused recovery” The authors are also concerned with regard to the issue of validation and plausibility of the existing models The underlying research contributions behind the text clearly “shape” its content and effectiveness The case studies provide the “raw data” as the authors develop an interesting comparative framework The key “tripod” for the analytical content of this book is clearly – Corporate Crisis, Risk Management and Optimisation Modeling ! quite a challenging and terrific intellectual “combinatorial explosion” ! Professor Luiz Moutinho School of Business and Management University of Glasgow vii This page intentionally left blank Else_IBM-ABA_cONTENTS.qxd 8/28/2006 4:52 PM Page ix Contents Preface, Abstract and Acknowledgement v Foreword vii List of Tables xv List of Figures xvii List of Appendices xix Introduction 1.1 Background 1.1.1 SMEs in Australia 1.1.2 Disasters and Business Disruptions in Australia 1.2 Modelling Crisis Management 1.3 Limitations of Current Literature and Motivation of the Research 1.4 Aims of the Research 1.4.1 General Aims 1.4.2 Specific Aims 1.5 Significance of the Study 1.6 Methodology of the Research 1.7 Structure of the Research 1 8 9 10 11 Planning for Crisis and Risk Management: A New Approach 2.1 Introduction 2.2 The Basic Concepts 2.2.1 The Concept of Crisis 2.2.2 The Nature of Financial Crisis 2.2.3 The Nature of Risk Analysis 2.3 Literature Review 2.3.1 Existing Literature 2.3.2 Limitations of Existing Literature 13 13 13 13 16 19 21 21 26 ix Else_IBM-ABA_rEF.qxd 344 8/8/2006 6:24 PM Page 344 References Frame, J D (2003) Managing risk in organisations: A guide for managers San Francisco: Jossey-Bass Freeman, R E (2000) Business ethics at the millennium Business Ethics Quarterly, 10(1), 169 Gallanis, M A (2003) Cash forecasting: Examining the ups and downs AFP Exchange, 23(2), 14–18 Gaujers, R., Harper, J., & Browne, J (1999) Guide to managing a successful small business in Australia Sydney: McGraw-Hill Gaujers, R., Harper, J., & Browne, J (2001) Smart marketing for small business: How to identify your target market and reach it successfully Roseville: McGraw-Hill Gay, G D., & Nam, J (1998) The underinvestment problem and corporate derivatives use Financial Management, 27(4), 53–69 Gebhardt, K (2000) Easing coverage conflict Best’s Review, 101(7), 102 Geczy, J., Minton, B A., & Schrand, C (1997) Why firms use currency derivatives Journal of Finance, 52, 1323–1356 Geeraerts, G (1984) The effects of ownership on the organisation structure in small firms Administrative Science Quarterly, 29(2), 232–237 Gellinas Jr., U J., Oram, A E., & Wiggins, W P (1990) Accounting information systems Boston: PWS-Kent Publishing Company Gentry, J A., Newbold, P., & Whitford, D T (1985) Predicting bankruptcy: If cashflow’s not the bottom line, what is? 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212, 220 Average rate of return, 46, 146, 147 Behavioural, 220 Business activity statement, 191 continuity planning, 23, 53, 102, 181, 185, 211 ethics, 27–29, 37, 53, 57–58, 202, 209, 217 impact analysis, 53, 181, 184 structure, 98–99 disruption, 3–4, 11, 216, 222 Capital budgeting, 6, 27–28, 37, 39, 46–48, 61, 73, 145–146, 148, 180, 212 cost of, 8, 17, 50 market, 20 structure, 6, 27–28, 30, 39, 50–51, 75, 177, 179–180, 211, 213 Capital Asset Pricing Model (CAPM), 5, 41 Cash flow, 4, 6, 8–10, 12, 17, 21, 25, 27, 30–31, 37, 40–42, 46–49, 60–63, 67, 69, 71–72, 79, 97, 101, 109–123, 126–143, 147, 150–153, 155, 160–162, 166, 168–178, 180–181, 187, 191–192, 204, 207, 211–213, 215–216, 223 gap, 141–143 management, 9, 19, 25, 43–44, 49, 61–62, 112–115, 118, 137, 139, 142, 212, 219 optimisation, 9, 28, 49, 61, 72, 75, 109, 118, 120–121, 126, 129, 135, 142, 219, 222 reserve, 216 Code of Federal Regulations, 23 Constraints, 44, 120–124, 126–128, 135–136, 139, 142, 153, 156 Corporate crisis, 41, 75 failure, 5, 7, 19, 25–26, 29, 51–52, 56 355 Else_IBM-ABA_index.qxd 356 9/5/2006 2:34 PM Page 356 Subject Index governance, 11, 24, 27–30, 37, 53, 56–57, 60, 63, 67, 75, 185, 202, 205, 209, 211, 213 Corporation law, 65, 75, 118, 139, 206 Crisis abrupt, 5–7, 16, 113, 213, 216–217 control, 27, 53–54, 181–182 cumulative, 14, 16 management, 1, 5–15, 17, 19, 21–41, 46, 49, 53–55, 57–62, 68, 72–75, 98–99, 106–109, 118–119, 145–146, 160, 167, 174, 176, 179–182, 185–196, 199–205, 207–209, 211–224 prevention, 22, 25, 29, 40–41, 54 Critical path method, 192 CRT, 30, 75, 213 D Curve, 33, 222 Debt finance, 50, 179 Depreciation, 48, 114–115, 133, 174 Derivative, 41, 59, 110, 113, 121, 203 Descriptive models, 111 Discounted Cash Flow (DCF), 17, 47, 147, 151 Disposal cost, 27, 39, 48–49, 145, 172, 175, 180 Early Warning, 7, 11, 16, 25–26, 52, 181, 186 EBIT, 51–52, 70, 115, 179 Equity generation, 45 Financial distress, 18, 21, 25, 27, 29, 37, 42, 50–51, 53, 179, 211 engineering, 26–28, 37, 39–40, 43–46 innovation, 43–45 modelling, 70, 72, 107, 110–111, 143 risk, 20, 21, 40, 42 Free cash flow, 115, 130–134, 136–138, 177, 180, 212 Gross margin, 115, 130–131, 133, 137, 163 H Curve, 33, 222 Holistic approach, 221 Insurance, 3–4, 6, 9–10, 21, 26, 28, 39–43, 51, 54, 62–63, 80, 82–83, 89, 102–103, 107, 114, 117–118, 134, 139, 142, 154, 156, 160–162, 164, 166–168, 171, 175–176, 178, 180–184, 186, 203–204, 208, 212, 214–216, 218–219 Insurable Risk, see Risk Intangible Assets, see Assets Interest expense, 131–132, 138–139, 143 Internal rate of return, 46, 146–147 Inventory, 71, 93, 141, 143, 157, 159, 165 Investment, 6–7, 9–10, 17, 19, 27, 30, 37, 39, 41–42, 44, 46–51, 60–62, 71–73, 75, 79, 118, 120–124, 126–129, 135–136, 145–157, 159–163, 165–167, 169–173, 175–181, 183, 190–192, 211–213, 217, 219, 222–223 Liability, 17, 42, 82, 114, 183, 206 Liquidity enhancement, 45 Marginal cost, 113 Marketing management, 27–29, 53, 59, 211 Else_IBM-ABA_index.qxd 9/5/2006 2:34 PM Page 357 Subject Index Maximise, 11, 42, 46–47, 57, 72, 109, 118–120, 122, 126, 135, 154, 212 N Curve, 32–33, 222 New3 welfare economics, 59 NPV, 46–48, 73, 146–148, 150–156, 160–161, 165–173, 176, 180, 212, 217 Objective function, 48, 120–122, 127 Optimisation model, 9–12, 27–28, 30, 37, 40, 46–47, 49, 71–72, 75, 98, 109–113, 118, 120–121, 126, 128–129, 135–137, 139–140, 142, 180, 211–213, 216, 219, 222–223 Option, 5, 24, 40–43, 45, 48, 61–62, 114, 121, 129, 173, 177, 217 Organisational system, 55, 57, 189 Outsourced, 84, 91, 195 Payback period, 46, 147 Payroll, 114–115, 117, 131, 133–134, 138, 191 PERT, 24–25, 30, 57, 71, 75, 86, 96, 167, 170–171, 177, 183, 185, 191–194, 201, 206, 213 Physical Assets, see Assets Planning, format, 8, 10, 29–30, 37, 212, 221 model, 1, 13, 29–30, 36, 40 Post loss investment decisions, 27, 39, 46–48, 71, 73, 145, 147–149, 151, 153–155, 157, 159, 161, 163, 165, 167, 169, 171, 173, 175–177, 179, 181 Predictive model, 71, 111 Prescriptive models, 71, 111 357 Pricing strategy, 197 Product strategy, 197 Profitability, 14, 30, 50, 64, 83, 98, 146–147, 187, 192, 197, 213 Projection, 101, 115–118, 120, 129–139, 142, 177, 180, 212 Promotion, 34, 59–60, 62, 75, 83–85, 90, 106, 146, 188, 191, 193, 196, 198–200, 208 Ratio analysis, 5, 10, 25, 61, 187 Real options, 174 Receipts, 45, 120–122, 125, 127, 135, 138 Risk, 9–10, 13, 19–23, 25–28, 30, 37, 39–47, 49–50, 54, 61–62, 66, 72, 91, 99, 102–103, 107, 111, 114, 118–119, 136, 145, 149, 156, 165–166, 176, 178, 180–184, 189, 204–205, 211, 215–216, 218, 223 Insurable, 19, 41–42 management, 9, 19, 26–28, 37, 39–44, 61–62, 66, 99, 102–103, 107, 145, 149, 156, 165, 176, 182–184, 205, 211, 215, 218, 223 operational, 19, 40 pure, 19, 41 transfer, 42, 45, 183 S Curve, 31–33, 222 Sales analysis, 130, 132, 136, 162 Salvage, 24, 27, 39, 48–49, 80, 98, 145, 172, 174–175, 180, 201 Scenarios, 23, 31, 46, 52, 55, 118, 136–137, 140, 142, 152, 165, 172, 192, 194, 219 Semi-deregulation, 83 Sensitivity analysis, 118, 139–140, 157, 171 Else_IBM-ABA_index.qxd 358 9/5/2006 2:34 PM Page 358 Subject Index Simulation, 10, 11, 61, 71, 111, 136, 142 SMEs, 1–12, 24–26, 28–29, 33, 36–40, 43–44, 46–49, 55–57, 59–64, 66–68, 72–75, 77, 90, 99, 101, 107–109, 112–113, 116, 118–119, 129–133, 136, 138–143, 145, 146, 148, 156–157, 159–160, 169–184, 186–195, 197–199, 201–202, 204–205, 207–209, 211–212, 215–224 Source of finance, 178, 180, 215 Stakeholders, 1, 5–6, 9–10, 23, 27–30, 37, 53–54, 56–60, 62–63, 69, 183, 188, 202–205, 208–209, 213, 217, 224 Stakeholders Analysis, 27–30, 37, 53, 57–58, 60, 202–203, 209, 213 Stock, 15, 18, 20, 30, 43, 45, 58, 61, 68, 70, 78–80, 82, 85–86, 89, 92–93, 98, 102, 133, 156–160, 180, 183, 187, 202, 213 Structural, 81, 93, 208, 220 Systems, 23, 35–36, 40, 52, 54–55, 60, 73–75, 81, 101–102, 181, 184, 186–187, 208 approach, 8, 10, 29, 35–37, 74, 189, 212, 221 Tangible assets, 9, 12, 30–34, 37, 146, 160, 164, 188, 193, 196, 200–201, 208, 212, 220 Third party insurance, 102 Thompson, 61, 77, 119, 194, 197, 212, 225 Tobin’s q, 145, 176 Trajectory, 52–53, 187, 208 Types of finance, 177–178 Underinvestment, 42, 154, 183 Underinsurance, 162, 168, 216 V Curve, 33–34, 222 Variables, 19, 25, 27, 30, 46, 49, 54, 68–73, 75, 98, 101, 111, 115, 120–123, 137, 151–155, 161, 166, 168–170, 182, 187, 193, 208, 213, 221 Warning system, 26, 40, 52, 181, 186–187 Working Capital, 48, 51, 61–62, 70, 137, 141 Z scores, 51–52