CAUSES OF COMMERCIAL BANKRUPTCIES * / Sj.i-tVp- i-urti t&'f&JS&i E&mt.'&tjw mm - OftES* mmiTY of mm m 0 7 1977 Mw tmm U. S. DEPARTMENT OF COMMERCE BUREAU OF FOREIGN AND DOMESTIC COMMERCE y V U. S. DEPARTMENT OF COMMERCE ROY D. CHAPIN, Secretary BUREAU OF FOREIGN AND DOMESTIC COMMERCE FREDERICK M. FEIKER, Director CY OC Domestic Commerce Series—No. 69 CAUSES OF COMMERCIAL BANKRUPTCIES By VICTOR SADD and^ ROBERT T. WILLIAMS A Study Made in Cooperation with the Institute of Human Relations and the Law School of Yale University UNITED STATES GOVERNMENT PRINTING OFFICE WASHINGTON : 1932 For sale by the Superintendent of Documents, Washington, D. C. Price 10 cents CONTENTS 21 C: PO rr 1 Foreword_ Significant facts- Methods and purposes of this survey- ' — Definition and use of terms. Commercial failures in general. _ Extent_ Nature and characteristics. General underlying causes. Freedom of enterprise, ntensified competi¬ tion_ Business changes and improvements_ Ease of securing credit. Ease of discharging debts_ Business fluctuations. _ Consequences_ Suggested remedies_ Personal data relative to 570 commercial bankrupts_ Education_ Experience_ Age and sex_ <5 Page IV 1 2 3 4 4 5 5 5 6 6 7 7 8 8 10 10 10 10 11 Personal data relative to 570 commercial bankrupts—Con. Citizenship and birthplace. Illness and medical ex¬ penses_ Number of dependents_ Summary of personal data. Causes of 570 commercial bank¬ ruptcies_ Inefficient management_ Business depression_ Insufficient capital_ Bad-debt losses_ Competition_ Adverse domestic and per¬ sonal factors_ Dishonesty and fraud_ Decline in value of assets. _ Excessive overhead ex¬ penses_ Inefficient and dishonest employees_ Other causes_ Statistical material_ in Page 11 11 11 12 12 16 18 20 21 23 25 26 28 29 30 31 33 u G 926480 FOREWORD Individual and commercial failures are, in general, preventable, and their occurrence is both a reflection and a burden upon our eco¬ nomic system. Heretofore, little thought and effort have been directed toward the problem of eliminating the causes which give rise to failure. Few attempts have been made to secure the experiences of unsuccessful business venturers for the consideration and benefit of others faced with similar difficulties of conducting a business profit¬ ably. An analysis of the facts underlying commercial failures and the widespread dissemination of these facts will ultimately, it is believed, bring about a more general avoidance of ruinous methods and practices. If certain causes are known by fact to result in fail¬ ure, the business enterpriser and his creditors may take the necessary precautionary measures and so avert failure. This reports consists primarily of a critical analysis of the causes of bankruptcy. The relative importance of the various causes of failure is determined, and from this and other similar studies there may be evolved effective methods for reducing the number of failures. The danger signals and pitfalls to be avoided are disclosed for the benefit of creditors, debtors, and prospective business venturers. If the facts herein presented are given careful consideration, it is believed that the resulting benefits will be numerous and pervasive in their application. The information presented in this report was secured from a detailed analysis of 570 commercial bankruptcies. The valuable assistance and enthusiastic cooperation secured from many persons resulted in the accumulation of the necessary and relevant data which are presented herein. Limitation of space, however, prevents the acknowledgment of appropriate and deserving recognition to each individual contributing member included in the following groups: The bankrupts and their creditors, trustees, lawyers, trade associa¬ tions, representatives of Yale University, and many others. This survey was conducted in cooperation with the Institute of Human Relations and the Law School of Yale University. The interviewing of bankrupts and examination of court records was made possible through the courtesy and cooperation of the Hon. Arthur Black, Hon. B. Loring Young, and Hon. Charles C. Cabot, referees in bankruptcy. The plans for the survey were formulated and devel¬ oped by Prof. William O. Douglas, of Yale University, and Dr. W. C. Plummer, of the Department of Commerce. Frederick M. Feiker, Director , Bureau oj Foreign and Domestic Commerce. September, 1932. IV CAUSES OF COMMERCIAL BANKRUPTCIES SIGNIFICANT FACTS 1. The major causes of bankruptcy disclosed by the data analyzed in this study are inefficient management, unwise use and extension of credit, adverse domestic and personal factors, and dishonesty and fraud. 2. The lack of economic opportunity, ability, and other requisites for successful business operation prevented the majority of the bank¬ rupts from succeeding. Their failure was, therefore, a consequence of an unjustifiable entrance into business. 3. Indiscriminate and careless granting of credit to the bankrupts by incurious creditors enabled many to start and to continue a busi¬ ness in which failure was inevitable. Three hundred and fifty prin¬ cipal creditors admitted that they did not know the causes of failure in 249 of their debtor concerns. 4. Over 68 per cent of the owners or managers had not completed a high-school education. 5. Over 51 per cent of the bankrupt businesses had no accounting records. A consideration of all direct and related evidence revealed that the accounting records of an additional 28 per cent of the bank¬ rupt concerns were inadequate for the needs of the business. 6. The open-credit losses of the bankrupt establishments for the year prior to failure amounted to 5.6 per cent of open-credit sales, which is approximately nine times greater than the bad-debt losses of active concerns. 7. Prior to ownership of their concerns, nearly half of the bankrupts were engaged in occupations which did not provide any experience in the business they entered. 8. Only 5 per cent of the 564 bankrupts reporting on the subject used credit bureaus. 9. Approximately 53 per cent of the owners had difficulty in paying creditors from seven months to two years prior to their bankruptcy. 10. In 72 per cent of the cases the amount of capital invested by the owners and creditors in the bankrupt enterprises at the date of their organization amounted to only $5,000 or less. Included in this group are 124 concerns in which $500 or less was invested by the owner and his creditors at the date of organization. 11. Scheduled assets (including real estate) of the 570 bankrupt concerns amounted to slightly less than 18 per cent of scheduled lia¬ bilities (including collateral and real estate loans). In other words, if assets were sold at the value placed upon them in the bankruptcy petitions, and if there were no costs of administration, creditors would receive only 18 cents on the dollar for their claims. The exact amount realized from a bankruptcy sale is usually much less than the total value of the assets scheduled in the bankruptcy petition, and the 1 2 CAUSES OF COMMERCIAL BANKRUPTCIES costs of administration paid from the proceeds of the sale are usually sufficiently high to prevent the creditors from receiving more than insignificant amounts for their claims. 12. Failures of all types and losses have been increasing rapidly. Commercial failures (exclusive of banks) have increased, according to R. G. Dun & Co.’s figures, from 8,881 in 1920 to 28,285 in 1931, an increase of over 200 per cent. Liabilities in excess of assets (scheduled) have increased from $99,618,000 in 1920 to $301,369,000 in 1931, an increase of over 200 per cent. Bankruptcies (including noncommercial), according to the At¬ torney General’s reports, have increased from 15,622 in 1920 to 60,322 in 1931, an increase of almost 300 per cent. Losses to creditors have increased from $179,403,062 in 1920 to $941,033,610 in 1931, an increase of over 400 per cent. The total loss for the 12-year period was $7,223,727,656. The average amount received by creditors for this period was 8.43 cents on the dollar. 13. A large proportion of commercial failures can be prevented by (1) maintenance of proper accounting records and efficient operation of a business by its owner, (2) selective and wise credit extension by creditors, and (3) enforcement of penalties for dishonest and fraudu¬ lent acts. METHODS AND PURPOSES OF THIS SURVEY The individual case method of study employed in determining the causes of failure made possible the collection of much pertinent and valuable information. The factual data were secured from several sources by representatives of the Department of Commerce and of Yale University. Directly after the conclusion of the first meeting of creditors, held in the bankruptcy court, the bankrupt was inter¬ viewed in an adjoining room and gave answers to many questions relating to his affairs and the events leading up to his bankruptcy; in cases where it was not possible to interview the bankrupt at this meeting, the questioning took place at the examination of the bank¬ rupt by the trustee. Creditors were interviewed or written to for information concerning a particular debtor and his activities, and their opinions and statements disclosed facts that would otherwise have been impossible to secure. Other sources of information utilized included court records and the files of credit associations, banks, and attorneys. The constant check of information from one source against another assures the accuracy of the results. The only cases included in this report originated and were settled in the bankruptcy court. In each case creditors suffered a loss on their claims. The jurisdiction of the bankruptcy courts from which the cases were secured extends over the counties of Middlesex, Norfolk, and Suffolk in Massachusetts, which includes the metropolitan area of Boston and surrounding towns. The area covered by these counties is estimated to have a population slightly in excess of 2,000,000 people. The cases studied reveal, therefore, the causes of bankruptcy among many different kinds of commercial enterprises. The period covered was from November, 1930, to June, 1931, CAUSES OF COMMERCIAL BANKRUPTCIES 3 One of the major purposes of this report is to determine the relative importance of the principal causes of failure which affect commercial enterprises. An unbiased study of many failures and the reasons for their occurrence provides facts which necessarily must be considered before preventive and remedial measures can be formulated. Another purpose of this report is to stimulate efforts directed toward needed improvement in credit practices. From the accumulated experiences, herein presented, of the many who entered business without sufficient training, ability, or other requisites, and later failed, may be deduced a realization of the urgent need for greater efficiency in credit exten¬ sion. The significant and disastrous consequences of unqualified entrance into business and unjustifiable credit extension discussed herein can no longer be ignored or disregarded. The mistakes made by others are set forth as danger signals and definite warnings for creditors and owners of existing concerns. To heed them and to take proper precautions may forestall failure. DEFINITIONS AND USE OF TERMS Most of the terms used in this report conform to general interpreta¬ tion and usage. The following terms are briefly defined and their usage explained to prevent any doubt as to the meaning attached to them in this report. Commercial failure. —A suspension of business operation by a cor¬ poration, partnership, or individual engaged in commercial activities which involves a loss to creditors. Bankrupt.- —The state of being insolvent as defined in the bank¬ ruptcy act. The only cases included in this report were commercial failures that were adjudged bankrupt and settled in a bankruptcy court. Inefficient management —The unprofitable and unsuccessful conduct of a business, due to lack of training, experience, ability, adaptation, or enterprise of its managers. Insufficient capital. —Lack of funds with which to pay operating costs and credit obligations as they accrue. Business depression. —The period in the business cycle characterized by a maladjustment between production and consumption, unem¬ ployment, decline in sales, decline in prices, and other disturbing economic factors. Bad-debt losses .•—Unpaid accounts or notes receivable considered uncollectable. Competition. —Rivalry in buying and selling of commodities or services. Adverse domestic and personal factors.- —Family or individual characteristics or troubles that were detrimental to the business; such as bad health, expensive family, excessive medical expenses, poor personality, gambling and drinking habits, laziness, and extravagance. Decline in value of assets. —Shrinkage in value of inventories, real estate, investments, and other assets. Excessive overhead expenses. —Overhead costs which were larger than warranted by the volume of sales. 4 CAUSES OF COMMERCIAL BANKRUPTCIES COMMERCIAL FAILURES IN GENERAL EXTENT Available statistics on commercial failures include only those enter¬ prises whose voluntary or involuntary withdrawals from business result in a loss to creditors, and whose property and affairs are settled through bankruptcy, composition, receiverships, or assignment pro¬ ceedings. Frequently the owner of a small establishment simply closes up and disappears without notifying his creditors, who divide up the remaining assets, if any, without the assistance of an outside agency. In such cases the discontinued business is not recorded in the failure lists. Furthermore, concerns that discontinue business with a loss to owners but not to creditors are not included in the statistics of commercial failures. If it were possible to secure the number of all commercial failures, the net result would be startling and would further reflect the need for improved methods in credit administration. The present record of commercial failures which shows that 28,000 occurred in one year is sufficiently alarming, however, to merit the serious consideration and appropriate action of all persons interested and influential in stabilizing business units, either individually or collectively. The reader will observe in the following table that the number of commercial insolvencies has increased steadily during the past decade, and at a greater rate than the increase in number of concerns in business. Commercial Failures in the United States Year Number of failures Number of business concerns Per cent of failures 1920_ 8,881 1,821, 409 0. 49 1921_ 19, 652 1, 927, 304 1. 02 1922_ 23, 676 1, 983,106 1.19 1923_ 18, 718 1, 996, 004 .94 1924_ 20, 615 2, 047, 302 1. 01 1925_ 21,214 2,113, 300 1. 05 Year Number of failures Number of business concerns Per cent of failures 1926_ 21, 773 2,158, 400 1.01 1927_ 23.146 2,171, 700 1. 07 1928_ 23. 842 2,199, 000 1. 08 1929_ 22, 909 i 2, 212, 779 1. 04 1930_ 26, 355 2,183, 008 1. 21 1931_ 28,285 2,125, 288 1. 33 Source: Dun’s Review. i The difference between this figure and the census total quoted later is due to (1) different methods of enumerating and (2) different definitions of what constitutes a business. The figures included in the following table were taken from the Attorney General’s annual reports and include all types of bank¬ ruptcies in the United States—wage earners, professional people, farmers, merchants, manufacturers, and other classes. The table definitely shows the extent of increase in bankruptcies for the past 12 years. The number of bankruptcies in 1931 exceeded those of 1920 by 44,700, and liabilities for 1931 exceeded those of 1920 by $807,027,613. The recorded loss to creditors through bankruptcy alone amounted to approximately seven and a quarter billion dollars ($7,223,727,656) during this 12-year period. The average amount received by creditors on their claims amounted to slightly less than 8 % cents on the dollar during the same period. In the year 1931 there were 38,507 no-asset cases. CAUSES OF COMMERCIAL BANKRUPTCIES 5 Number of Bankruptcies, Amount of Assets, Liabilities, and Payments to Creditors, United States, 1920-1931 - Year ending June 30— Number of cases Total assets realized Total liabilities Total paid to creditors of all classes Per cent of lia¬ bilities paid 1920_ 15,622 15, 200 $29, 598, 593 27, 278, 199 37, 899, 609 61,861, 449 71, 587, 136 85, 348, 873 93, 017, 550 96, 558, 929 90, 540, 062 88, 964, 116 106, 245, 487 89, 535, 070 $201, 626, 264 $22, 223, 202 11.02 1921.__ 171, 284, 367 22, 511, 406 13.14 1922_ 22,517 34,401 41, 649 255, 613, 895 486, 400, 908 663, 644, 791 747, 522, 847 806, 312, 992 885, 557, 335 830, 778, 611 883, 605, 665 948, 257, 731 29', 433', 987 47, 998, 037 54, 523, 254 63, 528, 049 70, 764, 864 72, 094, 328 66, 693, 405 66, 323, 364 81, 827, 464 67, 620, 267 11.51 1923_ 9. 86 1924__ 8. 21 1925__ 44, 440 47, 307 8. 49 1926__ 8. 77 1927_ 48, 269 53, 592 57, 039 60, 548 60, 322 8.14 1928_ 8. 02 1929_ 7.51 1930__ 8. 62 1931_ 1, 008, 653, 877 6. 70 Total._... __ 500, 906 890, 729, 936 7, 889, 269, 283 665, 541, 627 8. 43 NATURE AND CHARACTERISTICS Approximately 70 per cent of all commercial failures occur in the retail-trade group, according to one mercantile agency which records business failure statistics. 1 Manufacturers, wholesalers, and other traders form only a small portion of the total number. Over half of all retail failures take .place among food, clothing, and furniture stores. An elimination of the evils existing in retailing would ma¬ terially reduce the tremendous losses which arise as a consequence of failure. Huge savings and widespread benefits should result from a stabilization of all retail units, particularly among those where the risks appear to be most hazardous and the susceptibility to failure consequently greater. In areas and in trades where concentrated studies and efforts have been made to determine and eliminate causes of failure, results have been most encouraging. Bankruptcies have decreased, and profits to the surviving have increased beyond expec¬ tations. The vast majority of failed concerns are small enterprises employing relatively little capital, and though listed by mercantile agencies, are given moderate or no credit rating. At least 95 per cent of all commercial failures have very moderate or no credit ratings prior to insolvency. One authority 1 states that 87 per cent of all commercial failures employed $5,000 or less capital in their enterprises. Efforts to reduce failures and losses must, therefore, evolve from a careful study and analysis of the small business. GENERAL UNDERLYING CAUSES Freedom of enterprise .—The unlimited and uncontested right of every individual to engage in any business regardless of personal qualification enables many to enter business whose failure is almost certain. The previous occupations and educational training of those who failed in Boston during the period covered by this study as shown in Tables 11-17 indicate that the majority lacked both experience and training in their particular business. 1 Bradstreets. 131846°—32-2 6 CAUSES OF COMMERCIAL BANKRUPTCIES The responsibility of selecting capable and efficient business enter¬ prisers rests almost entirely with those who grant credit. Few enterprises can prosper without sufficient credit, and a denial of it would forestall many failures. Undoubtedly, keen competition and the insatiable desire for volume renders void many worthwhile de¬ cisions of credit grantors, which, if acted upon, would eliminate a majority of the unfit from business. An abundance of information concerning the credit worthiness of a business entrepreneur is provided by various mercantile agencies and credit bureaus to credit grantors, and is of great value in their selection of debtors. Creditors who neglect to secure adequate credit information, or who do not heed the facts contained in credit reports, permit many of the inefficient and wasteful to secure sufficient credit to operate a business, followed by almost inevitable losses to themselves. Intensified competition .—The ever-present speculative element involved in trade of every kind has been accentuated in recent years by a greater intensification of competition. There has been in the United States an appreciable increase during the last decade in the number of business units, somewhat greater than the increase in population. The final census reports reveal that approximately 2,000,000 concerns are engaged in manufacturing, wholesaling, or retailing. The total number of retail stores in 1929 was slightly less than 1,550,000, or 12.6 stores for every 1,000 inhabitants. Approximately 170,000 wholesale firms and 211,000 manufacturing concerns were engaged in the competitive struggle for profits. Although there has been an increase in the number of competing businesses, greater significance is attached to the increased intensity of competition prevailing in every branch of economic activity. The existence of surplus producing and distributing facilities is evident through the whole of our economic system. Consequently, the consumer’s dollar is being sought by a larger number of business units, and with much greater zeal and effort than ever before. The ingen¬ uity of manufacturers and merchants in creating new products and devising new methods of distribution has resulted in prosperity for some and failure for others. Conditions existing during the last decade have caused manufacturers and merchants in most instances to seek a larger volume of sales by creating, stimulating, and satis¬ fying demand, without due regard for the increased expenditures resulting from their efforts. To attract a greater number of buyers, prices have been reduced, and the increased volume of sales necessary to offset the decrease in unit profit margins has not been sufficient in many cases to meet the requirements of profitable operation. Profits are based on the production and distribution costs paid by the average firm, and during a period of depression the subaverage business is generally eliminated. Business changes and improvements .—In every phase of economic activity the process of progressive change is never ending. Although the individual business man has little influence in determining or controlling any or all of the many changes taking place, he should be intelligent with respect to them, and particularly he must be intelli¬ gent with respect to the changes taking place in his own field of endeavor. In this modern competitive business world, new inven¬ tions, ideas, and methods are constantly being forced into use. The methods of production and of distribution undergo frequent revolu- CAUSES OF COMMERCIAL BANKRUPTCIES 7 tionary changes, and the consequent effects are disastrous to many business men who are slow to heed and to conform to inevitable economic transitions. Some changes apparently have no conceivable bearing upon the enterprises effected, and the business man must always be alert to discern and understand the variable factors over which he has little or no control. Certain happenings result in price changes; some brought on by his own actions, some brought about by the action of his competitors, and some forced upon both him and his competitors by events that are shaped by the collective but unconscious efforts of all consumers. The business executive whose training and expe¬ rience give him a static conception of business problems can have but little hope of success. The slightest misjudgment of the actual course of events often means for the business but one outcome, failure. Ease oj securing credit .—Liberal creditors who are influenced in their decisions by an insatiable desire for a larger volume of business actually encourage many undeserving debtors to accept an unwarrant¬ ed amount of credit. A close analysis of the causes of bankruptcy discloses the fact that overbuying is a frequent cause. Every debtor is confronted with the problem of accepting or rejecting what appears to be an endless succession of “attractive propositions” presented by persuasive salesmen who insist that the signature to the order is all that is necessary to complete the transaction. The inefficient credit manager, when confronted with the debtor’s order, will probably accept the assurance of the salesman that the account is a very desirable one which, if rejected, will undoubtedly be accepted by competitors. Many of the necessary factors which should be con¬ sidered in the granting of credit are ignored to prevent competitors from securing the order. Another hindrance to effective credit management is the fear of losing a debtor’s good will, which restrains many credit managers from making a thorough investigation before extending credit. Most debtors, especially the poor risks, resent a thorough investigation of their affairs and competency which would prove the inadvisablity of accepting the credit offered by enthusiastic salesmen striving only for larger sales commissions. Even under the most favorable circumstances there is an unavoid¬ able trade mortality, but the ease of securing credit has increased the rate by making it possible for many incompetent and dishonest mer¬ chants to venture into business. Ease oj discharging debts .—The Department of Justice inquiries and studies of existing bankruptcy laws and their administration has revealed that the ease of wiping out debts through the assistance of the bankruptcy courts has resulted in a condition threatening the foundation of our credit structure. Regardless of the causes of fail¬ ure, of how the property was wasted, or of the responsibility for gross neglect and culpable conduct, the bankrupt is almost inevitably granted a discharge without inquiry or opposition (98 per cent of the commercial bankrupts are granted discharges). Thus, those who fail are allowed and encouraged to secure more credit and create further losses. It is logical to presume that a larger number of persons will seek to relieve themselves of burdensome debts if there is no fear of being held accountable for their acts. Creditors, granted the power to 8 CAUSES OF COMMERCIAL BANKRUPTCIES subject the bankrupts to an examination concerning their affairs, are notoriously lax in determining the guilt of a fraudulent or incap¬ able debtor and in opposing discharges. The wholesale dissipation of wealth by the dishonest or incompetent will continue to increase until some penalty or deterrent is attached to the waste and destruction of capital. The commercial and social stigma formerly attached to failure and bankruptcy is no longer in evidence with the same degree of significance. The utter disregard of credit obligations which are voided by prompt discharge of debts without any attendant penal¬ ties or hardships are in a large number of cases being considered as justifiable achievements. The apathy of the public in general, and of creditors in particular, toward elimination of bankruptcy evils has encouraged wanton and unnecessary waste of captial by unscrup¬ ulous or unfit business men. Since July, 1930, an exhaustive investigation has been conducted by the Department of Justice into the operations of the bankruptcy law. On February 29, 1932, the report was submitted by the President to Congress, at whose direction the investigation was undertaken. The report states that “the present bankruptcy law has failed to achieve its purposes. It has not insured a prompt and efficient realization and pro rata distribution of assets of insolvent debtors, and it has not discouraged commercial fraud and dishonesty by denial of discharges.” In order that they may be presented concretely, the conclusions reached as a result of this inquiry have been embodied in proposed amendments to the existing bankruptcy law. Business fluctuations .—From whatever aspect the causes of busi¬ ness failures are considered, it is illogical to ignore the cause or effect of extreme fluctuations in business activity. General business con¬ ditions during the last few years have been injurious to the economic welfare of both the large and the small business. The trend of busi¬ ness activity has been declining since the collapse of the stock market during the last quarter of 1929. The decline in stock and security values at that time reflected the accumulation of numerous business ailments which apparently are now being remedied. It can not be denied that the deflation in real estate values, decline in commodity prices, unemployment, contraction of credit, and huge depreciation of stock and securities values were responsible causes of failure in numerous cases during the last few years. Neither can it be denied that the majority of the total insolvencies could have been prevented under the guidance of prudent management. The business depres¬ sion served only to hasten the end of those lacking the necessary requisites of success and doomed to failure from the very nature of their operations. CONSEQUENCES The billions of dollars lost by owners and creditors of failed con¬ cerns and bankrupt individuals form only a portion of the total re¬ sulting losses. No representative estimate of the aggregate losses resulting from failures can be made, yet it is evident, after a consid¬ eration of the widespread effects on numerous groups of individuals and our economic system in general, that such losses are incredibly large. These losses are seriously detrimental to the public interest and to our economic welfare. Capital is wasted in unprofitable and unsuc- CAUSES OF COMMERCIAL BANKRUPTCIES 9 cessful ventures by incompetent and incapable business men. The loss of a normal rate of interest on wasted capital must be included in the total waste which occurs in this manner and which retards the increase of our national wealth. When debts are contracted beyond ability to pay, and later are annulled in the bankruptcy courts, it is obvious that respect for private contract rights has been destroyed, and that the integrity of individuals no longer assures the payment of an honest debt. . In many cases the communities in which failures occur are forced to provide food and shelter for those unable to secure employment or assistance from others. The total income of the community is decreased and the collective prosperity of its inhabi¬ tants is adversely affected. All failures involve losses which, in the final analysis, are borne by the public. The discontinuance of a business involves a keen hardship on its employees. They are forced out of employment, and the reduction of their purchasing power—even if it is only temporary—is injurious to their welfare and to the welfare of the community in which they reside. Many are fortunate enough to find other positions, but their connection with a bankrupt concern often increases the difficulty. Many wage earners have invested in the failed enterprise a portion of their savings, which they lose in addition to their positions. The total losses suffered by employees can not be estimated, yet it is certain that they are tremendous. It would appear that competitors of failed establishments would profit by their nonsurvival. On the contrary, they are forced to accept losses which in many cases are sufficient to wipe out profits and threaten their own solvency. The assets of a bankrupt business are sold at whatever prices they are able to command. The bankrupt sales which are being conducted in the same trading area, often in the same block, frequently prevent the maintenance of a necessary profit margin in an active business. Until the merchandise of a bankrupt business is sold, the active merchant must compete against a bank¬ ruptcy sale. An auctioneer or trustee is forced by clamoring creditors to dispose of merchandise at any price he can get. The consumer naturally buys where he can obtain the best bargain, and bankruptcy sales are well attended. The owner of an existing concern can not reduce the costs of doing business sufficiently to offset the loss of trade. His wages, rent, and other overhead costs must be paid. It is not unusual, therefore, for an otherwise stable business to become insol¬ vent after attempting to survive in a local market demoralized by a series of bankruptcy sales at which the buyer sets the price. (Case No. 152, on page 31, is a typical example of this point.) Owners and creditors of unsuccessful ventures suffer the greatest direct losses. The original and subsequent investments made in the business by the owner and creditors are lost. Creditors on the average in 1931, so the Attorney General of the United States reports, received less than 7 cents for every dollar they were owed by bank¬ rupts. The losses accruing to owners and creditors of the 570 estab¬ lishments discussed in this report, conservatively estimated, amount to more than $20,000,000. These losses, which occured during a period of less than nine months, are but a part of the total losses resulting from failures in one city. Insolvencies, assignments, and compositions settled outside the bankruptcy courts in Boston were not included in this report. A loss of $20,000,000 in one city in less 10 CAUSES OF COMMERCIAL BANKRUPTCIES than one year—a fact which if considered with the indisputable evidence that a large part of this loss was preventable, forces the acknowledgment of a costly weakness in our credit and economic structure. SUGGESTED REMEDIES The following suggested remedies, if applied, will undoubtedly result in a reduction of commercial failures and attendant losses. The remedies suggested are not all-inclusive, but are pervasive in their practical application and need only the collective action of business men to bring about the elimination of some of the causes resulting in failure. (1) Prevention of unjustifiable entrance into business, by extending credit only to individuals whose ability, training, experience, and other necessary requisites have been definitely determined and proved to insure qualified and competent management of an enter¬ prise whose existence is economically justified. (2) Discouragement of the use of bankruptcy as a method of dis¬ charging debts by amending and utilizing the existing bakruptcy law to assure (a) a thorough examination of every bankrupt case, ( b ) conviction of fraudulent debtors and refusal of discharge to the undeserving, and (c) creditors’ control of bankrupt estates vested in an agency that will actively and effectively function. PERSONAL DATA RELATIVE TO 570 COMMERCIAL BANKRUPTS EDUCATION Over 40 per cent of the total group of 570 bankrupts did not finish grade school. Approximately 70 per cent were not high-school graduates, although there were 145 high-school graduates in the group. Less than 10 per cent were college graduates. It may be inferred from the above facts that lack of education in many cases was a contributing cause of failure. Knowledge and training can be acquired both in school and through experience, but the disproportionate use of either method, except in unusual cases, is not conducive to success. The majority of the bankrupts did not secure the necessary knowledge and training in school. EXPERIENCE Less than 18 per cent of the group who failed were engaged in the same business as owners, prior to their proprietorship of the bankrupt concerns. Only 30 per cent has ever been business proprietors prior to their entrance into the failed enterprise. Sixty-four per cent of the total group who failed were commercial employees engaged in various nonmanagerial capacities before their unsuccessful venture into business. Those who enter business in many cases are clerks, salesmen, laborers in the building trades, factory workers, mechanics, policemen, and various other types of workers whose knowledge of business is very limited. The only capital required to establish a business in the majority of cases is the rental for the premises, an installment upon furnishings and equipment, and an advance upon merchandise pur¬ chased. It frequently happens that as the business progresses, the value of the creditor’s investment therein increases as compared CAUSES OF COMMERCIAL BANKRUPTCIES 11 with that of the debtor’s. The occurrence of the slightest misfortune places the business in a precarious position, and insolvency becomes imminent. As shown in Tables 12-16, the previous experience of most of the bankrupts studied in no way fitted them for the business they entered. AGE AND SEX Approximately 87 per cent of the bankrupts were between 25 and 54 years of age; only 10 were less than 24 years old, and 60 were over 55 years of age at the time of their bankruptcy. There were 479 men and 19 women who were owners of the failed establishments. Three concerns were owned in partnership by men and women. Sixty-nine of the bankrupt establishments were corporations. There appears to be no causal relation between age, sex, and business failure; the vast majority of persons engaged in business are men between 25 and 50 years of age, hence there are more failures among such individuals. CITIZENSHIP AND BIRTHPLACE Of those reporting on the subject of their birthplace (536), approxi¬ mately 50 per cent were foreign born (although nearly 70 per cent of the immigrants were naturalized citizens) and 76 per cent of the bankrupts were of foreign parentage. Of those qorn in other countries, more came from Russia than any other country, although Italy, the British Isles, and Canada were mentioned frequently. ILLNESS AND MEDICAL EXPENSES The number of bankrupts who stated that they were ill at one time or another during the year prior to their failure was compara¬ tively small. Only 138 reported that they were handicapped in their endeavors by various ailments during the year preceding failure. Sickness among the members of the bankrupt’s family was rather widespread, as 326 cases were reported to the examiners. Cases in which both the bankrupt and his dependents were ill, while numer¬ ous—80 cases being reported—were not sufficient in number to be considered significant. Medical expenses were in most cases low, and indicated that only in a few isolated cases were they sufficiently large to entail a hardship on the bankrupt. The medical expenses of 75 per cent of the total group was less than $250. Eleven per cent of all reporting on the subject of medical expenses stated that they did not have any medical expenses, and less than 17 per cent had medical expenses of more than $250 but less than $500. Illness and medical expenses, therefore, with the exception of a few cases, was not an important contributing cause of failure. NUMBER OF DEPENDENTS The bankrupt in 80 per cent of the cases had an average-size family; that is, from one to four dependents. Ninety-six bankrupts stated that they had five or more dependents. In analyzing the causes of failure as reported by the bankrupts and their creditors, the size of the family was mentioned as a possible cause in few cases. 12 CAUSES OF COMMERCIAL BANKRUPTCIES SUMMARY OF PERSONAL DATA To summarize the analysis of the personal data secured on the owners of the bankrupt concerns, it may be stated that, as a group, few had more than a high-school education; a vast majority apparently had insufficient business experience; approximately half of the total group were not born in the United States; practically all were middle- aged men, with from one to four dependents. Although sickness was somewhat prevelant among the bankrupts and members of their families, the medical expenses during the year prior to bankruptcy in most cases amounted to less than $250. CAUSES OF 570 COMMERCIAL BANKRUPTCIES The information secured from the bankrupt debtor, his or her creditors, and the examiner of the case is the basis of the following discussion relative to causes of commercial bankruptcies. The examiners attended the bankruptcy hearings, interviewed the debtors, wrote to the creditors, examined the bankruptcy schedules, analyzed the concerns’ books and records, if there were any, and considered mercantile agency reports of the concerns that were listed prior to failure. The enthusiastic cooperation of practically all persons in¬ volved in any of the 570 bankruptcies and their whole-hearted support of the project made possible the collection of the necessary and relevant facts. A knowledge of the causes of failure secured from the experiences of the many who fail discloses the mistakes and the methods to be avoided if success is to be attained. The ruinous practices revealed in business failures must be discontinued by owners of active concerns and heeded by creditors in order to avert failures and reduce losses. The hazardous and uncertain journey to commercial success is safer if the warning signs and danger signals are known and observed. The preponderance of accumulated facts concerning business failures supports the common belief that a majority of insolvencies are pre¬ ventable. An analysis and study of the causes of commercial bank¬ ruptcies by owners of active concerns and their creditors may in some cases stimulate investigations with beneficial results. A diagnosis of ailments must precede the selection and application of the remedies. The prevention of failure by the elimination of wasteful practices is an objective deserving the serious consideration of every business man. No failure occurs which is not preceded by significant warnings. These warnings ought not to pass unheeded, and in order to recognize them promptly it is necessary to know the causes of failure. In the examination of credit information, if the principal causes are known by facts and experience to result in failure, the credit grantor can determine whether any of the causes are in evidence as affecting the applicant applying for credit. It becomes a question of recognizing the symptoms in time, and involves reasoning from cause to effect. There are various causes which interact and cumulate to precipitate a bankruptcy. It rarely happens that one cause forces bankruptcy or liquidation. In obtaining the opinions of the owners and creditors of the business that failed, there were in practically all cases several reasons given for each case. The outstanding causes of failure portrayed in Figure 1 are the seriously considered opinions of both the creditors and owners of the bankrupt enterprises referred to therein. CAUSES OF COMMERCIAL BANKRUPTCIES 13 OWNERS’ CREDITORS’ 100 2L PERCENTAGE OF CONCERNS AFFECTED BY CAUSE 2£0 _ 25 _ 50 JL 100 INEFFICIENT MANAGEMENT INSUFFICIENT CAPITAL vyy//////ww////y/yy/y/yyyyyy//yy//////z v//////////yyy///y////////\ ADVERSE DOMESTIC AND PERSONAL FACTORS i BAD DEBT LOSSES DECLINE IN VALUE OF ASSETS W//s////, L X X COMPETITION T ssa v/yz/A v/yzvm LEGEND ■| TOTAL GROUP ^ MANUFACTURERS ^ WHOLESALERS VZ& RETAILERS (MERCHANDISE) ES3 RETAILERS (SERVICE) E23 REAL ESTATE AGENTS, BUILDERS AND CONTRACTORS BUSINESS DEPRESSION DISHONESTY AND FRAUD V//////////////////A d.d. esse-46 Figure 1.—Owners’ and creditors’ opinions of major causes of 570 bankruptcies in Boston, 1930-31 131846°—32-3 14 CAUSES OE COMMERCIAL BANKRUPTCIES Owners’ and Creditors’ Opinions of the Causes of Failure in 570 Bank¬ rupt Enterprises; Boston, Mass., 1930-31 Per Per cent of cent of Cause of failure (Owners’ opinions) enter- Cause of failure (Creditors’ opinions) enter- prises prises affected affected TOTAL GROUP 570 ENTERPRISES Business depression... Insufficient capital_ Competition_ Adverse domestic and personal factors_ Decline in value of assets_ Bad-debt losses_ Inefficient management_ Excessive overhead expenses_ Poor business location_ Losses from speculation_ Unfavorable changes in trading area_ Excessive interest charges on borrowed capital. Expanded too rapidly_ Losses from signing notes with recourse_ Buying too much on credit__ Real estate losses__ Lack of adequate books_ Automobile-accident loss_ Failure to carry sufficient insurance_ Unusual expenses_ _ Inefficient and dishonest employees_ 67.7 516 ENTERPRISES * 1 2 Inefficient management__ ...... 58.7 48.2 Dishonestry and fraud ... .. _ 33.7 37.9 Insufficient capital... _ _ _ 32.9 35. 1 Business depression. . 29.1 31.6 Adverse domestic and personal factors. . _ 28. 1 29.8 Bad-debt losses_ 17.6 28.2 Competition.. .... 9.1 24.0 Excessive overhead. ...... . . ... 8.9 14.6 Expanded too rapidly. - .. -_ 7.2 11.6 Decline in value of assets. . ... _ 5.8 11.2 Losses from speculation__ ... .. .. •_ 5.8 11.1 Buying too much on credit. . . 3.9 10.5 Poor business location. .... _ . 2.7 9.6 Decline in rental income. . _ 2.3 9.5 Lack of adequate books ..... 2.1 6.1 Excessive interest charges on borrowed 2.1 5.6 capital. Unfavorable changes in trading area. .. . 1.9 2.5 Signing notes with recourse__ 1.4 2.3 Real estate losses.. . 1.4 1.8 Unusual expenses .. _ _ 1.4 .9 Failure to carry sufficient insurance. ... .7 Automobile-accident, judgment .... .6 Inefficient and dishonest employees . .6 MANUFACTURERS 54 ENTERPRISES 48 ENTERPRISES 2 Inefficient management . __ 77.8 Inefficient management_..._ .. Business depression__ ___ 77.8 Dishonesty and fraud . _ . Bad-debt losses 55.6 Insufficient capital . _ .. . . Insufficient capital 50.0 Business depression. Competition.. .. 37.0 Bad-debt losses_ _ Adverse domestic and personal factors . 27.8 Adverse domestic and personal factors . Excessive overhead 18.5 Competition _. __ ... .. _ Decline in value of assets 13.0 Expanded too rapidly_ . Poor business location 13.0 Buying too much on credit. .. . _ Expanded too rapidly.. 11.1 Excessive overhead expenses . .. Real estate losses 7.4 Poor business location. .. _ _ ... . Inefficient and dishonest employees. _ 5.6 Inefficient and dishonest employees_ Unusual expenses 3.7 Automobile-accident judgment . . ... Automobile-accident loss__ . ... ... ... 1.9 87.5 50.0 47.9 45.8 16.7 12.5 8.3 6.3 4.2 2.1 2.1 2.1 2.1 WHOLESALERS 52 ENTERPRISES Business depression____ Insufficient capital_ Competition___ Adverse domestic and personal factors Bad-debt losses..__ Inefficient management_ Decline in value of assets_ Excessive overhead expenses_ Buying too much on credit_ Real estate losses-- 80.8 50 ENTERPRISES 3 Inefficient management.. _ __ . 48.1 Dishonesty and fraud_ . _ 44. 2 Business depression. . . .... 38. 5 Adverse domestic and personal factors. ... 34.6 Bad-debt losses___ ... 23.1 Excessive overhead expenses. __ 23. 1 Insufficient capital. _ __ 21 . 2 Expanded too rapidly. . ___ _ 19. 2 Competition__ _ .. ... 19.2 Lack*of adequate books. . __ 58.0 56.0 34.0 32.0 32.0 22.0 16.0 16.0 8.0 8.0 1 1,270 creditors submitted opinions on 516 enterprises; 350 creditors replied that they did not know the cause of failure of 249 enterprises. 2 129 creditors submitted opinions on 48 manufacturers; 33 creditors replied that they did not know the cause of failure of 18 manufacturers. 3135 creditors submitted opinions on 50 wholesalers; 38 creditors replied that they did not know the cause of failure of 28 wholesalers. CAUSES OF COMMERCIAL BANKRUPTCIES 15 Owners’ and Creditors’ Opinions of the Causes of Failure in 570 Bank¬ rupt Enterprises; Boston, Mass., 1930-31—Continued Per Per cent of cent of Cause of failure (Owners’ opinions) enter- Cause of failure (Creditors’ opinions) enter- prises prises affected affected WHOLESALERS—Continued 52 ENTERPRISES Losses from speculation_ Excessive interest on borrowed capital.. Expanded too rapidly_ Losses from signing notes with recourse Poor business location_ Lack of adequate books_ Failure to carry sufficient insurance_ Unfavorable changes in trading area_ Inefficient and dishonest employees_ Automobile-accident judgment... 5Q ENTERPRISES 17.3 Losses from signing notes with recourse... 6.0 15.4 Buying too much on credit_ _ 4.0 11.5 Losses from speculation_ _ 2.0 9.6 Failure to carry sufficient insurance_ 2.0 9.6 Inefficient and dishonest employees_ 2.0 7.7 5.8 3.8 1.9 1.9 Decline in value of assets____ 2.0 RETAILERS (MERCHANDISE) 218 ENTERPRISES 1 199 ENTERPRISES * Business depression .. __ .. 76.1 Inefficient management. ... . 54.8 Insufficient capital . . ... 55.5 Insufficient capital. .. . ... 36.2 Competition __ ... _ __ 55.5 Business depression _ 33.2 Excessive overhead expenses.. ... _ 40.8 Adverse domestic and personal factors_ 30. 7 \ d vptsp domestic and personal factors 39.9 Dishonesty and fraud... . ... .. 27.1 Poor business location 28.0 Bad-debt losses.... 16.6 Unfavorable changes in tradnig area _ 24.3 Competition.. _ _ .. 14.6 Inefficient man a cement 21.6 Excessive overhead expenses_... _ 13. 1 Bad-debt losses . . __ 21. 1 Poor business location_ ___ 5.5 pipeline in value of assets 14.2 Buying too much on credit_ __ 4.5 Excessive interest charges on borrowed 14.2 Losses"from speculation.. . _ 3.5 capital* Unfavorable changes in trading area_ 3.5 ■Rnvinc r ton mnoh on orodit _ __ 11.9 Expanded too rapidly_ .. ._ 2.5 T,nc Sm o co • 'O' a 03 • l-H u, 7.0 8.0 .6 1.6 20.7 6.7 28.0 19.2 20.8 100.0 25.6 34.8 1.2 21.3 9.4 3.9 15.8 03 03 a CS t- 3 CO q 6.7 .4 .1 os •rH o ^ a aj S’ 0 o D 80.0 98. 1 92.9 5.6 03 03 a co fl-2 « § §8 O 13.3 C/3 © C/3 o A £ 5.0 50.0 85.7 44.4 7.8 12.1 3.7 1.2 36.4 1.6 3.4 q q co 2 os q O co j». q •pH pti 10.6 16.6 31.2 20.5 45.9 64. 1 3.9 5.3 CAUSES OF COMMERCIAL BANKRUPTCIES 35 Table 4.—Source and Amount of Capital Invested in 69 Bankrupt Cor¬ porations at Date of Organization Per cent of total capital Classification Num¬ ber re¬ port¬ ing Total CO t-i r—i o o l r2 b co O iS r —1 03 •r—t o a § a- 0 Q Is a a c3 s-i Q, ° a a o (3 o o a 03 Q-i to a w c8 ‘CrO >1 a CO