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Alternative Financial Rationalities in Managing Corporate Failure

by Ahmed al Janahi, Chairman and Managing Director: Takaful International, and CEO: Investors Bank: Bahrain and David Weir, Professor of Intercultural Management at Ceram Sophia Antipolis:France Abstract Most studies of crisis management and business failure are based on research in western economic situations and assume western institutional patterns and attitudes. These assume that certain fundamental elements of financial rationality guide the intervention of banks and financial institutions in situations of incipient business failure. This study is based on an empirical analysis of companies in the GCC region of companies which are clients of banks which operate within the frameworks of the Islamic Banking System in the Arab Middle East. A sharp-bending orientation rather than a business failure model is used and conclusions are reached about the role of the banks and other financial institutions and their methods of managing difficult client situations. Some typical situations relating to problem loans, loan officers responses and behaviour and outcomes are reviewed. The role of the bank in triggering early problem-recognition is described and the response of the bank, subsequent actions and the sequence of recovery are described. Procedures and actions which would be regarded as irrational in a western cultural context are interpretable as rational within different cultural frameworks. We argue that there is no one universally-accepted framework of business rationality, and that financial rationalities are the product of deeply-embedded cultural frames of reference. Introduction The literature on corporate turnaround and on sharp-bending in particular is largely western in character but corporate decline and company failure are not exclusively western phenomena. (Grinyer, Mayes and McKiernan, 1988; Grinyer and Spender, 1979). However the frameworks used to interpret financial rationalities in relation to business decline and failure are infused with culturally-specific and largely western moral values. The research reported in this area is described as weak and the findings as inconclusive (Pandit, 2000) which argues there are many unanswered questions about what characteristics set turnaround firms apart from firms which continue to decline and eventually fail(Arogyaswamy, Barker and Yasai-Ardekani, 1995). The lack of an empirical base for prescription and the cultural specificity of much of the advice offered has not inhibited the growth of publications oriented at instructing or recommending courses of action to practicing managers faced with the responsibilities for leading enterprises in difficult circumstances. In many of these publications it is assumed that the strategies and tactics recommended have universal or trans-cultural application. This orientation provides a construction of financial rationality which implies certain apparently self-evident behavioural

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maxims. Thus small businessmen in the west will readily subscribe to such beliefs as the bank never loses, the bank gets its money if you do well or if you dont, when things are going well and you dont need it, everybody wants to lend you money, success has many fathers, when youre smiling, the whole world smiles with you; when you cry, you cry alone and the like. The framework of rational expectations which enshrouds business discourse in the west emphasises success and failure as logical alternatives. The rationalities imply individualistic models, winning and losing moralities, and an overall ethic that business success in some sense encapsulates elements of individual personal worth. Competitive behaviour as between individuals is accepted as normal, and collective altruism as deviant. We take issue with this emphasis and insist that management is largely a product of specific cultural practices and thus the modalities and techniques as well as the symbols and language will necessarily differ as between one cultural milieu and another. The definitions of enterprise, the legal frameworks in which management and business operate and the beliefs and expectations of managers and their clients likewise differ. Thus what is seen as rational behaviour differs from one cultural milieu to another, so universal prescriptions for turnaround and success are likely to be of limited viability. We wish to shift the focus from the failing firm as such, to the problem business situation in the context of the complex web of relationships in which its business is enmeshed and in which its principal banker performs a specific role as a major player. Thus we enlarge the perspective of analysis and pay less attention to the discourse of leadership and the heroic qualities of the management in turning around failing companies, which are characteristic components of the Anglo-Saxon models and permit a more comprehensive review of other significant factors in the sharp-bending situation, especially the role of the banks and other financial institutions. This perspective allows us to focus on the competing rationalities involved. Grinyer, Mayes and McKiernan (1988) define sharp-bending as a sharp and sustained improvement in performance. While therefore it may be regarded as equally irrational within a western and an Islamic framework to avoid failure and seek performance improvement, the actual behaviours which are implied by these tenets may differ quite markedly from one milieu to another. There have been few empirical studies of enterprise performance in the Arabian Gulf region, or indeed in the Arab Middle East. For similar reasons, compounded by a strong ethic of banking secrecy, there has been little research reported in the literature on the mechanisms and structures of banking in this region. This study aims to close this gap in the literature. The region covered by this study is that of the Gulf Co-operation Council (GCC) which covers the states bordering the Arabian Gulf, namely Kuwait, Bahrain, Qatar, United Arab Emirates, Oman and Saudi Arabia. Since the 1980s there has been a growing incidence of enterprise failure in the region. The rapid growth of wealth over this period, leading to increased standards of living, brought with it a steep learning curve in managerial skills and corporate competence during the study period as the economy moved on a path towards increased international com-

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petitiveness based on a diverse industrial base from a situation of relatively strong dependence on oil and derivative petro-chemical industries. In earlier publications we have drawn attention to the culturally-rooted nature of management and identified several characteristically distinct syndromes or paradigms including the American, the Japanese, the European and the Arab or Fourth Paradigm (Weir, 1993, 2000, 2001). These four paradigms are by no means exhaustive typologically but the differences in cultural expectations, socially-approved behaviours, attitudes to training, management development and other managerial practices and enterprise structure and governance between these paradigms are very striking. Likewise, attitudes to corporate failure, and the strategies and tactics involved in organisational sharp-bending differ between one environment and another. In a classic review of corporate decline and recovery, Slatter (1984) identifies 10 generic strategies available to companies. Some of these strategies are alternatives, while some can be pursued in tandem with others. Business and Banking in the Arab Middle East At first inspection, the behaviours and values characteristic of organisations in the Arab world appear especially unlikely to be empathetic to these recommendations of contemporary western business school theory. The western view of the Arab world in general is more likely to describe such aspects in terms of a discourse of traditionalism and to rely on such categories as respect for authority, and to see the prevailing approach to decision-making as top-down even if, through institutions like the diwaniah, it can also be characterised as consultative (Weir, 2000). But reality is more complex and in general we do not find the discourse of traditionalism and modernity helpful in considering the evolution of banking practice in this region. As with most aspects of Islamic economics, Islamic financial and banking institutions are relatively recent in origin and the theoretical underpinnings and philosophical expositions of good practice in these sectors are current and evolving. Most of the significant literature has been published in the past few decades. This is a dynamic and evolving, not a static and conservative system. Fundamental Principles of Islamic Finance An Islamic bank has to conform to the principles of the Sharia, and its activities are overseen by a Sharia Committee consisting of leading figures in the community. All Moslems are guided by the five pillars of Islam, namely: The Testimony of Faith, The obligation to pray five times daily, Giving Zakat as support to the needy Fasting during the month of Ramadan The pilgrimage to Mecca or Hajj.

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All business must take account of these values, which radically affect the relations between banks and clients. The Islamic religion implies certain theories about business, the possession of wealth and obligations to others in general. Wealth is held in trust for God by human beings, so it is wrong to undertake actions leading to the loss or diminution of wealth; strategies of individual profit maximisation or cost minimisation are not to be paramount over strategies oriented to more collective objectives. It is regarded as improper to earn money merely from the possession of wealth, through the operation of a rate of interest calculation, regardless of how well or badly the actual business that is the object of the loan fares. There is therefore a distinctly different approach to the basic assumptions of financial management. The rationality is rooted in differing philosophies of financial appropriateness. If the bank is risking its money, it must expect to risk losing it altogether in the case of default or to have to share in the losses of unsuccessful as well as the profits from successful trading. The social structures in the Arab countries emphasise the importance of family, kin and clan networks as sources of social support and also of business opportunity. The notion of the Ummah stresses the indivisibility of this community of believers but these concepts do not imply an avoidance of economic advantage or a preference for genteel poverty over the enjoyment of wealth created in business transactions. The economies of the GCC region have experienced significant economic growth and increasing diversification throughout the period covered by this study. In Bahrain, there are now more than 200 serious financial institutions. New industries of various kinds, tourism, leisure, construction, media, communication technology, financial services, consultancy and education have developed. This is a very dynamic economy. The predominant organisational structures in the region have also undergone changes as the largely state enterprises have been affected by economic liberalisation. Other changes have been directed to loosening the over-dependence on oil and the need to move from a state-subsidy culture to an enterprise culture and to create investment streams to create jobs for an increasingly well-educated labour force. There is a move towards creating a business environment in which Gulf nationals will play an increasing part, expatriate work-forces less dominant and business enterprises restructure to face the challenges of globalisation. The banking sector in Bahrain has been prominent in leading the introduction of technology, dismantling restraints on capital mobility and supporting efficient regulation. Criteria of Incipient Business Failure It was possible in this study to take as a criterion of impending business problems the factor of default on loans. Often it is not possible to access this level of data, due to reasons of commercial confidentiality. Default on loans relates to criteria that have been shown in the literature to have significant predictive power, relating to liquidity and cash-flow problems (Slatter, 1984; Argenti, 1976). Too often, studies of corporate decline and failure have become fixated on the internal processes of management and the characteristics of the key business-decision makers only in the company being studied and have discounted or ignored the roles and

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involvement of other actors in the drama. But business failure does not take place in a vacuum, unnoticed by clients, customers, suppliers or bankers. So this study has been designed to identify and characterise the ways in which commercial banks in the Gulf region view problem loans and the nature of their response. This research orientation has also enabled us to examine primary data of a quality and nature normally inaccessible to academic scrutiny. Both qualitative and quantitative data were used to discover how banks distinguish between decline and failure, what cues are used in this process, and the subsequent intervention strategies. The study develops a regression model to examine the joint effects of the various elements on the response strategies. Such factors as the size of the firms, lender liability and the variance between banks are reviewed. The study is predicated on the assumption, not that the view of the bank on the viability of a particular enterprise is necessarily correct but that the bank is in a relatively privileged position to identify early signals of impending problems and also that the banks role can influence the subsequent strategy of the firm. Findings It is an important objective of bank policy to recognize a problem loan early and to respond to it by attempting to work with the enterprise to correct the problem, rather than to wait for serious trouble to develop, possibly resulting in the liquidation of the company and the loss of the banks investment. In this process a series of factors, including soft signals are reviewed. In the early stages of problem identification, it will normally be the banks policy to bring doubtful or worrying factors to the attention of the client in the hope of achieving an early resolution. So at this stage there is congruence between the goals of the bank and those of the firm. The key distinction lending banks try to make is between problems which threaten the life of the firm and its survivability and those which do not. The key criteria in determining which situations are regarded as life-threatening concern the firms ability to repay the debt. Through a risk rating system, banks attempt to structure and formalise their recognition and response mechanisms. These operate to provide guidelines for decision and also to render as objective as possible a decision sequence which contains many subjective features. Methodological Issues The study included interviews with the bank officers in three categories: Lending officers who were normally senior policy makers and account managers, Loan review staff dealing with the review of accounts, Departments working directly with clients, turning loans around, liquidating and collecting them. The interviews were focussed and semi-structured instruments were used. Except in two cases it was possible to tape-record and transcribe these interviews. Questionnaires

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were used to seek specific information relating to loans regarded as problems from the loan officer or account manager concerned. Questionnaires were pre-tested and piloted. There were two parts to the questionnaire. The first dealt with the positioning of the respondent in terms of years of experience, number of loans handled, methods of monitoring loans, etc. They provided opportunities for respondents to report on how problems were diagnosed and monitored, and how judgements are made regarding the severity of the problems faced by clients. In the second part of the questionnaire, respondents were asked to focus on one particular client situation falling into the problem loan category. Clients who fell into the start-up category were eliminated as these posed different sorts of problems. There was no requirement to identify the client in question. The variables entering into the questionnaire were drawn from the relevant literature and included such factors as cues for recognition, causes for decline, objectives influencing the response, different types of interventions considered etc, but the aim of the data-collection was to obtain an understanding as far as possible in the respondents own words, to better understand their frame of reference in relation to the chain of decisions in question. The findings are complex and it is not intended to offer more than a summary of findings at this point. Undertakings of course were given to the effect that it would not be possible to identify specific cases or individuals in any subsequent publications. The average number of years of experience of the loan officers studied was 11.2 years, and the number of cases handled was 39. In terms of degree of specialisation, 85% did not specialise in a limited area or sector so could be classed as generalists. So these respondents can be classed as expert in relation to the discourses of lending and loan recovery. The majority of client firms were in retail, finance, insurance, real estate and services; others were in construction. In terms of size, 59% would be classed as small, and 41% as medium-sized. Responses were transferred as items to item cards created according to methods described by Myers and Huberman (1984) and Turner (1988) , in which low-level categories were recorded, reviewed and then combined throughout successive iterations until characteristic patterns started to emerge. This technique is described by Turner as botanical and also has similarities with the techniques used by Myers and Briggs to characterise behaviour types in terms of typical adjectival description, sorting and classification by hand and eye (Myers and McCaulley, 1985). The principal researcher has spent several years as a loan officer, works regularly in this milieu and is familiar with the modes of conceptualising, descriptive terms and judgemental aspects of this domain of discourse. In the overwhelming number of cases (82%) the cases related to situations in which the respondent was the principal loan officer or lead banker. It is important to understand that, in principle, banks do not seek to make bad loans but problem loans are recognized as any loan in which problems develop which may adversely affect the banks liquidity and increase the possibility of loss. While these situations may, in rare cases concern a borrowers unwillingness to pay, it is largely due to the borrowers inability to pay that problems arise. In operational terms, these loans may

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be described as non-performing loans. Typically, when a loan is recognised as having a problem, capital may no longer accrue to it. If terms of repayment have to be re-negotiated a loan may still be classed as non-performing if the expectations of repayment are lower than would be the case for other similar loans of that type. Loan officers were asked to identify under-performance under three categories: Where there is a clear violation of loan covenants in terms of dividends declared, assets acquired, reduction in security values, overdrafts beyond agreed limits, etc. Where there is a clear delinquency and payments have not been made according to plan. Where there is a perceived decline in the performance of the borrowers enterprise in terms of declining ratios, weak cash flows and other business-related indicators. The responses of the loan officers fall into two categories: 1. 2. Those identifying financial factors Those describing aspects of business and managerial performance. These respondents termed a problem loan, for instance, as any loan whose primary and secondary repayment sources are in actual or potential jeopardy, where the clients repayment capacity has been jeopardised and/or where quality of underlying security has seriously deteriorated, and any account where there are factors negatively affecting a companys viability creates an atmosphere where an account or loan can be a problem.

There was also an expressed difference between those respondents who responded in terms of standard bank policies and those who recognise that each case is different and you cant rigidly adhere to policies. Most banks utilised fairly formalised credit rating procedures to distinguish between those situations indicating a recoverable fall in the financial performance of a clients business and those where impending failure is perceived as a real possibility. Loans and their risk are categorised in this way at the outset and these assessments may change during the life of a loan, due to the banks on-going evaluation of the situation. The objective of the system is two-fold: To protect the banks exposure, To commence the recovery phase and hopefully the sharp-bending phase through early detection of situations of increased risk. The rating systems of banks are classed as confidential information. They are neither exchanged between banks nor transmitted to clients. One bank surveyed claimed not

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to have such a system but to act within the frameworks provided by the regulatory authorities. Another declined to provide a copy but described their system during interviews. The rating systems range from 6 to 9 types of classification of loans. Some banks tailor their scales to fit the particular sectors which dominate their operations. In accompanying work-sheets, each bank provided details to indicate how these systems worked in practice. Indicative findings of the categories used by the banks to order these materials are as follows: Bank A: Financials, Management, Industry status, Security, Terms of support, Account activity, and Competitor actions Bank B : Management, Money, Materials, Markets Broadly summarising these ratings and their operation in practice, the rating systems are used to classify firms into three groups: 1. 2. 3. Good or acceptable credit risks Non-performing loans which are believed to be recoverable Non-accrual loans.

There is usually a cut-off point at which firms may be put on a watch list for closer observation and monitoring. Thus the rating system tries to differentiate between cases in terms of the severity of the problems but also makes broad prescriptions about the likely response of the bank by tying the response to the category of risk. The difference most often cited between western and Islamic models of business is that in the western system, the chief measures of financial performance, criteria for earnings and returns are expressed in terms of rates of interest. Yet these methods are not available in Islamic financial and banking systems. It is important to appreciate that capital-related measures of financial performance used in Islamic banks are not mere surrogates for correct or rational calculations made in rate of interest terms, but function in terms of a different conceptual framework which embodies different approaches to the concepts of wealth, profitability and the business cycle in general. In other words, the underlying structures of rationality are different ab initio, and these differences imply different behavioural outcomes. These frameworks also incorporate characteristic attitudes to business relationships and to the maintenance of worthwhile avenues of enterprise suffering temporary difficulties. The problem cases identified by respondents are often characterised by poor use of management information and the absence of adequate financial controls. These findings support those of studies in other economic systems. The philosophy of the respondents banks in assisting their clients to make sharp-bends out of the downward spiral towards business failure may be summarised in three axioms; To manage first for cash flow, second to manage for achievement of a sustainable profit stream, thirdly to manage for business growth.

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A pattern emerges in the cases studied in which the bank enters into a partnership mode with the client, rather than moving at the first sign of impending crisis into recovery of what assets may be salvaged via a process of liquidation. This enables the bank to participate more directly in the business of the client and to enhance its understanding of the real issues facing its managers. This approach enables the bank to pass over the results of its more sophisticated methods of appreciating the business situation of the client and to encourage, first the principles of good business forecasting, secondly the most promising routes to possible profitability and thirdly the chance to recreate the banks capital at risk jointly with that of the client and finally to move on the path to sustainable growth for the clients business. Such an approach also fits the social considerations surrounding the dangers involved in a public display of overt failure and explicitly encourages greater competence and improved managerial capability in the client enterprise. Some situations will not be recoverable but over time the risk of catastrophic failure involving the loss of social wealth represented by the diminution of the business position of both bank and client is diminished and a climate of security and confidence maintained. The philosophy of the banking communities in the GCC environment may be therefore inherently more accommodating and less confrontational than in similar situations facing European banks. This approach is more in tune with the principles of Islamic economics, which is both more business-oriented and less inclined to see a divergence of interest between the real and financial parameters of practical business situations Alternative Management Rationalities The values of management are presumed in most of our professional discourse to be universal and to be those of western capitalism writ in individual terms; but as there is in the global world of management a diversity of cultures and differing norms of behaviour, so there is more than one culture of management: yet little attention has been paid to the ethical and philosophical bases of other paradigms than those with which we in western business schools are familiar. To the extent that economics is portrayed as positive science and the western variants depicted as having been justified by some implacable processes of historical inevitability, it will remain difficult for western observers to comprehend the vital rationalities which underlie and support business in the Arab Middle-East. Where other philosophical and ethical systems are encountered by western economists, they are apt to be dismissed with the discourse of traditionalism or underdevelopment, or stigmatised as inconsistent with the requirements of business efficiency. But many of these systems of ethics are embodied in cultural traditions which are, in origin, older than those of western capitalism, yet in contemporary societies are evolving and transmuting even more radically. It is incorrect and unhelpful to see them as merely deviant cases or as unsuccessful attempts to reproduce western modalities, in short as irrational. Every major economic culture sustains in its business activity and management practices a recognisable pattern of beliefs and processes that relates in a functional and supportive way to the generic culture in which it is embedded. Management has to lie within its culture rather than to be in opposition to the main trends of thought in society and the major axes of societal configuration.

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We, in the West, know little about management in the Arab world. It is complex and multi-faceted, but is different in many ways from the Anglo-American or European models and does not conform either to the Eastern or Japanese models. It is a convenient short-hand to regard it therefore as constituting a fourth paradigm, despite the evident existence of behavioural and cultural diversity. Islamic precepts and culture form the basic frameworks and elements of management in the region, but it is inadequate to characterise these aspects as constituting a traditional or conservative style of management. There are dynamic and evolving aspects and the political and economic context is especially motile. Various elements of the fourth paradigm indeed may be especially well adapted to the emergent needs of business in an increasingly global context. Bankers in the GCC region are not in principle any less interested than those in the West in undertaking profitable business opportunities, nor any less concerned about safeguarding their investment in areas of activity in which high risk may be associated with good possibilities of high return but the discourse of banking in this region, based on the rationality we have been discussing, stresses continuity rather than failure and collective wealth rather than individual reward, networked knowledge-management in which informal and soft data are equally as significant as numbers, key ratios and bottom-line realities. There is no strong evidence of a comprehensive cultural convergence of this fourth paradigm with other paradigms or of the imminent westernisation of these behaviours and beliefs. Accordingly, the approaches to the management of people and in particular to such western models as human resource management and corporate failure must be very carefully handled when attempting to apply them holus-bolus to the practice of management in the Arab Middle East or to dealings with the enterprises and organisations in this region. Per contra, it is perhaps in understanding the philosophical and ethical underpinnings of the styles of management and the practices of business that obtain in this region that much compatibility can be inferred with some of the implications of the knowledge society and of best practice in people management in the west and more generally. The learning from this exercise will not be only one way. Banking and the financial systems also need to adapt to the requirements of new forms of enterprise in identifying what it is they have to offer the global markets. This need not mean merely the adoption of greed-based high-risk corporate strategies and financial manipulation; these may indeed have run their course in the West also. But the techniques of corporate recovery, portfolio-balancing and organisational support are not alien to the new generation of bankers in the region. Islamic models of financing for house purchase, assurance, and investment are compatible with sustainable enterprise growth. Finally, it is precisely in the realm of culture that the enterprises of the region have least to fear: much expenditure of senior management time and consultants ingenuity takes place in the west and in Japan to achieve what comes naturally in economies where the key feature that is common, universal, and indefeasible is precisely the existence of a common culture, of practice rather than of precise doctrinal assent on minor matters.

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Central to this business culture are the understandings of good behaviour based on the indefeasibility of trust and the lack of the incoherence between behaviour in one context and another that are features of Western business models and legal restriction. The notions of limited liability and risk alike operate in a quite different manner in societies of shame and those of guilt. The underlying rationalities are different: but, once the cultural matrix is understood, the practices of business recovery and the roles of bankers and their clients may be readily interpretable. These elements of the banks interests contain long-term and developmental aspects. The orientation to short-term aspects which frames the relations between banker and client in the west is seen as inherently incompatible with Islamic understandings of wealth and the avoidance of usury as a non-wealth-creating activity. Involvement in the market cannot be a risk-free operation: and the general requirement on all participants in the business process not to diminish wealth and to avoid risky investment and to preserve capital already created implies a very significant role for risk management in the banks armoury of strategic instruments. Emerging practice in the West and in Europe especially may benefit from a closer understanding of how bankers and banking institutions work in practice in the Islamic world, permitting a wider connotation to our definitions of financial rationality. Note The paper is based on research undertaken by Ahmed al Janahi for a Ph D degree of the University of Bradford, under the supervision of Professor DTH Weir (Further details are available in Al Janahi 2002). One of the joint authors occupied senior positions in a leading investment banking institution for the duration of the study period, culminating in appointment as Chief Executive of the Bank in 1999.

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Al Janahi, A., 2002, Sharp-benders in Gulf Co-operation Council Countries, Thesis submitted for the degree of Doctor of Philosophy. University of Bradford. Argenti, J., 1976, Corporate collapse: the causes and symptoms, Halsted Press New York. Arogyaswamy, K., V.L.III Barker, Y. Ardekani, 1995, Firm turn-arounds; an integrative two-stage model, Journal of Management Studies, v 32, n 4. Bibeault, D.B., 1982, Corporate turnaround: how managers turn losers into winners, McGraw-Hill, New York. Grinyer, P., D. Mayes and P. McKiernan, 1988, Sharp-benders, Basil Blackwell Oxford, England. Grinyer, P., and J. C. Spender, 1979, Turnaround: Managerial recipes for strategic success, Associated Business Press, London. Myers, I.B. and M. McCaulley, 1985, Manual: a guide to the development and use of the Myers-Briggs type indicator, Consulting Psychologists Press, Palo Alto, California. Myers M.B.and A. M. Huberman, 1984, Qualitative data analysis, Sage New York. Pandit, N.R., 2000, Some recommendations for improved research on corporate turnaround, Management, v 3, n 2. Slatter, S., 1984, Corporate Recovery, Penguin Books, Harmondsworth, Middlesex, England. Starbuck ,W.H., A. Greve and B. Hedberg, 1978, Responding to Crisis, Journal of Business Administration, v9, n2. Turner, B.A., 1988, Connoisseurship in the study of organisational culture .in Bryman, A.,(ed) (1988) Doing research in organisations, Routledge: London and New York. Weir D.T.H., 1993, A fourth paradigm for management research: management in the Arab World in Alwani, M. and Weir, D.T.H. Proceedings of the first Arab Management Conference, University of Bradford Management Centre, UK. Weir D.T.H., 2000, Management in the Arab World: a fourth paradigm? in Denton, J. and Al-Shamali, A., Arab business: the global perspective, Kogan Page, London. Weir D.T.H., 2001, Management in the Arab world in Warner, M. Management in emerging countries, Business Press and Thomson Learning, London.