Investigating Insolvent Trading

This paper considers “how, when and why” a firm ought reasonably suspect insolvent trading via exploration of areas of law, management, psychology and economics. Factors given consideration include the difference between risk and uncertainty, the imperfection of market information, the risk appetite of entrepreneurs, the impact of corporate culture on self-awareness and finally criteria for assessing proximity to insolvency from both a case law and a common-sense perspective.

An essential difference between risk and uncertainty is the ability to quantify and therefore manage risk, since risk is associated with measurable repeatable events and accessible to a probabilistic analysis. Uncertainty on the other hand stems from unique events, which may be foreseeable but are certainly unpredictable (Wennekers). A wide variety of management models exist for managing risk (Net Present Value, Capital Asset Pricing Model etc.) but all assume away the element of uncertainty. The “how” of managing uncertainty will be a subjective matter and depend greatly on the individual entrepreneur or manager. At this point it is easy to see a potential divergence between courts and businessmen, unless courts are able to reasonably but prudently incorporate the typical entrepreneurial outlook. Entrepreneurs are “more optimistic”, “less averse to risk” and likely to “dispose of relevant information reducing uncertainty” (Wennekers). Whilst some latitude might be given by the courts to this mindset, an element of dispassionate analysis should remain. Where conventional management theory allows, the level of uncertainty in the firm’s marketplace should be assessed and included in any decision on potential insolvency. Where “uncertainty levels are low, th...

... middle of paper ...

...D., E Hogan, J. E., & Smith, G. R. 2003. Assessing the strategic value of business relationships: The role of uncertainty and flexibility. The Journal of Business & Industrial Marketing. Vol.18,Iss.4/5;p.376

Morrison, D. 2002. When is a company insolvent?. Insolvency Law Journal. Vol. 10, Mar. 02, p. 19-21

Robbins, S., Bergman, R., Stagg, I., Coulter, M. 2006. Management 4th Ed. Frenchs Forest. Pearson Education Australia.

Shiao-Yen Wu, L. 1988. Business Planning Under Uncertainty: Quantifying Variability. Journal of the Royal Statistical Society. Series D (The Statistician) Special Issue: Statistical Forecasting and Decision-Making. Vol.37,Iss.2;p.141

Wennekers, S., Thurik, R., Van-Stel, A., & Noorderhaven, N. 2007. Uncertainty avoidance and the rate of business ownership across 21 OECD countries, 1976-2004. Journal of Evolutionary Economics. Vol.17,Iss.2;p.133