By Donald Thomson (University of Dundee and Thorntons LLP )
Is insolvency stigmatised? And if so, to what degree? The answers to these questions are central to understanding company, and by extension, director responses to corporate insolvency, particularly in the early stages of distress, where ailing becomes failing.
A large body of academic literature[1] argues that there exists a strong sense of stigma surrounding insolvency and that this stigma contributes to the low uptake of rescue procedures, which remains remarkably low across most jurisdictions: 6% in the United Kingdom (UK); 2% in Ireland; 2% in New Zealand; and 1% in Switzerland, to name but a few.
In the UK, the Institute of Chartered Accountants of England and Wales claims that it is “the stigma surrounding going out of business [which] prevents many from looking for help at the time it would provide the greatest chance of turning a business around.”[2]
But is this stigma as influential, or as pervasive, as commonly believed? Our research, published in 2022 under the title “Is Insolvency Stigmatised?” in the International Insolvency Review,[3] explores this question by examining how causatively the issue of stigma truly affects insolvency outcomes. Using a blend of interviews with UK corporate directors and a comparative review of existing scholarship, our study probes whether the widely held belief in stigma’s role aligns with the corporate reality.
Understanding stigma in corporate insolvency
The study begins by delving into the prevalence of stigma in insolvency-related discussions. Internationally, institutions like the OECD[4] and World Bank[5] have highlighted that the stigma associated with financial failure may discourage companies from utilising rescue mechanisms.
This sentiment was echoed across numerous jurisdictions in our comparative literature review, where the stigma of business failure is often intertwined with a sense of moral or managerial failure. Directors, it is assumed, avoid rescue processes for fear of reputational damage, sometimes ending up liquidating their business as they have not opted for a possibly more favourable restructuring option. This stigma narrative suggests that directors fear insolvency as a social label of failure, judgment, and mistrust in their abilities, which may prompt them to delay seeking help until it is too late to turn things around.
However, our comparative exercise revealed that stigma does not seem to be universal. In countries like the United States (US) and France, where social and policy attitudes towards financial distress appear to lack the same negative associations, directors appear more comfortable engaging with insolvency processes early on. The data reflect this position: in the US, the uptake rate of rescue procedures sits at around 37% and in France, it sits at around 39%.
What corporate directors really think
In seeking to assess the real-world impact of stigma, Ghio and Thomson conducted interviews with directors of UK-based micro- and small-sized enterprises. These companies, often operating within the confines of limited legal or financial resources, represent a significant portion of the UK economy.
Somewhat unexpectedly, the directors interviewed did not universally identify stigma as a primary concern. While some acknowledged that stigma does exist to a degree, most viewed its impact as moderate or minimal. Instead, what these discussions revealed was a lack of knowledge and understanding about what insolvency is and how one would go about addressing business failure legally or financially. There was little to no awareness of the existence of rescue mechanisms. This lack of awareness became evident through the directors’ limited familiarity with (or complete incomprehension of) terms like “restructuring”, “rescue” or even “liquidation”.
Many participants admitted that their knowledge of insolvency processes was limited, with some considering insolvency to be simply “what happens when you fail”. Such a perspective may lead directors to view insolvency as a last resort, rather than an opportunity for strategic reorganisation.
Therefore, while there is a preponderance of stigma references in the literature, we argue that it may not exert as powerful an influence on actual corporate decisions as commonly believed. Instead, a lack of awareness may inhibit directors from engaging proactively with restructuring options, particularly if they do not, or cannot, recognise signs of financial distress early enough.
This lack of clarity highlights a broader issue within the insolvency framework: policies promoting a “rescue culture” may be misaligned with the needs and awareness of the actors they aim to serve.
Moving beyond stigma to knowledge
Our research therefore challenges the assumption that stigma is an important factor supressing uptake of insolvency procedures. Instead, we propose that the solution may lie in bridging the knowledge gap.
Our research reveals that the current insolvency culture does not fully align with the experiences and needs of corporate directors, especially in micro-, small-, and medium-sized enterprises lacking sophisticated, or even rudimentary, legal and financial resources. By promoting awareness and education, directors should feel more confident navigating the insolvency landscape and understanding that rescue mechanisms are not merely a consequence of failure, but a viable tool for recovery and, in many cases, a natural part of the business life-cycle.
We point to potential shortcomings in existing policy frameworks that promote a “rescue culture”. Policies often assume that directors are fully aware of their options and base their decisions primarily on rational, economic calculations. However, the limited knowledge observed among directors suggests that policy efforts promoting rescue may not be reaching the intended audience effectively, or that they audience they reach are incapable of being receptive to those efforts. As a result, the full repertoire of insolvency mechanisms remains underutilised as a strategic response to financial distress.
So, stigma: myth or reality?
Our findings suggest that the influence of stigma may not be as significant as previously thought. While stigma is undeniably part of the insolvency narrative, particularly within policy and academic literature, its practical impact on directors’ decision-making appears somewhat limited. Our study shows that real-world outcomes do not always align with the theoretical view of stigma’s determinative role. In fact, the literature’s assertion that stigma universally deters directors from seeking rescue appears to be overstated.
Ultimately, our research highlights the need to revisit the assumptions underpinning the promotion of a rescue culture. Reducing stigma, while important, may not be sufficient to change directors’ behaviour. Instead, fostering a rescue culture may require targeted efforts to improve knowledge and awareness about insolvency options and their potential benefits.
* This article is based on a paper originally published in the International Insolvency Review.
[1] e.g. Sutton and Callahan (1987); McIntyre (1989); Umfreville (2016); Tajti (2017).
[2]https://www.icaew.com/-/media/corporate/files/regulations/insolvency/publications/ip-survey-changing-attitudes-release.ashx.
[3] https://onlinelibrary.wiley.com/doi/10.1002/iir.1518.
[4]https://www.oecd.org/economy/growth/policies-for-productivity-the-design-of-insolvency-regimes-across-countries-2018-going-for-growth.pdf.
[5]https://openknowledge.worldbank.org/entities/publication/de2cc5c4-c1ec-55eb-ad20-d27e916d000f.