Dubai, UAE—In March, the world of business and finance was shaken by the sudden collapse of Silicon Valley Bank in the US. The regulators shut down the bank after its investments lowered in value and its depositors took out large amounts of money. Its fall was the second largest bank failure in US history.
The Middle East, too, is no stranger to highflying companies biting the dust, the companies which had been a permanent feature not so long ago of the Gulf business landscape. In fact, during the last ten years, a host of large companies have disappeared into oblivion: Drake & Scull International PJSC, NMC Health, Al Masah Capital, Arabtec, the Abraaj Group, and the Saad Group.
Why do businesses fail? Is there a way to stop the decline of a company into obscurity, and revive its fortunes?
Industry experts and analysts agree that it all boils down essentially to how a business is run, and the kind of decisions taken by top executives and its board of directors.
According to Dr. Ashraf Gamal, Chief Executive Officer at Hawkamah Institute for Corporate Governance, there is a whole set of reasons for the downfall of a business, some of them are market-based and some are governance-based.
During the last ten years, a host of large companies in the #MiddleEast have failed, disappearing into oblivion. @HamdanMohammed @MohamedBinZayed #Business #Arabtechhttps://t.co/gm4ZLxUyLl pic.twitter.com/1Yo81SuVCh
— TRENDS (@mena_trends) April 10, 2023
“While the market-based failures might be a result of macro-level crises such as the pandemic of 2020 or the international financial crisis of 2008, the governance-based downfalls lie mainly with the boards of directors, even if it might look like something else is responsible,” Gamal told TRENDS.
Bad governance, he believes, stems mainly from a bad board of directors. An insufficient control system or poor risk management structure is an illustration of disarray and poor decision making. “The board is ultimately responsible for the company and its performance, nothing can be blamed on the management alone.”
“Board composition is the first factor; who sits on the board? If the board does have the right mix of backgrounds, skills, and knowledge, then the board will never perform well. Companies need to have board members who understand the business of the company, but we also need those who understand financials, strategy, risk, economics, technology, and increasingly sustainability,” said Gamal.
In 2020, NMC Health folded up, after a report by activist investor Muddy Waters alleged that the company had inflated its cash balances and understated its level of debt.
A probe established that more than $4 billion of hidden debt led to the company’s failure. Investigators said documents were destroyed by executives as they tried to discover the scale of the fraud and who was responsible.
They said that executives at NMC Health were using loans to the company from 2013 to boost share price and their own pay packets rather than benefit the company, while forging documents to show the company was in good health.
NMC was found to have inflated its cash balances and understated its debt levels, leading to a significant overstatement of its financial position. It was also accused of providing false information in its financial statements and failing to comply with accounting standards.
The absence of independent directors and the concentration of power in the hands of a few individuals was blamed for the mismanagement of the company, factors that ultimately led to the downfall of NMC Health and its eventual delisting from the London Stock Exchange.
According to Jane Valls, Executive Director, GCC Board Directors Institute, corporate scandals and failures spring from poor corporate governance.
“A lack of understanding of corporate governance and how to implement it effectively at the top of the organization, a tick the box approach, director over boarding, over confidence, and sometimes just simple negligence or lack of care are all reasons why we see such scandals or frauds taking place” she told TRENDS.
Many experts blame disagreements within a board, or a lack of team spirit as the reason for tipping a company toward a slow demise. But despite having a board of directors with right mix and spirit, some boards still fail to interact with the top management.
“Some boards are conflicted, where some board members have personal interests and investments that may conflict with the companies they are on. Finally, some boards are too operational, interfering too much with operational issues that are not supposed to be their business.”
Drake & Scull International (DSI) is a prime example of how a well-established company can crumble.
It faced significant losses in the wake of a drop in oil prices in 2014, which resulted in a drop in the company’s new contracts and the difficulty in reclaiming receivables owed to it.
It struggled to cope with significant financial difficulties, including debt accumulation, which made it difficult for the company to secure financing and pay its bills. It also faced delays and cancellations of key projects, in addition to management challenges, including leadership changes and disputes, which negatively impacted the company’s ability to execute its strategy.
It eventually led to the downfall of DSI, and the company has since faced bankruptcy proceedings and significant restructuring.
What Gamal has observed during the course of many years is that many businesses have no strategy at all, and on top of that confusing targets. “Another mistake is to make the management responsible for strategy, so it becomes an operational plan rather than a strategy. And the third is poor strategic KPIs and lack of board follow-up on strategic developments.”
Valls on the other hand believes that many mistakes can be made, and yet having an effective board, whose role is to ensure the financial stewardship and strategic direction of the organization, oversee the risks, manage performance, and create value for all stakeholders, is still essential. And to ensure sound internal controls, independent internal and external audits are key elements.
Experts cite the example of the collapse of Arabtec Holding to emphasize their point. Its poor financial performance led to a loss of investor confidence, management changes and controversies, including allegations of mismanagement and corruption.
To stave off total ruin and collapse of a business, industry experts recommend for the board to take charge of strategy, in cahoots with the management. The board, according to them, must consider risk dynamics when discussing the strategy, and it must include ESG or sustainability factors. “Then the board needs to follow up on the developments multiple times each year and must adjust the strategy and its KPIs in response to major market, regulatory, or risk changes.”
According to Valls, poor corporate governance always causes the decline of shareholder value. Good corporate governance is important for all companies, private and public, as well as government entities, because it can help ensure long-term shareholder/stakeholder value.
“It is fundamentally about holding leadership (the board and management) accountable, facilitating sound decision-making, and ensuring appropriate checks and controls are in place for the organization’s long-term success and sustainability,” she said.
Gamal in turn feels that the consequences of poor corporate governance are manifold. The board is not focusing on the issues that it should be, and there is a lack of accountability between the board and management. Poor governance structure, poor internal controls, ineffective risk management, and a lack of strategic vision are the direct results.
“After a downfall, boards need to analyze the root-causes of failure, assess their strategies, risk frameworks, control systems, and the top executive profile and make the necessary changes. Shareholders need to closely follow what is happening in their companies and decide if they need to make changes to their boards and committees to fix the problems.”