Financial Strategies for Distressed Companies: A Critical Analysis and Operational Tools (Contributions to Finance and Accounting) 3030657515, 9783030657512

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Contributions to Finance and Accounting

Salvatore Ferri Federica Ricci

Financial Strategies for Distressed Companies A Critical Analysis and Operational Tools

Contributions to Finance and Accounting

The book series ‘Contributions to Finance and Accounting’ features the latest research from research areas like financial management, investment, capital markets, financial institutions, FinTech and financial innovation, accounting methods and standards, reporting, and corporate governance, among others. Books published in this series are primarily monographs and edited volumes that present new research results, both theoretical and empirical, on a clearly defined topic. All books are published in print and digital formats and disseminated globally.

More information about this series at http://www.springer.com/series/16616

Salvatore Ferri • Federica Ricci

Financial Strategies for Distressed Companies A Critical Analysis and Operational Tools

Salvatore Ferri Department of Business and Economics Parthenope University of Naples Naples, Italy

Federica Ricci Department of Law and Economics of Production Activities Sapienza University of Rome Rome, Italy

ISSN 2730-6038 ISSN 2730-6046 (electronic) Contributions to Finance and Accounting ISBN 978-3-030-65751-2 ISBN 978-3-030-65752-9 (eBook) https://doi.org/10.1007/978-3-030-65752-9 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Preface

Distress management is an important challenge for firms operating in an increasingly complex and networked environment where it is impossible to precisely predict how to make the firm achieve the lost economic and financial balance. This situation has become tragically evident with the recent spread of COVID-19 whose economic crisis has drawn attention from policymakers, companies, and investors. The global environment, indeed, has improved economic potential, but also introduced new, and unpredictable, vulnerabilities: in modern global economic system, the processes are often spread across firms operating in multiple countries. To overcome these issues, according to a strategic viewpoint, managers should perceive the crisis of the firm as an opportunity rather than as a threat. In doing so, they adopt a strategic approach characterized by a new attitude aimed at competition and discontinuity over time. The distress of the firm can evolve into the cessation of the business activity or, by way of a plan, to recovery. The management should promptly identify the alerts that occur but often the causes of the crisis remain hidden even for long periods of time, manifesting suddenly and unexpectedly. In this situation, a well-planned financial strategy plays a fundamental role. The aim of this book is to provide a comprehensive framework of distressed firms, with particular focus on the recovery plan and the financial strategy to adopt. This framework highlights the main dimensions of the distressed firm management by means of a structured recovery plan that detail the financial strategy for investment decisions among uncertainty and risk. Therefore, the book enriches firm distress literature and suggests insights for scholars and provides guidelines for practitioners. We would like to acknowledge our colleagues of the University of Naples “Parthenope” and Rome “La Sapienza” for their contribution and the useful advices and suggestions. Naples, Italy Rome, Italy October 2020

Salvatore Ferri Federica Ricci

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Contents

1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Financial Strategies and the Role of Corporate Governance in Complexity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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The Role of Financial Strategy in Firms: Financing and Investment Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Corporate Crises and Strategic Recovery . . . . . . . . . . . . . . . . . . . . .

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The Recovery Plan as a Strategic-Informative Tool Between Needs and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

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Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

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Chapter 1

Introduction

The topic of complexity, meaning the difficulties of understanding and uncertainty that characterise elements of the market, is becoming increasingly important as a crucial factor for effective corporate management. Firms find themselves operating in increasingly unstable environments and dealing with much more articulated and complex phenomena. Just consider the need to manage such an unpredictable scenario as that imposed by COVID-19. The various factors that contribute to forming this situation include technological advancement, which plays a crucial role in fuelling the level of environmental complexity, proving to be an element that is likely to modify any business. Strategic management, namely the set of decisions concerning the definition and implementation of the corporate strategy, assists companies in best understanding the phenomena that cause uncertainty and complexity. In fact, it allows the firm to determine its objectives, to put together policies and plans to achieve them, to define the businesses in which to operate, the organisation that it intends to build, and the nature of the economic and non-economic advantages that it intends to give to its shareholders. A firm that adopts a strategic approach is able to exploit its unexpressed resources and potential and, as a result, to grasp new opportunities and re-launch itself. The corporate crisis manifests above all at financial, industrial and managerial level, highlighting the weaknesses of the different corporate governance systems, requiring urgent interventions to restore consensus with rigour, transparency and strategic vision, but also the assumption of more efficient structures and processes, converging at international level. In an environment characterised by such complexity, in which the phenomena are difficult to predict, rapid in manifesting and strong in intensity, it is essential to develop governance systems that are flexible and thus able to be adapted rapidly to the changing environmental conditions. The management of such complexity requires, therefore, a strategic perspective in corporate governance. Financial strategy, namely the set of choices of forms of financing, taking account of the resources available within the firm and the opportunities offered by the © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 S. Ferri, F. Ricci, Financial Strategies for Distressed Companies, Contributions to Finance and Accounting, https://doi.org/10.1007/978-3-030-65752-9_1

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1 Introduction

financial market, has become crucial for the firm, becoming much more important than in the past. Studies on financial strategy are based upon a consolidated and broad corpus of literature, yet the published material often does not focus comprehensively on financial management in complex environments and in corporate crisis situations. The firm, in fact, encounters alternating phases of success and crisis during its life. This is the context in which the different concepts of decline and crisis are inserted; the firm’s intention to recover must be directed towards this scenario, requiring a flexible approach that is able to act both on the strategic and on the organisational structure. Among the various crisis resolution tools, this work will discuss in detail and in critical key the recovery plan for the firm which will allow it to be taken from a pathological state of crisis to a physiological state of development. The crisis, in fact, presents traits and elements common to the success of the firm. The analysis of the recovery process is completed with a specific examination of financial strategy, in its role as a tool for managing uncertainty and complexity. These two factors influence the firm’s financial structure. In general, economic-financial strategies consider relationships with lenders and the necessary investment requirements to achieve or maintain the competitive advantage. There is clearly a link between the firm and the financial market, regulated by the risk-return relationship, in supporting the firm’s opportunities and investments plans. There is, in fact, a lack of structured models that explain, in a sufficiently structured manner, the resolution of the corporate crisis in complex environments, through the use of the recovery plan, by way of the strategic management of corporate finance. In that sense, our aim is to provide a global framework on financial strategy for firms operating in complex contexts, supplementing the results of previous research works. To achieve our objective, we have split the book into four chapters, indicated below: In the first chapter we have analysed financial strategies and the strategic role of governance in complex environments. We have introduced concepts of strategic management and operating management as part of corporate governance, the system of corporate strategies in conditions of uncertainty, and the evolution of finance in strategic corporate management, with particular reference to competitive economicfinancial strategies. In the second chapter we have analysed the role of financial strategy in firms. In particular, we have considered the selection of sources of financing and the assessment of investments in uncertain and complex scenarios and the main models of measuring exposure to financial risks. In the third chapter we have analysed corporate crises and strategic recovery. We have focused on the different paths of decline and on the respective economicfinancial consequences, the causes of the crisis, the strategic recovery process and financial recovery and turnaround opportunities.

1 Introduction

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In the fourth chapter we have analysed the importance of communication to the different stakeholders and the recovery plan as the document able to represent the strategic and operational actions and the respective economic and financial impacts.

Chapter 2

Financial Strategies and the Role of Corporate Governance in Complexity

2.1

The Strategic Role of Governance in Environmental Complexity

With the consensus of numerous authors, complexity can be split into an external component, concerning the turbulence of the external environment in which the firm finds itself operating, and an internal component, which refers, on the other hand, to the increasing expansion of product-customer-market combinations which complicates the internal life of the firm and has a strong impact on its internal processes (Ward and Chapman 2003; Williams 1999 Ashmos et al. 2002; Singh and Singh 2002). The increasing difficulty of understanding the different phenomena at play and the uncertainty they entail now makes the relationship between firms and the market even more complex. The quicker those phenomena occur and the greater intensity with which they develop, the more the complexity and turbulence increase for the firm. Firms must, therefore, accept that today’s greater difficulties represent a challenge for control systems which must, while realising that not everything can be covered by procedures, be able to recognise clearly the real drivers of corporate performances (Battram 1999; Dekker et al. 2011; Pich et al. 2002). The increase in complexity results from the expansion of the competitive context, the growing importance of technological components, the diversification of productions and, often, the reduction in the life cycle of many products. However, some elements clearly emerge, including: deficiencies in corporate governance and supervision systems, both internal and involving external supervisory bodies; clear shortcomings in the transparency of firms, highlighting the limits of market-oriented governance systems; the arrival of a new set of threats and opportunities that involve, in various ways, all international economic operators (Shumway 2001; Barker and Mone 1994; Chowdhury and Lang 1993). Incidentally, one of the paradoxes of the crisis lies precisely in the fact that, against significant advancements made in the corporate governance systems applied © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 S. Ferri, F. Ricci, Financial Strategies for Distressed Companies, Contributions to Finance and Accounting, https://doi.org/10.1007/978-3-030-65752-9_2

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in the main industrialised countries in this early twenty-first century, economic dynamics tend to pinpoint the governance failings. Across the world, there are actually laws and recommendations aimed at guaranteeing the effectiveness of governance and controls in the interest of company stakeholders; however, the crisis is revealing the limitations and the broad margins for improvement in place at regulatory level and, above all, in terms of corporate behaviours. Dynamic congruity between corporate structure, external environment of reference and internal subsystems leads to corporate success (Gaspary et al. 2018; Yazici 2009; Teller et al. 2012), being the strategic objective of corporate governance. The organisation of elements and relationships is not random or imposed but is the result of choices made by persons who, in their different roles, are engaged in governing the firm. Those responsible for corporate governance must interpret management unitarily, implementing an effective and efficient internal management model and, at the same time, a balanced relationship with the different stakeholders. The system of risks originates from the dyscrasia that connotes changes in the environment with respect to those of the firm itself. In fact, the firm is faced with two alternatives: project itself to the future in order to attempt to trigger or anticipate external changes or await signs of the same in order to react. In both cases, the choices may turn out to be wrong, on one side, due to inaccurate forecasts and, on the other, due to late adjustment mechanisms. Corporate governance, which can be defined as the set of responsibilities and practices exercised by the board of directors and by company management which characterises the strategic guidance, guarantees the achievement of objectives, ensures that risks are managed appropriately and verifies that resources are used responsibly. The need to develop flexible governance systems has been pointed out not only by numerous researchers but also by various professional bodies. The governance body, in fact, through the many separate strategies for each perspective (internal, external and boundary) operates by monitoring external factors and organising internal capabilities and competencies in order to produce a competitive advantage overcoming difficulties and avoiding all possible crisis situations. The corporate structure, both in its organisational and operational component, is not open to change; rather, it leans towards stability, emphasising the difficulties of management in periods characterised by extreme environmental dynamicity. The possible inadequacy of corporate structures ultimately has an effect across the entire risk system, threatening economic prospects. Crisis situations can, in fact, endanger the future profitability, growth and survival of an organisation (Altman 1984; Baldwin and Scott 1983; Trahms et al. 2013) if the corporate governance does not decide to act quickly and promptly to return the company to a situation of balance. Crisis situations can be defined as specific, unexpected, non-routine events or series of events that create high levels of uncertainty and a significant or perceived threat to high priority goals (Seeger et al. 2003) or also as an unpredictable major threat which might produce negative effects and harm organisational legitimacy and reputation if it is improperly handled (Anderson

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1999; Barney and Griffin 1992; Berry 2010; Hoskisson et al. 1993). These are just some of the definitions found in literature linked to the governance action aimed at implementing all necessary measures to distance the firm from crisis situations by defining its overall unitary strategic design in which the different strategies come together as inseparable parts of the organic system of corporate strategies (Coda 2008). As crises are considered to be unusual events that threaten underlying structures, introduce strong uncertainty and impose time pressure in the decisionmaking process, the firm should implement strategic planning in order to respond to threats and opportunities deriving from the increasingly dynamic and complex environment, as well as support a certain strategic approach in which corporate management is seen as change management in a very unstable context, characterised by strong competition and discontinuity (Remington and Pollack 2016; Anderson 1999; Saunders et al. 2015). In general, during processes of decline and crisis, firms lose some of the requirements that characterise their normal existence. A firm prospers over time if it is able to operate in conditions of economic and financial balance. Only the existence of those balances gives the firm the characteristics of cost-effectiveness, durability and autonomy that it requires. In the writer’s opinion, decline and crisis situations can be defined as situations in which the firm loses at least one of its two fundamental balances. In that context, therefore, a crisis can be defined as a loss of economic and/or financial balance (Guatri 1995) which, if it has not already become irremediable (, can generally be resolved through profound strategic changes (Datta et al. 2010; Scherrer 2003; Trahms et al. 2013; Garzella 2005) that avoid the destruction of value over time (Guatri 1995) as the long-term outcome due mainly to incorrect corporate decisions and the harmful effects of environmental factors that slowly and negatively corroded the corporate system, interrupting its purpose and objectives and leading to its disintegration. Economic balance refers, by definition, to the medium-long term with regard to the firm’s capacity to produce profit for the shareholders at least equal to the opportunity cost of equity capital (Botosan and Plumlee 2002; Sherris 2006; Arrfelt et al. 2013), while financial balance requires an optimal relationship between total cash flow and business development, as well as a financial structure able to maximise the firm’s value. In practice, a permanent economic balance, being a necessary condition for the firm to continue, tends to strengthen its position in terms of competitive advantage strategically over time, by shaping the economic and financial advantage and satisfying the conditions for success (Raz and Michael 2001; Fortune and White 2006; Ibbs and Kwak 2000). Profitability, growth, advantageous market position and capacity of the firm to deal with competitive challenges are the four dimensions that define success, which finds in a unique and original strategic formula the key ally allowing the firm to renew itself over time and hold a level of qualitative-quantitative superiority over its competitors on the relevant market (Matzler et al. 2010; Shenhar and Dvir 2007; Kieser and Nicolai 2005). In business studies, the concept of success is often used to refer to a firm’s financial performance. However, there is no universally accepted definition of success, as it has been subject to numerous interpretations (Yazici 2009; Slatter

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1984; Cooke-Davies 2002). The interpretation adopted in this work define success as an inter-functional phenomenon with progressive action and capacity of growth directly linked to the systematic level of the firm (Bertini 1995). That perspective reveals the qualifying elements of success, namely the long-term outlook of the economic entity; the ‘vitality’ of its equity capital; its management quality; the systematic nature and flexibility of the organisation and the strategic orientation of management (Bredillet 2007; Müller and Turner 2007; Christenson and Walker 2008). They are closely interconnected with the multiple strategies chosen by corporate governance, which, being responsible for the firm’s success and development, must consider the complex scenario in which it operates—characterised by uncertainty and volatility—in order to achieve competitive superiority, which can be transformed into a strategic advantage, materialising in economic and financial results. The awareness of how and where a strategic advantage is created is fundamentally important to the strategic design. That advantage, by its nature, can be attributed to corporate activities and to the chain or constellation of values into which the firm’s structure is split. In fact, an advantage can be generated: – at business level, along the value chain; – at corporate level; – in the connections between several value chains of the same firm or with other companies (Invernizzi 2004; Collis et al. 2012). Therefore, having full knowledge of critical success factors as combinations of activities and processes that must be designed to achieve outcomes specified in the company’s objectives or goals, once again draws attention to the role of the governance body, capable of defining the succession of winning strategies on which the firm’s lasting and not ephemeral success depends (Chapman and Ward 2003; Johnson and Broms 2000; Bertini 1995). As the majority of firms encounter a crisis sooner or later, the role of governance becomes even more significant in terms of strategic decisions. In light of those considerations, corporate governance must, from time to time, continuously adapt the strategic models in place, constantly updating them. Once the winning strategies have been identified and implemented, the virtuous spiral spreads across all corporate functions and all organisational levels, infiltrating the firm as a whole (systemic perspective). The corporate phenomenon described as a system of parts joined together in a functional and vital whole is mentioned by Bertini (1990) who illustrates in detail the crucial aspects that define the framework in which the corporate system is inserted. The scholar expressly refers to the general theory of systems and repeatedly highlights the concept of dynamicity that emerges predominantly from the theory of systems; in fact, it is dynamic balance that explains the different phenomena in terms of interaction of their vital processes. The firm’s systemic thinking has had a significant influence in studies, representing an evolution of the historical method with which the firm was defined in strategic terms. The progressive horizontal action by which success spreads out across all functions non-simultaneously stands alongside the progressive vertical action according to which success cannot be identified in momentary situations, but must be seen as a

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phenomenon of economic growth over time (Jugdev and Thomas 2002; Patanakul and Shenhar 2012; Bertini 1995); hence, strategic management should not be considered an occasional or episodic activity. The growing environmental dynamic, the greater competition between firms and the emergence of innovative elements represent the underlying reasons that require a firm constantly to rethink its strategy. The progressive action over time thus materialises through the capacity to renew the culture that pervades the organisation, guiding it towards the change necessary to offer an adequate response to the continuous increase in environmental complexity (Qureshi and Kang 2015; Stacey 1995). What approach, then, should be taken in the face of that environmental complexity? In this context, the firm always finds itself faced with a system of specific risks that lead to the possibility of it not being able to remunerate adequately the resources and factors used (general economic risk) (Ramasesh and Browning 2014; Remington and Pollack 2016; Rouse and Daellenbach 1999). Faced with the system of risks, a firm has three different response options, entailing three different methods of action: 1. adopt a passive approach, by which the firm awaits changes in the environment and adapts to them once they have occurred; 2. adopt a reactive approach, by which the firm makes decisions able to influence the environment; 3. adopt an anticipatory or forward-looking approach, acting as an engine for change. In fact, the aim is to pre-empt environmental changes by anticipating them and developing corrective measures.

2.2

Strategic Management and Operational Management: Corporate Governance

In the systemic management unit, ideas, decisions, and operations can also be assigned to two different sub-systems belonging, respectively, to strategic management and day-to-day management. The role of strategic management, both in the policy phase and in the implementation phase, is to define the firm-environment interaction model, its main characteristics and the material and organisational structure likely to provide the best support to this process (Normann 1987). Strategic management can be attributed to ideas, decisions and actions aimed at defining, creating and directly modifying the structural system of operating conditions internal and external to the firm. Winning ideas must be transformed into coherent and profitable decisions and actions that guide change processes to make a transition from a state of equilibrium to a new state, characterised by more favourable competitive, economic and financial prospects than those of the market competition. Therefore, strategy—seen overall—defines the specific characteristics of the firm, its strengths and weaknesses and the opportunities and threats relating to it. It also determines its fundamental goals and long-term objectives (Chandler 1962) through

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the process of creative rationalisation, an essential condition of the strategic approach (Bertini 1995; Mintzberg 1998; Kahneman et al. 2011). In that regard, it is worth identifying the characteristics that define management as strategic, namely those characteristics that allow it to be classified as such and to differentiate it from day-to-day management. Those requirements are listed below: • structural impact, as the strategy determines the firm’s internal structure and its structured relationships with the environment; • change, as the strategy is based on innovation, on structural changes in the firm’s economy; • reference to long-term sustainability, as strategic activities often take some time to be implemented and to produce their economic effects; • impact on resources, as a structural change presupposes that a firm’s tangible and intangible assets undergo significant changes following the process of formation, acquisition and development of critical and distinctive resources seen as an important contribution to the firm’s success and overall competitiveness; • the reference to the firm in its entirety, as ideas, decisions and strategic actions, even those specific to areas, are significant due to their overall structural impact; they take on form and meaning only in a unified vision of the corporate phenomenon; • a cause-effect relationship with the firm’s success and development. The reasons for a firm’s success (or lack of success) and the fundamental stages that characterise its development path can be understood by observing the fundamental strategic decisions it makes. The link formed between strategy and change thus becomes so inseparable as to allow strategy to be defined as a governance action entailing significant changes, namely radical changes to the system of internal and external relationships, usually stable, that characterise the firm, implementing the conditions for a “leap of state” (Danovi and Gilardoni 2000). Unlike strategic management, day-to-day management involves the convenient use of a structured system of operating/competitive conditions. Day-to-day decisions and actions, unlike strategic ones, focus on the existing material and organisational structure and the interaction model with the environment that characterises the firm in this phase of its life in order to work in conditions of utmost efficiency (Khanna and Tice 2001; Winter and Szulanski 2001; Chatain and Meyer-Doyle 2017). The structure represents the relationship between strategic and day-to-day management, being the result of the former and the premise of the latter. Strategic governance can therefore be seen as the transformation process of the firm’s subjective factors into a structural system of objective operating/competitive conditions on which to base the production activity and the exchange of relationships with the environment. Both the structured interaction of the firm with the environment of reference and the internal structure that supports such interaction play a fundamental role in strategic management. Therefore, it can be said that a firm’s development and success depend jointly on the efficiency of its internal operating processes (production, sale, research and development, administration,

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etc.) and on the effectiveness of its structured relationships with the outside world (customers, suppliers, competitors, lenders, etc.). In that sense, strategy reveals its dual role in management activity, as a model for seeking economic balance in internal operating processes and as a coordinator of relationships of exchange with the external environment. A logical path in which it indicates the different activities characteristic of a continuous and circular strategic process (Turner 1999; Ibbs and Kwak 2000; Shenhar and Dvir 2007). Those activities concern: • strategic diagnosis, which includes the analysis of the strategy implemented and in place, with a view to outlining the firm’s strategic problems; • generation of strategic alternatives, separately for each strategy and for the overall design; namely, a series of possible strategic alternatives are formulated with a view to achieving a competitive advantage in terms of value creation; • assessment and choice of alternatives based upon specifically established criteria; in this phase, the situational analysis and the economic and financial forecasts are assessed; • strategy implementation, by commencing the structural actions of change that this involves. A series of tactical choices are made that facilitate the achievement of the strategic objectives; • strategic control, split into all those activities which verify the achievement of the strategic objectives and validate the hypotheses assumed. This is a monitoring action which is able to ascertain the effectiveness of the strategy implemented. The strategic process occurs in conditions of informative uncertainty, given the internal and external relationships and the qualitative and quantitative variables at play. That process, split into logical-sequential phases ranging from the formulation of the strategy to its implementation, and going so far as control, is emergent in nature, as the ideas and strategies are formed and modified as a result of a spontaneous learning process based upon a specific operational development and guided by unexpected external and internal factors of the firm. The notion of emergent strategy was consequently developed by several authors (Mintzberg 1988; Balogun and Johnson 2005; Spender 2014). That approach highlights how the emergent decision-making process is based upon reactive organisational behaviour and on adaptive organisational learning (Senge et al. 1999). Learning expands the possible actions that a firm may take in every function of the value chain but requires a large amount of information (Osland and Yaprak 1995). In fact, strategic management increases the firm’s informative requirement, demanding a true strategic intelligence system, namely a system of analysis and collection of knowledge required for strategic management (Galeotti 2009). Although nowadays the majority of corporate information systems are oriented towards strategic analysis, many strategic decisions are made in situations of informative asymmetry, essentially due to the presence of an approximated and incomplete informative framework as a result of the excessive costs and timescales involved in receiving information. The acknowledgement that information is imperfect, costly, distributed asymmetrically and influenced by strategic behaviours of agents has provided some explanations of economic and social phenomena that

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would otherwise have been difficult to understand (Kale et al. 2000; Kaplan and Henderson 2005; Lippman and Rumelt 2003). Therefore, on that premise, it follows that the firm operates in the market of reference despite not having a complete cognitive framework. So how can the governance body make successful strategic decisions? The role and reactivity of corporate governance is able, through intuition, originality and creativity, to make adequate strategic decisions. Several leading figures in the organisation are involved in the entire strategic process, from the board of directors and the chief executive officer to senior persons in the managerial techno-structure (general manager, heads of division, area managers), to functional senior management (CFO, head of marketing, production manager, head of R&D) and staff bodies such as planning. Having identified the figures that contribute to strategic governance processes, the moments at which they occur must then be defined. In actual fact, those moments are more suitably configured as stages of progress of the strategic process which are interconnected; in fact, each of them interferes with the others, influencing them and being influenced by them (Karim and Capron 2016; Lovallo and Sibony 2010; Menon and Yao 2017). In that regard, we can distinguish: a. the system of strategic ideas that acts as a conceptual network for defining the strategy in place; b. the strategy in place which refers to the question: What does the firm intend to become? c. the current strategic profile (or strategy implemented) which answers, on the other hand, the question: What is the firm currently? In particular: a. The system of strategic ideas is constituted by representations of corporate phenomena developed and shared by the key players (Dranikoff et al. 2002; Bertini 1995; Sakhartov and Folta 2015). This is a sort of thinking process that allows the economic entity to carry out dual reasoning which involves, on one side, internal and external developments that can, in some way, be identified and ordered and, on the other side, the selection and controlling of the business strategies. The ideas in question become coherent and systematic in the overall strategic design which stimulates, fuels and guides the inter-subjective dialectic that develops within the firm in formulating policy guidelines and making management choices (Walter and Barney 1990; Folta et al. 2016). The value of strategic ideas in corporate governance is determined by their quality and, in particular, by their capacity to develop creatively (Bertini 1995), in line with the evolution of the environmental system (Coda 2008), creating opportune business learning processes. Such decisions are intended to make this project concrete and thus to introduce or modify the firm/environment interaction process and the material-organisational structure in support of this process. The transformation process of a system of business ideas into a system of actions takes place gradually, with the time factor playing a crucial role (Porter

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1987; Puranam and Vanneste 2016; Teece et al. 1997). It is equally crucial to understand the criticalities that such a moment brings with it. In that sense, one of the main problems lies in the difficulty of communicating the strategic plan to employees and collaborators, who have not participated in preparing it, causing the subsequent stage of progress represented by implementation to be somewhat complex. b. With respect to the system of ideas, the strategy in place arises as a logically subsequent stage (Coda 2008). Putting a strategy into place means implementing it and making it explicit, namely doing everything necessary to achieve the objectives defined in the previous phase. It requires a rationalisation phase in which ideas are translated into concrete operating guidelines which, after discussion, are transformed into action models that are, in turn, formalised in plans and programmes. It entails practical problems, including communication difficulties and medium-low management skill levels. Although in literature, there is an imbalance between the apparent importance of formulation and implementation (Okumus 2003; Otley 1999; Beer and Eisenstat 2000), implementation sometimes presents weaknesses essentially linked to the failure to execute the strategies devised by the organisation, as well as the underestimation of the time necessary to implement the system of ideas; as a result, due attention must be paid during the planning stage (Alexander 1985; Mintzberg 1994). Having defined the problems linked to these two phases, we can focus on their implementation methods which, for both, can be implicit and explicit depending on the awareness or otherwise of strategic management, namely depending on whether or not strategic management assumes—in the specific corporate situation—the nature of an informed process, in which the moment of formulation and the consequent moment of implementation can be identified separately. c. Finally, the current strategic profile consists of the structural system of operational/competitive conditions that characterise the firm at a given time in its life, defining its actual methods of functioning (Nickerson and Argyres 2018). That real system is incorporated in the internal tangible and intangible structure, as well as in the structured external relationships; as such, it delineates the qualitative and quantitative contours of day-to-day management. The current strategic profile coincides with the concept of strategic formula, which is defined by the state assumed by a set of aggregated and coordinated variables, as clarified in more detail below. The current strategic profile, substantially, summarises the firm’s history and its real identity and identifies its level of strategic development. In order for the strategic formula in place (strategy implemented) to keep its economic potential unchanged, it must evolve incrementally. Hence, change, as an innovation process of the productive combination, becomes a response to the continuous dynamicity of the competitive and environmental context. Corporate governance will, therefore, be oriented more towards change management than to continuity management. It is change that allows firms to grasp the opportunities for success that are hiding in new business designs (Hayward and Shimizu 2006; Helfat and Eisenhardt 2004; Fiorentino 2011), but only if it assumes strategic value. As a consequence, it is increasingly important for firms to modify and

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revitalise their productive combination frequently, radically innovating its contents, as the leadership “of today” does not automatically create the leadership “of tomorrow” due to continuous changes in the internal and external environment (Mintzberg et al. 2005). In this new world order, it is becoming increasingly important to implement a successful strategy. In fact, the system of strategic ideas, as a method of reasoning or a conceptual network that oversees management processes, comes to play a primary propulsive role, becoming the essential foundation of the firm’s strategic governance (Fortune and White 2006; Chapman and Ward 2003; Christenson and Walker 2008). While the structural system of operating/competitive conditions constitutes a crucial factor for the firm’s prospective economic success, the human system has an equally profound effect on its future, being a bearer of ideas—thus decisions and operations—that are inserted into those conditions, modifying and improving them. The interest in human capital as a strategic resource arose during the development of the Resource Based View (RBV, which will be analysed in the paragraphs below) in strategic management (Boon et al. 2017) contributing and generating value within the firm and greater net economic benefits compared to the competition. The human system is not, however, the only one present in the internal structural context; in fact, the latter includes all tangible and intangible elements that characterise the firm, in a relatively stable manner, and that form the set of operating conditions capable of differentiating the individual firm, placing it in a situation of advantage and guaranteeing that it has a dominant role in a given competitive field. In fact, it is precisely the coordination activity of resources, people and capital in a firm that allows for its objectives to be pursued. From this profile, the significant elements on the strategic level are attributable to: • resources, whether tangible or intangible. In a strategic perspective, they are often considered systemic, i.e. strongly dependent on other resources in order to function correctly (Andersén 2011); • value-generating activities which allow the firm to achieve competitive superiority. Accordingly, a dual analysis perspective ensues, in terms of strategic significance. The first perspective is linked to the value creation process and the second relates to the physical-technical transformation process of production factors into products. For value-generating activities, we refer to the contributions offered by Porter (1982) on the value chain. More specifically, the author highlighted that the physical-technical process, from the design to the sale and assistance of a given product, representing activities performed in a certain strategic business area, can be analysed through the value chain; • organisational structure meaning the structure through which decisions on division, ordering and coordination of work, closely related to strategy, are made; it must not only function but also allow for the strategic objectives to be pursued (Gabrielsson and Winlund 2000); • governance system defined as an articulated set of rules, relationships, roles and functions that links the shareholders and the other company stakeholders, contributing to determining the structure and functioning of firms. It has been widely

2.3 The System of Corporate Strategies in Conditions of Uncertainty: Positioning of . . .

15

analysed in literature by virtue of the relationship of coherence that exists between governance mechanisms and corporate strategy. The literature of reference has emphasised, through various empirical research works, the relationship between strategy and governance. More specifically, studies have analysed the role of the board of directors, highlighting how the board’s level of independence influences the possible strategic choices (Baysinger and Hoskisson 1990; Westphal and Bednar 2005). The topic will be discussed and developed later.

2.3

The System of Corporate Strategies in Conditions of Uncertainty: Positioning of the Firm in the Economic-Social System

In the environment in which it operates, the firm, by carrying out the economicsocial functions that are the purpose of its operations, establishes itself as an institution destined to last over time, to survive, not in static conditions or crystallised in a stationary and repetitive balance (Capron et al. 2001; Belderbos et al. 2014) but in dynamic conditions. The concept of dynamicity, arising on numerous occasions, is linked to decline and crisis situations in which firms may find themselves—due to conditions of uncertainty—in strongly variable contexts, forcing governance bodies continuously to review the decisions they have made. This is precisely why scholars and the different legal systems have combined the static definition of insolvency with the dynamic definition of business crisis, due to the persistence of conditions of uncertainty and change prevalent in today’s global market. The company’s dialectic with the environment is expressed in a way that is anything but predictable, such that the corporate system corresponds to a symmetrical system of risks precisely to emphasise that every idea, every decision and every action encompasses the possibility of error or the possibility of damaging the firm’s economic success. To respond to these uncertainties, the corporate strategy system must be sufficiently flexible as to be adapted to the reactions of competitors, suppliers, employees and others, both inside and outside the organisation (McClell 1994). As a result, strategic governance must be analysed in more detail; it is split into three different perspectives: • external relationships with the environment; • internal company structure; • the boundary area between inside and outside. In particular, strategic governance addresses three separate external fronts: the real markets, the financial markets and the social context, with multiple subjects such as: resources, assets, organisation, governance system, intra-sector competition, extra-sector competition, financial competition, social responsibilities; and it spreads across several organisational levels, ordered hierarchically: the corporate level of the

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Fig. 2.1 The strategic formula of the firm. *Source: Adaptation from De Luca et al. (2017)

firm as a whole and that of the individual Strategic Business Units (SBU) into which the same is subdivided. Given that strategies involve the entire firm as a whole, we will analyse individually the different strategies in relation to the particular perspective to offer a broader overview of the strategic possibilities that may be implemented by a firm in response to increasing environmental instability. The strategies aimed externally, defined as positioning (Porter 1985), have a precise purpose: to define and strengthen the firm’s role in the various environmental contexts in which it is inserted. To answer the question “in which business or in which businesses do you want to compete?”, the company can choose (Fig. 2.1): 1. a business strategy (competitive strategy) or a multi-business strategy, as appropriate; 2. a financial strategy. The financial strategy is a choice of positioning through which current financial means are exchanged with future cash flows; however, as these flows are only probable, the confidence that the firm is able to acquire on the capital market becomes significant (Teece et al. 1994; Dranikoff et al. 2002; Folta et al. 2016). In this work, financial strategy will be interpreted in the dual meaning of the term: as an external strategy, or positioning on the capital market, and an internal strategy aimed at seeking the optimal capital-financial structure in which investment and financing decisions are balanced; 3. a social strategy. The overall strategic design must include ideas, decisions and operations aimed at achieving a positive social positioning for the firm. In parallel to external strategies, there are strategies with an internal focus which are essentially structural strategies in the sense that they are aimed at defining the firm’s support structure. In this sense, the following strategies can be identified:

2.3 The System of Corporate Strategies in Conditions of Uncertainty: Positioning of . . .

a) b) c) d)

17

the strategy of resources; the strategy of operations; the organisational strategy; the governance strategy.

At a more in-depth level, the individual strategies, both of positioning (external perspective) and structure (internal perspective) can be examined in detail (Nickerson and Argyres 2018; Puranam and Vanneste 2016; Sakhartov and Folta 2015). In particular, the first category includes business strategy, with which the firm illustrates the subject of the competition and delimits the competitive scope in which it works or intends to work. The business strategy is aimed at defining the competitive positioning in the individual sector, as the business is often identified with the industrial sector or with the market. In fact, the reference to the sector/market or to segments is not sufficient to define the competitive strategy, as the sector, on one side, is positioned at an aggregation level that is too high, incorporating heterogeneous elements, while, on the other side, the segments, despite being homogeneous between them, are incapable—by default—of fully comprehending the economic field in which competition between firms develops. To fully understand the limits involved in making recourse to the concept of sector and of market, we must first take a step backwards and clarify the definition of those terms. Industrial sector means the portion of the economic system in which demand and supply meet; similar firms operate in the sector, producing similar goods and being interdependent between them. Industrial sectors are often not uniform and are classified by the presence of segments constituted by homogenous groups of customers, not homogeneous to other segments. Each segment, in relation to its specific aspects, is likely to constitute an autonomous market objective for the firm, forming a relatively independent competitive system to be controlled with a specific strategy. This sector segmentation plays a central role in delimiting the competitive scope, constituting, on one side, the basis for defining the focus strategies and, on the other, an essential element of knowledge for applying broad spectrum strategies, highlighting segments that may be attacked by focused companies and less attractive segments that may be abandoned. With regard, on the other hand, to the concept of market, this is similar to that of sector, although it attributes greater significance to the identification criterion based upon demand (Kaplow 2010; Bergh and Lim 2008; Cassiman and Veugelers 2006). Based upon these limits, a different elementary unit of reference has been identified for the strategic analysis: the Strategic Business Area (SBA), meaning a portion of the industrial sector that can be defined in terms of its product/market/ technology combination, characterised by strategic and operational autonomy. It identifies the firm’s business and presents itself as a relatively homogeneous and unitary whole and thus as a unit of synthesis and responsibility with its own economic-financial structure. The concept of SBA plays a primary role in strategic analysis as it facilitates the full correspondence between the firm’s scope and its competitive strategy; in addition, in the case of a multi-business firm, it allows the sub-units of the corporate organisation, in charge of managing the competitive

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processes, to emerge. In general terms, therefore, the SBA represents a significant step for the improvement of strategic corporate governance (Invernizzi 2004). The SBA theory was developed based upon the observation that the firm’s competitive space is identified through the combination of three different dimensions (Abell 2006): 1. function of use, meaning customer needs that will be met; 2. groups of customers, meaning customer groups that will be served; 3. technologies, namely technology that will satisfy the needs. In that way, SBAs come to be seen as a combination of technology, product and market, characterised by a sufficient level of strategic autonomy and by a sufficient dimension in terms of business turnover. At organisational level, an SBU, which is structured based upon the relevant business, corresponds to one or more SBAs. Another strategy relating to the firm’s positioning is the multi-business strategy which refers to the concept of synergies. Synergy is usually defined in terms of cost, as “potential cost savings arising from economies of scale or scope” (Besanko et al. 2000), and in terms of value creation as super-additivity in valuation of business combinations (Davis and Thomas 1993). It follows that the corporate system has a higher value by virtue of the interrelations that characterise its main processes and its main strategic areas, as opposed to the value of the sum of the individual elements considered atomistically (Garzella 2000; Zappa 1937). The higher business value arising from it explains why the search for synergy is at the centre of corporate strategy in the multi-business firm. Another important strategy to be analysed, then, is the financial strategy aimed at defining the firm’s financial positioning on the capital market. The financial market is a highly competitive system to which it is worth applying strategic analysis models developed for the real markets and focused on concepts of increased competition, industry attractiveness and competitive advantage (Porter 1982). In applying those analysis models to the financial sector, the fundamental action lines for achieving advantageous economic-competitive conditions can be positioned more clearly. The focus then turns to the expectations of lenders and shareholders, particularly those who remain external to corporate governance and see the firm as a financial investment opportunity. The investor’s perspective in corporate management is thus affirmed; this means that the firm is judged and assessed in its performances from the perspective of the capital market, based upon its capacity to meet expectations in terms of risks and returns. Therefore, to satisfy the expectations of lenders and to guarantee financial stability, firms must critically assess their corporate processes and review their business development models (Allegret et al. 2016). Given the aim pursued by financial strategy, namely to guarantee profitability and financial stability and to maximise the firm’s value through the effective and efficient use of financial resources and the capital structure, through financial and technical methods and leverage, financial strategy contributes to making the firm competitive (Wang 2007; Follmer and Schied 2002). More specifically, the firm must no longer only express its competitiveness on the real product markets but also on the capital

2.4 The System of Corporate Strategies in Conditions of Uncertainty: The Firm’s. . .

19

market. Therefore, it must be able to attract and retain capital (both equity and financing) putting itself forward as a convenient investment opportunity from the profile of the risk/return combination compared to other alternative forms of financial investment (Billett and Mauer 2003; Kaplow 2013; Galeotti 2008). In conditions of uncertainty, it increasingly assumes the value of an action plan associated with the risk for achieving long-term objectives by way of formation, coordination, distribution and use of the firm’s financial resources (Mitra et al. 2015). The topic will be discussed in more detail in the paragraphs below. Finally, the last strategy of the external perspective to be analysed is the social strategy aimed at obtaining the consent of the various social stakeholders in order to achieve and maintain a certain positioning in the environment in which it operates. The consent of the firm’s stakeholders is reflected in the company reputation and in its consequent success in terms of positioning. More specifically, strategic social positioning arises in the face of the firm’s differentiation compared to its competitors with reference to social issues. Given that obtaining social consent and creating value in a highly unstable competitive market environment is difficult and costly, the governance action must be focused upon the capabilities that play an important role in the development and execution of non-market strategies (Miller 1987; Baysinger 1984). There are multiple studies in doctrine on the topic which propose different types of social strategies (Griffin and Mahon 1997; Margolis and Walsh 2001; McWilliams and Siegel 2001; Orlitzky et al. 2003). Given that social responsibility goes way beyond satisfying the applicable legal obligations, investments must be made in human capital, in the environment and in relationships with other stakeholders, as a strong social commitment—as broadly demonstrated in literature—has positive repercussions in terms of profit and better market assessment. Therefore, social strategy, using the firm’s resources and capacities, aims to satisfy social objectives and financial performance objectives. In brief, it strives to satisfy the dual need to promote a social asset and to create value in excess of that of other available projects.

2.4

The System of Corporate Strategies in Conditions of Uncertainty: The Firm’s Structural Strategic Framework

Having defined strategies from the external perspective, we note a different analysis perspective to the vision of positioning, on the assumption that market activity is based upon the firm’s internal resources (Barney 1991; Wernerfelt 1984) and therefore we analyse the strategy of resources which uses the RBV as the analysis perspective. The Resource Based View attributes major importance to intangible, tacit, complex and socially incorporated resources as the main sources of superior and sustainable corporate performances. Over time, this has moved from an analysis aimed at identifying an attractive environment in which to penetrate to the analysis

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of the firm’s internal factors to the formulation of the RBV according to which existing resources and competences represent the driving forces of strategy. That study perspective focuses on factors internal to the firm, such as the availability of resources in quantitative and qualitative terms, its distinctive competences, and its organisational structure and cost structure, considered fundamental to acquire and maintain a sustainable competitive advantage and to select, as a result, the competitive field in which to assume a certain position. The firm is seen as a heterogeneous set of resources and competences representing the basis for achieving a competitive advantage; in that sense, the RBV is not intended to be a theory of the firm’s structure and conduct but aims to explain and forecast the reasons why some enterprises achieve positions of competitive advantage (Grant 1996). That line of studies has contributed to defining resources and capacities as “bundles of tangible and intangible assets, including the capabilities of corporate management, its processes, organisational routines, information and knowledge that it controls” (Barney et al. 2011) which can be used to help firms to choose and implement strategies. Important spin-off perspectives have arisen from it, in particular, the knowledge-based vision, the natural resources-based vision (NRBV) of the firm (Hart 1995) and the dynamic capabilities-based vision (Teece et al. 1997). That definition is not unique; in fact, in literature there are different definitions of resources. In our work, we will use the concept of resources that analyses the tangible and intangible factors present in the firm that can potentially contribute an economic advantage (Galbreath 2005). This happens if the resources cannot be readily obtained on the factor markets or cannot be easily imitated by competitors. Otherwise, they do not represent a significant source of economic advantage (Patanakul and Shenhar 2012; Michalisin et al. 1997). An analysis of the resources and capabilities possessed assists the firm in understanding its possibility of grasping business opportunities that arise on the market. The decision-making process suggested by the RBV can, therefore, be summarised in the following phases: 1. identification of the firm’s distinctive resources and capabilities; 2. searches of the market in which those resources and capabilities can be exploited; 3. formulation of strategies to achieve a position of competitive advantage. The RBV is based on the presupposition that every firm is different from the others precisely due to the combination of the specific resources it owns, and which are difficult to imitate. This difference between firms represents precisely the strategic lever on which to seek a competitive advantage, as that position cannot be achieved by the formulation and implementation of a strategy based upon the imitating behaviour of competitors. Resources and capabilities are, therefore, the foundation on which to formulate a strategy as they indicate its direction and constitute the primary source on which to create value. Resources represent observable, exchangeable assets with high added value through which firms create products and provide services for their customers. The resources to which exponents of the RBV refer are considered to be a set of assets, capabilities, organisational processes, attributes, information and knowledge, controlled by a firm, which allow it to devise and implement strategies to improve its efficiency and effectiveness.

2.4 The System of Corporate Strategies in Conditions of Uncertainty: The Firm’s. . .

21

Again from the internal perspective, we then find the strategy of operations which includes all those decisions aimed at structurally defining the activities that should be carried out by the firm and those that should be left to other firms, how they should be split into operational processes, the links that should exist between the various activities and how they should be integrated and coordinated systematically, between each other and with respect to those executed outside the firm. For a strategy to be effective it must not only be appropriate (i.e., be well-fitted to its competitive environment) but it also must be communicated and widely understood throughout the organisation (Boyer and McDermott 1999). The strategy of operations thus materialises in the systematic model of decisions, relating to operational activities, made by a firm. Those decisions may be the foundation for the firm’s success when they contribute to the acquisition of a competitive advantage by allowing the current activities to be carried out more effectively and/or efficiently than competitors. It also has a positive impact on corporate performance (Patanakul and Shenhar 2012; Yazici 2009; Kieser and Nicolai 2005). A competitive strategy based upon operations can be considered a critical factor for the firm’s success as it focuses on the strategic significance of two complementary approaches: the first relating to the value creation process and the second relating to the physical-technical process of transforming production factors into products (Raz and Michael 2001). In literature, many authors claim that superior operating excellence is not only useful for strengthening the firm’s existing competitive position but above all it can help the firm to achieve a sustainable competitive advantage, being based upon operating capacities that are incorporated in the firm’s resources and processes, thus being intrinsically difficult for the firm’s competitors to imitate (Barney and Griffin 1992; Peters and Waterman 2004). On the other hand, on the current real markets, there has been a rapid increase in activities which were traditionally carried out internal to firms being implemented via outsourcing processes. At the same time, firms have access, through the use of Enterprise Resource Planning (ERP) systems, to an increasing amount of information on corporate processes. The increasing popularity of the internet creates new interaction methods between firms and between firms and customers. The introduction of new management models and new technologies improves the efficiency of corporate processes. Competition on a global scale, on one side, increases the level of competition between firms and, on the other, offers new opportunities to seek production efficiency and flexibility (Jugdev and Thomas 2002; Bredillet 2007; Müller and Turner 2007). The search for operating effectiveness and efficiency, however, is not sufficient to guarantee a competitive advantage. The firm’s success depends strongly upon the conduct of its operating activities in conditions of competitive superiority. That superiority may derive from a different method of performing the operating activities and/or from the capacity to identify and implement different operating activities compared to the competition. In that sense, the configuration of the processes and activities becomes significant in the strategic governance of the firm and not in its day-to-day management, so much so that the

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strategy of operations assumes autonomous significance on the internal side (Coda 2008). The organisational strategy is another internal strategy that refers to the choices relating to the organisational structure; it influences the overall structural framework internal to the firm. Internal structural framework means the set of all tangible and intangible elements that characterise the firm in a relatively stable manner and that form the set of operating conditions capable of differentiating the individual firm. The strategy-structure alignment is justified by the fact that the defined strategic objectives cannot be achieved without an adequate internal structural framework. In fact, in agreement with Miller (1988), we believe that specific structural characteristics actually influence performance. It follows that the organisational strategy requires due attention from the governance body, even more so when the firm is operating in conditions of uncertainty. It must then be ascertained which structural dimensions and strategies must be present in order for the firm to achieve high performance levels (Zeffane 1989). There is no optimal organisational structure; therefore, each firm must seek a solution that is as adequate as possible to the competitive advantage pursued. The relationship between strategy and organisational structure has been the subject of many studies and can be analysed and constructed by following different schemes of reference. The three main approaches can be summarised as follows: linear or classic, interdependent, and evolutionary. According to the linear or classic model, the organisational structure must be coherent with the strategic choices made. Based upon that position, once the strategy has been developed, the firm must design an organisational structure that allows it to be implemented, to guarantee its economic success. The strategy therefore precedes the organisation and indirectly determines variables such as the tasks of the organisation, the technology and the environments, and each of these elements, in turn, influences the organisation structure. This type of linear relationship generated the strategy-structure paradigm, in which the organisational problem is contained in the structure. That situation appears to be found, in real terms, mostly in new firms, in which managers have the privilege of being able to develop a strategy only then to establish the strategic structure. A model of this type, on the other hand, demonstrates clear limitations in more turbulent and complex situations. In fact, in Chandler’s model, managers make rational decisions: the structure and organisational mechanisms are instrumental to the objectives, assuming the existence of a stable environment. The interdependent model, on the other hand, assumes a reciprocal influence between strategy and organisational structure. According to this approach, the organisational problem should not only be considered when implementing the strategy, but it comes into play as early as when formulating the strategy itself. Consequently, the organisational structure can be said to be an integral part of the strategy (Grant 1997). In particular, the latter should be able to tolerate the necessary changes. A further development of the approach examined above leads to the evolutionary model in which the organisational structure is related to the action of multiple internal and external entities. The organisational model is thus positioned in a broader context that includes the environment of reference with the social,

2.4 The System of Corporate Strategies in Conditions of Uncertainty: The Firm’s. . .

23

institutional and political context. The organisational strategy may influence the soft components of the organisational context directly, going on to have an effect on the leadership, on the management style, and on the business culture, and indirectly on the hard variables constituted by the strategic-organisational architecture and the strategic management mechanisms. It is important to understand here how much the relationship between corporate organisation and competitive advantage is likely to change over time; therefore, both the strategy and the structure must be constantly updated. What a firm needs, therefore, is strategic flexibility, namely the corporate capacity to respond to various requirements originating from dynamic competitive environments (Sanchez 1995). Strategic flexibility depends jointly on the intrinsic flexibility of the resources available to the company and on the capabilities of the managers and their incentives to develop effective short and long-term restructuring strategies (Das and Elango 1995; Harrigan 1985). The concept of strategic flexibility is linked to the last of the internal strategies, the strategy of governance, which, as already highlighted above, assumes even greater significance in our times as a result of their strong dynamism. In fact, it is crucially important to identify solid corporate governance mechanisms in order to reassure the company stakeholders (Kolk and Pinkse 2010). More specifically, the governance body is, in the strict sense, considered to be responsible for protecting the interests of the shareholders and for distributing the surplus to the shareholders and, in the broader sense, for guiding firms to support the creation of value (Bhagat and Black 2002). Therefore, it is known to have an influence on the firm’s performances and on its long-term survival (Filatotchev et al. 2006); in fact, governance choices can influence the creation of economic returns, providing access to valuable and rare resources that are costly to imitate and are not replaceable, as well as mediating their appropriation (Coff 1999). Hence, this research topic has been the subject of numerous studies in recent years. Having ascertained the importance of the role of corporate governance, we can define its content by referring to what has been highlighted by some scholars (Cremers and Nair 2005; Gompers et al. 2003), according to whom corporate governance is the result of norms and traditions, habits and behaviours, generated in individual industrial systems as part of legal and cultural traditions developed in different countries which have, until now, justified the maintenance of some substantial diversities in the governance and corporate control models actually adopted. The majority of research on corporate governance is still incorporated in theories that focus on the distribution of value (D’aveni 1989), among which the agency theory dominates. The agency theory (Jensen and Meckling 1976) equates the relationship between shareholders of large firms and Board members to the relationship between a principal and an agent: the former delegates the conduct of an activity to the latter, which must act in the interest of the former. Institutionally, therefore, in those firms, there is separation between the owners and the management; the former waive the right to exercise some of their prerogatives, such as directly controlling the actions of management and assessing its performances, delegating those functions to its representatives: the Board members. That theory was developed based upon the

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characteristics of the governance structure attributable to the Anglo-Saxon capitalist tradition, as opposed to the German-Japanese system (Bianchi Martini 2001). Consequently, despite economic-financial globalisation, there are still significant differences between corporate governance systems operating in different countries. The Anglo-American capitalist system known as market-oriented attributes predominant significance to the role of the equity capital market. In that model, corporate governance focuses on a well-developed stock market, strong investor protection and banking relationships at market conditions (Landsman and Valdez 2003; Venter 2004; Jeremy et al. 2000). Large firms operating in the United States and in the United Kingdom are frequently listed on the stock exchange and characterised by an extremely fragmented shareholder base (e.g. public companies), in which small savers and institutional investors hold the majority of the capital. Considering the ownership structure typical of Anglo-Saxon firms, the structure given the main governance role is the Board, consisting of persons deemed reliable and capable by the shareholders and to whom the latter delegate control of the management actions. However, large Anglo-Saxon companies do not usually have a shareholder or a group of shareholders of reference (so-called lead capital). The GermanJapanese capitalist system, on the other hand, is characterised by the presence of numerous relationships between large-sized firms in which there is a controlling shareholder and the existence of large groups. It is a model that attributes a major role to long-term manager-investor and enterprise-bank relationships. There is concentrated ownership and cross holdings between firms and between firms and financial institutions. It is known as a network oriented or insider system. These are often unlisted companies that have a shareholder of reference represented by other industrial companies. The latter hold significant shares of capital (Galeotti 2008). In that model, the Board has different characteristics from Anglo-Saxon firms; in fact, the dualistic model prevails, in which management is entrusted to the management board appointed by the supervisory board, while control is entrusted to an external auditing company. The Italian method, on the other hand, is mixed (Zattoni 2006; Barucci 2006); the separation between owners and management is significantly reduced and a major role is given to family groups which represent the ownership concentration, while any recourse to the financial market is marginal. As highlighted, moreover, depending on the perspective adopted and on its associated theories, corporate governance scholars have conceptualised different board behaviours to describe its cognitive results (Forbes and Milliken 1999). Corporate governance is still today at the centre of a vast and lively debate involving the operational and academic world, as the strategy referring to it concerns the firm’s management structure. Since its original discussion by Berle and Means (1966), interest in this topic has gradually increased, driven by complex phenomena such as market globalisation, growing financialization of the economy and competition between firms which increasingly involves no longer just the competitive markets but also the financial markets. In governance models of firms functioning normally, subject to what is stated above in relation to the concentration or otherwise of the ownership capital, the shareholders, as residual claimants, have the maximum decision-making powers

2.4 The System of Corporate Strategies in Conditions of Uncertainty: The Firm’s. . .

25

over the firm and, in particular, by way of the shareholders’ meeting vote, they decide who must administer the company (the managers). In crisis situations, ordinary governance models may no longer be efficient. They can generate, for the shareholders, a strong incentive to continue the firm’s activity, even if this reduces the value of the initial investment (which could already have been nullified due to the losses accrued), and for the creditors, correspondingly, a strong incentive to interrupt that activity in order to satisfy their claims by liquidating the assets (without running the risk of additional management losses further deteriorating their credit claims). Even if there is a real prospect of recovery, the uncertainty connected to no longer being able to manage the process is so high as to render the liquidation solution comparatively more convenient for creditors, based upon the much lower risk. These distorted and inefficient incentives are the main reasons behind the radical change in governance for firms in crisis. Those changes normally lead at least to a separation between the owners and the control of the company. The ownership remains with the shareholders, from which the control is removed, or weakened, so as to avoid the incentive to risk and over-investment damaging creditors and the community (Anderson and Reeb 2003; Fama and Jensen 1983). In situations of inefficiency, crisis procedures must be managed within the specific procedures envisaged in the different legal systems. The latter therefore act as organisation tools of decision-making procedures in business crisis situations that cannot be resolved promptly through extrajudicial agreements. In essence, if the firm obtains the support of its major stakeholders, the decline and the crisis can be resolved with private extrajudicial agreements; otherwise, the law intervenes through crisis and insolvency proceedings. In relation to the latter for firms in crisis, this may entail the following approaches: – an initial approach, coherent with the logic of the shareholder value maximisation theory, according to which insolvency proceedings must pursue, as a priority, the interests of creditors and maximise the realisation value of the assets, as they bear the full risk of the business activities; – a second approach, coherent with the stakeholder theory, according to which insolvency proceedings must reconcile the interests of the different company stakeholders. The position assumed with respect to the aforementioned approaches characterises a country’s bankruptcy law. In that sense, a distinction is made between: – creditor-oriented system, where safeguarding the creditor is paramount and can sometimes even lead to the firm’s inefficient liquidation; – debtor-oriented system, where safeguarding business continuity is paramount and can sometimes even lead to a sacrifice for the creditors. Having analysed all strategies of the internal structural system, we must now examine the boundary strategy which can be defined as a connection strategy. This is

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because it concerns the connection between two different areas of reference: the internal and external. In fact, a firm’s boundaries represent the transition zone between internal and external, which delineates the resources and activities over which the firm is able to exercise discretion and over which it extends its influence and control (Garzella 2000). Essentially, the resources that fall within that area are intangible resources, such as knowledge and image, which are elements having high uniqueness and incrementality; information technology as a boundary variable necessary to activate and implement a system of relationships of superior order which includes: customers, suppliers, workers, etc.. Through the use and combination of those resources, the firm is able to respond and adjust to environmental changes. Delimiting the boundaries meets the need to remove or reduce the impact of critical contingencies and is a function of the organisational design. Traditional models of management and strategic analysis have leveraged and relied upon interpretative schemes based upon the firm-environment distinction (Bertini 1990). Strategic development processes were thus separated into development strategies for internal or external lines and the firm was identified in its structure/product/market relationships (Amaduzzi 1995; Bertini 1990). The continuous changes dictated by the market then allowed for the new forms of strategic development to be connected to the boundary concept, resulting in an attempt to conceptualise the possible removal of the boundaries and the onset of the concept of a firm without boundaries. Although this interpretative stance has been supported by high environmental dynamism, it is still not fully convincing, also because it is often noted that boundaries are precisely the unifying element of these new corporate development methods. In fact, the transition from the conceptual dimension to the strategic management dimension requires an investigation and understanding of the elements that characterise the boundaries so as to be able to govern them strategically. In order to do this and to be able to identify the boundary strategies, it is worth focusing on the qualifying elements of the new management methods, cited above and already intuitively positioned within strategic boundary management. By analysing the new development models, it emerges that boundaries not only exist, but they extend and increase the resources that cannot be considered internal or even external. In other words, when the boundary resources increase and their strategic relevance grows, the boundaries are extended and become a “boundary area” which is aimed at improving the firm’s cost-effectiveness (Gibbert and Välikangas 2004). The different strategies have been illustrated here as, in conditions of uncertainty, every single strategy becomes significant in terms of the opportunity of reducing risks. In fact, the strategic approach to uncertainty is designed to allow managers to recover an absolute percentage of control over their own destiny, allowing them to choose proactively the accepted risk level and enabling the firm to exploit the opportunities offered by that uncertainty (Lippman and Rumelt 2003; Mallette 2004; Matzler et al. 2010).

2.5 The Evolution of Finance in Strategic Corporate Management

2.5

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The Evolution of Finance in Strategic Corporate Management

Although the financial aspect is just one of the dimensions of the system of corporate strategies, it is quite clear that in situations of environmental complexity, financial balance is the problem to be managed with greater urgency (Ross et al. 2002; Arbogast and Kumar 2018; Brandtner 2013). The attention paid to the financial logic is not aimed at relegating the economic aspect of management but, rather, is based on the belief that, in situations of difficulty and decline, the various stakeholders are primarily interested in the firm’s financial capabilities. The governance of the firm’s financial dynamic is based upon the need to construct and renew an entrepreneurial design able to generate value in terms of overall prospective cash flows. The creation of value for all persons involved in various guises in the firm’s dynamics is the ultimate aim of the financial function, coherent with the guidelines followed by corporate management. Therefore, in light of the value model, financial strategy can be seen as a means for increasing the firm’s economic value. This is achieved not only through the use of tax shields, but also by making money on the financial markets through appropriate marketing policies and rates lower than market rates, and by seeking to achieve financial synergies between the different strategic business areas as well as applying instruments of control that facilitate the effective allocation of funds. Some scholars, while claiming that firms’ financial targets affect their strategy, emphasise the importance of cash flow as a measurement of performance (Grant 1997). Similarly, other authors highlight the role of finance in the execution of the strategy, emphasising the capacity of the main financial functions to convert abstract ideas into tangible objectives and promoting an approach to the decision-making process regulated and based upon facts (Calandro and Flynn 2007; Brennan 1995; Gamba and Triantis 2008). Therefore, finance—considered as a discipline that involves investors, managers and financial intermediaries in the capacity of stakeholders having competing interests and interacting strategically over time—must also be analysed from a strategic perspective. The increase in importance of the financial function within the corporate organisation, by virtue of the strong competition, which pushes corporate management towards more careful and informed control of financial flows, international financial tensions, instability and capital market dynamism have made the fertile soil for numerous studies and contributions on corporate finance. This is partly due to the importance assumed by the financial markets in our times, having had a significant effect on governance processes, particularly for listed companies in which the relationship with lenders has taken on greater meaning in the strategic area in reference to financial market positioning (Galeotti 2006). In fact, corporate finance continuously influences and, in turn, is influenced by the entire management and, more specifically, by the corporate decisions of managers in

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relation to the absorption, distribution and allocation of financial resources, under the close control of corporate governance. Consequently, being aware of its evolution over time becomes a necessary step in offering a comprehensive picture of the strategic relevance of the financial function. In fact, the value of strategies is expressed and measured in relation to the firm’s financial dynamic and to the financial value of time and risk, essential variables in the context of a strategic analysis. In the evolutionary process of corporate finance studies, two different perspectives can be pinpointed: the traditional and the enlarged perspectives, with which to examine corporate finance problems and the methods by which firms cope with a continuously evolving economic and financial environment. The traditional perspective identifies a concept of corporate finance limited to the obtaining of financial means on the capital markets, with related analysis of the rights and obligations that this entails; the enlarged perspective considers finance as a set of decisions and actions with which to govern financial resources in order to achieve costeffectiveness for the firm. In the context of enlarged finance, problems related to the acquisition of financial means integrate with those relating to both financial and operational investments. The evolution of corporate finance studies at international level has seen some different analysis approaches put forward over the years. This began with the banking technique, in which the subject of attention was the lender, as well as financial instruments and financing operations, only to move on to studies highlighting the perspective from which the firm’s decision-maker addresses financial matters. That extension of the analysis approach according to which a firm’s value is dependent upon its financial performances and on the business risks focuses on the interrelation between corporate governance, the firm’s performances and risk (Chichilnisky 2013; Banks and Dunn 2003; Chang et al. 2015) thereby marking the transition to corporate finance in the proper sense. That perspective (1950–1975) after the phase of traditional research (1930–1950)—the precursor of which was the US scholar Dewing (1920)—saw scholars analyse the interactive relationship between the firm’s financial and operating information and the firm’s value based upon the capital market. The traditional research phase must be positioned at the start of corporate finance dynamics in the United States in around 1920, following the rapid development of the financial markets. In fact, the financial markets significantly affect the approach of firms towards financial problems expressed by management (Van Horne 1984). The subsequent phase saw the onset of studies on portfolio selection (Markowitz 1952), the Theory of Capital Structure (Modigliani and Miller 1958), the Capital Asset Pricing Model derived from the Portfolio Theory and the Separation Theorem (Tobin 1963, 1964), the Options Pricing Model (Black and Scholes 1972) and the Arbitrage Pricing Theory (Ross 1976). The traditional research phase and the (subsequent) modern research phase are opposed to each other, as, in the first phase, problems relating to investments of operational nature are considered mostly external to the roles and competencies typically attributed to the financial area.

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It has come to be seen as a technical-application discipline characterised by numerous studies on the arrival of new financial products and the consequent need for firms to choose between a growing number of different types of financing. From the mid-1900s, finance studies in the internal perspective developed across two levels, invariably intertwined in the most in-depth analyses: the technicalspecialist level focusing on financial instruments and practices and in particular on accountancy and mathematical-statistical aspects (problems of recording, financial analysis and mathematical-financial valuation methods). In this phase of modern research (1950–1975) financial management opened up to the external environment, no longer looking at the costs-benefits ratio and the firm’s internal perspective, but considering the relationship between corporate management, financial information and the share price on the capital market. The discussions thus moved on to “enlarged finance” which integrates problems concerning the acquisition of financial means with those relating to both financial and operational investments, according to analysis logics inspired by principles of economic convenience and monitoring of the financial dynamic. The angle from which we approach corporate finance changes; namely, we focus on the relationship between operating investments and the obtaining of resources on the capital markets, taking account of the economic objective of the corporate system at which the management decisions are aimed. Consequently, there is a close correlation with the capital market or the financial market. In the financial market, the most concerning issues are returns on investments, risks and also their relationship with prices. The origins of this paradigm, although being lost over time, should be sought in many related disciplines: from economic doctrine, particularly in the line of studies on capital theory, accounting theories aimed at representing capital and its dynamic, and, finally, managerial economics contributions in relation to assessing the profitability of investments (Cokins 2017; Uhl and Gollenia 2016; Abran and Buglione 2003). Those contributions highlight the close correlation between return and risk and require us to make a regression; therefore, before going on to analyse the changes that occur in the transition from traditional finance to enlarged finance, we define the concepts of risk and return that represent the operational levers of the financial strategy to be implemented by the firm in order to compete on the financial market and which will be analysed later in the competitive economic-financial perspective. The analysis of those components is significant as it allows for invested capital to be expressed as the sum of the expected prospective flows discounted at a rate proportionate to the risk assumed by the investor. In this way, the various uses of capital are perfectly comparable to direct the choices of investors, who will opt for the offer that maximises ex-ante the current value per unit of invested capital. To understand the importance of the risk/return analysis, we define firstly the return of a financial asset as the ratio between the initial capital and the profits produced by investment or sale operations in a specified period of time (Acharya 2009; Billio et al. 2012; Droguett and Mosleh 2013). It is closely linked to the firm’s future capacity to produce wealth. The investor’s ability to achieve the expected remuneration and, of course, to maintain the integrity

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of the capital contributed or loaned depends on that capacity. Conversely, risk can be defined as the level of uncertainty expressed by the market on the actual realisation of the expected returns or, adopting the perspective of the financial markets, it expresses the conditions of variability and uncertainty in which all economicfinancial flows produced by management accrue. These are conditions characterised by the presence of internal and external factors. A distinction can then be made between specific and systemic risk, which form part of the operating risk and the financial risk. The systemic risk, according to numerous authors, is considered to be an economic market shock or institutional failure that causes a chain of bad economic consequences for financial institutions or the large-scale distribution of financial intermediation with enormous economic and social costs (Bartram et al. 2007; Huang et al. 2009; Nier et al. 2007). According to the European Central Bank, it can be defined as a financial instability risk that is so widespread as to compromise the functioning of a financial system to the point where economic growth and well-being suffer materially (Besley et al. 2020). Unlike the systemic risk, the specific risk reflects the peculiarities of the system of operating and competitive conditions of the specific firm (Lin et al. 2018). Finally, the financial risk expresses the further share of variability of prospective flows determined by the obligations and restrictions imposed by the firm’s financial structure, namely the level of borrowing, liquidity situation, investment turnover, level of immobilisation of loans, etc. As those obligations and restrictions increase (particularly financial leverage), the uncertainty of future economic-financial performances, and thus the risk from the perspective of the financial investor, increases (Lindley 2006; Dubois 2010; Fahimnia et al. 2015). The interdependence between operating and financial risks incentivises firms to adopt integrated risk management so that such risks can be analysed in an overall vision. After clarifying the foregoing, we can continue by highlighting that the transition from traditional finance to enlarged finance not only changes the breadth—narrow or broad—of the study topic, but also the methods by which the different problems are addressed, highlighting the need for a systemic interpretation of the relationships between management costs and revenues. A complete and systematic research framework is generated which refers to the concept of the firm as a system. Corporate finance, therefore, seen in the enlarged sense, transitions from being an exclusively technical-specialist discipline, useful only for those responsible for financing operations, to a corpus of principles and related methodologies necessary for the culture of general management, as well as for a firm’s senior management activity (Simons 2000; Van Veen-Dirks and Wijn 2002; Cattani et al. 2017). From the 1970s–1980s a further phase of post-modern research began (1975–2020) which saw the financial topic being integrated with other disciplines. In that regard, the above-mentioned Jensen and Meckling (1976) who, highlighting the relationship between agency, corporate governance and financial management issues, also refer, for the latter, to the concept of integration in the corporate system. Similarly, Fama (1990) provides a rare example of integration between capital structure and theory of organisations. These are works in which a firm is not simply

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defined as the sum of components readily available on the market but, instead, a unique combination, which may be worth more or less than the sum of its parts. In particular, in the US doctrinal context, the analysis approach known as new finance has arisen, which has its origins in studies on portfolio theory and in those on utility (Rubinstein 1973). That approach addresses mathematical-statistical methodologies as well as the scientific contents of economic theory (microeconomics and macroeconomics) and has become a prevalent approach as it explains, in conditions of uncertainty, the behaviours of all operators involved in a resource allocation process. The current trends of corporate finance studies essentially integrate the different study lines with an orientation towards interdisciplinary work, along with a leaning towards inter-functionality and an interaction between corporate finance and strategic management. Interdisciplinarity emerges in different international contemporary corporate finance studies (Arbogast and Kumar 2018; Arrfelt et al. 2015; Chang et al. 2015). More specifically, due to the creation and increasing dissemination of sophisticated derivative instruments (futures, options, swaps, forward rate agreements, etc.), corporate finance has assumed a central role in business risk management, which, precisely due to the excessive use of derivatives, has ended up aggravating, in some cases, the risks of firms and of the economic system, constituting an instability factor that threatens international macroeconomic balances. A close relationship with risk management, with internal auditing and with issues of IT security and, not least, with strategic management emerges, inevitably touching upon the strategic role of governance in financial dynamics. The function of risk management is to identify the risks that require attention, distinguishing between those that can be hedged with instruments that transfer the effects to third parties from those that can be managed (Mitra et al. 2015; Paté-Cornell 2012; Galeotti 2008). Among the main works that have dealt with risk management activity is the contribution of Doherty (1987) who identifies the same as being systematic risk management activity. The main objective is to minimise losses and to maximise the effectiveness and efficiency of the production processes. In that context, the issue of strategy is closely connected to that of decisionmaking of the firm’s various governance and control bodies and, therefore, to issues of corporate governance. In addition, that connection is also evidenced by the fact that, in large firms, the financial manager assumes the role of Chief Financial Officer, positioned alongside the Chief Executive Officer. Therefore, the financial function analysed in the dual capacity of technical-operational and strategic function leads to a distinction, albeit in awareness of the interrelations and intrinsic links, between financial issues of technical-operational nature (typically dealt with, in medium and large firms, by ad hoc organisational units) and problems of economic-financial strategy (typically aspects of general management). Therefore, we believe that financial flexibility and financial theory present strong advantages in strategic terms; this is why a careful and meticulous study of the same, in light of an overall assessment rather than one that focuses on separate and

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autonomous projects, can be of assistance (Arbogast and Kumar 2018; Henderson 1970). We refer to specialist studies for technical investigations of the functional area. Therefore, we believe that strategy, if directed towards opportune financial guidance, with the related benefits in terms of flexibility, is able to assess entire strategic programmes and not just separate and autonomous projects; for that reason, this field is worthy of specific analysis. Based upon those assertions, we will focus below on the firm’s economicfinancial strategies.

2.6

Competitive Economic-Financial Strategies

The logic of economic competition reigns supreme in the financial markets, where firms contend with alternative investments that are available on the market in attracting capital in quantities and conditions adequate to sustain their development; they do so by offering to investors returns in line with their economic expectations. Based upon the fact that the correct management of financial decisions (investment, financing, working capital and dividend policy) is essential to the financial performance of firms (Khan and Jain 2008; Levine 1997; Butt et al. 2010), when a firm’s activity deteriorates to the point of no longer being able to fulfil its financial obligations, it can be said that it has fallen into a state of financial difficulty (Van Horne and Wachowicz 2008; Baldwin and Scott 1983). To avoid the state of difficulty, the firm must manage its resources optimally and above all position itself on the financial markets as an attractive investment opportunity. Traditionally, the financial markets are seen as the economic space in which capital is exchanged: from the side of demand, firms request and acquire the financial means necessary for their own investments; from the supply side, the capital holders transfer the financial means, assuming the capacity of shareholders, lenders or bondholders depending on the financial product purchased. In that perspective, the need that is satisfied is the financial requirement of firms. Therefore, an analysis of the financial market involves an explicit reference to the behaviours of investors on the market. This approach, in the firm’s perspective, may be subject to changes that lead to a redefinition of the subject of exchange and reallocate the related positions of operators on the market. In fact, the subject of exchange becomes the capital investment opportunity, meaning the methods of use of financial means or the acquisition of a prospective flow of wealth connoted by a certain level of uncertainty/risk. Capital investment opportunities in the form of financial products are differentiated in technical-legal terms, assuming the form of shares and bonds, or mortgages, leasing contracts, current account credit lines and so on. In addition to these different forms, an increasing number of new financial products are being created, whose articulated and complex forms escape the above classification, united by the presence of a common economic characteristic: the function of use characterised by the need to

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profit from the available financial capital. According to that approach, the demand is characterised by investors seeking profitable investments and acquiring prospective flows of wealth, while the supply, in parallel, is characterised by the presence of firms which must make interesting offers of prospective flows of wealth (Metrick and Yasuda 2011; O’Brien 2003). The expected returns are not the only element on which to base the competitive strategy; instead, they stand alongside a response to the increasing requirement for economic-financial information, associated with administrative transparency and reliability of the management processes. As stated previously, risk and return are the operational levers that firms can use to orient, in their favour, the conduct of financial investors, inducing investors to provide them with the means as well as to contain the remuneration required for such capital. More specifically, it is the risk-return combination that determines the essence of the strategy of competition on the financial markets. The management levers to compete on the financial markets are made up of variables that can be governed by the firm in order to produce an advantageous offer for investors, inducing them to provide credit and/or debt capital (Dhaene et al. 2003). The competitive levers consist of the following profiles: a) b) c) d) e)

return; risk profile; administrative transparency and strategy communication; corporate governance and reliability of management processes; differentiation of the financial offer.

From an investor’s perspective, as highlighted above, the return of the capital provided or contributed is linked to the future capacity to produce wealth. The competitive levers included in the return driver can be identified in the following factors which determine the economic-financial prospects: – – – – –

attractiveness of the relevant industry; competitive advantages held by the firm; synergies implemented; monetary component of income flows; strategic development options.

More specifically, by adopting the competitive advantage theory, the corporate profitability, at the level of the individual SBA, depends upon the attractiveness of the industry and the competitive positioning of the firm (Porter 1987). Attractiveness expresses, in the corporate perspective, the intrinsic profitability of the industry, namely the long-term return achieved by firms operating in that industry, on average, and, from the perspective of investors, the potential profitability, which can be influenced by the firm through its portfolio strategy by which it selects the most profitable industries to enter. Attractiveness changes over time; it is not homogeneous in all industries and is the result is a set of competitive forces. The attractiveness of the industry alone is not sufficient to define the economic performance of the individual firm, as it goes alongside the relationship of

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interaction strategically established by the firm with the competitive system to which it belongs. We therefore speak of positioning. It is a direct consequence of corporate decisions in terms of production activities and transactions implemented with the market. If those decisions facilitate the achievement of a competitive advantage, which may be of cost or of differentiation depending on the corporate focus, and place the firm in a superior position in terms of strengths with respect to critical success factors (Raz and Michael 2001; Slatter 1984), then these are strategic decisions with which the firm improves the ratio between product value and respective production costs. Competitive advantage is, in fact, created and sustained by companies that develop and make effective use of strategic value creating assets that tend to be intangible, rare and hard for others to replicate (Lev 2017). This argument, valid for mono-business companies, should be expanded when the firm deals in several strategic business areas, or when relating to a diversified company. In fact, in multi-business companies, an additional element to be considered consists of the synergies that have rapidly disseminated in the majority of strategic management, finance and accounting studies (Gruca et al. 1997; Zhou 2011). Defined as synergic interrelations between different business areas that improve the profitability conditions of the individual strategic units or the firm as a whole (Ross et al. 2002; Schmalensee 1985; Carpenter and Petersen 2002), they require, in the decisionmaking process, an assessment of the risks of a poor assessment of the synergy expectations, as a substantial difference in value may occur between the realisation of the synergy and the synergy expectations with related repercussions on the expected return. Additional factors on which the return depends in the perspective of the financial markets are the strategic options and the monetary component of income flows. Strategic options express the opportunities for growth connected to future structural changes of the business formula, namely complementary or alternative hypotheses of growth with respect to those linked to management continuity with the firm’s current situation. Their value will be determined by the capacity to determine the “leaps” in the economic prospects of management, compared to the hypothesis of continuity of the firm’s current structural framework. In that case, the portfolio of strategic options available to the firm, being an important component of the corporate return in the appreciation of financial investors, is an important competitive lever of economic-financial strategy. Unlike strategic options, the monetary component of income flows expressly refers to the level of liquidity of future income, namely the so-called cash flow that will allow for the financing obtained (cash flow in service of the debt) to be returned and/or for the profits produced to be allocated in the form of dividends (shareholders’ cash flow). The management of cash flows and actions able to modify their performance, such as, for example, decisions on the amount and timescales of investments, on the average receipt and payment timescales, on the consistency and turnover of the inventory, are, therefore, reflected in the expectations of financial investors related to the return, forming major elements of the firm’s economic-financial strategy. The attractiveness of the industry, the competitive advantages, the synergies, and the monetary component of income flows, as components of the return, do not exhaust the analysis perspective of financial investors,

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which instead extends to the long-term; it is from this perspective that the firm must be considered a dynamic phenomenon that evolves over time. Alongside the return there is the risk, which expresses the conditions of variability/uncertainty in which economic-financial flows produced by management accrue. The intensity of the risk varies from firm to firm, and for the same firm, over time, due to the varied combination of different factors. Some of these are under the firm’s control, as it can manipulate them through its management decisions. Management of the corporate risk can effectively mitigate the cash flow risks and, as a result, influence the appreciation of the values granted to them (Joshi and Lambert 2011; Jüttner et al. 2013). Such conditions affect the behaviour of financial investors by virtue of their institutional aversion to risk (Blackhurst and Wu 2009), which translates into a greater demand for returns as a condition for contributing or lending capital to the firm. We have already previously discussed the determinants of business risk, split into operating and financial components, and we will refer back to them in the analysis of the relevant variables. As regards the systematic operating risk, those variables should be sought along two lines: the sensitivity of the industry to macroeconomic variables and the elasticity/flexibility of the firm. With reference to the first variable, this concerns the relationship between the profitability of the specific business and the changes that occur in the general contextual conditions, which cannot be governed by the firm. The latter therefore has only one option: operate in the industry or remove itself from it. The second variable, namely the firm’s flexibility, expressly refers, on the other hand, to the ability to adapt the corporate combination to environmental changes, maintaining the conditions of cost-effectiveness. The higher the flexibility, the lower the firm’s vulnerability and, as a consequence, the related risk. In fact, the majority of corporate managers across the world consider financial flexibility to be one of the most important determinants in decisions on the capital structure (Graham and Harvey 2001; Bancel and Mittoo 2004; Brounen et al. 2006). The ways of achieving financial flexibility are linked to the firm’s capacity to obtain external funds and to restructure its financing to low cost (Gamba and Triantis 2008; Byoun 2008). In the specific operating risk, however, the determinants are found in the operating and competitive conditions that characterise the individual firm. Finally, in the financial risk, the determinants that constitute competitive levers on which to build the firm’s financial strategy are the level of borrowing, liquidity situation, turnover of investments, level of immobilisation of loans, capital assets, and financial leverage. The firm’s financial strategy is constructed on those levers. In that regard, we believe that financial strategy adds value to the firm, as the appropriate formulation and execution of the same encourages the success of any commercial business. In fact, it is directly linked with its superior performances. Therefore, it can be said that financial strategy increases the value of the firm and maximises the wealth of its shareholders. That statement contrasts with what was claimed by Modigliani and Miller (1958) who believe that the value of a firm does not correlate with the method by which the firm is financed. The financial strategy implemented in the firm should be constantly updated along with the key components of the transactions; unfortunately, organisations are often inert in their strategic actions (Mallette 2004).

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Constant update and revision allow firms to have a general framework in which to assess systematically their financial strategy to ensure that it is coherent internally and aligns with the corporate operations. To overcome any crisis situation, frequent assessments and adjustments must be carried out due to the rapid changes that occur in the firm’s operating environment in the moving and globalised world. Therefore, to achieve the aim of maximising the value for shareholders, firms must adjust their financial strategies during the different phases of their life cycle (Droguett and Mosleh 2013; Dubois 2010; Graham and Harvey 2001). Continuing in the analysis of the financial market from the perspective of the financial investor, it should then be added that risk is inversely proportional to the trust placed in the persons who manage the firm and the degree of knowledge of the firm’s situation. As a result, the role assumed by the unit in control of corporate management becomes essential. Administrative transparency and the reliability of management systems therefore constitute two further variables of financial strategy which can be leveraged upon in order to compete effectively on the capital market. In fact, gaps in that area inevitably translate into penalisation for the firm, in terms of the lower propensity of investors to finance the firm itself. Those gaps can be bridged by guaranteeing adequate quality, quantity and reliability of economic-financial information, so as to properly meet the expectations of investors. Consequently, there is an inevitable focus on the role of corporate governance and a change of perspective from which to examine the relationship between the firm and the financial markets. In fact, the concept of financing operation changes alongside the view of the competitive context in which it takes place. By adopting that perspective, the type of financial product offered by the firm (newly-issued shares, private equity fund, investment project to be financed) loses significance, as it translates into an investment opportunity that, if assessed as convenient compared to the possible alternatives available, will be acquired by investors. In parallel, those financial products are comparable and therefore considered fungible assets in competition with each other. Thus, the competitive contrast essentially takes place by comparing the different forms of investment from the risk/return ratio profile (Kalkbrener 2005; Acerbi and Tasche 2002; Artzner et al. 1999). The reference to the risk/return comparison is aimed at highlighting the essence of the competitive clash between capital investment offers proposed by firms that operate according to a very precise logic. Supply and demand are made up as follows: all capital borrowers are positioned on the side of supply of investment opportunities, i.e. firms, irrespective of the specific industry to which they belong, as well as all entities that, in the view of investors, constitute investment alternatives. In that regard, these include banks, which offer remunerated deposits or own-issued securities with which they obtain funds; the State, which sells short and medium/ long-term securities; Public Administrations, which place on the market bank loans, bonds, etc.; private entities that offer to the market the opportunity to grant mortgage loans for the purchase of properties or consumer credit (even in the form of credit cards); and various institutions (associations, foundation, non-profit organisations), which source funding. The firm comes up against those entities, aiming to make more convenient investment proposals for investors on the financial market. From

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the side of demand, investors seeking suitable investment opportunities include banks, private savers, pension funds, asset management companies, insurance companies, private equity funds, etc. As highlighted above, the decision-making and technical issues of the firm’s functional areas have been widely investigated in corporate studies over the years. In particular, more extensive and articulated conceptions of corporate strategy have been put forward, giving rise to different lines of further investigation (Tregue and Zimmerman 1980). More specifically, according to doctrine and practice, corporate level strategies can be classified as: organisational strategy; business portfolio strategy; social strategy; economic-financial strategy. Although there is a large area of overlapping and a systematic link between the different classes, at this point of the discussion, we will examine the role of economic-financial strategy, as we have already provided an analysis of the characteristics and the role assumed for the others. For further information, see the specialist discussions. In choosing its financial strategy, a firm finds itself at a crossroads: deciding whether to increase or distribute its finances with reference to the strategic decisions implemented by corporate governance. More specifically, economic-financial strategies define, for the specific firm, the interaction model to be implemented in the financial environment (financial brokers, markets, supervisory bodies, other competing companies) based upon the need to pursue the business design economically. Therefore, economic-financial strategies consider relationships with lenders and the investment needs required to pursue and maintain the competitive advantage, in close harmony with a systemic interpretation of the firm’s financial problems. Therefore, the subject of the analysis of economicfinancial strategies is both financing and dividend decisions and investment choices. In that regard, we refer to what has already been stated by some authors who claim that financial management practices should be seen as the management process of financial resources, including budgets, accounting and financial reporting and risk management. Several authors are of the same opinion, defining financial management practices as the capacity of management to manage the credit risk, the budget and the working capital (Butt et al. 2010; Varis and Littunen 2010; Teece and Pisano 2004). Therefore, the capacity to penetrate new markets and acquire new customers depends upon the ability to make rapidly and easily strategic decisions that enable the firm to appear as a valid investment opportunity. Thus, economic-financial strategies become the tool through which the firm looks to both the requirements to pursue an effective and efficient implementation of the operating entrepreneurial formula and the requirements to implement a new strategic design. In fact, the strategic analysis process initially considers problems relating to the current situation and subsequently defines, in relation to the opportunities and requirements for change, the action lines to be undertaken. It is based upon the assessment of the current situation, which concerns the verification of: 1. liquidity, namely the firm’s capacity to cover, promptly and conveniently, the

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financial commitments due in the short-term; 2. solidity, namely the firm’s financial capacity to resist and absorb significant adverse events; 3. dimensional development, namely the firm’s capacity to identify and undertake paths of growth; 4. profitability, namely the firm’s capacity to generate income and, in their most advanced formulations, the ability to create value. This leads us to state that economic-financial analyses are aimed at controlling the economic-financial-capital balance, continuously seeking efficient conditions for the survival and lasting development of the firm. From analysing the current situation, the economic-financial problems to be addressed by the firm can be identified. Having thus identified them, the subsequent phase begins, concerning the development of the economic-financial strategy, which will be focused on various points: 1. maintenance of margins of financial flexibility directly linked to liquidity; 2. control of financial risks (closely connected with the concept of solidity); 3. production of an adequate economic return for contributors of equity capital linked to profitability; 4. promotion of the firm’s competitiveness, guaranteeing the necessary resources for the development of the competitive strategies connected to development; 5. implementation of a profitable system of relationships with financial stakeholders. In the process of developing the economic-financial strategy, the formulation of the business plan is a key moment in which a systemic analysis of the objectives, characteristics and decision-making paths is carried out in order to generate coordination and integration between the requirements of competitiveness in the business with those of the overall economic-capital-financial balance. In the process of implementing and evolving the economic-financial strategy, the planning and control system becomes crucially important, as it allows for the economic-financial dynamic to be supervised. Finally, it is important to note that particularly in listed companies or in those that are about to offer their securities on the stock market, the relevant indicators of economic-financial strategy are expressed in relation to the objective of creating economic value for the shareholders, thereby meaning the capacity to pursue levels of operating profitability of the investments higher than the opportunity cost of capital. Given that the creation of value, seen from the perspective of stakeholders, materialises in relation to the capacity to generate wealth for the different stakeholders, the system of relationships with current and potential financial interlocutors becomes even more significant. All the more so in situations of crisis. In fact, in situations of serious financial difficulty, a significant conflict of interest arises between management and the other shareholders. Management may make decisions aimed at obtaining personal short-term benefits rather than overcoming the financial distress, due to job insecurity. Therefore, a particular form of control is required from corporate governance aimed at guaranteeing to all stakeholders the common will to overcome the crisis and once again achieve conditions of

References

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economic balance. In fact, if the firm returns to conditions of cost-effectiveness and becomes profitable again due to its results in terms of liquidity, solidity, profitability, competitiveness and development, the system of relationships with the corporate interlocutors will inevitably be eased, as the firm is considered an excellent investment opportunity. Indicators (of liquidity, solidity, profitability) alone are not sufficient to define corporate competitiveness and other factors play a leading role in those terms, such as business and managerial reputation, capacity to communicate results, relational competence, investment quality, risk management policy effectiveness, and so on. Ultimately, it can be said that economic-financial strategies are at the centre of the corporate strategy system; they support the other strategic decisions with models and analytic tools and they contribute to acquiring and generating resources for development, but the simple definition is not enough. Firms must have a clear and coherent design in order to communicate the business project effectively to financial stakeholders.

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Chapter 3

The Role of Financial Strategy in Firms: Financing and Investment Decisions

3.1

Change Management and Financial Strategy: Introductory Elements

Based upon what has previously been stated on the economic-financial strategy required to guarantee corporate balance, we will now position financial strategy also as a useful tool for companies to dominate situations of uncertainty and complexity. In fact, as authoritatively claimed (Bertini 1990), “governing companies today means, on one side, recognising early the changes that may occur on the market, and, if possible, anticipating and developing them with adequate strategies; on the other, adjusting the internal structure to the new plans and programmes. Everything else is just ordinary administration: almost taken for granted”. This chapter will therefore be structured based upon the principle that change is an essential element of corporate governance. Change is dominated by uncertainty, as it can be defined as the evolution, the transition, from an initial situation—which we will call A, to a subsequent situation—which we will call B. What characterises the transition from A to B is that A, being the initial situation, is, by definition, known. Conversely, B, being the subsequent situation, is, by definition, unknown. Having said that, change can be seen as an essential element of corporate governance that incorporates its own dimension of uncertainty and complexity. However, the most accredited literature has always recognised business as an economic institution connoted by uncertainty and, therefore, by complexity (Marchi 2014). In social systems, complexity also relates to divergence of the elements that make up the system. This is also particularly true of corporate systems where there may be periods of instability to be overcome by seeking and/or restoring the economicfinancial balance that permits survival.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 S. Ferri, F. Ricci, Financial Strategies for Distressed Companies, Contributions to Finance and Accounting, https://doi.org/10.1007/978-3-030-65752-9_3

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3 The Role of Financial Strategy in Firms: Financing and Investment Decisions

This chapter will focus attention on financial strategy as a tool for managing uncertainty and complexity. In general, as broadly argued in the previous chapter, to which full reference is made, economic-financial strategies consider relationships with lenders (funds side) and investment requirements needed to pursue and maintain the competitive advantage (investments side).

3.2

Investment Decisions Among Uncertainty and Risk: The Role of Financial Strategy

In management and accounting studies, the issue of uncertainty has always been important and has, moreover, often been correlated to the concept of risk; although, in common parlance, the two terms are often used as synonyms, there are some important differences between the two phenomena (Rejda 1997; Bertini 1987). In the more traditional setting, risk refers to the manifestation of unfavourable events (Zappa 1956). It has also been observed that business risks form a system: it follows that they do not have autonomous economic significance. However, the informed appreciation of the general economic risk does not mean the necessary process of isolating the individual risks from the system that they make up can be ignored: if nothing else, this is essential in the observation phase when those risks are examined in their particular characteristics of manifestation (Ferrero 1968). Knight (1960) emphasises that uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. Uncertainty can therefore be defined as the human incapacity to predict the occurrence of future events, and it encompasses two logical theoretical positions: measurable uncertainty and unmeasurable uncertainty. Measurable uncertainty is risk. The latter is uncertainty in the strict sense that is not measurable, precisely because it is associated with non-repeatable events of which only the possible results are known, but not the probability distributions. Similarly, Bertini emphasises that measurable uncertainty can be represented by a model which facilitates the determination, by calculating an index, of the frequency of occurrence of each event. Every time it is not possible to measure uncertainty, this is the sphere of unmeasurable uncertainty. In line with the previous chapter’s approach, financial strategy is seen as the set of decisions aimed at achieving advantageous economic-competitive conditions with respect to the expectations of investors and lenders. Therefore, again citing chapter I, where—as we have seen—the aim pursued by financial strategy is to ensure profitability, financial stability and maximizing the value of the company, through the effective and efficient use of financial resources and capital structure (Votchaeva

3.2 Investment Decisions Among Uncertainty and Risk: The Role of Financial Strategy

49

2012), financial strategy is classified to all effects as a competitive tool for the company on the capital markets. Financial strategy in general concerns investment/financing decisions concerning the decisions made by management with respect to the initial outflow of cash flows, with a view to obtaining future economic benefits, or incoming cash flows in a higher quantity than the initial amount, as well as at later times after the initial outflow. While it is true that investment/financing decisions are always connoted by a degree of uncertainty, in the circumstance where investment decisions are made in conditions of excessive insolvency risk, distortions or informative incompleteness, as well as high unpredictability of the expected results, they are connoted by an even higher level of uncertainty. In that scenario, the function of time preference is not sufficient to resolve the trade-off between consumption and investment, as the preference function must also be considered with respect to the degree of predictability of the results. The utility function, therefore, will be influenced both by the return and by the level of uncertainty. In general, the decision-making process that leads to the choice of investments can be split into three main phases (Van Horne 1984): (1) quantification of economic-financial flows associated with an investment; (2) evaluation of the aforementioned flows; (3) selection of investments. In the first phase, financial management must acquire, with the contribution of the different company areas involved, the necessary information to estimate the positive and negative economic-financial flows expected from the individual investment. The flows must be determined differentially, by comparing the incomings and outgoings that would occur in the event of the investment being made or not (Brugger 1979; Van Horne 1984). It is wholly evident that the acquisition of information to produce an estimate of the expected flows related to the investment is made even more difficult in scenarios of uncertainty. Companies can obtain financial resources through internal sources, external sources, credit or venture capital and self-financing. In doctrine, the problem of determining the financial structure, through the comparative analysis of sources and the resulting assessments of convenience, has given rise to three main lines of study: – a school of thought that, based upon Miller-Modigliani’s well-known theorem, assumes the irrelevance of the capital structure. It follows that there is no optimal capital structure as financial decisions do not influence the company value (Modigliani and Miller 1958); – a line of studies that, based upon the existence of a trade-off between the benefits and costs of debt, argues that an optimal combination of financing sources can be identified and through it the company value can be maximised (Damodaran 2001);

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– an approach that, despite affirming the non-existence of a single optimal structure for all companies, supports the need and opportunity in each individual case to seek the relatively most convenient relationship between different financing sources (Onida 1971; Caparvi 1972). Investment decisions, according to the traditional model of expected utility, hypothesise a rational investor—albeit having limited rationality—who maximises his utility by choosing investments with higher returns over investments with lower economic returns. That assumption is also valid in contexts of uncertainty, where the risk is higher, and the decisions must be even more weighted. Several international studies have focused attention on companies in situations of particular financial stress. On this point, Bhagat et al. (2005) conclude that investment behavior of distressed firms is presumably different from that of healthy firms. Other works have focused on the conditioning of investment decisions posed by the level of debt, cash flows and the legal system in relation to insolvency (Whited 1992; Bhagat et al. 2005; Pindado et al. 2008). López-Gutiérrez et al. (2014) conclude that “Investment behavior is not uniform for all companies facing financial distress, and the propensity to under-invest depends on the investment opportunities available to the company”. It emerges that companies in situations of uncertainty are even less able to choose the best investment and those decisions often turn out to be sub-optimal. That approach, moreover, entirely follows that of Modigliani and Miller (1958) according to whom market imperfections do not allow operators to make optimal investment decisions. Therefore, based upon this assumption, it can be stated that investment decisions of firms in scenarios of particular uncertainty are dictated mainly by the availability of investment opportunities. Where several investment opportunities arise, it has been demonstrated that firms, despite being connoted by difficulties, behave in the same way as other healthy firms. Conversely, a tendency towards under-investment is observed. It has been seen that the scenario of particular uncertainty that characterises firms may not only make their investment decisions difficult but may even influence the investment decisions of competitors operating in the same sector (Lang and Stulz 1992; Jorion and Zhang 2007; Benmelech and Bergman 2011; Hertzel and Officer 2012; Fazzari et al. 1988; Kaplan and Zingales 1997). In a recent study it is demonstrated that: “Firms which are more constrained cut their yearly investment rates by around four percentage points (or 10%) more than otherwise similar firms in the same industry that do not need to refinance their debt. [. . .] This effect is stronger in the most competitive industries, where firms have little margin to adjust prices to compensate for the lower financing, and where information is more dispersed. Moreover, effects are stronger for smaller and unrated firms, cash-poor firms, highly indebted firms, and firms with reduced debt capacity” (Garcia-Appendini 2018).

3.3 Objective and Subjective Constraints of Financial Strategy

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Having said that, financial strategy must necessarily be interpreted as a tool for managing the uncertainty, complexity and risk linked to investment/financing decisions, where it is necessary to identify the objective and subjective constraints that must be considered in selecting the opportunities offered by the market.

3.3

Objective and Subjective Constraints of Financial Strategy

Risk and uncertainty generally influence the company’s financial structure, together with general market conditions. The choices for defining sources of financing that make up the financial structure can theoretically be attributed to at least two selection criteria: one objective and one subjective. The objective parameter refers to the structural constraint according to which long-term investments must be covered by stable sources of financing, namely with equity or medium to long-term credit capital; the subjective parameter refers, on the other hand, to the choice of economic subject with respect to the possible alternatives. With regard to the subjective dimension in financing choices, Mazzoleni (2016) proposes a matrix that systematises companies into six quadrants based upon profitability, the capacity to repay financial debts, and growth (Table 3.1). The companies in quadrant 1 are classified as excellent and are characterised by high profitability and high growth, but also by a high financial debt ratio. They are able to use debt instruments not only represented by the banking channel, but also other debt instruments (minibonds, for example) or the capital market through private equity operators. The companies in quadrant 2 are so-called mature companies, characterised by contained profitability and a low level of debt. They would require a change management strategy to return to growing at their past rates. The necessary investments may be made in research and development activities. For companies belonging to this type, the favoured interlocutor is the banking system, which grants credit based upon historical results. Quadrant 3 includes companies at the beginning of declining, characterised by low profitability and a high financial debt ratio. Those companies struggle to obtain financing from the banking system and, similarly, from the financial system, except in circumstances where a strategic redevelopment process is commenced (Giacosa and Mazzoleni 2012). Quadrant 4 includes companies in the development stage, characterised by high profitability and potential growth, but with medium-high levels of debt. Despite the high profitability, those companies experience difficulties in accessing the banking system where the obtaining of credit is subject to historical elements.

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Table 3.1 Profitability matrix. Source: Mazzoleni (2016)

These are the companies that suffer most from informative asymmetries in communications with the financial system. Companies in crisis are positioned in quadrant 5, characterised by a high debt ratio which prevents them from accessing the banking market not only due to problems linked to negative historical results, but also due to their low probability of survival. Quadrant 6 includes companies in turnaround, characterised by high levels of debt and high profitability that allows them to obtain financing despite the high level of debt. The obtaining of sources of financing by management is, however, strongly influenced by the conditions of uncertainty and risk in which the company operates and which are also reflected in the lenders. The risk/return analysis in fact allows the capital invested in the company to be expressed in terms of risk-adjusted present value, meaning the sum of expected prospective flows (by way of repayment and return) discounted at a rate proportionate to a risk assumed by the lender. Expressed in risk-adjusted present value, the various opportunities of capital use are perfectly measurable and comparable on the quantitative level of the investor, which will deem the most convenient one to be that which ex-ante maximises the present value by unit of capital invested (Galeotti 2008).

3.3 Objective and Subjective Constraints of Financial Strategy

53

The financial markets thus come to represent a fully-fledged competitive system in relation to which companies are required to formulate a beneficial competitive financial offer in order to be considered as a concrete and valid investment opportunity (Nadotti et al. 2013). In that context, risk assumes a significant connotation, particularly for companies operating in crisis and decline scenarios. When the company’s debt increases above certain limits, its risk level also increases; when the financial structure is characterised by a large amount of thirdparty capital, company management must ensure that monetary resources are high to allow for the payment of interest and the repayment of capital, and to avoid the debts possibly not being renewed (Lamboglia 2017). For those firms, the strategic formula must assume an even more original connotation. On the point, Garzella and Galeotti note that “the company policy will never become strategic if it does not set itself the objective of continuously improving the economic-financial conditions deriving from obtaining the strategic, competitive and economic advantage” (Galeotti and Garzella 2013). The intensity of the risk, which increases as the debt rises above certain thresholds, affects the policies of the financed company. A financial structure with a high amount of third-party capital constitutes for the company an element of financial instability which produces the following effects: having to cover, in set timescales, through outgoings, the repayment of the debt and the payment of its cost; the outgoing flows are “basically fixed” while the incoming flows, linked to operational dynamics, are “basically variable”; the need to generate cash resources that are also sufficient to obtain an adequate “credit rating” to have access, in future, to the necessary hedging sources of prospective financing requirements. In analysing the constraints of investment decisions, we must consider the phenomenon that physiologically occurs where the firm starts to perceive signs of crisis. One of the first actions taken by it, to recover financial resources that allow it to survive in the short-term, is the sale of its assets. Although this is an instrument that generates immediate liquidity, it is not always an effective strategy for re-establishing the economic-capital-financial balance. Leaving aside the circumstance of voluntary liquidation, which involves, at the end of the procedure, the extinction of the company itself, we will focus on the simple circumstance of the sale of fixed assets as a solution for redevelopment. The sale of assets is, for the company, a way of generating cash and, as a result, repaying the debts due in the short-term. In line with what is stated by Brown et al. (1994) the disposal of fixed assets by companies in distress is an operation that is advantageous almost exclusively for creditors. Asset sales used to repay debt result in lower average share price reactions than when sales proceeds are retained by the firms (Brown et al. 1994).

This derives from the fact that the sale is not principally aimed at increasing the efficiency of the productive organisation or generating higher value, given the low value in use of the asset within the company itself. A disposal of this nature

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originates mainly from demands made by creditors which, seeing their credit position in danger, attempt to cover themselves from any higher losses. Ultimately, it should be noted that an operation of this nature is oriented solely at short-term balance. If not correctly assessed, this could represent in itself a prologue to the firm’s future liquidation. The realisation of the sale, despite being retained in the company and not being used to pay creditors, must originate from a need for efficiency, renewal and not from a logic intended to cover payments of due debts. This type of operation should be structured in such a way as to guarantee a going concern, so as to create the conditions for redevelopment and rebalancing of the financial structure.

3.4

Selection of Sources of Financing

The comparative analysis of sources of financing, particularly in scenarios dominated by high uncertainty, should be guided by the systematic analysis of some main factors (Marchi 2014): 1) cost of financing sources; 2) composition of investments, financing and their correlation (evolutionary analysis of the financial structure); 3) level of financial elasticity; 4) financial leverage.

3.4.1

Cost of Financing Sources

The cost of capital is a quantity aimed at measuring the expected rate of return required by the market in order to contribute the necessary resources to finance a given investment or business project (Guatri and Bini 2009). Pratt notes: “cost of capital has many applications, the two most common being valuation and capital investment project selection. These two applications are very closely related” (Pratt and Grabowski 2008). There are different configurations of the cost of capital. From a liability perspective, for example, the cost of capital is the supposed economic cost for a firm to obtain capital from its equity holders and creditors. Second, from an asset perspective of firm’s balance sheet, the cost of capital is the rate at which future cash flow of investments that the firm aims to conduct should be discounted to present values (Pratt and Grabowski 2010). Donovan (2020) defines the cost of capital as the investors’ pricing of the risk of an investment, and as a threshold return that potential investments have to meet to be viewed positively.

3.4 Selection of Sources of Financing

55

The cost of capital is affected by conditions of crisis and decline that, in actual fact, make the capital markets not perfectly competitive and efficient. A doctrine developed in the late 1970s theorises the benefits of debt as a disciplinary mechanism: the recourse to credit capital forces management to use the available cash flows more carefully (Jensen and Meckling 1976; Damodaran 2001; Dallocchio and Salvi 2005). According to supporters of this theory, the benefits are even greater in firms where there is a clear separation between owner and manager, when the use of debt can represent an indirect instrument of management control. The recourse to borrowing, however, exposes the company to the risk of default and possible bankruptcy if difficulties arise in fulfilling obligations to return the capital shares and interest payable (known as financial distress costs) (Dallocchio and Salvi 2005; Damodaran 2001).

3.4.2

Composition of Investments, Financing and Their Correlation

The importance of correlating financing and investment decisions involves the preliminary classification of the investments, requirements and sources in relation to the characteristics of duration. Investments, as is widely known, can be split into: – structural, intended to remain in the company for a long time, gradually transferring their utility into multiple production cycles of goods/services and of sale of the same (a system, a building, a car, a computer, etc.) and they give rise to so-called fixed capital (or fixed investments); – current, intended to remain in the company for a short time, transferring their utility into a single production cycle (raw materials, services, credits, etc.) and giving rise to so-called working capital (or working investments) (Quagli 2003). The characteristics of the investments determine the nature of the firm’s financing requirement. Structural investments produce a requirement that tends to be lasting, since on one side, in conditions of economic balance, the “elementary requirement” generated by the single investment will gradually be reduced by the flows generated by the sale of products; on the other, that reduction effect is counter-balanced by interventions of replacement, restoration, development, for the set of structural investments in place, which tend to leave the amount of the overall requirement for the firm substantially unchanged. The correlation between sources and investments can be analysed both to examine the structure of invested capital and internal and external sources of financing, and to obtain a balanced situation from the time perspective.

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In other words, in order to improve the structural balance, firms must maintain a correlation between sources and investments that is congruous and coherent with their relevant sector and not increase their level of borrowing beyond physiological levels. Therefore, appropriate interventions must be made in order to maintain temporal balance between sources and investments, to ensure that long-term activities are covered by long-term sources and vice versa (Cinquini et al. 2016). A balanced financial structure needs investments to be financed by sources compatible with the nature of the system of requirements: the part that tends to be permanent, generated by the set of structural investments and by the physiological component of the current investments, should be covered by sources that tend to be lasting; the fluctuating part should be covered by sources that tend to be short-term (Giannessi 1969; Bertini 1990; Ferrero 1981; Caramiello et al. 2003). The need for qualitative correlation should not, however, be interpreted in precise terms as correspondence between individual investments and individual sources but in a systematic perspective between the set of investments and the set of financing, taking account of the cycle of realisation of factors and the cycle of return of sources: that principle can partially be derogated without incurring the risk of excessive financial strain if the cycle of return of short-term sources can be reconciled with the cycle of realisation of current investments and if the company is able to maintain sufficient financial elasticity. However, it is undoubted that the more short-term debts finance fixed investments, the less solid the firm’s financial structure can be considered to be on equal terms. It is essential to have a financial structure which is solid and, at the same time, balanced with the financing requirements of the firm itself in order to achieve longterm balance. In cases of lasting imbalances, management must correct those anomalies in order to avoid steering the firm into unsafe waters. Credible and professional management of the firm’s financial requirement similarly reduces the conditions of uncertainty to which it is subject, influencing, as a result, also the conditions of its access to credit, as well as its costliness.

3.4.3

Level of Financial Elasticity

Financial elasticity, in Giannessi’s approach (1969), can be defined as “the ability of the firm to have appreciable ‘room for manoeuvre’ in covering its financial requirements”. The possibility of having some financial elasticity may allow the firm to cover the requirement deriving from valid future investments, balancing the need for economic liquidity and value creation. The level of financial elasticity is based upon: – liquidity reserves, also known as cash holdings. – flexibility in relationships with lenders; – timeliness in accessing sources.

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57

Theoretically, a firm has several reasons to hold cash. A principal motive are transaction costs. A recent literature provided that cash holdings are negatively connected to the size of a firm (Swain 2015). Other studies have examined the effect of corporate social responsibility on cash holdings and have shown that CSR and board size are negatively related to cash holdings (Liem et al. 2020). As suggested by Damodaran, those responsible for financial policies should identify the adequate level of financial elasticity by assessing the trade-off between the described benefits and the costs for maintaining unused debt capacity or holding cash in excess of management requirements (Damodaran 2001). In a context, such as today’s, characterised by strong market instability, financial elasticity is a strategic element that can be used by the firm. In order to address the variability of the present scenario, a financial policy must be adopted that is capable of making the firm flexible to possible changes. The determinants of financial elasticity, described above, must therefore be interpreted in the perspective of managing uncertainty. The availability of liquidity reserves, flexibility in relationships with lenders and timeliness in accessing thirdparty capital represent the firm’s strategic-financial response in order to be able to cope with those periods of financial stress originated by various aspects linked to business activity.

3.4.4

Financial Leverage

As is known, the leverage effect, which describes the effect produced on the profitability of equity by the relationship between the return of invested capital and the cost of credit capital, should guide financing decisions. Analytically, this concerns the relationship between the following economicfinancial indicators (Kaplan and Norton 2002; Marchi et al. 2003; Caramiello 1989; Ferrero et al. 2003; Rappaport 1989): – the ROE (Return on Equity), equal to the ratio of net income to equity, which summarises the rate of return on venture capital; – the ROI (Return on Investment), equal to the ratio of operating income to invested capital, which expresses the rate of return on capital invested in core business; – the CDf (Cost of Debt Capital), which indicates the rate of third-party sources. The links between the three indicators are described through the formula (Caramiello et al. 2003; Invernizzi 2004; Solomon 1972): ROE ¼ ½ROI þ ðROI  CDf Þ  Df =Kp  ð1  t Þ ¼ ½ROI þ ðROI  CDf Þ  q  ð1  t Þ whereby:

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Df ¼ debt capital Kp ¼ risk capital t ¼ incidence rate of direct taxes q ¼ debt ratio, equal to the ratio between debt capital and risk capital If the ROI is lower than the interest rate on credit capital, the ROE decreases as the debt ratio increases. This effect is notoriously known as the leverage effect or financial leverage effect. If, on the other hand, the ROI is higher than the rate of the cost of financing sources with loan capital, there is a positive leverage effect, as the increase in leverage acts as a multiplier of the ROE, while if the ROI is lower than the rate of the cost of financing sources, the inverse, i.e. negative, effect occurs. The financial leverage mechanism is not free from risks and uncertainties; many firms have in fact financed their growth with excessive use of credit capital when it appeared convenient, but when the scenario changed—because the ROI lowered, or the rate of financing increased—they saw the leverage effect transformed (Potito 2017). If the financial leverage is positive, it is more convenient for the firm to finance investments using credit capital rather than equity. In the presence of a positive leverage effect, the profitability of the equity rises with the increase of the debt ratio and the different financing choices between venture capital and debt capital reflect to a different extent on the firm’s overall profitability. However, if the firm achieves negative financial leverage, following an inversion of the trend in the profitability of the invested capital or a variation in the interest rates, the impact on net profitability will be amplified by the multiplicative effect produced by the debt ratio. This latter consideration requires a more careful analysis of the use of the leverage effect, which must be assessed in light: – of the multiple elements of uncertainty, based upon the subjectivity, indeterminacy and interrelations to which the estimate of the considered variables is subject; – of the likely increases in the interest rate on debt capital, when borrowing increases over physiological levels. Ultimately, it can be said that financing choices through debt capital, in the presence of a positive leverage effect, contribute to value creation if the company is able to identify the right balance between the opposing pressures on the cost of capital.

3.5 Main Methodologies of Investment Evaluation

3.5

59

Main Methodologies of Investment Evaluation

This paragraph will focus on the methods most frequently used by doctrine to evaluate investments with particular reference to firms operating in situations of clear uncertainty and complexity. The evaluation of investments in contexts dominated by uncertainty is a process that is even more complex than the evaluation of future cash flows linked to investment proposals in general contexts. Among the multiple approaches developed to take account of uncertainty in the absolute and relative choice of investments and to clarify the possible causes of failure of the proposed projects, we focus our analysis on: 1) 2) 3) 4)

sensitivity analysis; break-even point analysis; Monte Carlo simulation method; decision tree.

3.5.1

Sensitivity Analysis

The sensitivity analysis aims to identify the sensitivity of the NPV calculation to the variation of the underlying hypotheses. Through this approach, the aim is to measure the impact that may result from variations of the basic hypotheses on the economic and financial indicators. A decline in sales forecasted in the business plan, for example, may negatively impact the return of a project. Therefore, with a view to assessing that possibility correctly, it is worth considering not only the base level of combined cash flows (base case) but also a more pessimistic alternative scenario (worst case) and possibly a scenario dominated by more favourable conditions (best case). Therefore, the sensitivity analysis facilitates: – the identification of a minimum threshold of acceptability of the project based upon the maximum acceptable negative variations; – the adoption of any corrective measures to mitigate the negative effects deriving from the investment (Gangi 2011). The sensitivity analysis is particularly useful in evaluating investments in scenarios dominated by uncertainty; however, that analysis may be affected by the discretion of managers asked to isolate the hypotheses and evaluate the variables that could contribute to the result. Amongst other things, to produce precise forecasts based upon each isolated hypothesis, financial management should consequently gather a higher amount of information on the key variables so as to increase the accuracy of the respective forecast.

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However, financial management should always be aware of the fact that the sensitivity analysis is still based upon estimated information that cannot be raised to the level of certainties on the future. In addition, the individual variables are considered separately, assuming their independence, when, on the other hand, they are often related (Brealey and Myers 2003). To avoid this problem, the managers of the financial area may perform a scenario analysis. The sensitivity analysis is developed by examining the changes in net present value in alternative scenarios, characterised by correlated sets of modified variables.

3.5.2

Break-Even Point Analysis

A complementary approach to the sensitivity analysis is constituted by the breakeven point analysis which determines the amount of sales required to reach the break-even point, allowing the risks connected to incorrect forecasts to be identified. The break-even point analysis adopts a logic opposite to that of the sensitivity analysis, asking: “to what extent must the forecasts be wrong in order to change the judgment on the investment offer?” The break-even point is the point where total revenues equal total costs. That equality is verified for a given amount of sales “X”, which can be analytically determined as the ratio between fixed costs and unit contribution margin: X¼

FC ð p  bÞ

whereby: FC ¼ fixed costs b ¼ unit variable costs p ¼ unit sale prices The break-even point analysis gives an understanding of the effects on the assessment of convenience of the investment as a result of the variation of prices, sale volumes, fixed costs and variable costs. However, that analysis, as it is based upon book values, does not highlight, for production volumes that allow for the break-even point to be achieved, the effects on the process of value creation for the company as it overlooks the opportunity cost of capital. This limit can be easily overcome by replacing the book values with the current value of incoming and outgoing cash flows (Brealey and Myers 2003; Ross et al. 1997). In that case, by equating the current value of cash flows of opposite sign, it is possible to identify the quantities to be sold to have a net present value equal to zero.

3.5 Main Methodologies of Investment Evaluation

3.5.3

61

Monte Carlo Simulation Method

The Monte Carlo simulation method is a technique for dealing with problems connoted by a high degree of uncertainty. It is a useful tool for interpreting not just a limited number of alternative scenarios, but the entire range of possible combinations induced by changes to the variables that affect the value of an investment proposal. By computer, the Monte Carlo simulation method constructs the frequency distribution of the investment value, identifying the average result and the upper and lower limits. The main phases into which that method can be split are represented by: – construction of the model, based upon the variables and the interdependencies between the variables, at least the main ones; – determination of the probabilities associated with the isolated variables; – simulation of cash flows, which leads to the calculation of cash flows expected from the investment in each period; – estimate of the probability distribution of cash flows, which, by recording the value of the processed cash flows, highlights the distribution of value generated by the investment. The Monte Carlo simulation method is particularly useful in scenarios dominated by uncertainty and also to make financial management aware of the need to examine carefully the uncertainties and interdependencies between the multiple variables involved in the investment evaluation process. Conversely, the model has some weak points relating to the complexity and elements of subjectivity of the analysis.

3.5.4

Decision Tree

The decision tree is one of the most effective methods in scenarios dominated by uncertainty, as it is theoretically able to evaluate the uncertainty linked to the sequence of decisions that arise in an investment project, allowing for the explicit analysis of possible events or future decisions (Magee 1964). Decision trees allow management to abandon the hypothesis of a single initial decision-making moment, so as to be able to consider the various alternatives that are posed at key decision-making moments. In general, investment proposals are marked by a decision-making process characterised by a succession of moments of choice conditioned by the different amounts of information that become available as time passes (Anthony et al. 2011). In Magee’s approach, the decision tree is constituted by a series of nodes and branches, where the nodes represent the possible scenarios that may occur and the branches the possible alternatives of choice. That tree helps to identify the alternative

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that, at a particular decision-making point, is combined with a higher economic return. The overall method can be structured as a series of main phases: – identify the decision points and alternatives existing at each point; – identify the points of uncertainty and the alternative events at each point; – estimate the values necessary for the decision-making analysis (probability for each event, costs and revenues associated with each event) – identify the best possible alternative. The decision tree method illustrates the different options involved in an investment process and highlights the relationships in place between present and future decisions. However, one critical aspect of the decision tree analysis consists of the use of the same cost of capital to discount the cash flows of different management activities, characterised by non-homogeneous uncertainty levels that actually require specific discounting rates (Anthony et al. 2011). Nevertheless, despite being an effective system of representation of the effects of future situations, it does not eliminate the risks linked to the uncertainty of the estimated values (Brealey and Myers 2003).

3.6

Financial Risk Management

Interest in corporate risk has been strongly increasing in recent years. In an increasingly dynamic and turbulent environmental context, companies find themselves having to address multiple risks affecting management processes, with a view to safeguarding the cost-effectiveness of the productive combination (D’Onza 2008).

This is determined by the fact that an excessive concentration of risk factors has the capacity to engender expectations of uncertainty on the achievement of the company targets, calling into question its very capacity to generate value over time. As highlighted in literature by Bertini, risk—in the economic-business logic— derives “from the juxtaposition of two phenomena, the first objective, the second subjective: the changing manifestation of events and the human inability to foresee such changes” (Bertini 1969). The significance assumed by rating agencies and financial scandals that characterised the start of the century turned the spotlight on the need for greater commitment by management in identifying the risks to which the company is exposed, to measure them and to implement tools to protect the economic balance over time. This conviction has for some time pushed management to allocate resources towards controlling risk factors. From the most significant moments, the analysis and assessment of the risk profile in negotiating the cost of third-party capital is undoubtedly among the most important. Relationships with investors, whether they are shareholders, bondholders or

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credit institutions, are among the most exposed: any company default may have repercussions on the economic-financial balance of all those who, by investing liquidity, support its development. More specifically, this refers to the new perspective that characterises competition on the financial markets, as emphasised by Galeotti and Garzella (2013) and consequently the variables to be monitored. Attention is thus to be focused on the expectations of lenders and shareholders, particularly those remaining external to the governance of the company and looking to the latter as a financial investment opportunity. In that way, the perspective of the investor in the management of the company is affirmed; this means that the firm is judged and assessed in its performances from the perspective of the capital markets, based upon its capacity to meet expectations in terms of risks and returns (Galeotti and Garzella 2013).

Acting as an alternative preferable to other investments, the level of attractiveness for third-party capital is strongly linked to the implicit risk of the company. If the exposure depends upon the very variables of the capital markets—interest rates, exchange rates or other macroeconomic factors—rather than on elements of competitive nature (market share, competitive position, level of process innovation, product maturity) the company risk can be kept under control by leveraging—as well as on portfolio diversification strategies—on systematic risk management activity. The function of risk management in business is to identify the risks that require attention, distinguishing between those that can be hedged with instruments that transfer the effects to third parties from those that can be managed. Risks that cannot be hedged, for example, include operating risks. “The operating risk is associated with the variability of the economic-financial flow inherent in the core business and it is measured with reference to operating income” (Galeotti and Garzella 2013). Despite the attention paid to this class of risks, there are currently few instruments that allow the company balance to be immunised from the repercussions of their occurrence, facilitating that reduction in exposure only in some cases. This limited availability of hedging instruments of the operating risks is a result of their costliness: for example, some insurance contracts, which reduce the effects on the general economic balance if very remote specific events occur, have such high insurance premiums as to make them less desirable solutions. Therefore, as the majority of operating risks are not yet adequately modelled, the possibility of one of them occurring is closely linked to the coordination of the organisational processes and the effectiveness of the internal control systems. These have attracted significant interest from the financial and academic community, giving rise to the Co.So. Report, a useful framework of reference for defining internal control processes. Unlike what has just been considered for operating risks, the effects of financial risks, or market risks, can be managed through the combination of different hedging instruments. The market risk is the risk produced by unforeseen events that have the potential to affect the value of the company assets due to a variation in prices. Those variations may be linked to the economic situation of the market, in which case we speak of the generic risk, or to specific conditions of the financial instrument

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(for example, changes occurring in the tax treatment of the market in which it is issued, financial difficulties of the issuer). These types of risk arise in relation to unexpected changes in the values (prices) of certain market variables: – – – –

interest rates; exchange rates; prices of commodities; prices of financial instruments (share certificates, bonds, other financial instruments).

If they cannot be nullified through careful financial management, they can be transferred to other entities using specific financial instruments. That possibility is offered by derivative instruments, namely financial contracts traded on specific markets, used above all to manage open positions with a view to hedging. Financing instruments exposed to financial risks fit into the main categories such as bonds (in general, all debt securities), share certificates, foreign currencies, goods and commodities. In addition to the risk categories cited above—which represent the risks typically subject to interest in Corporate Financial Risk Management activity— there are other equally significant ones, identified residually. These include: – credit risk; – settlement risk; – sovereign risk. The credit risk occurs when an unexpected change in the creditworthiness of an entity in relation to which there is exposure generates an unexpected change in the market value of the credit position (Sironi 2005; Duffie and Singleton 2003). Based upon the definition presented here, some interesting considerations can be drawn. Addressing the credit risk does not just mean considering the event of complete insolvency of the debtor; it also occurs when there is a deterioration in its creditworthiness. Secondly, the change in the creditworthiness of the counterparty must also be unexpected. The settlement risk arises at the time of settlement of the transaction. It is not connected to the availability of liquid resources to honour the financial commitment but, rather, to the uncertainty that burdens the counterparty in relation to the fulfilment of the performance. The sovereign risk arises when the debtor is unable to fulfil the financial obligation assumed due to problems attributable to the economic-political situation of the country in which it is based. With regard to Corporate Financial Risk Management, it is interesting to introduce some new areas of research that have been engaging scholars in recent years. In particular, we refer to the study relating to the human dimension of the decisions made in relation to risk hedging. The interest has shifted to the person who makes risk management decisions within the company context in order to fully understand the underlying reasons.

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In literature, there are various risk management studies in response to the business crisis, but we intend to focus on the analysis of the reason why an executive makes a risk management decision (Smith and Stulz 1985; Stulz 2013; Nance et al. 1993; Geczy et al. 1997; Gay and Nam 1998; Graham and Rogers 2002). “The «human element» plays a key role in both the active management of risk and the measurement of the firm’s risk exposure” (Bodnar et al. 2019). More specifically, we aim to highlight that age, educational background and remuneration methods influence the risk aversion of the person called upon to make decisions. An interesting study is thus outlined in relation to the determinants—of subjective nature—of this business activity, which are often overlooked in favour of other key variables of objective nature. In order to produce an in-depth examination of the subject in question, the following two paragraphs introduce derivative financial instruments for risk hedging and the main models for measuring exposure to business risks.

3.7

Derivative Financial Instruments

Not all types of risk can be immunised through adequate instruments. For some of them, such as operating risks, the potential effects can be limited through insurance contracts or planning and control systems. Financial risks are a different matter and involve several hedging opportunities. The financial community has, in recent years, produced extremely complex financial instruments—whose structure is based upon combinations of rights and obligations even of very differing natures—which offer hedging possibilities of financial risks connected to unexpected changes in the variables upon which they depend. This type of risk can now be transferred to third parties having expertise in risk management. That activity, arising originally within the finance area of credit institutions, is now also present in industrial companies and is known by the acronym CFRM, Corporate Financial Risk Management. International legislation has dedicated great attention to financial instruments in relation to the introduction of the IAS/IFRS, the international accounting standards. IAS 32, IFRS 7 and IFRS 9 deal with regulating the positions assumed in derivatives by companies and the information to be provided periodically to the market as to their use. In the international arena, accounting standard IFRS 9 has now been introduced for some time, which contains an interesting definition of derivative financial instrument. The derivative is defined as a “Financial instrument or other contract within the scope of this Standard with all three of the following characteristics:

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a) its value changes in response to changes in the so-called ‘underlying’, i.e. the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable. In case of a non-financial variable, the variable must not be specific to a party to the contract (sometimes known as “underlying”); b) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts with a similar response to changes in market factors; c) it is settled at a future date” (IFRS 9). The definition of a derivative financial instrument, therefore, is that of a contract whose value is based upon the price of an underlying asset, such as, for example, stocks, bonds, commodities, stock market indices, interest rates, exchange rates. The value of those instruments, therefore, is strongly linked to the performance of the value of the financial market variables to which they are linked. Originally created to manage the risk connected to the performance of the market price of commodities, derivative instruments are now also widely used for speculative purposes in investment strategies, as they assist, in combination with different instruments, in maximising the returns of financial investments. In fact, derivative instruments such as futures, swaps and options, can also be used to maximise the value of an investment, assuming an open position on a risk associated with the fluctuation in value of an underlying asset or liability. With the reform introduced by Italian Legislative Decree 139/2015 the domestic accounting framework also regulated the principles for the recognition, valuation and recording of derivative financial instruments in the balance sheet. From a regulation that considered these off-balance sheet transactions, thus outside the cognitive perimeter of the company stakeholder, the legislator gave an initial strong sign of openness towards the necessary information relating to these instruments, now widely used in the corporate finance world. Financial instruments that can be recognised in the definition of derivative instruments offered by IFRS 9, which will be presented below, are those commonly used in the implementation of risk hedging strategies linked to changes in the value of assets and liabilities. Those strategies may be implemented to hedge fluctuations of value in market variables likely to modify: – the fair value of the financial instrument (Fair value hedging); – the cash flows linked to the financial instrument (Cash flow hedging). In the former case, hedging reduces the volatility in the market value of financial assets/liabilities held in the portfolio, thus avoiding unexpected losses that may deteriorate the quality of the income and equity composition; in the latter case, the risk of variability of cash flows linked to specific assets/liabilities or future transactions already planned or highly likely is hedged. The main derivative financial instruments used in strategies to transfer financial risks are the following: – Financial futures; – Forward rate agreement;

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– Option; – Swap; – Credit derivatives. Financial futures is a derivative contract, standardised in its elements so that it can be traded on regulated markets, entered into between parties that agree to exchange a certain quantity of a specific financial instrument at a set date and at a set price. Futures used in hedging financial risks allow for: – the risks connected with the offer of fixed-rate loans to be reduced; – the return of an investment that may be made to be pre-determined; – a future increase in funding costs to be avoided. The process of financial innovation has allowed companies to use a broad range of futures contracts, each characterised by a different underlying. Therefore, hedging through this instrument depends upon the underlying of reference: there are therefore different types of futures. The most well-known include interest rate futures, currency futures, stock index futures, commodity futures (on assets listed in regulated lists). Given its popularity, as well as the attention paid to it by the Italian Accounting Body (OIC), the commodity futures contract is worthy of more in-depth discussion. Based upon the definition offered of commodities derivative, the contract must be considered a derivative financial instrument if its settlement is for cash and not for delivery of commodities. The dual nature of this type of contract, popular also in industrial enterprises, is thus underlined, revealing its origins in the possibility of fixing a future price for those commodities exposed to changes in production, thus making future trading prices volatile. Similar to the previous type, the FRA (Forward Rate Agreement, or just “forward”) is a derivative contract that commits the contracting parties, at a certain future date established when signing, to pay, or collect, an amount linked to the performance of an interest rate traded on a particular market of reference. By virtue of the agreement, at maturity, the parties exchange a cash flow, the amount of which is proportional to the differential between the future rate (or “forward”) indicated by the market performances and the rate agreed between the parties when signing the contract. The agreement, therefore, reduces the uncertainty linked to any future interest rate changes. With respect to futures, where the settlement of the position occurs daily, forward contracts are settled only at maturity. The investor who has purchased the financial asset (long position) delivers it at maturity in exchange for a cash sum equal to the fixed delivery price. Therefore, a key variable of the contract is precisely the market price of the asset: the value of a forward contract over time assumes, or loses, value in relation to the performance of the price of the asset subject to the contract. If the market price of the underlying increases, the value of the long position becomes positive and, by reflection, the value of the short position becomes negative. Options are derivative contracts by which one party (seller) gives to the other (buyer) the right to purchase (call option) or to sell (put option) a certain financial

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instrument at a certain date at a set price, subject to paying the purchase cost of the option (premium). This allows the holder of the right (buyer) to obtain economic benefits deriving from the fair value variation of the underlying financial instrument; while the issuing entity (seller), through the option contract, assumes an obligation to sell (call option) or to purchase (put option) if the holder of the right intends to exercise it. From a risk hedging perspective, the option contract offers the possibility of hedging positions subject to fair value variations; in fact, it minimises the risk of variation in value of a certain asset or liability, paying only the purchase cost of the right of option. Options are split into two classes, European options and American options, depending on the possibility of exercising the right of option at a different time from their natural maturity. The former may be exercised only at maturity; the latter, on the other hand, may also be exercised during their useful life, namely before their maturity, if that is convenient. American options, unlike European ones, are more widespread in the international markets as, given the possibility of early exercise, they provide greater opportunities of being used in investment or hedging strategies combined with financial instruments having different maturities from that of the option. One instrument widely used in the management of industrial firms to hedge financial risks linked to variations of interest and exchange rates is the swap. This instrument involves an exchange of obligations between parties which agree, at a certain price, to exchange cash flows at certain due dates, usually representative of interest payments or capital transfers. If exposure to interest rate risk variations is to be managed, the Interest Rate Swap (IRS) will be used; if it is exposure to the exchange rate risk, the Currency Swap (CS) contract will be used. The peculiar characteristics of these instruments, whether they are on interest rates or currencies, make them particularly useful in the management of risk exposure. Their flexibility is a strongpoint that facilities the overcoming of rigidities of the most widespread financial products by offering the possibility of modelling hedging or investment strategies at reduced costs. Finally, it is worth emphasising the capacity of those contracts to align the maturities of the asset and liability, thereby correcting any imbalances relating to the financial duration of the posts (Monti 1994). One instrument that, in recent years, has become increasingly widespread in the management of exposure to a type of risk subject to close attention by the international financial community, despite being of non-financial nature—the credit risk— is credit derivatives. These instruments separate the credit risk from the underlying security, whether it is a bond or a loan, transforming it into a readily transferable security. They are used in risk management as they limit any losses on loans disbursed to operators subject to changes in credit rating. These instruments expiate the inconvenience of poor tradability on the markets. The majority of trades of this type of contract occur in relation to the specific requirements of specialist operators, thus outside official regulated markets. It follows that their use in risk management is limited to hedging just the credit risk,

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as the use of those instruments may simultaneously expose the firm to other risks such as operating, counterparty and liquidity risks. The most common operations involved in hedging through this particular derivative instrument are bond loans, investments in corporate bonds and over-thecounter derivatives, and financing in favour of developing countries. In international literature, the subject of the use of derivative financial instruments has always been of great interest to scholars (Smith and Stulz 1985; Shapiro and Titman 1986). “Financial risk management can reduce the probability of encountering such states and thus lower the expected value of costs associated with financial distress” (Bartram et al. 2009). Even in more recent times, the matter has been addressed by other authors— including Lee (2019)—who have highlighted the importance of the use of derivative instruments in managing the business risk in entities experiencing financial difficulties. Obviously, this should not be misleading, as the use of such sophisticated instruments requires a solid and competent organisation. For this reason, the use of derivatives should not be seen as a remedy for all ills, but may represent, under certain conditions, a useful instrument for dealing with situations of crisis in which the firm may find itself during its existence.

3.8

Main Models of Measuring Exposure to Financial Risks

To understand how best to use derivative instruments for corporate risk management, a preventive analysis must be introduced to assess the impact that any manifestation of financial risks is likely to produce on the income results and overall performances. In Finance, there are different risk measures (duration, convexity, beta, delta, gamma, vega), which offer risk measurement for each instrument used and not a homogeneous measurement, namely an indicator that summarily quantifies the firm’s overall risk in terms of financial exposure to different market variables. Risk exposure must therefore be measured by identifying the relationships that link the main risk factors to the potential impact on the firm’s economic-financial balance. There are several models of measurement and assessment of the impact of specific factors on the overall corporate risk. They can be separated based upon their level of sophistication in calculating the overall exposure. With a view to managing exposure only to financial risks, however, only some are worthy of consideration. These models, separated in relation to the type of risk to be hedged, can be split into measurement models of exposure to: – the market risk; – the credit risk; – the interest rate risk. Here, we consider only the first. Those adopted to measure exposure to the credit risk and to the interest rate risk are typical of financial management in firms of

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financial and insurance nature, which must, by their nature, cover themselves from those risks. It is rare, on the other hand, for these to be adopted by commercial and production companies, which more typically adopt insurance contracts and specific derivative contracts, without, therefore, using complex statistical-quantitative models. The most frequently used models for measuring market risks are probabilistic, estimating the exposure to the fair value risk or the cash flows of assets recorded in the financial statements. Among the measurement models of exposure to financial risks constructed on mathematical-probabilistic bases, the VaR (Value at Risk) model, established as part of the financial management of financial and insurance companies, is the one that has become most widespread even in industrial companies. The VaR methodology produces an estimate of the maximum expected loss to which a portfolio of financial assets is exposed, in a timeframe of reference, a confidence interval and a reference currency. The VaR model is based upon two main hypotheses of distribution of risk factors: – the prices of the market variables have a random walk; – the rates of change in the prices of those variables are distributed normally, namely the change in value of a financial portfolio is a linear function of the variations of the securities of which it consists. These two hypotheses, although simplifying, are at the basis of the calculation models of the VaR, as, without them, it would not be possible to adopt a probabilistic type model. The calculation of the maximum loss exposed to the market risk with the VaR approach can be addressed with at least three separate categories of estimation models: – analytical models (parametric models) known as variance/covariance models; – simulation-based models (non-parametric models), such as the Monte Carlo model; – Extreme Value Theory-based models (semi-parametric models). The Variance-Covariance Method is the quickest and simplest way of calculating the VaR: having estimated the correlation matrix between the returns of the portfolio assets, by exploiting the properties of normal distribution it is possible to calculate the desired percentile of the distribution of movements of the expected values of the portfolio. The VaR calculation formula is expressed analytically by the following ratio: VaRt ¼ α  VM i σ i whereby: α ¼ constant that identifies the chosen confidence level; VMi ¼ market value of the financial instrument “i” at the VaR calculation time; σi ¼ standard deviation of the financial instrument “i”.

3.8 Main Models of Measuring Exposure to Financial Risks

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As can be noted analytically from the formula, the VaR is given by the product of the value of the position and the volatility of the instruments used, taking account of the correlation between them. Using the VaR, it is possible to measure the capital exposure to individual risk factors (exchange rate risk, interest rate risk, price of securities) as well as the overall risk, despite the heterogeneous nature of the indicated variables (Metelli 1999). The calculation of the described method seems sufficiently simple, but this should not be misleading, as it also has some limits. First of all, the hypothesis of the normal distribution of returns is poorly realistic as it presents, in effect, as a leptokurtic distribution, having, that is, “fatter” tails than the tails of normal distribution. That aspect has also been addressed in a recent international publication that claimed that executives more adverse to risk consider a fat-tailed distribution rather than a Gaussian distribution in their assessments (Bodnar et al. 2019). Secondly, the hypothesis of linearity actually excludes the applicability of this approach to those financial products that present non-linear payoffs, such as products having optional components. The US investment bank J.P. Morgan has designed its own model, called RiskMetrics®, based precisely on the variance/covariance approach illustrated above. Despite its broad dissemination, it presents several simplifications, making it no superior to others in measuring the risk to which the fair value of a financial instrument or the cash flows linked to it are exposed. The historic simulation approach calculates the VaR using past variations recorded by the observed portfolio. The risk is quantified by simulating the potential loss in the circumstance where the portfolio does not undergo changes in the chosen timeframe (holding period). Having identified the financial instruments of which it consists and having assessed the hypothetical return of the portfolio, the distribution of historical returns is used to determine the potential loss of the portfolio. Models belonging to this class present significant advantages, such as the immediate understanding of the data provided, the relationship of independence from the distribution model (normal) of returns, and the absence of specific assumptions on variance, covariance and correlations between financial instruments in the portfolio; however, at the same time, they present some clear weak points. The first criticality to be noted concerns the basic assumption according to which the historical data are considered good indicators of future market behaviour. Secondly, the sensitivity of the final data depends strongly on the temporal extension of the historical series used, the latter not easily obtainable. These elements make the historical simulation method of determining the VaR one of the less effective with a view to hedging a financial portfolio from market risks (Sironi 2005). Unlike the historical approach, which attempts to forecast the expected evolution of the variables using past observations, the stochastic simulation approach uses mathematical-probabilistic models to simulate hypothetical future scenarios. Among the most widespread, the Monte Carlo method is the most well-known. It differs from the previous ones as it is a non-parametric model, thereby meaning that it does not require hypotheses on the characteristics of the observed phenomenon, such as the normal distribution of portfolio returns.

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Summarily, the method measures the risk exposure of a certain portfolio using a mathematical function (Monte Carlo algorithm) which describes the behaviours of the variables that affect it. The simulation process calculates the distribution of value of the portfolio before and after the changes occur. The method, by generating “new data”, in fact, overcomes the problem linked to the lack of historical data relating to historical simulations. Against this benefit, the model presents a clear defect: the onerous nature of the computational calculation required to generate the future possible alternatives (Facile 1996; Brealey et al. 1999). Finally, it is worth mentioning the Extreme Value Theory, which has achieved significant success in recent decades. Developed in the Nineties, the model is based upon the assumption that a risk manager must be focused on the extreme values of the distribution of payoffs, whether they are profits or losses. This approach estimates the distribution of the tails of the return series to measure the losses and the probabilities of occurrence even for those that are most extreme, given a certain confidence level. The benefit of the model, therefore, lies precisely in the possibility of focusing attention on the tails, more specifically, analysing each of them without making recourse to the simplifying, and often unrealistic, hypothesis of normal distribution of returns. The firm intending to contain its exposure to financial risks must equip itself with adequate expertise in Corporate Financial Risk Management allowing it to achieve two mutually complementary objectives: – to monitor constantly the relationships between financial instruments and the requirements of the financial cycle of the business; – to contain the overall financial exposure to risk. This is possible using risk measurement instruments aimed at assessing the most likely impact on the overall risk profile of the firm in the event of a change of the specific elements that characterise the financing instruments themselves (amounts, interest rates, exchange rates, maturity structure). Therefore, an adequate financial policy is required to check the sensitivity of the risk profile to variations in factors able to modify the structure of the financial obligations assumed by the firm. It is therefore necessary to identify the correlations between the required investments to the operating requirements, to adopt financing instruments adequate to maintaining over time a flexible and sustainable financing structure, and to recognise any other risks connected to counterparties or to the financial instruments adopted. Risk is one of the key parameters that must be taken into account in assessment processes of the firm’s performances. The performance analysis conducted looking also at the evolution of risk constitutes a very interesting and useful aspect for positioning the risk management process in the context of value safeguarding actions (D’Onza 2008).

Effective Corporate Financial Risk Management activity, namely of management, control and monitoring of the financial risks, is aimed at achieving adequate

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protection from unexpected changes in market factors. It is a fundamental activity for the survival and achievement of corporate success in view of an increasingly dynamic and turbulent competitive context. On one side, it is aimed at satisfying those complex financial requirements that characterise corporate life, whether they are expressed in terms of strengthening of financial availability, maintenance of the capacity to honour financial commitments assumed and management of financial costs; on the other, it must mitigate, or even eliminate, those unexpected economic impacts caused by the financial risks assumed. However, it should not be forgotten that in business economic practice, risk situations—or those of particular complexity and uncertainty—can degenerate into decline and, in the even more extreme hypothesis, into crisis. The next chapter will focus widely on this scenario.

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Modigliani F, Miller MH (1958) The cost of capital, corporation finance and the theory of investment. Am Econ Rev 48(3):261–297 Monti E (1994) I mercati derivati e i titoli sintetici, LUISS G. Carli Nadotti L, Porzio C, Previati D (2013) Economia degli intermediari finanziari. McGraw-Hill Italia, Milan Nance D, Smith C, Smithson C (1993) On the determinants of corporate hedging. J Finance 48 (1):267–284 Onida P (1971) Economia d’Azienda. Utet, Turin Pindado J, Rodrigues L, De La Torre C (2008) How do insolvency codes affect a firm’s investment? Int Rev Law Econ 28(4):227–238 Potito L (2017) Economia Aziendale. Giappichelli, Turin Pratt SP, Grabowski RJ (2008) Cost of capital. Wiley, New York Pratt SP, Grabowski RJ (2010) Cost of capital: workbook and technical supplement, 4th edn. Wiley, New York Quagli A (2003) Bilancio di esercizio e principi contabili. Giappichelli, Turin Rappaport A (1989) La strategia del valore. Franco Angeli, Milan Rejda GE (1997) Principles of risk management and insurance. Addison-Wesley, Boston Ross SA, Westerfield RW, Jaffe JF (1997) Finanza aziendale. Il Mulino, Bologna Shapiro AC, Titman S (1986) An integrated approach to corporate risk management. In: Stern JM, Chew DH Jr (eds) The revolution in corporate finance. Basil Blackwell, New York, pp 215–229 Sironi A (2005) Rischio e valore nelle banche: risk management e capital allocation. Egea, Milan Smith C, Stulz R (1985) The determinants of firms’ hedging policies. J Financ Quant Anal 20 (4):391–405 Solomon E (1972) Teoria della finanza aziendale. Il Mulino, Bologna Stulz R (2013) How companies can use hedging to create shareholder value. J Appl Corp Finance 25(4):21–29 Swain S (2015) Role of marketer in corporate social responsibility: an Indian perspective. J Decis Mak 15(2):143–149 Van Horne JC (1984) Teoria e tecnica della finanza di impresa. Il Mulino, Bologna Votchaeva AA (2012) The financial strategy of the company: the concept and role in the financial management. SSSEU 2(41) Whited TM (1992) Debt, liquidity constraints, and corporate investment: evidence from panel data. J Finance 47(4):1425–1460 Zappa G (1956) Le produzioni nell’economia delle imprese. Giuffrè, Milan

Chapter 4

Corporate Crises and Strategic Recovery

4.1

The Different Paths of Decline: What Are the Economic-Financial Consequences?

As stated, firms can find themselves in crisis situations which require them to implement recovery actions; in that context, the adoption of the economic-financial strategies previously examined will not, alone, be a sufficient guarantee of success and value creation. In fact, it is rare for crisis situations to be linked exclusively to financial aspects. Accordingly, when the causes are of economic origin (such as inadequacy of the product mix, organisational unsuitability, inefficiency of sales policies), restoring the financial balance alone is not sufficient to remove the causes of the losses which will, in later periods, go on to generate new financial imbalances. Crises and recovery are some of the most studied topics in business administration and, for this reason, identifying a unique definition for these two concepts is quite an arduous task. A crisis is a systematic process that deeply affects the firm in its complexity, where there is an economic-financial imbalance which, if it has not already become irremediable, can generally only be resolved by implementing profound strategic changes (Altman and Hotchkiss 2006; Scherrer 2003; Trahms et al. 2013). From this perspective, a decline is typically the stage prior to the state of crisis in which the firm’s profitability begins to be eroded and the corporate image tends to weaken in the eyes of its stakeholders (D’Aveni 1989; Furrer et al. 2007; Bibeault 1999). The stage of decline may evolve into a turnaround, namely a systematic process of recovery and re-launch of the firm, characterised by a set of interventions implemented during the decline stage but before the full manifestation of the crisis (Balcaen and Ooghe 2006; Guatri 1995a; Schmuck 2013), or into a crisis, when it has reached a certain intensity which, conversely, represents its dysfunctional stage (Chowdhury and Lang 1996; Müller 1985; Santanaa et al. 2017). If the crisis goes as

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far as reaching a condition of default, it will result in the firm’s closure (Amburgey et al. 1993; Schendel et al. 1976). A crisis often arises during the life of a firm that operates in a complex competitive context and is caused by the incapacity of the corporate and managerial group to govern the complex relationships between external environmental factors and internal variables. The firm becomes incapable of achieving or maintaining its economicfinancial balance and thus to satisfy the needs of entities which participate in the firm’s life over a medium to long-term time period. In fact, that condition differs from negative situations which alternate periodically with positive ones during the firm’s life (Altman 1984; Guatri 1995b). The corporate crisis occurs when an economic-financial imbalance is created which is likely to remain in place for some time and, in the absence of appropriate recovery interventions, to generate a state of insolvency (Chowdhury 2002; Moulton et al. 1996). Turnarounds are widely and consistently classified as either “operational” or “strategic” (Filatotchev and Toms 2006; Robbins and Pearce II 1992; Trahms et al. 2013); in particular: – operational turnarounds mainly include cost retrenchments and asset retrenchments, whether short-term or long-term. That turnaround process intercepts problems triggered by internal factors, such as poor management, inefficient cost structure, non-optimal debt structure, over expansion, or poor control environment. The aim of that process is, therefore, to fix those problems; – strategic turnarounds centre on off-loading businesses and increasing market position in the businesses a firm has chosen to retain. They are often triggered by external factors, such as industry, social, macro-economic, or technological factors, and aim at either achieving a better competitive position in the same business or to enter a new business altogether. Such turnaround efforts typically include the investment in, and execution of, strategic repositioning steps, such as acquisitions, new products, new markets, and increased market penetration. In practice, however, the distinction between strategic and operational turnarounds becomes blurred and difficult to identify (Hambrick and Schecter 1983; Hofer 1980). As stated, the decline heralds the state of crisis and, when it manifests, the firm does not create value but destroys it. The intensity of the decline is measured by the extent of that destruction in a more or less lengthy timeframe (Moulton et al. 1996). It follows that a decline not only occurs when there are negative final economic results but also, and more markedly, if a reduction in prospective economic flows is predicted. Furthermore, the loss in economic flows will also be systematic and irreversible, in the absence of appropriate corrective interventions. The crisis represents a further development of the decline—its degeneration— which occurs as a result of significant losses of profitability and capital value, major and increasing repercussions on financial flows, loss of credit capacity and lack of confidence by stakeholders. The distinction between crisis and decline, on the other hand, does not always appear to be immediate. It may be the case, for example, that a

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crisis situation seems, in the early stages, to be a reversible decline or that the firm without financial commitments is able to postpone its cash difficulties but manifests economic imbalances (Balcaen and Ooghe 2006). The crisis is not an inevitable fact, or a sudden and unexpected event: on the contrary, it results from an incorrect assessment of the trends or negative events that have occurred during the firm’s life, as well as from the absence of control mechanisms on its state of health. The recovery of a firm in crisis requires a different methodological approach from interventions implemented during the stage of decline. In fact, a crisis situation requires both a rethinking of the strategic structure—and thus the business areas in which the firm is engaged, their architecture and their level of importance—and of the organisational structure—and thus the organisational framework that combines roles and individuals, organising them in a hierarchically coordinated manner (Atiase et al. 2004; McKinley 1993; Sheppard 1994; Siggelkow and Rivkin 2005). Two apparently contrasting requirements must also be reconciled: the need to make short-term cash and the need to avoid disposing of strategic areas that are able to guarantee the firm’s future. In this perspective, the solution of off-loading the firm’s strategically significant business areas does not actually appear to be an optimal solution to guarantee its productivity: this involves the risk of being left with liquid cash but without critical resources to facilitate the development and growth of the business. In some cases, firms can find themselves in situations where they do not yet have negative results but the degenerative process has already begun, or where there are still very negative results, but the inversion of the process from vicious to virtuous has already started. In those situations, it is essential to ascertain quickly—even before the values signal a fully-fledged crisis—if the firm is already in a degenerative process and, in that case, if it is worth attempting a recovery and how to intervene. The negative stages that characterise a firm’s life may be cyclical or structural (Guatri 1995a). In the first case, they manifest with a periodic rhythm in which positive stages are followed by negative stages. In general, the firm is used to that alternation and is aware of the need to prepare itself in advance to be able to cope with unsuccessful periods. In that circumstance, the outcome may be the cessation of the business activity, if the negative stages are not managed effectively. In the second case, the causes of the failure remain hidden even for long periods of time, manifesting suddenly and unexpectedly. The crisis can evolve into the cessation of the business activity or, by way of a recovery project, it can lead the firm into the development stage. That recovery process occurs after the manifestation of the crisis and is characterised, in general, by the presence of symptoms of absolute emergency and by the need for sacrifices from all those involved. In turn, the recovery process may involve a turnaround implemented once the basic conditions of cost-effectiveness have been re-established. The process illustrated above is outlined below (Fig. 4.1). The recovery stage could be further broken down, for representative clarity, into two sub-stages in which the set objectives and priorities differ (Bibeault 1999). In

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Fig. 4.1 The development path of negative stages. *Source: Adaptation from Guatri (1995a)

particular, there may be an “emergency stage in the recovery process”, a subsequent “stabilisation stage in the recovery process” and a “return-to-normal-growth stage”. In the first stage, the aim is to guarantee the firm’s survival by seeking the minimum cash flows to meet urgent requirements; the firm must focus on searching for activities that, in the immediacy, can contribute to this objective (even if accompanied by negative profitability). In the subsequent “stabilisation stage in the recovery process”, on the other hand, the financial logic is replaced by the economic logic, seeking to create the presuppositions for the firm to return to profitability. Finally, in the “return-to-normal-growth stage”, having recovered its profitability, the firm must develop its market share and implement its medium to long-term strategic objectives. Literature on the topic is extremely vast (Schweizer and Nienhaus 2017; Garzella 2005; Weitzel and Jonsson 1989) and is focused mainly upon macroeconomic studies, predominantly analysing the structural dynamics of the economic system as a whole, in a systemic perspective, and upon economic-business studies, concentrating largely on causes, indicators, predictive models and methods for resolving the state of crisis. Numerous contributions have highlighted the need to divide the recovery process into several stages, given different levels of significance based upon their most distinctive characteristics, whether they are operational, strategic or financial in nature (Brancati 2015; Mazzucato and Semieniuk 2017; Sudarsanam and Lai 2002). In particular, with regard to indicators and predictive models, their practical utility is demonstrated by the great interest shown in the topic from as early as the 1930s. Those instruments facilitate the assessment of the results achieved by the firm and also support the decision-making process (Altman 1968; Bijnen and Wijn 1994;

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Eccles 1991); they include both qualitative and quantitative models, some more oriented towards financial aspects and others, on the other hand, more balanced. In relation to the resolution methods of the state of crisis, literature has identified, in a generally concordant manner, two consequential strategic stages (Chowdhury and Lang 1996; Robbins and Pearce II 1992), namely the reduction of costs (retrenchment) and the recovery, which consist, respectively, of a structural recovery stage aimed at stabilising the decline and at the reduction of costs and activities, followed by the implementation of a long-term strategy after sufficient stability has been achieved.

4.2

Causes of the Crisis and the Identification Process

As a process, the crisis is characterised by and presents traits and elements common to the success of the firm, with which it shares complexity, durability and systematicity, but from which it differs as it moves in the opposite direction, namely vicious and not virtuous (Acharya et al. 2007; Andrade and Kaplan 1998; Campbell et al. 2008). A crisis is anticipated by a series of warning signs, against which there is generically some resistance from entrepreneurs or managers in terms of interpreting them correctly and making the necessary prompt interventions. In fact, those signs are often misinterpreted and underestimated by management, as they are considered to be transient events that are likely to disappear without the need for any intervention (Balgobin and Pandit 2001; Chowdhury 2002; Jansen 2004). However, it is crucial to intervene promptly. In that regard, several indicators are considered to signal a more or less accentuated phase of difficulty, distinguishing those that are financial (such as a negative Equity/NWC ratio, non-repayable shortterm payables, overdrafts, negative cash flows) from those that are managerial (represented by the resignation of directors or managers, the revocation of concessions and supply contracts, the loss of important markets, workforce difficulties) and from those of another nature (such as share capital below the legal minimum, existence of legal and tax disputes, legislative changes to the business sector, difficulty in contacting company representatives). The ability to “interpret” those signs in good time is often crucial, as a lengthy negotiation period often involves the closure of ordinary operations, increasing the losses of the period; more importantly, it can also lead to the loss of some elements that constitute the very conditions for any restructuring, such as the relationship of trust with customers and suppliers. Faced with such a situation, firms must question whether the crisis is reversible or irreversible. In other words, firms must assess the existence of their business continuity, the possibility of activating interventions able to generate new cash flows, the compromised condition of the capital/financial situation, whether or not the same can be remedied in the short to medium-term and whether or not their corporate governance is coherent with future scenarios.

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If a crisis is considered to be reversible, as there is business potential that, albeit temporarily deteriorated, can be recovered, the firm must promptly assess the different technical-legal instruments that can be activated to maintain and revitalise its activities. The pathological process develops gradually and spreads into the corporate system, producing increasingly negative economic-financial results, ultimately compromising its continuity (Abebe 2009; Altman and Hotchkiss 2006; Bernardo and Talley 1996). The traditional approach to recovery starts with seeking and analysing the causes of the crisis, only then to focus on removing them. This approach, as we will see below, has given rise to a multitude of doctrinal studies that have had a large response in practice. Alternatively, the imbalanced firm can continue its activity if suitable financial means are made available to cover its losses and liquidity problems, namely for as long as the entrepreneur or owners intend to keep the firm going. Analysing and removing the causes of the crisis thus takes on a central role, such that there are numerous studies and classifications in that field (Elkamhi et al. 2012; Elloumi and Gueyié 2001; Gilson 1989; Gordon 1971). The causes that may lead to decline or crisis depend upon the critical success factors of each firm, as well as the position covered in its competitive field: consider the availability of resources and skills, of strongly innovative and successful ideas, of trained personnel, and of the firm’s contractual strength externally. Sometimes, these aspects compromise—even irreversibly—the typical balances of the firm and its very survival (Schendel et al. 1976; Slatter and Lovett 1999). Only a careful analysis of the causes at the root of a decline or crisis can produce the correct diagnosis of the underlying problems and allow for the precise identification of the strategy to be implemented, pinpointing the objectives, timescales, policies and interventions (Denis and Denis 1995; Santanaa et al. 2017; Thain and Goldthorpe 1989; Winn 1997). The process of identifying the causes underlying a decline or crisis situation may not attribute to them the same margin of certainty. Those causes, as well as being sought where a competitive advantage is present, require considerations valid for the sector to which the firm belongs, which may be suffering from a period of decline or crisis. The causes of the decline and crisis can be analysed by adopting two different approaches, one subjective and one objective (Chowdhury and Lang 1996; DeAngelo et al. 2002; Eichner 2010; Bibeault 1999). In particular, from the subjective perspective, the causes may derive from the conduct of those involved in the firm’s life (particularly management), seen as the only source and protagonists of the firm’s success or failure. Removing those persons could resolve the situation of inefficiency (Chaganti et al. 1985; Clapham et al. 2005). According to that approach, “bad management” is the cause of all corporate problems. Consider, for example, inadequate management composition, ineffective control of financial aspects or management of resources, management that is too costly compared to the objectives to be satisfied, results achieved, lack of distribution policies, errors in strategic approach and in the conduct of extraordinary operations, inaccurate investment policy, organisational incapacity. In that context, it is claimed that senior management is almost always involved, directly or indirectly,

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in a crisis and in its subsequent recovery. The subjective approach is not comprehensive in identifying all causes of the decline and crisis, as some phenomena may escape management control (Daily and Dalton 1994; Danovi and Quagli 2008). In the objective approach, the causes identified from the subjective perspective are combined with other reasons that may have led to or may have aggravated a crisis situation, beyond the firm’s sphere of influence. Furthermore, in relation to the motivations, five factors that determine a crisis can be distinguished. These are: inefficiency, overcapacity/stiffness, decay of the products, lack of programming/innovation, financial/capital imbalance (Bijnen and Wijn 1994; Brown et al. 2006; Chang 2009). In a crisis caused by inefficiency, the production area is generally the one most involved (obsolete tools, incapacity or scarcity of labour, use of dated technology, incorrect location of production plants, etc.). The inefficiency crisis condition is diagnosed by using the industrial cost configuration and also by investigating some efficiency indicators (hours of work absorbed per product unit, production speed of individual machines, quantification of production waste, energy consumed per unit of product, index of use of production capacity, etc.). The overcapacity crisis develops if the firm, following a reduction in business demand, is not ready to adapt its cost structure to the new level of revenues earned, particularly its fixed costs. The crisis from overcapacity/stiffness can be diagnosed through a lasting reduction in orders obtained by the firm, a lasting reduction in business demand due to loss of market shares or an increase in revenues not aligned to forecasts: the firm finds itself with higher production capacity than is actually used, incurring a series of fixed costs. The crisis from decay of the products is caused by the reduction in positive margins between product prices and costs, meaning that fixed or common costs cannot be covered or a satisfactory profit cannot be achieved. The indicators that best quantify product profitability are gross margin and contribution margin. The crisis from lack of programming/innovation can derive from the incapacity to adapt corporate management to the changing requirements of the environment or even to pre-empt that change in the direction most favourable to the firm. The crisis from financial/capital imbalance involves high financial costs not aligned to those of competitors due to high borrowing and a higher cost of capital agreed with lenders. The causes that lead to decline and, later, to crisis are, in general, a combination of related events: that situation is never attributable to a single defined cause but to various factors that combine and amalgamate, causing complex crises. Another crucial factor in terms of the impact of the crisis is the “robustness” of the firm’s successful business formula (Balgobin and Pandit 2001). The five crisis factors indicated above come into play at different times, distinguishing the causes in relation to their time manifestation. In that sense, a distinction can be made between first and second line factors. The former are positioned at the origin of decline processes and are, in general, represented by a lack of programming/innovation, by inefficiencies or by decay of the products. The latter, on the other hand, come into play at a later stage, aggravating the crisis situation. These are stiffness and financial imbalances. Those crisis factors are linked by a cause/effect relationship or by relationships of interaction: financial imbalance,

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for example, is generated by one or more of the other crisis factors but, in turn, it aggravates them; a lack of programming and innovation can generate both a decay in the products and inefficiencies which, in turn, develop both a financial imbalance and stiffness. Another distinction can be made which concerns the time origin of the crisis, namely a crisis of birth, resulting from errors committed in the phase of designing and constructing a new firm. Consider strategic mistakes linked to the stage of establishment of the firm and the management crisis, connected to events occurring during the firm’s management, in respect of which the firm is incapable of implementing the necessary changes flexibly. Depending on the subject, on the other hand, a distinction can be made between a widespread crisis and a particular crisis. The former affects entire sectors or segments within them. The exit from the crisis is the result of a form of natural selection of firms, where only those that had the ability to survive remain in life. The latter, on the other hand, involves individual firms, by virtue of their weaknesses in the face of external variables or errors committed by senior management. On the same lines, a distinction can be made between types of crisis in terms of their origin, differentiating between crises with external matrix and crises with internal matrix (Galeotti 2016). In the first case, the influence of factors not controllable by senior management is dominant. Those types of crisis involve one or more economic sectors and, within them, the relevant segments. The causes triggering a sector crisis, requiring a production reconversion strategy, may be of economic nature (drop in demand, increase in unemployment, rise in prices of raw materials), of ecological nature (linked to phenomena that cause damage to the environment and also have repercussions on firms’ actions) or of catastrophic nature (linked to accidental events that cause damage to the economic fabric of the local area). In the second case, the determining cause is represented by strategic and organisational errors by senior management. Different types of crisis of internal nature may be the result of various reasons: strategic errors (for example, mistakes made when defining the investment portfolio mix), crises of positioning (mistakes in selecting the market segments or niches on which to focus), dimensional crises (the firm may be undersized or oversized with respect to its production requirements and the results achieved), crises from inefficiencies (imbalance between costs incurred and results achieved). Crises with internal matrix can, in turn, be split into: – crises linked to investments, where investments may derive from incorrect planning or realisation. They may not be sufficiently flexible in relation to changing market requirements; they may have been abruptly interrupted, generating negative effects on the income statement; they may not be appropriately renewed or may not be integrated with investments previously made; – crises deriving from the absence or lack of innovation: the innovation factor may not reflect market requirements, may not be given significance in corporate decisions or may even be deficient compared to that of the competitors;

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– crises from lack of flexibility: the firm may have flexibility issues from a strategic, structural and operational point of view, not being able to respond promptly to changing market requirements. In relation to financial difficulties, these can largely be explained by problems linked to operating efficiency and financial structure; however, (Whitaker 1999; Turetsky and McEwen 2001; Yazdanfar 2011) they may also arise due to external causes that cannot be controlled by the firm. Those causes must be promptly identified in order to address the manifestation of financial difficulties rapidly (Yazdanfar and Öhman 2020). For this reason a recovery plan should be produced that best develops the elements of strategic management and contains financial solutions. Financial recovery is in fact the key element around which the financial strategy of the firm experiencing a crisis situation revolves. As will be discussed below, in recovery plans aimed at overcoming a crisis, access to new finance becomes particularly important in order to guarantee business continuity. This is a rather complex operation overall, due to the conditions of deterioration in which the firm finds itself and the high number of factors and conditioning that come into play. The possible interventions in that sense include: asset operations, recovering part of the invested equity and freeing up resources to be used for the objectives contained in the plan (sale of properties and non-instrumental assets, non-strategic investments, disposal of business areas and product/market combinations outside the core business, lease-back operations on instrumental assets), liquidation mixes, repayment plans and request for new supplies with reference to exposures towards suppliers, based upon the willingness of the individual counterparties, and debt consolidation and/or restructuring operations with the banking system. The latter materialise, depending on the circumstances, in the direct revision of repayment plans and the cost of debt, and in the liquidation and transfer of positions in “datio in solutum”, resulting in the acceptance by the banks of a performance other than repayment, consisting of the transfer of ownership of assets or other real rights. In this context, particular importance is given to accessing new sources of financing, both by capital increases and by the provision of new credit lines”. Although drawing on “new finance” is one of the major elements of many recovery plans, such an operation is not easily achievable as it entails particular risks for the lender. The topic will be addressed and investigated later. It is clear that the traditional approach to resolving a crisis is no longer sufficient and that, conversely, a strategic approach must be taken. Excessive effort spent on trying to identify the causes of the crisis and to remove them actually risks wasting energies that could be used in other areas, for example, to formulate a new strategic and financial proposal to the stakeholders. In fact, when the crisis reflects a pathology that affects the firm as a whole, seeking and understanding the causes of the crisis may be useful to avoid committing similar errors in future, but it is certainly not sufficient to facilitate any re-launch. Furthermore, paying too much attention to seeking the causes of the crisis may also be harmful; it risks sending out a message that if the firm does the opposite of what went wrong in the past, it will do well in the future. The strategic approach, on

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the other hand, does not completely exclude any removal of the causes of the crisis, but it assigns to this process an accessory and not a predominant role.

4.3

The Strategic Recovery

Over the years, the most influential factors in determining the success of complex corporate recovery processes have been identified through direct observation. As already highlighted, when a crisis occurs, the firm must ascertain whether or not the presuppositions are in place to attempt a recovery and, if so, the process to be followed. Based upon that approach, the logical succession of activities to be implemented involves some initial interventions aimed at re-establishing the conditions of economic and financial balance, recovering the consent of the different stakeholders on the business project (recovery), and a subsequent or simultaneous phase of new development of the firm. To that end, the firm must identify its distinctive resources and unexpressed potential and define the most suitable methods for their complete activation and comprehensive development, leveraging on the firm’s propensity towards innovation and its ability to identify new market opportunities. In other words, the recovery action must take a dual approach aimed, on one side, at solving urgent problems and, on the other, at re-launching the firm by seeking new sources of competitive advantage, new strategic positioning and a virtuous economic-financial path capable of allowing the firm to create value again. Having completed the strategic analysis of the firm’s distinctive resources, the recovery process must be assessed and the value of the strategy must be compared with what would occur if the firm were to be liquidated; finally, the instruments to be used for managing the recovery process should be identified (Penrose 1959; Wernerfelt 1984; Barney 1991; Starbuck et al. 1978). To prepare and direct a recovery strategy, a strategic-industrial plan must be produced which is capable of communicating and effectively transferring the positive points of the recovery strategy to the different stakeholders. That instrument must be formulated based upon the conviction that a crisis situation inevitably involves some strategic actions aimed at re-launching the firm, including a competitive and organisational reorganisation and financial rebalancing (Prahalad and Hamel 1990; Garzella 2005). These actions are interconnected and constitute the unifying element in the majority of successful recovery processes, such that they can validly represent the analysis scheme mentioned above and also be reflected in the recovery plan structure. The actions must be arranged in order of importance, giving priority to those having a greater effect on the firm’s financial and economic dynamics. It is also worth introducing the time factor as a third qualifying element, in the awareness that economic and financial flows find underlying convergence in the long-term, while they are sometimes characterised by “dangerous” trade-offs in the short-term. Many scholars agree that the turnaround should take place over a timeframe of 24–36 months; as early as in the first 6–9 months, there must be clear signs of inversion of

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the trend, with the firm beginning to produce its first positive results in the next 12 months. A firm being restructured must radically modify its strategic formula, connecting the unexpressed resources with the potential in order to realise positive interrelations with other current and future business areas. A flexible system must therefore be established, which can be adapted to the specific elements of the individual cases, in order to maintain business continuity and, with it, the intangible values correlated with the organisation and functioning of the firm. Rapid solutions must be developed without inhibiting the firm. In that context, the firm must satisfy two interconnected and fundamental requirements, namely revitalise its unexpressed potential and win back the confidence of its various stakeholders. To do so, a realistic and credible recovery plan must be prepared (Teece et al. 1997; Garzella 2008) which allows the resources and elements of potential that have not yet manifested to be expressed to the best possible extent. In that sense, the strategic recovery and the interventions on resources occur in three main ways, which can, in some cases, be implemented simultaneously, namely by improving the management of existing systems and removing the braking factors; by adding complementary resources to those that already exist; by developing, starting with existing resources, radically new ones. A general model can be used in relation to the recovery project of the firm in crisis, analysing its composition, formation process and aspects relating to its communication, both internally and externally. Very often, the success of recovery projects (whose stages are characterised by profoundly different objectives, implementation strategies, instruments and durations, requiring very different professional skills from their implementers) depends upon the achievement of the objectives imposed in the development phase (Bibeault 1999). That approach is even clearer when analysing the methods by which, in the different structural phases of the recovery project, the relationship between the firm and the market of its products/ services is governed. The traditional approach to recovery, in that sense, despite being valid in many cases, presents some weaknesses which can sometimes and in some situations make it inadequate. These include the aforementioned dysfunction, which is widespread across the whole corporate system, or at least in a large part of it, and the state of urgency and centrality of the time factor that often accompanies recovery processes. In those situations, a recovery plan that best enhances the strategic management elements is required. In this type of context, a spasmodic search for the causes of the crisis and an excessive effort to remove them could detract time and attention from the definition and formulation of a new strategic proposal to the various stakeholders. When the crisis affects the firm, the search for and understanding of the causes of the crisis may be useful in order to avoid committing similar errors in future, but it is certainly not sufficient to guarantee any re-launch. In managing crises, the success of the recovery process is often more likely if resources and intentions are focused upon pursuing a clear, ambitious and realistic objective, rather than focusing on achieving the sole negative objective of avoiding the crisis (Senge 1992).

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There is another risk involved in focusing on seeking the causes of the crisis: the message sent out when a firm behaves completely differently from how it conducted itself before, thus identifying that behaviour as the resolution of the problem. In that sense, in fact, changing from asking “why are we going through a crisis now?” to “how can we be successful in future?”, although not excluding the removal of the causes of the pathological situation, assigns to the latter an accessory role. In fact, in a successful economic situation, there will be little room for dysfunctions that are likely to have determined a state of crisis and these must necessarily be removed. Therefore, to pursue the strategic recovery, while avoiding the risks of the traditional model, the distinctive resources and unexpressed potential of the firm must be identified. The recovery process must follow an approach aimed at solving urgent problems and re-launching the firm in order to identify new sources of competitive advantage, new strategic positioning and a virtuous economic-financial path (Abell 1980; Prahalad and Hamel 1990; Tsoukas and Knudsen 2003). By applying this approach, the recovery action becomes strategic and the crisis becomes an opportunity for development, requiring a fully-fledged complete structural reworking of the firm (Mueller et al. 2001; Normann 2002; MacIntosh and Beech 2011). In this perspective, a strategic approach requires the firm to pursue positions of excellence, and not merely of balance, as in the traditional model. To achieve this, the firm’s organisational and operational structure must be radically changed. In this context, short-term actions are dictated by the impelling need and by urgency, which act almost autonomously and appear to be only minimally related to long-term development plans. The business crisis, despite degenerating suddenly, often develops through several stages. In fact, it evolves from a latent or potential stage to an acute stage, passing through a stage of development (Argyris 1990; Bogner et al. 1999). Throughout that process, the interventions implemented to slow down that pathological situation gradually increase as the acute period of crisis approaches. In that context, by taking a strategic approach to the crisis, weak signals can be perceived which allow the firm to anticipate the development of the crisis and to implement the recovery process more quickly. If the firm is able to perceive the situation of danger quickly, it may be able to avoid having to manage the full-blown crisis stage (Helfat et al. 2007; Whittington 1993; Tsoukas and Chia 2002). In that sense, the firm must be aware that the short-term decisions implemented to turn around an urgent crisis situation will inevitably end up characterising the firm, more or less strongly, even when a situation of balance has been achieved. The recovery process in a strategic perspective can be split into various consequential stages: identification of the system of resources and unexpressed potential; identification of new strategic formulas in which those resources can represent critical success factors; implementation of the necessary actions to activate those resources, if appropriate even through their synergic composition with new resources; development of those resources as an engine to drive the firm towards new conditions of success; preparation of a systematic recovery plan; monitoring, control and communication of the recovery process.

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Having identified the key resources, therefore, the firm must focus on their management methods and on the respective strategic decisions. In fact, the choice of competitive methods depends upon the resources available to the firm, and it is through the strategic actions and monitored businesses that the management of those resources develops. Critical resources must be identified in view of the preparation of a new management model that allows for their exploitation and that will be used, defended and renewed in order to obtain benefits in terms of competitive positioning and financial flows. The time factor is an essential element in managing a crisis as the more evolved the stage of crisis, the clearer the urgency of the situation. The urgency of the interventions and the need to obtain immediate financial resources are, in fact, characteristic traits of corporate pathologies and it may often seem necessary to ignore a more profitable option in exchange for a quicker alternative in terms of financial return on the investment (Stacey 1995; Lamb 1984; Feldman 2000). The criticality of the situation imposes radical changes in relatively short timescales and priority should be given to actions having a greater effect on the firm’s financial and economic dynamics (Pfeffer 1993; Barney 1991; Brown and Eisenhardt 1997). The foregoing is an initial basis for preparing a general recovery plan, which must contain strategies to guarantee the capacity for growth and sustainability over time of the competitive advantage. To do this, the resources that are able to generate the re-launch must be renewed and new value must be produced in order to accelerate the re-launch and to conquer new “income positions” (Grant 1994; Collins and Montgomery 1999). That approach, which is focused on controlling resources and generating new commercial advantage opportunities in a business crisis situation, may seem optimistic; however, as already stated above, the presupposition of a recovery strategy consists precisely in the need for resources and competences not adequately developed by the current management (Porter 1991; Garzella 2005; Chiesa et al. 1996).

4.4

The Management of Complexity and Competitive Reorganization

Firms, as complex organisations, are influenced by many internal and external factors which can endanger their continuation in a perspective of business continuity (Van de Ven et al. 1999; Stacey 1995; Utterback 1994). Crises can be overcome if the firm is able to reorganise itself effectively through a recovery plan that gives priority to actions having the greatest impact on its financial and economic dynamics. In the absence of a recovery programme, firms risk remaining in persistent dysfunction. For this reason, in order to re-launch itself, the firm must have a new agreed vision, whose strength is expressed through its capacity to combine energies

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and ideals and to consolidate the firm’s culture, sense of belonging and team spirit (Ramanujam 1984; Robins 1993; Rosenblatt and Mannheim 1996). In fact, for recovery strategies to be successfully completed, they must facilitate the development of widespread entrepreneurship and must develop the distinctive resources that can arise at every organisational level (Crossan and Berdrow 2003; Morrow et al. 2007; Mueller et al. 2001). At the same time, a coherent approach must be taken towards a financial and organisational reorganisation. In that sense, the implementation of a recovery plan that includes a successful competitive formula is an essential requirement to recover the difficult situation that has been created and to guarantee future development. The planning of the recovery process is a critical strategic action which allows the firm to identify its vulnerabilities, both general and specific (Seegar et al. 2003; Lerbinger 1997), and to identify its main resources, along with its key team and communication channels members (Gonzalez-Herrero and Pratt 1996; Nudell and Antokol 1988). That activity is implemented in order to reduce uncertainty, decisionmaking time, response and recovery (Lerbinger 1997). In parallel, on the competitive front, the firm’s capacity to position itself in attractive businesses in rapid timescales places it in a favourable condition compared to the possibility of crisis (Prahalad and Hamel 1990; Kaplan and Norton 2000; Teece and Pisano 1994). In that context, trust also constitutes an extremely significant element on which the firm bases its capacity to obtain new capital, which is required in order to overcome the state of difficulty in which it finds itself. The ways in which the firm operates in a crisis situation, in order to maintain the relationship of trust with the market, are closely related to the strategic decisions that are implemented to reaffirm its image. The biggest probabilities of recovering the economic-financial balance in fact relate to the image that the firm has built on the market and its current capacity for value creation, being the main guarantees on which the relationship of trust established with the various stakeholders was forged. Therefore, based upon the internal and external resources available, the firm must seek convincing, original and practicable solutions, with a view to generating an improvement in its performances (Prahalad and Hamel 1990; Verona 1999; Powell 2014). When a firm experiences a decline in performance, its relationship with stakeholders deteriorates due to the degeneration of the results (Bititci et al. 2012; D’Aveni 1989). To deal with this situation, the firm must realign the expectations of its stakeholders with the new situation, in order to gain their support and allow the firm to obtain the financing necessary to exit the crisis (Filatotchev and Toms 2006; Trahms et al. 2013; Pajunen 2005). Declining firms tend to adopt “harvest” strategies where the main aim is the collection of as much funds as possible. Often, in fact, financial difficulties materialise in the probability of bankruptcy, depending on the availability of liquidity and credit (Hendel 1996). In that context, the financial strategy aimed at identifying the corrective measures to be implemented to improve efficiency, to control costs for investing in strategic resources and to obtain financial resources must be defined organically.

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The firm in crisis represents a certain attraction for lenders if it is able to meet their expectations, obviously taking account of the risk. In order to attract borrowed capital as well as equity risk capital, the firm must therefore be able to generate the necessary economic/financial resources to offset both the time differential between the investment and its remuneration and the risk associated with the volatility of that remuneration, which, in recovery strategies, can even become a risk of non-remuneration. So, how can the firm, after a crisis period, re-acquire credibility in the eyes of its lenders unless it first acquires credibility in the eyes of its customers? It is essential, in fact, for a successful firm to gain the consent of its customers and this becomes even more crucial in a crisis situation. Credibility in the eyes of customers is regained through the product, which represents the point of contact between the firm and its customers, as it illustrates the values on which the firm built its history (Kim and Mauborgne 1999; Kogut and Zander 1992; Leonard and Rayport 1997). Sometimes it is worth making a corrective intervention in that direction to recover competitive capacity on the market. For example, the possibility of the firm presenting itself on the market with a completely new and innovative product, or even trademark, could allow it to conquer competitive shares more rapidly and to regenerate its resources more quickly. The firm will perform monitoring of the stage of progress of the recovery with indicators of consent (Kaplan and Norton 2002; Galeotti 2006; Brown and Eisenhardt 1998). In particular, turnover represents the main value of reference, as it reveals, in economic terms, the reaction of customers to the value creation proposed by the firm (Galeotti 2006). In a strategic perspective, the aim must therefore be to focus and leverage on resources in order to completely redesign the business (Fiorentino 2011; Powell et al. 2011; Rappaport 1989). The recovery carried out through radical innovations and the “creation” of new business involves a substantial reconfiguration of the firm’s generation process to other organisational units (Hamel 2006; Saleh and Wang 1993). Studies that focus on the financing of innovation agree in claiming that decisions in that regard are of strategic nature, even more so in a recovery process (Casson et al. 2008; Demirel and Mazzucato 2010). In fact, the firm, through a financial strategy aimed at supporting innovation anchored to an action and a credible project, is able to generate consent rapidly and, in turn, to reactivate the self-financing process and to generate intangible resources, fuelling the relational circuits of the firm itself with the other categories of stakeholders. The planning of a successful recovery must also involve suppliers, as the relationship between the firm and its suppliers facilitates new forms of managerial collaboration in which the active participation of suppliers in the productive combination is necessary to generate new value, all the more so in the recovery phase. Therefore, in crisis situations, the relationship with suppliers takes on strategic value, as the support of the latter allows the firm to avoid interrupting its production, encouraging the firm’s recovery. It is during crisis situations that the firm can make its recovery strategy successful, thanks to the collaboration of suppliers, which are positioned upstream along the production chain (Dougherty and Hardy 1996; Figg 2000).

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As stated previously, the relationship of trust with suppliers can be affected by the firm’s lack of solvency; therefore, the firm must have the capacity to present a convincing offer to suppliers in order to continue to develop the procurement policy. Suppliers, alarmed by the firm’s insolvency, tend to block supplies and to demand the prompt repayment of their credit which, not being covered by guarantees, immediately places them in a position of alert, affecting and aggravating the state of difficulty. With a view to avoiding such circumstances, the firm, relying upon the relationship of trust that we have broadly discussed, can propose a valid plan aimed at recovery, which is the ultimate objective desired by both parties (Peteraf 1993; Platt and Platt 2002; Prahalad and Hamel 1990). Suppliers could provide a fundamental contribution, for example, by actively participating in the implementation of an innovative project where the productive combination is reviewed in light of the new market demands. The firm-supplier relationship thus evolves and is no longer limited to the financial plan but moves to a subsequent level where the exchange of resources and skills produces a virtuous cycle able to generate value. Value can only be generated if suppliers understand that their support and their trust are even more important when the risk level increases. Thus, in a crisis situation, suppliers can actively contribute to a recovery plan if they see the firm and its customers as an opportunity to keep their turnover high. In fact, the bankruptcy of a firm-customer will inevitably mean the supplier has to seek other customers with which to establish a relationship of trust in order to avoid a reduction in its profits. In situations of crisis and great change, in addition, a strong action is required to avoid a dangerous fracture occurring between the economic entity, top management and the techno-structure. In those cases, the firm, through its governance bodies, must take the first step by asking what it is able to offer to its workers and to the market in order to ensure that it retains their trust and the consequent flow of economic functionality. A lack of financial resources aggravates the situation as it makes it difficult, if not impossible, to guarantee, without the prospect of continuity, the presence of qualified managerial and operational resources (Roussel et al. 1991; Leonard 1995). The demoralisation and pessimism of suppliers increase when the urgency of the interventions required by the situation of financial precariousness begins to compress, sometimes indiscriminately, the firm’s workforce. In the case of a crisis that is considered surmountable, when industrial and financial interventions can be applied with a view to maintaining and revitalising the corporate activities, linked to the presence of “production potential”, the firm must promptly assess the different technical-legal options that can be activated. Therefore, the perspective from which the firm views the crisis changes, moving from a negative spiral, in which restructuring is often identified as a cost-cutting programme (in terms of personnel, research, product promotion and corporate image) to a positive process where the exit route is represented by the strategic approach assumed in the face of financial difficulties, aimed at strengthening the firm’s position on the competitive market. The strategic approach in question is closely linked to the human factor; in fact, there are many cases where the lack of the human factor is one of the main

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contributory causes of the corporate crisis (Abell 1980). The recovery of costeffectiveness conditions thus requires a requalification of the labour factor by recovering productivity and cutting surplus or unproductive resources. At organisational level, the model in use must be radically re-discussed when the results produced by it have been so negative to the point that the firm is no longer able to fulfil its financial obligations. As a result, the appropriateness of the governance system and the results that it has produced following the decisions made must be questioned. These results can, ultimately, be attributed to the quantity of value created or destroyed. It is therefore clear that a recovery process involves essential radical changes to the governance system and the organisation model resulting from it. The recovery process, in fact, requires, along with the identification of strategic resources and a new organisational structure (McKinley 1993; Sheppard 1994; Siggelkow and Rivkin 2005), the activation of change processes not only in the formal structure and in the corporate culture but also in the system of human resources. In fact, in a crisis situation, great pessimism often arises within the productive combination, having repercussions on enthusiasm and consequently on the productivity of individuals who decide to remain in the firm, often because they are unable to reposition themselves elsewhere. To counter that pessimism, a greater effort is required from workers who must engage in the recovery phase to develop the internal business capacity (Amburgey, et al. 1993; Christenson and Walker 2008; Routledge and Gadenne 2000). In that context, the identification process can be of assistance, performing a preventive function in that sense: the life of the organisation and its success become the main objectives of the worker who identifies him/herself in the corporate organisation. At this point, it is reasonable to expect a strong and decisive reaction in view of the awareness of the progressive deterioration of the conditions of cost-effectiveness and functionality of the productive combination. To avoid individuals leaving the firm during the phase of difficulty, their behavioural decisions must be addressed so that they can contribute to achieving the recovery plan in full harmony with the purpose pursued by the firm itself. Financial difficulties, which often characterise corporate collapse situations, make it difficult to retain the best resources or to attract new ones. In this sense, however, it is very important to develop the identification process of workers in the firm, enhancing their social identity of belonging. Social identity can be defined as the individual’s awareness that he/she belongs to some social groups; this is linked to emotional and value meanings (D’Aveni 1989; Francis and Desai 2005). For this reason, the capacity to build a new vision of the future which reinforces the loyalty and faithfulness of individual workers, the corporate institution and the group feeling becomes fundamental, leveraging, in essence, on their pride in order to maximise their capacities. In effect, the sense of challenge and the opportunity to feel they are truly involved in recovering cost-effectiveness and even in achieving a successful future for the firm represent, as evidenced by the most widespread and modern management theories, one of the main motivating factors (Sheppard 1994; Rolstadas 2008; Shenhar and Dvir 2007; Yazici 2009). In addition, the organisational system experiences many difficulties in activating and completing the cultural and operational transition without the crucial stimulus

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from senior management and from the dominant power group. In fact, it is the firm that directs and guides the strategic decisions aimed at achieving the recovery. This is why changes must sometimes be made to the firm’s senior representatives, as the different stakeholders struggle to believe in the business ability of those who contributed to the state of crisis. The stakeholders are seeking a clear sign of inversion of the trend, which can be found in the replacement of the directors or even in the introduction of an external consultant to guarantee the validity of the new corporate strategies implemented (Ketchen and Palmer 1999; Rolstadas et al. 2011; Patanakul and Shenhar 2012). The role of the external consultant is critical as, on one side, he is asked to regulate the relationships with workers and, on the other, he finds himself, on the side of the lenders, having to guarantee the firm’s compliance with the financial objectives established in the recovery plan. The external consultant thus requires extreme confidence as they must question the old system of relationships. In addition, acting as an intermediary between the different stakeholders of the firm, they must be able to satisfy the informative requirement which is so strongly felt in situations characterised by high risk and complexity. Using external consultants is fundamental to make the recovery plan even more credible, to manage change processes and to respond to the innovative requirements that are necessary (Boyne and Meier 2009). An external business consultant can assist the firm in a restructuring process concerning not only the economic, capital and financial aspects, but also purely organisational and managerial aspects. The ability for a firm to be supported and monitored by an external consultant represents an opportunity for growth: in practice, the firm is able to obtain expertise from a person who, despite the involvement in supervision processes, remains external and able to have a more objective overall vision. The process of discussing, comparing and sharing the requirements and the vision of the firm will form the basis for understanding the strategy to be followed. The consultant will then support the firm in achieving the set goals. The consultant will illustrate the costs, timescales and improvements hypothesised by a certain strategy and will strive to ensure that the recommended decisions lead to tangible and quantifiable results.

4.5

Financial Recovery and Recovery Opportunities

Competitive strategy and financial strategy are positioned at the centre of recovery processes; it is due to the capacity to define the competitive potential that the attractiveness of the capital will be increased or reduced (Barney 1986). In fact, if the firm in crisis is able to offer suitable loan repayment guarantees obtained through the uniqueness/superiority of its productive combination, its capacity to attract different lenders will be increased. It is primarily important to identify and define a path of financial recovery within the recovery plan whose actions are established in order of importance, giving

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priority to those having a greater effect on the firm’s financial and economic dynamics. The financial tensions that characterise situations of crisis and the lack of synchrony between investments and returns in terms of liquidity of the different recovery interventions involved in the plan make it extremely important to cover the firm’s financial requirement. In order for the restructuring and recovery plan to be successful, in fact, financial solutions are always crucial (Bowman et al. 1999). In particular, in recovery plans aimed at overcoming the crisis, the firm’s business continuity must be guaranteed by accessing new finance both through capital and by the provision of new credit lines, even in the form of hybrid forms of financing. However, this is a rather complex operation, due to the conditions of deterioration in which the firm finds itself and the high number of factors and conditioning that come into play. The distinction between borrowed capital and equity risk capital, being the main classification of sources of financing, draws attention to the different categories of lenders and to their different requirements (Holder-Webb et al. 2005; Morrow et al. 2007; Galeotti 2011). Financial re-balance is a direct consequence of strategy, as it involves the corporate system as a whole; it is precisely due to the impact that the sources obtained have on the management, governance and financial area (Campbell et al. 2008; Eberhart et al. 1999; Garzella 2005) that the focus must be placed on the distinction between recapitalisation subscribed by new equity risk capital and re-financing and/or consolidation of the debt granted by lenders through a loan. That classification, as stated, can also be supplemented by new finance and hybrid forms of financing (Routledge and Gadenne 2000; Molina 2005; Lai and Sudarsanam 1997). Satisfying the expectations of entities who have invested their capital, by offsetting the risk linked to the investment, becomes the main objective of the competitivefinancial strategy aimed at attracting not only borrowed capital but also equity risk capital, satisfying the expected risk-return ratio that, in situations in crisis, risks remaining unfulfilled. The involvement of equity risk capital in the crisis state will be an active part of the recovery if the firm is able to offer a new strategic perspective that guarantees the appreciation of the invested capital with a view to regaining the confidence of investors. Confidence is the key aspect that allows the firm to build opportunities to obtain new equity risk capital which can be accessed through different methods. The first “traditional” method aims to regain the financial balance through recapitalisation provided by the major shareholders which may also lead to the expulsion of the figures deemed responsible for the state of crisis. The involvement of capital contributors must trigger a mechanism of awareness and solidarity towards the corporate system, which, by obtaining new capital, will be able to re-establish the balance of its financial structure. As examined previously, the relationship between the firm and its lenders plays a fundamental role, as the firm must put itself forward as an investment opportunity in the capital market (Gilson et al. 1990; Mella-Barral 1999; Galeotti 2016).

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The second method, on the other hand, involves both the entry of a new shareholder into the corporate structure and the recourse to external partners; in this way, the firm looks to the possibility of obtaining new financial resources and of generating synergies to restore its effective and efficient management. In a state of crisis, as highlighted above, it is also important to ascertain which strategic assets are able to produce value and which supports are required in order to create a competitive advantage. To bring out the unexpressed potential that would otherwise risk remaining fruitless, the possibility of combining two or more corporate organisations together reveals how a firm that is considered to be isolated and no longer able to generate economic value could still be in possession of resources that, when combined, are once again able to produce value. The search for a partner for the recovery will thus take place based upon the synergic value arising from the combination between different corporate systems; therefore, it will analyse the potential entrants into equity risk capital to identify those with which there is greater strategic affinity (Altman and Hotchkiss 2006; Whitaker 1999). The recovery process, for obvious reasons, is also a delicate moment by virtue of the choice of partner with which to generate synergies, as it is a limited choice, given the financial difficulties that the firm must face, but one of fundamental importance, as the entry of new entities into the firm gives a clear signal of corporate solidity. In fact, the entry of new and reliable entities into the corporate structure reduces the difficulty of recovering the credits of both suppliers and banks. In conclusion, the recovery strategy that uses external partners has a clear and well-defined objective: to leverage on the synergic effects of operational nature deriving from the combination with one or more corporate organisations in order to restore the balance and to initiate all changes to the power relationships currently existing between the stakeholders involved in corporate governance in order to redefine the business climate and its processes. The identification of external partners does not exclude the identification of a simple financial partner which, by acquiring company shares, can provide the necessary means for the recovery. Managerial expertise will, in fact, determine the choice that is most coherent with the recovery plan in question. In this case, solutions that involve the entry of investment funds and, more generally, private equity operators may be practicable and, in some sense, desirable, as such organisations make investments in turnarounds aimed at restructuring firms in crisis and with a view to achieving a significant recovery of value and thus, in the mediumterm, a return adequate to the risk. The support of the latter type of investors is particularly interesting, as it is not merely limited to the provision of equity risk capital but is extended to the know-how provided to the firm in repositioning companies adequately to their competitive situation and establishing a managerial paradigm in terms of governance, organisation, communication and finance (Berk et al. 2010; Noe and Wang 2000; Almeida and Philippon 2007). Following what has been analysed in relation to the financial aspect of equity risk capital, we must move on to analyse the relationship with credit institutions and with other financial intermediaries (private equity funds have already been analysed in capital operations). In that regard, we must firstly state that the firm-banks relationship is to be interpreted from the perspective of financial recovery; the costs and

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waivers that are made in light of a recovery plan will be repaid in terms of the lower losses or the benefits that can be obtained from the complete recovery. It is clear that the plan must achieve the consensus and confidence of the groups involved in the fates of the firm—namely the shareholders, banks, staff, trade unions, customers, suppliers, local communities and other institutions involved—which must be kept informed of the state of crisis, the dynamic of its evolution, the effectiveness of the corporate values and, in particular, the actions to be taken for its resolution. The main types of borrowed capital used in the composition of financial sources are debt consolidation in the strict sense, waiver of shares of capital or interest, investment of new borrowed capital in support of the recovery plan and conversion of credits into equity risk capital (Abebe et al. 2011; Chen and Hambrick 2012). All listed options are assessed in light of the new financial strategy defined on the basis of the severity of the state of crisis in which the firm finds itself. Through consolidation, the maturities of existing debts are re-formulated, extending the timescales for payments of capital and interest, or having a longer timeframe available to ensure that the financial outlay is equal to the firm’s available liquidity (Campello et al. 2011). If the firm then finds itself in a state of crisis on the verge of recovery, sometimes the suspension of the payment of capital is required and only the share of interest is paid. The consolidation may be permitted both by credit institutions exposed towards the firm and by new lenders; it sometimes materialises not only in the renegotiation of the cost of capital but also in the request for new financial resources required to re-launch the firm. To facilitate the re-launch, some regulatory interventions have been made in different countries to safeguard the continuity of production processes and to protect the entities that step in to rescue firms, by financing them in spite of their clear difficulties. These are so-called bailout agreements which, with the involvement of the set of lenders, establish a truce with the creditors without considering the specific nature of the individual relationships. Those regulatory interventions1 can be identified as a further step in the process of overcoming the corporate crisis. With the introduction of the pre-deduction mechanism, if a creditor disburses further loans, it is granted the right to be satisfied—within the limits of capacity of the assets realised—before the other corporate creditors and prior to the bankruptcy allocation. While it is true that such a right does not guarantee any return to The reference point of those regulatory interventions is definitely the famous “Chapter 11” of the US Bankruptcy Act which regulates reorganisation procedures. In Italy, for example, the bankruptcy law underwent some major changes following the introduction of the new Business Crisis and Insolvency Code in 2019. In particular, the reform dealt with regulating the rules of pre-deductible credits, now contained in Articles 111 and 111(2). The bankruptcy law grants, in addition to the pre-deduction mechanism, further factors to incentivise the avoidance of insolvency proceedings. More specifically, it provides an exemption for crimes of bankruptcy for actions implemented in execution of recovery plans (Art. 217(2) of the bankruptcy law), exemptions for revocation actions (Art. 67, paragraphs 3 and 4 of the bankruptcy law) and the particular tax regime established in Italian Presidential Decree no. 917/1986 (Consolidated Law on Income Tax) at Articles 88, 101 and 106 for the regime of deduction of losses from write-offs for creditors.

1

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cost-effectiveness or even remove the risk of bankruptcy, it encourages conditions in which loans paid to firms subjected to insolvency proceedings are sufficiently protected from specific risks and from the civil and criminal liability indicated previously (Minnetti 2011; Schafer and Zimmermann 2009; Modina 2015). The legislator’s aim is clear: to finance procedures aimed at rescuing firms in crisis by offering, in exchange, prompt repayment in the event of bankruptcy. The pre-deduction is therefore granted primarily for those implemented in execution of an insolvency procedure. As an implicit but necessary condition, the plan must contain a specific description of the loans and their essential elements, without which the professional control figures (for example, the plan certifier) and the creditors would not be able to assess the coherence with respect to the implementation of the plan and therefore, ultimately, the interest of the creditors. These loans, which do not pose any problem in terms of authorisation as they are disbursed as a result of an insolvency procedure, must necessarily comply with what is envisaged therein, such that it is the very approval measure sealing their correctness and feasibility that acts as a legitimising factor. The restructuring can also be managed through extrajudicial solutions focused on private debt renegotiations, materialising in the signature of specific agreements with banking and commercial creditors also known as “rescue agreements”, which generally involve a moratorium in payments, the repayment of the debt (in whole or in part) or the extension of the deadlines and specific contractual commitments. This is a flexible system adaptable to the specific nature of the individual cases that aims to manage the recovery in conditions of business continuity so as to be able to maintain, at least partly, the intangible values related to the firm’s organisation and functioning and allow the parties to develop rapid solutions without inhibiting the firm. It involves, in general, ease of negotiation and higher percentages of recovery of credits than those achieved in insolvency proceedings. The extrajudicial solution, however, poses some problems, such as: the high number of entities that are often involved in those operations; the peculiar nature of the interests pursued by each of them and the particular requirements regarding the conformation of the recovery plan; the coordination of creditors, which have the power to decide if the firm can continue its activity or should be subjected to proceedings; the lack of stability and protection against acts implemented in executing the recovery plan. The participation in the recovery strategy should, therefore, also involve credit institutions, which, by opting for greater exposure, will benefit from the numerous advantages involved in that type of agreement (Minnetti 2011; Winn 1993; McGahan and Porter 1997). In addition, where the strategic perspective of the recovery plan is fully implemented, the firm will find itself not only recovering its market positioning but also representing in future a client of value. However, access to credit must consider the possibility of non-repayment of the firm’s debtor position due to the aggravation of the financial imbalance if the new recourse to borrowed capital fails to resolve the imbalanced composition of the sources; therefore it may be a solution that is not easily accessible, being particularly risky for the entity providing the credit. To avoid liability and risks, in fact, banks limit themselves in

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granting new finance to firms in crisis. In principle, while banks are open to rescheduling and extending payment timescales and converting credits into shares and/or participatory instruments, they are rather hostile to granting new finance and seek to limit their exposure with a view to recovery, avoiding any increase. However, following the regulatory interventions on bankruptcy in the various countries, that stance has altered as lenders’ responsibilities have changed. In that regard, in the area of credits, banks usually establish a restructuring division to deal with overseeing the affairs of firms/groups in a situation of corporate crisis requiring a re-working, a recovery or a restructuring of their existing exposures, in the technical forms and according to the regulatory circumstances considered to be feasible each time. More precisely, the division: (i) analyses the risk profile of the counterparties for which a recovery process has been commenced and the relevant context of the manoeuvre in order to verify the opportunity and methods of participation at negotiating tables, (ii) prepares the preliminary reports required for resolutions on approving or rejecting the proposal, (iii) monitors the performance of the plans, verifying the respect of the conditions and deadlines envisaged. It is well-known that bank loans are fundamental factors in business management, significantly integrating borrowed capital and equity risk capital: hence, the role played by banks in the financing of firms is a central issue in the crisis phase, which, we reiterate, is—due to the very dynamic of competition—an innate period of business activity (Scott 1989). In those situations, we see the strong party in the relationship—the creditor which risks having its credit unpaid—assuming further commitments, rather than taking action to protect itself. In effect, when there is an increase in credit risk, banks sometimes do not request a parallel increase in its cost, but they accept a reduction. In some cases, they even decide to increase their exposure by making a new disbursement in the expectation that this further investment, of relatively small amount compared to the initial exposure, will reduce or even avoid the risk or danger of losing a large part of the initial credit. This would explain why it is often the most exposed banks that actively participate in recovery strategies. If lenders directly participate in preparing the recovery strategy and plan, they acquire the right to intervene in corporate management, sometimes even having a direct influence on defining the roles of the persons positioned within the firm’s senior management. The different options should be analysed as part of the new strategic perspective assumed to implement the financial plan that facilitates business prosperity in competitive terms, balancing the flows of day-to-day management, those deriving from the management of investments and those of the financial area (Eberhart et al. 1999; Vassalou and Xing 2004; Gilson 1997; Fich and Slezak 2008). In that context, the recovery plan must identify the ways of achieving economic/ financial/capital rebalance, recovering margins and returning to profit, along with the due payment of future financial commitments and the regularisation of previous payables. The plan should also clearly specify the essential elements of the new finance required (amount, maturity, characteristics), its intended use, its functionality

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for conserving the value of the corporate equity and its repayment methods, in order to satisfy the informative demands of lenders. In fact, the document must illustrate all information held by the firm on its economic, capital and financial condition. Transparency is one of the central requirements for opening a dialogue with financial intermediaries. In addition, the information conveyed must be current, absolutely reliable, of good quality and able to illustrate the strategic approach that the firm intends to adopt in order to involve the various financial stakeholders in the recovery (Courtney et al. 2013). In fact, that strategic approach will trigger the injection of new capital which, from a communication perspective, is fundamental for re-establishing the trust of the various stakeholders and is particularly appreciated by banks involved in the recovery process (D’Aveni 1989). The aim is to attract, in banks, an important partner having strong technical-specialist knowledge, mainly aimed at management aspects and control of correlations between economic and financial performances. In the next chapter, the writers will formalise the possible content of a recovery project, proposing a model which is obviously open to changes and additions in relation to the individual specific circumstances and which could represent a reference point for preparing such a document. In particular the need to re-establish “trust” with the different stakeholders and shareholders gives a central role to tools for communicating and controlling the recovery.

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Chapter 5

The Recovery Plan as a Strategic-Informative Tool Between Needs and Opportunities

5.1

Scope of Reference: The Recovery Plan

The previous chapter systematically outlined the crisis situations that could affect the life of a firm and highlighted the strategic role of the recovery plan. In light of those considerations, in this chapter we will again focus on the topic of the recovery plan, illustrating it as a strategic tool for managing the crisis, particularly in terms of the information to be provided to the main categories of stakeholders. As previously described, a crisis—often defined as an ascertained state of economic-financial difficulty likely to lead to the debtor's insolvency—can affect many different entities. In an initial attempt to systematise the parties involved in the dynamics and outcomes of a corporate crisis, a firm’s owners are interested in the dynamics of its survival by way of investments made in the form of venture capital, as well as the commitment in terms of time, expectations and ideas, in situations where they participate directly in managing the firm. The board and the governance bodies are given direct responsibility for the firm’s balance and survival and therefore have a very strong interest in that regard. Stakeholders also include creditors, employees, suppliers, and customers which, in various capacities, project their expectations and demands on the firm and are therefore affected by its fates. So, while corporate management must take account of the stakeholders’ expectations in ordinary, everyday situations, their needs must also not be ignored in crisis situations. Rather, it is precisely in such situations that stakeholders have even more marked requirements, as asymmetric information could occur to their detriment. As recently claimed, in fact (Rosslyn-Smit et al. 2020), “when a firm experiences financial distress, these issues can often be concealed from various stakeholders, as there is an asymmetric availability of information amongst various stakeholder”. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 S. Ferri, F. Ricci, Financial Strategies for Distressed Companies, Contributions to Finance and Accounting, https://doi.org/10.1007/978-3-030-65752-9_5

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In this circumstance, the recovery plan represents a strategic tool for satisfying the informative needs of the stakeholders and bridging any asymmetric information gaps. Therefore, the recovery plan can act as an informative tool which illustrates the strategic and operational actions (and the respective economic and financial impacts) through which the firm intends to exit the crisis situation, restoring conditions of economic, financial and capital balance, in the interest of its stakeholders, avoiding, insofar as possible, any asymmetric information. On that basic assumption, the next paragraph will identify—albeit with the due brevity—the main contributions on stakeholder theory—to ascertain how a firm can produce mapping of its stakeholders. The problem of asymmetric information, which can be solved by the recovery plan, will also be discussed.

5.2

The Recovery Plan Between Stakeholder Theory and Asymmetric Information

It is widely known that stakeholder theory represents a dominant theoretical framework in business administration as it deals with the issue of value creation and reporting to end recipients. In fact, stakeholder theory answers questions of the calibre: “In whose interest does the firm create value?” “Who are the recipients of the firm’s external information?” The most traditional stance taken by doctrine (Freeman 1984) defines the stakeholder as “any group or individual who can affect or is affected by the achievement of the organization’s objectives”. Freeman’s vision is notoriously opposed to the conventional input-output model of the firm in which the latter is seen as an economic activity in which economic resources are collected with the aim of making profit for the shareholder owner. It is difficult to systematise comprehensively the contributions present in the vast theoretical domain of stakeholder theory also because such a theory has given rise to interdisciplinary interpretations, involving issues such as law, health, public administration, environmental management and ethics (Freeman et al. 2010). Donaldson and Preston (1995) have produced a systematisation of the classification of methods of use of stakeholder theory according to the following branches: – descriptive branch; – strategic-managerial branch; – normative branch. The descriptive approach investigates how firms consider, in their day-to-day practice, the objectives and demands of their stakeholders (Brenner and Cochran 1991).

5.2 The Recovery Plan Between Stakeholder Theory and Asymmetric Information

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Donaldson and Preston (1995) claim that this approach is used to describe different phenomena relating to corporate life and the relationship with stakeholders, such as: (a) the nature of the firm (Brenner and Cochran 1991); (b) the way managers think about managing (Brenner and Molander 1977); (c) how board members think about the interests of corporate constituencies (Wang and Dewhirst 1992), and (d) how some corporations are actually managed (Clarkson 1991; Halal 1990; Kreiner and Bambri 2017). Subsequently, Jawahar and McLaughlin (2001) return to the topic, assuming that a corporation’s survival and continuing success depend upon the ability of its management to create sufficient wealth, value, or satisfaction for all primary stakeholder groups. Having said that, there may be different groups of stakeholders capable of determining the possibility of corporate survival and success based upon their importance to the firm. The fundamental contribution they make is correlated to the relationship between the life cycle phase in which the firm is positioned and the requirements arising from it. At each phase of the cycle, the firm finds itself dealing with different demands from its stakeholders. It follows that the firm will see a change in the needs and groups of stakeholders which must be addressed, based upon its current phase of life. It can thus be said that the strategy adopted by the firm in relation to its stakeholders alters as the life cycle of the firm in which it is positioned also changes. The strategic approach, also known as instrumental, envisages that managers, for reasons of strategic opportunity, must take account of the requirements of its stakeholders, with a view to achieving survival and economic balance (Freeman 1984). Instrumental theory establishes (theoretical) connections between certain practices and certain end states. There is no assumption that the practices will be followed or that the end states are desirable (Jones 1995). This theoretical approach is aimed at describing what will happen if the firm or the managers behave in a certain manner. Finally, normative theory aims to systematise some moral standards that managers must implement in relationships with stakeholders. The theory is used to interpret the function of the corporation, including the identification of moral or philosophical guidelines for the operation and management of corporations. Normative concerns dominated the classic stakeholder theory statements from the beginning (Dodd 1932), and this tradition has been continued in the most recent versions (Carroll 1989; Kuhn and Shriver 1991; Marcus 1993). Even Friedman’s (1970) famous attack on the concept of corporate social responsibility was cast in normative terms (Donaldson and Preston 1995). Exponents of the normative theoretical branch consider stakeholder theory to be a moral theory which carefully establishes the obligations of firms towards their stakeholders. In contrast, Jones and Wicks (1999) explicitly claim that there are important connections among the parts of stakeholder theory and that the differences are not as sharp and categorical as Donaldson and Preston (1995) suggest. Similarly, Freeman (1999) explicitly rejects the idea that we can sharply distinguish between the three

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branches of stakeholder theory. He argues that all these forms of inquiry are forms of story-telling and that all three branches have elements of the others embedded within them (Parmar et al. 2010). Evan and Freeman (1988) identify the moral foundation of stakeholder theory in the Kantian principle of respect for individuals, according to which every human being must be treated as a person having their own purpose and not instrumental to the achievement of objectives of higher order. From that perspective, stakeholders are treated as moral entities holding their own autonomous rights. Two inferences derive from that assumption: – firstly, that the firm’s purpose must be redesigned based upon the legitimisation of the expectations of stakeholders, requiring coordination; – secondly, that the legitimisation of the expectations of stakeholders is constructed on a fiduciary basis, requiring managers to act in the capacity of agents of those stakeholders (Goodpaster 1991). Other authors (Clarkson 1995; Carroll and Bucholtz 1993; Gibson 2000) have proposed a classification based upon the level of relationship in place between the firm and the stakeholder, defining two separate groups, primary and secondary stakeholders. Clarkson (1995) states that: “A primary stakeholder group is one without whose continuing participation the corporation cannot survive as a going concern. Primary stakeholder groups typically are comprised of shareholders and investors, employees, customers, and suppliers, together with what is defined as the public stakeholder group: the governments and communities that provide infrastructures and markets, whose laws and regulations must be obeyed, and to whom taxes and other obligations may be due”. The author also states that secondary stakeholder groups are defined as those “who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival. The media and a wide range of special interest groups are considered as secondary stakeholders under this definition. They have the capacity to mobilize public opinion in favour of, or in opposition to, a corporation’s performance”. In recent times, a new branch of research has become consolidated in Stakeholder Theory relating to the issue of value creation. Here, this means value creation for the firm and for all its stakeholders in a contextual vision broader than that of the classic theory. The work recently published by Freeman et al. (2020) is particularly interesting, emphasising the relationship between shareholder and stakeholder through an innovative interpretative key. The real issue is not shareholder versus stakeholder, but a narrow/reductionist versus broad/holistic perspective on business. It is the difference between a value chain (linear and singularly focused on financial value) and a value network (which includes the importance of shared purpose and values). A value chain has one end point and one desired outcome for one stakeholder, the shareholder; all other players in the system are a means to that ultimate end. In an interconnected and

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interdependent system, each stakeholder must be a means and an end. Each contributes to collective flourishing and each must also benefit for the system to continue flourishing. Because the corporation is a system, understanding and effectively leading it necessitates adopting a systems perspective (Kast and Rosenzweig 1972; Rousseau 1979). This must include consideration of all the component elements, their interactions and interdependencies and their long-run viability. A system view of the business thus demands a stakeholder perspective (Freeman et al. 2020). In Freeman’s vision, as in that of other authors (Porter and Kramer 2006, 2011), the paradigm to be considered in this economic-social scenario has profoundly changed. The relationship between shareholder and stakeholder, just like that between firm and company, must no longer be seen in the competitive sense, but an overall vision must be adopted which guarantees growth for all entities involved within the business dynamic. The systematisation of stakeholders becomes a fundamental step in preparing the recovery plan, because—as always occurs in the preparation of informative business management documents—it is essential to keep in mind the recipients of the information, as well as the purpose of the information itself. Who, then, are the entities interested in the information contained in the recovery plan? In addition, what information should be contained in that plan? Preliminarily, it is worth specifying that this chapter is positioned in the strategicmanagerial branch of stakeholder theory, from the perspective that management must consider the expectations of stakeholders in order to obtain social consent, for the pursuit—or recovery—of economic-financial balance and to safeguard the firm’s very survival, which is the supreme goal. That approach is central to the discussion on the recovery plan, which is classified as a useful tool for identifying the relevant stakeholders from the perspective of recovery. As occurs for the corporate social responsibility report—or other forms of non-financial disclosure—the recovery plan must be considered an informative tool capable of satisfying the demands for dialogue that exist between the firm and its stakeholders and between the stakeholders themselves (Rusconi 1988). With this vision, then, although retaining a strategic-managerial view of the plan as an informative support to stakeholders, we will attempt to correct any distortion deriving from stakeholder capture, namely the situation where, in some circumstances, the plan could be used—along with other reporting tools—merely to protect the firm’s dominant position (Rusconi 2006). In fact, the ultimate aim is precisely to reduce, insofar as possible, any asymmetric information between the firm and its stakeholders. Asymmetric information refers to the phenomenon where one of the parties involved in a transaction has a smaller information set than the counterparty, with that difference having the potential to affect their reciprocal decisions and interactions (Stigler 1962; Akerlof 1970; Spence 1973; Rothschild and Stiglitz 1976).

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The concept of asymmetric information was first introduced in Akerlof’s 1970 paper The Markets for “Lemons”: Quality Uncertainty and the Market Mechanism. In this paper Akerlof develops asymmetric information with the example case of automobile markets. Sellers are aware of the state of health of the cars, unlike buyers, who only know that cars in good condition and cars in poor condition are available on the market. The parties have different prices in mind: from the side of demand, buyers form a reserve price for cars in good condition and one for those in poor condition. The same reasoning will be applied from the side of supply by sellers. Considering, initially, the side of demand, the buyer, not having detailed information on the quality of the cars sold, will form a single reserve price, resulting from the weighted-average of the two prices due to the probabilities of receiving, respectively, a car in good condition and one in poor condition. The resulting price is less than the seller’s reserve price for a car in good condition, meaning the seller will leave the market as he is not interested in selling at a lower price than the one he or she had in mind. In addition, the buyer’s single reserve price will be higher than the price applied by sellers of cars in poor condition. Clearly, therefore, in a market characterised by asymmetric information, such as the used car market described above, the formation of the buyer’s reserve price, influenced by the informative distortion, sees superior products leaving the market, with only inferior products remaining, but at higher prices. Asymmetric information, therefore, acts as an obstacle to achieving market efficiency precisely because it introduces a distortion into the decision-making process. This distortion, depending on the moment it manifests, assumes two separate connotations. If the asymmetric information is ex-ante in nature, it is defined as “adverse selection”; conversely, if it occurs ex-post, it is known as “moral hazard”. Therefore, depending on the moment the distortion in the informative structure occurs, two separate phenomena may arise which, in turn, lead to different consequences. In the case of moral hazard, asymmetric information affects the parties after signing the contract and not before, as occurs in adverse selection. Cases of moral hazard classically reported in literature relate to the labour market or the insurance market. In the labour market, there may be a situation where a worker, not supervised by his or her employer during work hours, behaves dishonestly by not fulfilling the agreed duties. The same reasoning can be applied to circumstances of insurance against motor car theft. The insured, not being supervised by the insurance company, may not take all measures to reduce the risk of theft of the motor car, as he or she is covered by the insurance policy. In both cases, such behaviours do not accord with what was initially agreed between the parties but, due to an absence of control, or, rather, due to asymmetric information in the behaviours of the insured or the worker, situations of moral hazard may arise.

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So, how does the issue of asymmetric information come into play in the business recovery plan? It is well-known that when an economic-financial imbalance occurs, the firm will find itself in a condition of crisis, which, if not correctly managed, may degenerate into insolvency. The tool that allows the firm to escape from this condition and to recover its balance is, in these circumstances, the recovery plan. The following paragraphs will highlight the potential aspects of the recovery plan in informative terms, namely how it is—potentially—able to restore confidence between the firm and its stakeholders through informative content. The recovery plan could allow for several critical aspects to be resolved: (a) (b) (c) (d)

5.3

involve the key stakeholders; agree the future perspectives on managing the recovery; correct any aspects of asymmetric information; reduce the costs introduced by any resistance to change.

General Principles for Preparing the Recovery Plan

The business recovery process is aimed at restoring the economic-financial balance of a firm that finds itself in a state of crisis. In order to overcome that situation of difficulty, the firm’s management must identify a credible recovery path in line with the objectives of the stakeholders. The key tool for that process is identified as the recovery plan. According to authoritative Italian doctrine (2017), also in line with best practice, the recovery plan is defined as the “document prepared by the delegated body and by management [. . .] which represents the strategic and operational actions (and the respective economic and financial impacts) through which the firm intends to exit the crisis situation, restoring conditions of economic, financial and capital balance”. The plan is a fundamentally important document in the recovery process as it allows management to carry out a critical examination of the situation in which the firm finds itself, adopting a pragmatic and quantitative approach. The plan should not be seen as a collection of good ideas, with no greater specification, for guiding the firm towards a fruitful future. It is, in fact, an analytical document aimed at understanding (a) the firm’s state of health, (b) the strategy implemented until that time, (c) the firm’s fundamentals, (d) the possibility of restoring conditions of economic, financial and capital balance and, finally, (e) the strategy to be implemented to overcome the situation of difficulty. Doctrine is concordant in stating that when preparing the document, management must respect essential general principles of correct and reliable planning. The recovery plan, as the term suggests, is considered to be a planning tool when the firm finds itself in a condition of crisis. Typically, it is aimed at restoring conditions of economic-financial-capital balance from a business continuity perspective, but it may take on two separate configurations. It may be of extrajudicial nature, namely deriving from the

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autonomous will of the firm, or of judicial nature, namely included in a procedure regulated by law. For the purposes of this work, the recovery plan will be seen as a document of extrajudicial nature prepared by the management body—or by consultants external to the firm. This means that it represents the free will of the firm and is not subject to obligations of certification by a professional and/or approval by a court and the specific analyses required by law. Understanding the nature of the plan, therefore, allows us to ascertain the restraints imposed upon its preparer in relation to the structure and contents of the same. Having clarified these preliminary concepts, we can now investigate the contents of the plan and ascertain: (a) its recipients, (b) its objectives and (c) the general principles underlying its preparation. The recovery plan is aimed at satisfying the needs of different categories of stakeholders, including at least the following: – – – – –

Creditors Lenders Shareholders Employees Customers

For a detailed analysis of the plan recipients, see the previous chapter. In this context, financial stakeholders are split into three sub-categories (creditors, lenders and shareholders) precisely to highlight their different requirements in a recovery procedure and, consequently, the impact upon them. Creditors, which also include suppliers, are the beating heart of the firm’s shortterm financial activity, as they determine the structure, characteristics, costliness, and maturities of the working capital. The plan must contain comprehensive information on the business relationship with them as the possibility of overcoming the crisis phase is strongly influenced by the confidence and stability of the relationships with these stakeholders. Strong tensions in this type of relationship would compromise the continuity of supplies, their quality and, not least, the deferral conditions offered by these stakeholders, which may turn out to be strategic to the economic-financial rebalance. While creditors relate mostly to corporate operations, lenders and shareholders are directly involved in the firm’s financing decisions. Banks and other financial intermediaries are, for the firm, the key players in its recovery process as they are responsible for the short, medium and long-term financial balance. Those groups are particularly interested in the firm’s fates with regard to loans already granted, as well as for new finance to be injected into the same. It follows that information shared openly with these stakeholders leads to an increase in trust, greater stability and lower cost of debt and, as a consequence, a more effective recovery attempt (Rosslyn-Smith and Pretorius 2018; Arogyaswamy et al. 1995; Hambrick 1985; Slatter 1984; Pajunen 2006; Decker 2018). It is not only lenders that contribute new finance to the firm’s financial structure, but that role is also often played by the shareholders. They may contribute new

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capital by refinancing the firm and providing it with higher capitalisation. One of the causes of the crisis, from a structural perspective, can often be found precisely in its systematic undercapitalisation. The shareholders have a personal interest in the firm’s prospects as they hold the venture capital and are therefore subject to its fates, and because they are responsible for any recapitalisation that may become necessary. Aside from the firm’s financial management, the other entities involved in the plan are employees and customers. The former are closely linked to the firm’s affairs as their main source of income is typically the salary they receive. Any dismissal would have a very significant impact on their lives and on those of their relatives. The severe inefficiencies that can be seen on the labour market, poorly contained by public intervention, further aggravate this phenomenon. On the other hand, employees are particularly motivated by the firm offering them open and shared information, as they are consequently more reassured about their future and more involved, at least in the executive phase, in the firm’s recovery (Pajunen 2006; D’Aveni and MacMillan 1990; Arogyaswamy et al. 1995; Sutton and Callahan 1987). The final category is that of customers, namely those who determine the firm’s possibility of survival on the market. The relationship with customers determines the amount of future revenues on which the firm can rely; their monetary component will consequently determine the short-term financial structure. Hence their centrality to the discourse linked to recovery, given their fundamental contribution. In preparing the plan, the firm will aim to rehabilitate its image and reputation on the market so as to gain back the confidence that has potentially deteriorated among its customers (Sutton 1990). The strategies to be adopted by the firm will be, on one side, of conservative nature, attempting not to lose its current customers and, on the other side, of supplementary nature, namely the firm will attempt to conquer new market shares. Having outlined the recipients and their informative requirements, it is clear to see the set of objectives that the plan generally attempts to achieve. Firstly, in line with what was stated in previous paragraphs, the main aim of the plan is to inform all stakeholders of the current crisis and the recovery strategies to be implemented. The firm thereby intends to provide open information, internally and externally, involving all persons whose contribution is essential for that process to be successful (Arogyaswamy et al. 1995; Pajunen 2006). The information conveyed through this tool is not only directed towards stakeholders positioned outside the corporate perimeter, but also to persons forming part of the firm’s structure. Like all tools used in corporate planning, the recovery plan is a fully-fledged guide for future action in the implementation phase of the strategy and a valid tool for carrying out an analysis of any deviations during the control phase. In implementing the recovery strategy put together by the board, management can rely upon the detailed analysis contained in the plan to guide its actions. In the same

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way, during the subsequent phase of control, the forecasted data contained in the plan will highlight any deviations in the final results. In that way, the actions undertaken by management can then be re-worked in order to realign the plan in the right direction. At this point, we can introduce the general principles for preparing the recovery plan. They can be classified into three different categories: – General principles on methods and techniques used – General principles on contents – General principles on form

5.3.1

General Principles on Methods and Techniques Used

A recovery plan must be timely: it must guarantee the rapid identification of the state of crisis by the firm, formulating a recovery strategy aimed at restoring conditions of economic, financial, and capital balance. Timeliness is fundamental from various aspects. On one side, the first hints of the crisis can be identified promptly, so as to intervene in its resolution. On the other, it enables the firm to operate with greater freedom, giving it a high number of strategic options and greater contractual power, ceteris paribus. As noted above, it is a process of iterative nature as its construction is subject to a continuous exchange with the firm’s stakeholders in which the balances previously reached will continuously change. It is based on a repeated process of exchanges with stakeholders and a rolling-type logic in subsequently assessing the results achieved as opposed to what was expected. These elements constitute two key principles of the methods used for preparing a recovery plan. In addition to these two central aspects, the resources, structures and competencies required to formulate a reliable plan must be analysed. Given the complexity inherent in the recovery process and the technical difficulty in making predictions as to some key variables, some fundamental elements are considered necessary in the firm, such as: – – – –

An administrative-accounting system A planning and control system An adequate data acquisition and processing system Financial, administrative, commercial, and legal competencies

The main input of a recovery plan consists of final accounting and management data and significant knowledge of the business and its financial, economic, and commercial logics. For this reason, those systems are fundamental in formulating a plan that is as truthful and reliable as possible. Data are central to this type of dynamic. The more correct and truthful the data, the more reliable the result of the estimates made on the basis of those data will be.

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Any forecast made on a variable future is, by definition, uncertain, as the future cannot be predicted. The only element that can guarantee greater reliance on the estimates, therefore, is the data accuracy, which means the forecasts can be based on solid assumptions.

5.3.2

General Principles on Contents

Moving on to examine the contents of the plan, the basic principles can be defined. The plan must be systematic, namely it must take account of the entire firm and not just an individual SBA. Therefore, starting with an analysis of the current situation, in order to achieve the subsequent objective of recovery, that analysis must be then carried out on the entire corporate system as a whole. One of the characteristics most highlighted in debates regarding recovery processes is that of reliability. A recovery plan is deemed to be reliable if it is produced on the basis of realistic hypotheses and if the expected results are reasonably achievable. It must be reasonable and above all demonstrable. That principle forms the foundation of the entire theoretical system relating to corporate recovery as it is the only element that guarantees the forecasts and consequently the only way to assess the successfulness of the attempt to overcome the firm’s crisis. At the basis of the previous principle is that of coherence. Coherence means the interdependence that exists within the system of hypotheses constituted to project the firm’s results forward over time. Coherence should be assessed not only among the individual variables, such as between the increase in the level of advertising revenues and costs, but also between the recovery strategy and the evolution of the competitive context, or even more so of the macroeconomic context of reference. Finally, the plan must be sustainable over time. It is unthinkable to formulate a recovery strategy aimed at restoring the short-term economic, financial and capital balance. It must cover a lengthy timeframe; it is crucial to build the foundations on which to base the firm’s future success, not simply to allow it to survive in the shortterm.

5.3.3

General Principles on Form

After giving a brief overview of the principles on the contents, we will now introduce those relating to the form. The plan is a written document split into two macro areas, an initial part of descriptive nature and a second part of quantitative nature. This initial distinction will be particularly useful for understanding the structure of the plan analysed in the next paragraph.

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The structure introduced below should not be considered rigid or mandatory but is the result of consolidated doctrine and best practices followed by firms. Although not mandatory, it is a good idea for the plan to introduce in its first, descriptive section the firm in question, the initial situation and, thereafter, the basic hypotheses, intervention strategies and predicted results. The key essential elements to be inserted in this first section include: – – – – – –

the subject of the plan the timeframe covered by the plan the preparation date the relevant accounting data the approval by the administrative body any limitations on the circulation of the document

The second section of the plan represents all prospective economic, financial and capital data accompanied by the assumptions that led to the determination of those results. All data and expected transactions must be presented analytically and with a level of detail that allows for the due assessments to be made as to the feasibility of the plan. In addition, because the plan is an informative instrument, it must satisfy the specific requirements of the stakeholders of a specific firm. The level of detail should, therefore, also be based upon that variable, which must not be overlooked. For that reason, it is worth entering a separate paragraph to examine the recovery plan of a small or medium enterprise.

5.4

The Recovery Plan

After identifying the general principles underlying the preparation of the plan relating to methods, techniques, contents, and form, we can now discuss the subject of this chapter, the Recovery Plan. As defined previously, this is a corporate document aimed at informing the firm’s stakeholders of its intention to undertake a path of recovery aimed at restoring economic, financial and capital balance. The document is prepared in writing and, depending on the nature of the plan, may or may not follow the procedures laid down by law. In our case, the Recovery Plan is extrajudicial in nature and thus the result of an autonomous decision by the administrative body. Being extrajudicial, it does not involve constraints in terms of content, form and procedure of any nature, although in professional practice different guides have been formalised identifying the best practices to be adopted. In the remainder of this paragraph, we will outline a model for preparing the plan capable of supporting decisions made by the board at this delicate stage of the firm’s life. This proposal reflects the best practices adopted at national and international level and is aimed at:

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Table 5.1 Business plan model 1. General initial context 1.1. Description of the firm 1.2. Economic and financial data 1.3. Analysis of the product/service 1.4. Analysis of the sector/market 1.5. Technology used 1.6. Diagnosis of the crisis 2. Recovery strategy 2.1. Analysis of assumptions 2.2. Industrial structure 2.3. Financial structure 3. Operating plan 3.1. Sales and marketing 3.2. Production 3.3. Organisation and staff 3.4. Investments/divestments 4. Financial manoeuvre 4.1. Definition and objectives of the financial manoeuvre 4.2. Shareholder equity 4.3. Debt 4.4. Management of taxation in the financial manoeuvre 5. Action plan 6. Prospective data 6.1. Prospective income statement 6.2. Prospective balance sheet 6.3. Prospective cash flow statement 6.4. Treasury plan 6.5. Sensitivity analysis

(a) increasing the level of reliability of the plan, (b) encouraging the involvement of the numerous corporate players in the recovery process, (c) increasing the level of confidence in the tool and, finally, (d) raising the level of effectiveness in overcoming the state of crisis. A representation of the plan model is offered below, which will then be analysed in detail (Table 5.1). The structure of the plan indicated above is split into two ideal sections. The first, which covers points 1 to 5, is descriptive and contains all information relating to the firm, the business, the state of crisis and the recovery strategies formulated to overcome the current state of difficulty. This section, although including some essential quantitative elements, is characterised by its qualitative approach in describing the elements indicated above. This should not, however, betray the analytical soul that connotes the recovery plan, as it must contain specialist forecasts

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and information, and not just a jumble of good ideas devoid of any technical foundation. The second section, represented by the final point of the structure presented above, is quantitative in nature and contains all historic and prospective economic, financial, and capital data. This section is considered the fulcrum of the entire plan as it contains all information, analyses and assumptions presented in the previous section formalised in the form of numbers. As stated for the descriptive part of the plan, and even more so for this section, the data represented in the form of numbers are the result of an attentive and rigorous analysis conducted following economiccorporate best practices which reflect the reasoning of the previous section. As can be seen from what has been stated thus far, although the preparation of the plan, to a less expert eye, may appear to be quite simple, it is in fact a very delicate analysis period for the firm, of the business, its state of health and consequently its possibility of survival. In order to produce a serious and reliable plan, as analysed in the previous paragraph relating to the preparation principles, the firm will need to obtain assistance from qualified, professional and competent individuals. The alternative would be an unreliable document containing a series of ideas that cannot actually be applied in reality and are difficult to achieve. It follows that the planning process should be an activity performed coherently and technically by persons of high professionalism and not an activity performed occasionally by persons not having a history of technical-corporate expertise. The first section of the plan opens with a description of the general initial context, namely a representation of the firm’s initial situation, in awareness of the state of crisis in which it is currently found. The paragraphs contained in that point could follow the structure outlined below: – – – – – –

Description of the firm Economic and financial data Analysis of the product/service Analysis of the sector/market Technology used Diagnosis of the crisis

To understand the subject of the plan, the firm in question must be presented, outlining—albeit summarily—its basic characteristics. That description should contain some fundamental data, such as: – – – – – – –

Company name, registered office and legal status Ownership structure and any membership of a group Significant events for the purposes of the plan Organisational structure Activity performed Strategies in place Main causes of the crisis

The subject of the plan is thus outlined, at least generally, understanding its scope and possible consequences.

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Subsequently, the plan should provide an overview of the firm’s final economic, financial, and capital data, along with the provisional accounting forecasts. A brief analysis of the fundamentals of those data should then be provided to ascertain, on one side, the possible causes of the situation of difficulty and, on the other, the areas of intervention on which the plan should be focused. In addition, using the past provisional data, the preparer will be able to develop a further analysis based upon the deviations that can clearly be seen from the state of crisis. The data presented here must be useful for identifying the state of health of the firm; therefore, a reflection must also be provided in terms of the timeframe and perimeter of reference. The historical data observation period should be based upon the firm’s state of health and its history; it is impossible to provide a value that will apply to every situation. Instead, that period should be congruous to the particular firm being analysed. With regard to the perimeter of reference, this must obviously consist of the firm, as emphasised in the general principles, but, in some specific cases, the corporate dimensions may require further detail. Consider, for example, a multi-business enterprise characterised by n-SBA. In this case, the historical and provisional data must be reported while also considering the individual SBAs and not just the overall corporate level. After providing an overview of the firm’s data and fundamentals, the plan should analyse what the firm offers on the market and the competitive area in which it is positioned. In analysing the product, it will be worth describing its main characteristics and functionalities, the requirements satisfied by it, its competitive positioning and life cycle phase, and the evolutionary-technological lines that may arise in future years. The firm, in offering its product, will be subject to the dynamics of the relevant market. In this sense, the plan must provide an understanding of the structure, competitive dynamics and phase of life of the sector and its prospects. Based upon the recovery strategy proposed by the plan, a series of analyses typical of the branch of corporate strategy studies must be presented (Galeotti and Garzella 2013). To do so, the plan must focus on: – – – – –

the relevant market and its possible evolutions the strengths, weaknesses, opportunities, and threats (SWOT analysis) the competitive dynamics the Critical Success Factors the Value Chain

Considering the strong driving force of technology in the entrepreneurial context that significantly characterises the business world, it is also worth analysing this aspect which has become central to the corporate discourse. More specifically, the technological portfolio and evolutionary profiles in the paths of adoption and replacement of the latest technologies should be analysed. By initially ascertaining their content and quantity, they can then be assessed

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strategically, seeking to understand their impact in economic-financial terms and their current and future competitive dynamics. That level of analysis is particularly useful if the firm finds itself dealing, for example, with a technological change within its business, as such a phenomenon could determine its future success as well as its decline. The final point of this initial part of the plan represents a very important period of reflection aimed at understanding the causes that triggered the crisis in which the firm finds itself. Such an analysis is not easy to perform as it requires strong technical-corporate expertise and analytical intuition. The firm must gain an understanding, in the current state, of the reasons why an imbalance has occurred in economic, financial and capital terms. The diagnosis of the crisis must be based upon the careful study of the initial situation carried out in the previous points, comparing it with the analysis of a system of specifically constructed indicators. The causes of the crisis may originate from multiple factors. A summary tool that could assist in preparing the plan may be the analysis of the Corporate Strategic Formula (De Luca 2018) and its components. It is characterised by three key components: – Business – Internal Structure – Capital Market Analysing these three components and their underlying relationships is a useful tool for understanding the flaws inherent in the corporate system with regard to its internal and external relationships. As well as analysing the firm and its adjacent external context, the conditions of the economic system in which it operates should be assessed. This means performing an analysis of the macroeconomic scenario, understanding the influence of the variables in question on the enterprise and, at a greater level of detail, how they affect certain critical factors. For a complete examination of the causes of the crisis, see specialist literature (Argenti 1976; Coda 1977, 1989; Slatter 1984; Guatri 1986, 1995; Hambrick and D’Aveni 1988, 1992; Confalonieri 1993; Sciarelli 1996; Moliterni 1999; Piciocchi 2003; Bertoli 2004). After introducing the general initial situation and identifying the causes that led the firm into its current state of difficulty, we will now address the point relating to the recovery strategy. To have an idea of the matters to be discussed, it is worth providing a breakdown of the paragraphs contained in the aforementioned point as follows: – Analysis of assumptions – Industrial structure – Financial structure The Recovery Plan consists of a set of ideas, decisions, and operations (Galeotti and Garzella 2013) which will allow the firm to restore its conditions of economic,

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financial, and capital balance. To do this, the plan must start by analysing the initial general situation only then to turn its focus to the future. The focal point of the discourse is centred precisely on this future orientation, as, by definition, the future, not being predictable, brings with it a high level of uncertainty. Typically, the plan refers to a timeframe ranging from 3 to 5 years, precisely to mitigate the risk inherent in forecasts. Such a reference period will not apply to all enterprises and must be chosen based upon the characteristics of the firm, its business, and its current state of crisis. Any forecast proposed in the plan must be supported by assumptions which make this future projection reliable and coherent. The second point of the proposed outline opens with the analysis of the assumptions at the basis of the provisional model. At a later stage, these will be discussed more analytically to support the numerical data inserted in the provisional tables of the plan. In this context, the preparer merely formulates these underlying assumptions on which to base the plan, coherently with: (a) (b) (c) (d)

the context in which the firm operates, the organisational structure, the production capacity, the macroeconomic expectations.

Depending on the strategy adopted, some specific elements should be indicated. If, for example, the strategy is based upon the disposal of corporate assets, an independent professional will need to value the asset or an actual show of interest by a purchaser must be received. Based upon the sector and/or the business model, the firm should also provide specific indications of the variables that characterise that situation which must be taken into consideration. The forecasts, depending on their level of uncertainty, are supported by different data collection methodologies. Those marked by a high probability of realisation find a valid tool of support in the firm’s historical series, as historical trends—in this case—are able to approximate future performances with good certainty. For elements whose price is constantly monitored by the market, as in the case of raw materials or interest rates, macroeconomic estimates proposed by valid institutions or research bodies can be used. Finally, for variables connoted by a high level of uncertainty, greater attention will have to be paid to the estimates, adopting sophisticated mathematical-statistical models. In practice, that circumstance occurs frequently, as the Plan is commonly characterised by operational and strategic discontinuities precisely to regenerate the conditions for the firm’s future value creation. Having described the basic assumptions on which to base the provisional model and having identified the models to be adopted to complete those projections, the focus then turns to defining the strategy to be adopted, firstly in industrial terms and then in financial terms.

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The actions presented here concern medium to long-term decisions and are aimed at describing how, in this broad timeframe, the firm will be able to restore its economic, financial and capital balance. Starting with the analysis of the industrial structure that management intends to achieve, a series of possible corrective actions can be identified based upon the diagnosis of the crisis made in the previous point. Those interventions can be classified as follows, merely by way of example: – – – – – –

Redefinition of the markets to be served; Revision of the product lines; Diversification of the product portfolio; Revision of the cost structure; “Make or buy” decisions relating to some assets; Modification of the organisational structure.

Finally, if the plan involves the implementation of extraordinary operations such as transformations, mergers, demergers, contributions, capital increases or reductions, they must all be considered carefully in their legal, economic, financial, and capital aspects. This aspect is particularly important if the operation changes, or even deteriorates, the relationship with creditors or shareholders or if it significantly affects the future business dynamics. To conclude this part concerning the identification of the strategies to be adopted by the plan in a medium to long-term timeframe, we must examine the financial structure to be achieved within that period of time. The interventions described here must refer to the balance sheet posts: – Net working capital – Shareholder equity – Net financial position As well as systematising the interventions on those elements, the firm must analyse the financial coverage of the investments and their maintenance. Depending on the element under consideration, the plan must envisage a series of operations to be completed to correct any imbalances that have occurred within the financial structure. Leaving the part relating to the definition of the relevant strategy, the two subsequent points to be analysed by the plan represent the impact of those strategies in the operating and financial field. Starting with the operating plan, this consists of a description of the interventions to be implemented by the plan and it can be classified into four areas of interest: – – – –

sales and marketing; production; organisation and staff; investments/divestments.

With regard to the part linked to sales and marketing of the product, the firm must provide:

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– an analysis of the relevant market, highlighting its attractiveness, historical trends and expectations; – the commercial and marketing strategies to be adopted; – the sales plan. In particular, the final point is worthy of particular attention, as it represents a central point in preparing the prospective documents that will be analysed in the second section of the plan. The sales plan describes analytically the forecasts relating to the dynamics of revenues throughout the whole timeframe of reference and any interventions to be made to the sales structure. It depicts the starting point for preparing the prospective income statement and, as will be seen below, a whole series of estimates relating to the cost structure are connected to it. As noted above, the plan must represent discontinuity with the past for those critical areas that led the firm into a state of crisis. This clearly means the firm will have to make new investments to remedy the criticalities that emerged in the previous analyses. Those investments must be explained clearly, considering their consequences in terms of lower costs and/or higher revenues. The focus on corporate operations should not refer solely to the sale and marketing of products, but to all actions that are to be implemented in the production process. Starting with the analysis of the current production capacity, its technological level and its degree of efficiency, the plan must identify those critical intervention areas in order to improve some fundamental elements, such as: – cost; – quality; – production times. Taking these three elements as drivers of reference, the plan will be able to estimate which investments—and how many—to make in the production process. Another area of interest to which the plan must pay attention relates to the organisation. Based upon a description of the current chosen organisational form, the size of the workforce, the managerial lines and the key figures, the plan must indicate the objectives to be pursued. In particular, three key elements should be highlighted within the organisational structure relating to three aspects that may come to light in a recovery process: – – – –

managerial discontinuity; organisational restructuring; significant workforce interventions; management of redundancies.

In a recovery process, managerial discontinuity, on one side, plays a fundamental role in the relationship of trust with stakeholders and, on the other, allows the firm to be renewed by distancing itself from the paths followed up until that time.

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Management figures having greater experience, expertise and professionalism will facilitate the removal of some behaviours that have become inherent over time within the organisation and will give a new impetus to the firm to achieve results that are sustainable over time. One problem that often affects small and medium enterprises is precisely the lack of managerialisation, or even the absence of a management structure, with the whole of management being centralised in the business owner. This is an element to which particular attention must be paid if a recovery path is to be undertaken. If the firm is able to complete its recovery process, restoring its economic, financial and capital balances, a lack of reorganisation, or even structuring, of its managerial lines would lead to a short-sighted result. The good result achieved hypothetically would immediately be compromised by the failure to remove one of the main problems that, in all likelihood, originated the state of crisis. The interventions described thus far represent the possible actions that can be taken in relation to the senior part of the company organisation. Other possible actions at lower level could, for example, involve the entire organisational structure, completely restructuring the same. In that case, the plan must present the new organisation model, highlighting the reasons why that decision was taken. Very often in a recovery process, the workforce is reduced. That process must be seen as strategic and not merely as a cost-cutting exercise, as this would have negative repercussions on the firm’s production capacity; it must be a reduction which renders the objectives of the plan coherent with the resources required by it. If that intervention is likely to be significant, greater detail must be provided at this point, highlighting how it will actually benefit the recovery from the perspective of sustainability of the results. The plan must not ignore the need to detail the costs connected to the management of redundancies; it should, therefore, describe all extraordinary costs, financial outlay and timescales relating to that situation. Finally, the operating plan must contain a part concerning the planned investments and divestments. In that situation, the corresponding historical data must be compared with the plan’s provisional data. Here, attention should be paid to two key points: – investments in production capacity; – divestments of corporate assets. With reference to the first point, the consequences in terms of production, outsourcing decisions or even delocalisation of plants and the consequent repercussions must be indicated. The divestment plan could represent a way of financing the firm’s subsequent recovery but the operational consequences of such an operation must be analysed carefully. The aim must always be to build the foundations for a return to value creation and not a mere divestment to satisfy short-term creditor claims; otherwise, this would constitute a liquidation plan and not a recovery plan.

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In the divestment plan, the preparer must indicate the motivations, timescales, and economic-financial impacts. As stated above, the heart of the recovery plan consists of two central points: the operating plan, concerning aspects linked to corporate operations, and the financial manoeuvre, concerning aspects linked to the financial structure. The financial manoeuvre will be developed by outlining some fundamental aspects: – – – –

definition and objectives of the financial manoeuvre; shareholder equity; debt; management of taxation in the financial manoeuvre.

Firstly, the objectives to be pursued must be defined. The aim is to rebalance the capital situation and achieve economic and financial recovery, attempting to reduce the financial stress under which the firm finds itself. From one side, the level of debt is to be brought within sustainable levels and, from the other, the financial requirement of working capital must be efficiently met. In this case, the intervention and involvement of some key stakeholders is essential (Decker 2018; Pajunen 2006; Arogyaswamy et al. 1995) to the success of the recovery process. All those means of covering the financial requirement, both in the form of own capital and in the form of debt capital, must be identified. The manoeuvre may thus require the participation of various corporate players: – – – – –

current shareholders and/or new investors; banks and other financial intermediaries; bond subscribers; suppliers; treasury;

Each of them, according to the state of crisis and the need for intervention, will be asked to contribute new finance, grant extensions, or restructure the previously contracted debt, to allow the firm to restore the balance and improve the level of confidence held by its various stakeholders. This latter element, although distant from economic-financial measures, plays a crucial role in the success of the firm’s recovery. Breaking down the analysis of the manoeuvre into the two classic forms of corporate financing, we will focus, initially, on the shareholder equity requirement and then on the requirement relating to debt. As noted previously, one of the causes of the business crisis is often identified in the systematic undercapitalisation of the business. As there is no perfect combination between own equity and third-party capital, each firm must find its own balance between the two sources. From the perspective of corporate recovery, the plan must envisage a new contribution by the existing shareholders, or new investors, so as to rebalance the capital structure.

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Another possibility lies in the conversion of certain forms of financing into venture capital, thereby transferring a debt, which at maturity must be repaid, into new capital invested in the firm. Debt capital is a more complex subject. The financial manoeuvre on debt must consider multiple interconnecting aspects, such as: – effects of the manoeuvre on shareholder equity; – maximum level of debt; – coherence between the form of debt and the requirement. One way of increasing capital lies in the conversion of debt into equity. That operation releases the firm from the burden of repaying the subscribed capital, avoiding further financial outlay at the maturity of the contract. This aspect must not be overlooked and the plan must indicate all aspects of the operation in question. The crisis may, inter alia, present symptoms of over-indebtedness, when the firm’s capital structure is weighed down by excessive debt which it will not, given its fundamentals, be able to sustain. In this sense, the plan must consider the maximum level of debt and, if the firm is in an extreme situation, bring that level back into safe waters. Often those levels are imposed by some loan contracts in which there are clauses, known as covenants, which involve the requirement to return the debt exposure even only when some budget indicators are exceeded. In seeking new finance, the preparer of the plan must consider a fundamental element for correctly determining the coverage of the requirement: the coherence between the form of debt and the financial requirement. The short-term requirement should be addressed with instruments coherent with the working capital dynamics, while anything that does not relate to the short-term must be covered by medium to long-term debt instruments. Finally, we must highlight a fact that is not always obvious. The search for new finance must not be considered as a way of creating over-indebtedness, but must be a procedure aimed at improving the conditions of the short and long-term balance of the financial structure. Finally, the financial manoeuvre should contain a part analysing the effects of the tax component, considering the sums due, receivables from the Treasury and various social security and welfare bodies, due dates and any extensions granted. The final point referring to the first section of the plan, still descriptive in nature, is reserved to the Action Plan. It must describe the: – – – – – –

Activities and execution methods Impact of the actions on the corporate organisation Responsibilities of the persons instructed to execute the plan Investments and divestments Resources necessary to execute the plan Timescales of execution of the plan

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Focusing briefly on the final point, the Gantt diagram is a useful planning instrument of the operations and individual activities for executing the plan. This model shows graphically the actions and the timescales in which they must be performed so as to be able to monitor their progress constantly. Finally, all those actions previously described in the operating plan and the financial manoeuvre must be described so as to ascertain, for example, how it is possible to increase the revenues, reduce costs, develop or reduce the assets and make the working capital efficient. Having carried out a detailed and careful analysis of the firm, the basic reasons for its imbalance and the recovery strategies, we now turn to the section reserved to the quantitative amounts. This section includes the prospective accounting tables, as well as the analyses aimed at understanding any scenarios in which the assumptions proposed by the model are not achieved. All data represented here are not the result of qualitative estimates made by the preparer, but originate from the previous section of the plan. The analyses, valuations and assumptions proposed materialise into numbers, forming an essential quantitative corpus for understanding the plan’s actual feasibility and its capacity to achieve the ultimate objective of restoring the economic, financial and capital balance in a long-term perspective. This section is broken down as follows: – – – – –

prospective income statement; prospective balance sheet; prospective cash flow statement; treasury plan; sensitivity analysis.

The prospective income statement should contain all forecasts of the income components that will contribute to forming the expected results. For the purposes of a clear representation of the results, it is worth adopting a scalar form so as to provide greater information to the stakeholders affected by the plan on the formation of net income through the interim results. All costs and income deriving from the recovery process must be classified separately so as to provide information that is not affected by extraordinary events connected to the execution of the plan. The outline proposed by Art. 2425 of the Italian Civil Code, namely a reclassification that considers the informative requirements of the stakeholders in relation to the nature of the document and the peculiar characteristics of the firm and the business, can be followed. A possible outline of the prospective reclassified income statement is presented below (Table 5.2). The prospective balance sheet should contain the prospective assets and liabilities, as well as the evolution of the shareholder equity, in order to determine the internal and external sources and provisional investments.

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Table 5.2 Prospective reclassified income statement n Actual

n+1 Plan

n+2 Plan

n+2 Plan

n+3 Plan

n+4 Plan

Revenues from sales Other income Net Operating revenues Direct Operating costs Gross Profit Costs of research and development Costs of marketing Costs of administration Costs of advisory Costs of employees Costs of leasing and rent Other general operating costs EBITDA Amortization of intangible operating assets Depreciation of tangible operating assets Provisions for employees, risks, charges, taxes EBIT Financial revenues Interests on debt Other financial costs EBT—OPERATING Non operating financial revenues Non operating financial costs Amortization of intangible surplus assets Depreciation of tangible surplus assets EBT Taxes NET INCOME

As highlighted in the prospective income statement, also in this case, the plan must also provide detailed and specific information based upon the characteristics of the firm and the business in which it operates. The classification must satisfy the informative requirements of the stakeholders, highlighting, if possible, the net financial position assumed by the firm. Below is a possible outline of the prospective reclassified balance sheet (Table 5.3). The prospective cash flow statement should contain the forecasts of the financial requirements necessary to achieve the plan throughout its entire timeframe. It will be split into: – cash flow from operational management – cash flow from investment activities – cash flow from financing activities

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Table 5.3 Prospective reclassified balance sheet n Actual

n+1 Plan

n+2 Plan

n+2 Plan

n+3 Plan

n+4 Plan

Net operating intangible assets Net operating tangible assets Financial operating assets CAPEX Trade receivables net Trade Payables TRADE WORKING CAPITAL—TWC Inventory Others operating receivables net Others operating payables NET WORKING CAPITAL—NWC Provision for employees Provision for risks, charges and taxes PROVISIONS CAPITAL INVESTED—CI EQUITY Long-term financial debts Long-term financial credits LONG-TERM FINANCIAL POSITION Short-term financial debts Short-term financial credits Marketable assets Cash SHORT-TERM FINANCIAL POSITION NET FINANCIAL POSITION—NFP CAPITAL STRUCTURE—CS

More specifically, it should highlight, year by year, the flows in service of the existing debt and the flows in service of the debt deriving from new finance. Below is a possible outline of the prospective cash flow statement (Table 5.4). Finally, the treasury plan should indicate the dynamics of the short-term financial incomings and outgoings. The timeframe used should be based upon the peculiar characteristics of the firm and the business in which it operates. It must be constantly updated, as it is strongly subject to changes. Deviations that are not excessively significant should not automatically infer the lack of feasibility of the plan. Below is a possible outline of the Treasury Plan (Table 5.5). The plan is connoted by major uncertainty as to the results considered in the same as it contains forecasts regarding the firm’s future performance. The future, by definition, is unpredictable but thanks to a detailed analysis and the use of mathematical-statistical models, the business economist is able to project the

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Table 5.4 Cash flow statement prospective n Actual

n+1 Plan

n+2 Plan

n+2 Plan

n+3 Plan

n+4 Plan

EBITDA Taxes Change in inventory Change in trade receivables Change in trade payables Change in Trade Working Capital Change in others receivables Change in others payables Use of Provisions Cash Flow From Operations Change in tangible assets Change in intangible assets Change in financial assets Investments Extraordinary income and expenses Change in equity Cash Flow Available For Debt Service Change in long-term financial debts Change in long-term financial credits Change in short-term financial debts Change in short-term financial credits Financial revenues and costs Net Cash Flow Cash and cash equivalents beginning of period Cash and cash equivalents end of period Net change in cash

performance of certain key variables of the firm. These projections must be supported by assumptions, which represent the central fulcrum of the entire provisional system. These assumptions should be subject to sensitivity analyses; the resilience of the plan must be tested if they fail or deviate from what has been stated. To do so, all risk factors to which the firm and the plan are subject must be identified and measured. In assessing their impact on the resilience of the plan, analyses can be used that have been created for the individual risk factor, or in a more sophisticated manner, by hypothesising a relationship between the various factors. Among the possible assessments to be carried out, the stress test is one of the most effective, as it is aimed at assessing the effects of a change, mainly negative, of a variable on the expected results envisaged by the plan. It is important to assess those situations for two reasons. The first is linked to the specific assessment of the plan, namely its reliability and resilience in circumstances of scenario changes. The second is connected to the possibility of overrunning the limits established by credit

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Table 5.5 Outline of treasury plan Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Opening balance Income Trade receivables Divestments of assets Financial Debts Equity Others Total Income Expenditure Trade Payables Investments in Assets Employees Severance Payment Taxes Social Security Institutions Financial Debts Leasing Bank expenses Others Total Payments Final balance

covenants. In that case, a chain process of enforced debt repayment would be triggered, which would severely test the feasibility of the plan itself. The recovery plan, as presented up to now, is an informative tool for the corporate stakeholders which is essential for overcoming the crisis by restoring the economic, financial, and capital balance. A fundamentally important element in this sense is represented by the involvement of all those corporate players affected by the fates of the firm so as to increase the level of confidence in that process. As emphasised by a good part of international literature (Decker 2018; Pajunen 2006; Arogyaswamy et al. 1995; D’Aveni and MacMillan 1990; Gilson 1990; Sutton 1990; Sutton and Callahan 1987; Hambrick 1985; Slatter 1984) in a period of crisis, the firm intensely requires the consent of its stakeholders to be able to recover from that state by exploiting the tangible, intangible and financial resources contributed by them. The firm in a state of difficulty does not only need new finance to restore its financial balance. It will need to rethink its entire business model, creating new presuppositions for the firm’s future success. The plan is not only a means of conveying information outside the firm’s perimeter, but it also guides the action of the managerial and operational lines in order to implement the interventions envisaged by it and subsequently to monitor their advancements.

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A final point on which to focus is the underlying logic that links the recovery action of the plan with the issue of value creation. The firm’s aim is to create value, seen in different ways depending on the currents of thought present in literature. In that regard, it is interesting to note that the recovery action proposed by the plan must be seen as a process aimed not only at restoring conditions of balance but also at laying the foundations for the firm’s future success. The crisis is a transition period in which the firm has two fundamental possibilities: cease to exist in the business world or rebuild a virtuous path of growth and development. Any other middle solution merely prolongs the existence of an organisation that is unable to survive in the market, probably forcing it into a situation of future difficulty. The recovery plan is aimed precisely at identifying, if they exist, the conditions for the firm to be able to survive over time and laying the foundations for a new way of creating value. Creating value means exploiting the tangible and intangible resources positioned internally and externally to the organisation to achieve a better result of the elements used in the transformation process. The value created by the firm is classically measured by the final line of the income statement but, in this context, the value in question is an amount not fully captured by accounting indicators. It must be measured taking account of the entire production system, involving all company stakeholders. Suppliers, customers, lenders, workers, and the community are all entities that share the value creation. This measurement escapes accounting logics, as it is a value that cannot always be defined in monetary terms. The recovery must involve a logic of Creating Shared Value (Porter and Kramer 2011) as only in a perspective of this nature will the firm be able to remove the causes that originated the crisis and equip itself with all those resources that are key to its future success.

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Chapter 6

Conclusions

The current economic scenario, characterised by strong uncertainty and recurring economic crises, albeit at different intensities, has negative repercussions on all industrial sectors. Different factors, such as market globalisation and the entry of numerous emerging enterprises originating from developing countries, have given a strong impulse to the increase in complexity and uncertainty. In such a context, pursuing economic, financial and capital balance is a vital element for guaranteeing a firm’s continuity. For this reason, we have analysed systematically the decline and crisis of the firm and the tools for their resolution, with particular reference to financial recovery. The vast literature on the topic agrees in defining the crisis as a pathological state in the life of a firm, characterised by a condition of economic and financial imbalance which continues over time and with the consequent difficulty of continuing to create value. That imbalance, if not managed appropriately, may lead to the firm’s insolvency and thus its ultimate collapse. The firm must, therefore, radically and promptly change its strategic formula and consider complexity as a resource which, once understood and managed, can allow the firm to build positions of success, exploiting the crisis in its favour. Yet, in corporate economic practice, management often takes an ambiguous and controversial approach to complexity. Strategic management must assist firms in better understanding the phenomena that cause uncertainty and complexity and in identifying the distinctive resources and unexpressed potential and the most suitable methods for fully activating them. Successfully turning around a firm in crisis requires the adoption of an underlying strategic orientation in which a sharp change of route takes place, directing the process towards complete discontinuity with the past. The recovery thereby assumes strategic value if it is not merely limited to returning to balance but pursuing a fully-fledged organisational restructuring process that strategically re-orients the firm towards a path of development. By taking this viewpoint, the crisis represents an opportunity for development, as it requires management to rethink the firm in its entirety. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 S. Ferri, F. Ricci, Financial Strategies for Distressed Companies, Contributions to Finance and Accounting, https://doi.org/10.1007/978-3-030-65752-9_6

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Conclusions

In economic periods of decline of demand and deleveraging, as in the one we are experiencing, sales volumes reduce and cash flows slow down. Those situations, if not carefully monitored and managed, risk leading the firm—even in a short space of time—into insolvency. The crises of recent years and the recent situation of uncertainty induced by the spread of Covid-19 are further confirmation of how the firm is intrinsically subjected to risk and how, to guarantee management continuity, it needs a constant strategic analysis that interprets the organisation as a complex and adaptive system. Success, in fact, derives from the capacity of adaptation and change and the “evolved model”. In contrast with the “traditional” model, the evolved model is based upon the presupposition of complexity, the assumption that the future is unpredictable and turbulent and that it is therefore important to govern instability by following modifiable decision-making processes that are continuously questioned. The new paradigm allows for turbulent phases to be managed dynamically from a long-term perspective, following a strategic approach that pursues positions of excellence, and not just of balance, as in the traditional model. Based upon these premises, this work highlights how corporate governance of firms in crisis requires a change of perspective, where it is no longer possible to rely exclusively on the intuition of the entrepreneur, but where a structured programme must be developed at strategic level. The crisis and its management are extremely complex concepts and a sufficient judgment requires a dynamic analysis of the firm and the environment in which it operates. The new paradigm, in fact, requires firms to rethink their overall strategic approach to the crisis, interiorising the difficulties which therefore become an opportunity from which to attempt to re-launch the activity. Decision-making processes implemented according to the traditional model follow a precise procedure which commences with the construction of models that lead to the prompt identification of any anomalies of profitability and capital and financial deficits. In fact, when a firm starts to see the first signs of crisis (financial tensions, payment delays, drop in turnover, etc.), the crisis is very often already in progress and its first real manifestations occurred much earlier; therefore, seeking to intercept the crisis through anomalies of budget indicators or by measuring the extent of the economic or capital deficit is often not the best possible solution. Literature of economic-business nature on the issue is extremely broad and has, from the outset, focused, as a priority, on systems of prompt identification of the causes of the crisis and the methods for resolving it. Further studies have demonstrated that heavily indebted firms are more at risk in periods of recession when the drop in domestic demand and the rationing of credit can constitute causes of crisis and bankruptcy; conversely, other studies confirm that many firms, during crisis periods, record significant phases of development and economic growth. We have focused in detail on the dominant literature in the business administration field on the topic, demonstrating that the traditional approach can be inadequate in contexts of corporate crisis. The most frequently used models, in fact, essentially of quantitative nature, are focused on some indicators able to identify the deterioration of management. They are certainly valid models but often they only allow for

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the negative dynamics to be identified when they are already in progress. When the turnover declines or the operating margins reduce, namely when financial problems are created, it is very likely, in fact, that events—internal or external—that will compromise the competitive advantage have already occurred. The analysis, therefore, should take an approach that is aimed not so much at seeking the causes of the crisis but, rather, at identifying the resources that will facilitate the re-launch, particularly those having strategic significance with which to build a new way of doing business, completely rethinking the firm. An excessive emphasis on seeking the causes of the crisis and on the methods of their removal, in fact, risks wasting energies that could be used in formulating a new strategic and financial proposal to the stakeholders. In light of the crucial role played by the regulation of the financial markets, we have also focused on the challenges faced at international level with regard to the coverage of the financial requirement of the firm in difficulty. It is well-known, in fact, that international consensus in the definition of norms and standards significantly increased in the financial services regulatory architecture after the 2007 financial crisis which highlighted the urgent need for a reform of the financial services sector. There are numerous initiatives at Community level aimed at developing market finance and various measures have ensued in short timescales, with modifications and replacements. Those initiatives are coherent with the aims pursued by the Capital Markets Union, namely the European Union action plan aimed at encouraging the diversification of sources of financing for enterprises, increasing investment opportunities for savers and achieving full freedom of movement of capital. In this manuscript, in particular, we have analysed the different instruments for covering the financial requirement of firms, namely the use of venture capital rather than debt capital. In particular, we have illustrated that argument in the context of corporate crises and insolvency procedures, analysing the mechanism of pre-deduction, aimed at strengthening the protection of those entities (banks and other intermediaries) that agree to provide new finance to firms in crisis. The recovery process can be split into various consequential phases, ranging from the identification of the system of resources and unexpressed potential to the preparation of a recovery plan having functions of control, oversight and communication of the entire process. A strategy must be established that focuses not so much on the traditional business but on the distinctive resources, namely those able to generate value and competitive advantage. The recovery process must also involve the creation of a new organisational structure as the processes of change must be directed at the system of human capital. The economic entity, in a situation of crisis, as well as implementing interventions aimed at restructuring the internal organisation and proposing innovative ideas for competitive repositioning, must identify and be able to attract the most suitable financial means, represented by venture and debt capital, that are necessary to trigger and sustain the new recovery process. That context is the backdrop to the financial strategy that sees the firm as a financial investment opportunity in which the same is valued by its performances from the perspective of the capital markets, based upon

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its capacity to meet expectations in terms of risks and returns. Financial recovery thus represents the key element around which the financial strategy of the firm in crisis revolves. The economic entity, in fact, must obtain recapitalisation subscribed by new venture capital or through re-financing and/or a debt consolidation granted by lenders by way of credit. The return to balance, from the financial point of view, is very difficult in a period of decline, as, having created the crisis conditions and lost the confidence placed in the firm, the venture capital often suddenly leaves, with simultaneous requests for return of credits by external lenders. Yet, the firm’s recourse to new venture capital represents an essential tool for winning back its financial reliability, through which the new economic entity makes explicit its convictions on the real possibilities of success of the recovery. The firm must be able to return to economic balance and that aim can only be achieved if it is able to satisfy the expectations of entities that have invested their capital, also compensating the accepted risk. To obtain venture capital, the enterprise must undertake three paths which, in practice, are usually combined. The first involves a recapitalisation of the firm implemented mainly by one or more figures already forming part of the economic entity, in order to redefine the relationships of strength between the different players of the area in question. The second may materialise in both the entry of a new shareholder within the existing corporate structure, and with the external development in which two or more functioning business organisations are combined. In both cases, the change of power relationships between the forces and players present in the area of the economic entity and the likely changes in leadership style and in some key people definitely give strong strategic significance to this reorganisation process. Finally, the third decision concerns the hypothesis of a new, mainly financial, partner, if the economic entity has rediscovered, by modifying its organisational and competitive spheres, new business capacity. If, instead of obtaining venture capital, the intention is to request the intervention of banks and other institutional lenders, there are four available options. The consolidation of the existing debt is the tool by which the firm is able to obtain from its creditors a renegotiation of the terms of the existing debt, thereby achieving a postponement in the payment deadlines of capital or interest. The waiver of capital shares or interest, on the other hand, takes place through the pactum de non petendo and covenants in the strict sense, while the conversion of past credits into venture capital and the provision of new loans supported by the right to their future conversion into venture capital represent the possibility of banks waiving their credit in exchange for an investment, with consequent remuneration, even more anchored to management performances. In order to present a convincing and reliable plan, the various available tools must be analysed as a whole, and not individually, in order to obtain the best synergic benefits. When a firm finds itself in a situation of economic and financial imbalance, it experiences a decline in performances and a deterioration in results and, for this reason, its relationship with the stakeholders tends to fall apart.

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In this case, the development of a plan can circumvent the risk of insolvency, restore the balance of the firm and allow for its re-launch, winning back the confidence of the stakeholders and realigning the informative requirements. In this sense, therefore, the plan must be capable of communicating effectively the appropriateness of the recovery strategy to the different stakeholders as, in order to achieve the success of the turnaround, widespread entrepreneurship must be developed which enhances the distinctive resources at every level of the organisation. The plan must achieve the consensus and confidence of the various stakeholders which must be made aware of the state of crisis and the actions to be taken to resolve it. In order to obtain their support and, therefore, the financing necessary to exit the crisis, the economic entity must win back their confidence by directing the firm towards a new agreed vision and by strengthening the corporate culture. In a strategic perspective, therefore, this is a more structured level of the relationship between firm and stakeholder which is no longer merely limited to the financial area but intervenes at the level of exchange of resources and competences, generating a virtuous circle able to produce value. The plan must increase the perception of value of the firm among third parties, by increasing the confidence of stakeholders and especially lenders, namely banks, which represent an important partner having high technical-specialist expertise. The plan, in fact, is a tool required and appreciated by the credit system, as it allows for banking relationships to be reactivated and also for new finance to be obtained, which is essential to the recovery. In corporate practice, it is often the case that the bank, which represents the strong party in the relationship and which risks seeing its credit unpaid, rather than taking action to protect itself, accepts further commitments in the expectation that, with a further investment (of small amount compared to the initial exposure), it can reduce or even avoid the risk and danger of losing a large part of its initial credit. The firm must obtain the consensus of customers which becomes even more necessary in a crisis situation. Its credibility in the face of customers is won back through the product, as this describes the values on which the firm builds its history. The turnover, in particular, represents the main value of reference, as it illustrates the reaction of customers to the value creation proposed by the firm. In the plan, relationships with suppliers also become strategically important, as their relationship with the firm facilitates new forms of collaboration useful for generating new value and their support is crucial for avoiding the interruption of production and encouraging corporate recovery. Suppliers, in fact, frightened by the firm’s insolvency, may block supplies and demand the rapid return of their credit. Situations of corporate collapse often make it difficult to keep human resources within the organisation. To overcome that problem, the loyalty and faithfulness of the individual workers must be strengthened, by enhancing their identification process. It clearly emerges, therefore, that the adoption of strategic orientation for firms found in conditions of crisis—or of lasting economic and financial imbalance—is the most reliable path for overcoming their difficulties.

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For that orientation to materialise in opportunities, it must be supported by a recovery plan based upon transparency and the involvement of the various stakeholders, which enhances elements of strategic management and contains financial solutions. In that perspective, the recovery plan is seen as a strategic tool aimed at restoring the balance through a detailed communication to the stakeholders of the operational actions of financial nature, necessary to restore confidence, always with the supreme aim of achieving business continuity.