previous sub-section
Chapter One— The Importance of Financial Institutions in the Political Economy
next sub-section

Corporate Crisis

Observers typically define corporate crises in vague and narrow terms of managerial discretion (or indiscretion). For example, Ross and Kami (1973, 21) argue that corporations experience crises when managers violate the "Ten Commandments of Management" governing managerial behavior and the internal structure of the firm. This focus implicitly examines the firm in isolation and fails to acknowledge the external constraints on managerial discretion. For example, relations with financial institutions, networks of corporate board interlocks, and joint ventures between firms all serve as constraints, as does the general state of the economy. Economic definitions thus equate crisis with low or declining profitability, overlooking corporate crises that have nothing to do with low profitability. Furthermore, the restricted definition of crisis does not consider possible dynamic or interactive aspects of the phenomenon, treating it instead as a singular event or point in time (see James and Soref 1981).

One perspective that includes some notion of external constraint on managerial discretion is the theory of the "invisible hand" (Smith 1776). According to this view, widely accepted by business analysts, unseen forces of the market act as an external constraint on managerial discretion. But that constraint appears as a neutral mechanism free of conscious or subjective interference. In this sense the invisible hand defines managerial decisions as the cause of corporate difficulties and defines crisis, once again, as a situation of low or declining profitability.

I argue that a corporate crisis is not always a mechanical economic reaction of the invisible hand of the market brought on simply by low profitability. Rather, it is a reflexive definitional process, involving shifting levels of discretion and constraint, that can seriously damage a firm's long-term business trajectory. Because


20

banks play a central role in capital flow relations, they often control this definitional process. And the structural organization of the banking community enables them to enforce their definition.

According to W.I. Thomas (1928, 572), "If men [sic ] define situations as real, they are real in their consequences." Banks' collective definitional perception and self-fulfilling prophesy determine whether a given corporation's financial position will threaten its business trajectory (Merton 1968, 475–490). Once banks define the situation as a crisis, other persons and institutions will respond as if it is. Consequently, in a reflexive process these responses may actually produce the crisis presumed to exist. As a self-fulfilling prophesy, the crisis is then no longer a subjective political decision but a matter of economic fact. Indeed, sometimes the crisis may escape the control of those whose definition originally precipitated it.

Financial decline and corporate crisis are thus not synonymous. Declining financial health may result from poor managerial decisions, from decisions constrained by economic imperatives that are detrimental to the firm in the long run, or from a poor general national economy. But until a declining performance is defined as a crisis, no real crisis exists. I argue that the financial institutions can exercise this definitional power because of the banking community's collective control of capital flows.

The business press often refers to self-fulfilling prophesy as the "herd effect." Individuals and small institutions assume that large financial institutions act on "inside information." They therefore follow the large institutions' lead for fear of being the last investor to sell their holdings or to call in their loans from a crisis-ridden firm. The more institutions that divest in or deny loans to a given firm, the greater the chance that other investors will follow suit. The herd effect also operates when financial institutions determine that a firm is "healthy": "The more institutions that invest [in a firm], the greater the chance that the others will follow" (Business Week , 28 Jan. 1980, 87). Furthermore, the herd effect is often long-term or permanent. In contrast, singular responses by the banking community to individual instances of low profitability are not necessarily permanent or without alternatives. Other competing banks can define the situation differently. Ongoing and active intervention by the banking community into corporate affairs is unnecessary to perpetuate the banks' definition of the situation.


21

Some observers argue that banks would only invoke bankruptcy or stock dumping as a last resort to extreme situations. For example, Emerson (1981, 1) claims that "last-resort" sanctions are invoked only when "'normal remedies' . . . are specifically inappropriate or . . . have failed to contain the trouble." Although Emerson focuses on the use of last-resort sanctions in social control institutions (such as mental institutions, correctional institutions, and so on), his thesis suggests that extreme bank behavior such as stock dumping and provoking bankruptcy and default could also be interpreted as actions of the last resort. In the following chapters we will examine case studies to determine whether the banks' decisions to pull their collective purse strings were indeed remedies of the last resort after less extreme approaches had failed.


previous sub-section
Chapter One— The Importance of Financial Institutions in the Political Economy
next sub-section