Official figures show that, in 2011, 230,000 companies de-registered for VAT. That’s a closure rate of 10.6 per cent. Such a high rate is not an artefact of our weak economy; even in the best year (2006), 9.4 per cent of firms de-registered. The ONS estimates that of the firms that set up in 2006, only 45 per cent were still going five years later.
Granted, these death rates reflect the fact that mortality rates for very small and young firms are extremely high. Nicholas Oulton at the LSE’s Centre for Economic Performance points out that death rates decline sharply as firms get older and bigger. This is not entirely a causal relationship; older, bigger firms have shown an ability to survive, which augurs well for their continued survival. But even for these firms, death rates are significant.
Take, for example, the members of the FTSE 100 when the index was created in 1984. Of those firms only one-third are still independent, quoted firms. Five of them have since gone bust. Another two (RBS and Lloyds Bank) would have done so but for a tax-payer bail-out, and perhaps others would have failed had they not been taken over. This implies an annual death rate of 0.3 per cent – and more, if you assume that some of the companies that had been taken over would have failed otherwise.
In other words, the life expectancy of even blue chip firms is no better than that of the average man in his late 40s.
However, there is a difference between big companies and we middle-aged men. Whereas humans’ health and vigour tends to decline, companies are brittle; they can go from good health to deathbed quickly. One reason for this is that whereas firms become successful through many good small decisions, they fail because of single disastrous ones, such as the wrong choice of strategy or an ill-judged takeover. Another reason is that firms embody a particular vintage of technology and – as HMV and Jessops have shown – they struggle when technical change renders that vintage obsolete. Whilst firms are usually good at upgrading existing technology, it's difficult for them to adopt wholly new technologies and move into new business areas; one of the rare exceptions to this – Nokia’s move into mobile telephones in the 1980s – looks less brilliant now than it did a few years ago.
I say all this for two reasons. One is that it means a common way of valuing firms is mistaken. The simplest versions of the dividend discount model assume companies can grow into perpetuity. But they can’t. And even low death rates multiply nastily over time. An annual death rate of one per cent implies that there’s a more than one-in-four chance of a firm not surviving for 30 years. If you’re applying low discount rates to future cashflows, this can make a big difference, causing us to overvalue companies. Perhaps the "short-termism" of which some market observers have complained isn't so irrational after all
Secondly, this reminds us of Joseph Schumpeter’s words – that a central fact of capitalism is "the perennial gale of creative destruction". The emphasis here should be on "perennial"; the destruction of jobs and companies is high even in normal times. In this sense, it is a mistake to regard HMV's death as somehow unusual. It's not.
Indeed, I fear that our tendency to under-rate the prevalence of destruction serves an ideological function. It distracts us from the fact that millions of workers face huge amounts of uncertainty. And it perpetuates the illusion that companies' future can be secured by clever and well-paid management.
