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Dependability and Organizational Bankruptcy: An Application of Agency and Prospect Theory

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  • Richard A. D'Aveni

    (Amos Tuck School of Business Administration, Dartmouth College, Hanover, New Hampshire 03755)

Abstract

This paper proposes and tests a new model of organizational bankruptcy based on agency and prospect theory. The paper argues that debtors with unprestigious top managers, low liquidity and high leverage signal that they will be undependable exchange partners. The model proposes that survival is contingent on maintaining an acceptable, minimum level of these financial and managerial assets. If a firm falls below that threshold level, it has a higher probability of bankruptcy because creditors withdraw their financial support from the debtor. Consistent with agency theory, this implies that bankruptcy can be viewed as the legal resolution of severe shareholder-creditor conflicts about the levels of financial and managerial assets that the debtor should maintain. This new model proposes that maintaining a minimum level of these assets is a necessary, but not sufficient, condition for bankruptcy. Some undependable firms delay bankruptcy by using strategies that create the hope that they will become dependable in the future. According to prospect theory, these strategies work because creditors wish to avoid recognizing significant losses, and thus take on more risk than they might otherwise assume.

Suggested Citation

  • Richard A. D'Aveni, 1989. "Dependability and Organizational Bankruptcy: An Application of Agency and Prospect Theory," Management Science, INFORMS, vol. 35(9), pages 1120-1138, September.
    • Handle: RePEc:inm:ormnsc:v:35:y:1989:i:9:p:1120-1138
    DOI: 10.1287/mnsc.35.9.1120
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    Citations

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    Cited by:

    1. van Witteloostuijn, A. & Boone, C.A.J.J., 1997. "A game theory of organizational ecology : a model of managerial inertia and market selection," Research Memorandum 005, Maastricht University, Netherlands Institute of Business Organization and Strategy Research (NIBOR).
    2. Amankwah-Amoah, Joseph, 2016. "An integrative process model of organisational failure," Journal of Business Research, Elsevier, vol. 69(9), pages 3388-3397.
    3. Northcraft, Gregory B. & Preston, Jared N. & Neale, Margaret A. & Kim, Peter H. & Thomas-Hunt, Melissa C., 1998. "Non-linear Preference Functions and Negotiated Outcomes," Organizational Behavior and Human Decision Processes, Elsevier, vol. 73(1), pages 54-75, January.
    4. Thornhill, Stewart & Amit, Raphael, 2003. "Learning from Failure: Organizational Mortality and the Resource-based View," Analytical Studies Branch Research Paper Series 2003202e, Statistics Canada, Analytical Studies Branch.
    5. Simon, Mark & Houghton, Susan M. & Savelli, Sonia, 2003. "Out of the frying pan...?: Why small business managers introduce high-risk products," Journal of Business Venturing, Elsevier, vol. 18(3), pages 419-440, May.
    6. Thornhill, Stewart & Amit, Raphael, 2003. "Comprendre l'echec : mortalite organisationnelle et approche fondee sur les ressources," Direction des études analytiques : documents de recherche 2003202f, Statistics Canada, Direction des études analytiques.
    7. McKinley, William & Ponemon, Lawrence A. & Schick, Allen G., 1996. "Auditors' perceptions of client firms: The stigma of decline and the stigma of growth," Accounting, Organizations and Society, Elsevier, vol. 21(2-3), pages 193-213.
    8. Edwards, Kimberley D., 1996. "Prospect theory: A literature review," International Review of Financial Analysis, Elsevier, vol. 5(1), pages 19-38.
    9. James, Sharon D., 2016. "Strategic bankruptcy: A stakeholder management perspective," Journal of Business Research, Elsevier, vol. 69(2), pages 492-499.
    10. Kim, Jerry W. & Higgins, Monica C., 2007. "Where do alliances come from?: The effects of upper echelons on alliance formation," Research Policy, Elsevier, vol. 36(4), pages 499-514, May.

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