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11-010-XIB
Canadian Economic Observer
October 2006

Feature article

National and regional trends in business bankruptcies, 1980-2005

by C. Lecavalier*

Introduction

Bankruptcy is part of the firm life cycle: new businesses are constantly beginning operations, others are voluntary closing their doors and some, because of ineffective management or various adverse trends present in the market place, are unable to remain viable and are forced to declare bankruptcy. When the property and assets of a business or corporation are no longer sufficient to meet their financial obligations and there is no chance of remedying the situation, bankruptcy is the means of liquidating the assets to the benefit of creditors.1

Business bankruptcies are of considerable interest because they provide one metric of the stress to which businesses are subject. They are indicators of the economic pressures associated with economic downturns of the country or region or the health of business management. The growth or decline of business bankruptcies across Canada reveals how different regions react to these pressures and provides a basis for the comparison of the health of regional economies.

The average annual number of business bankruptcies over the past 25 years was around 10,000. This paper provides an overview of the long-run trend in business bankruptcies in Canada, examines bankruptcies by region and analyses the relation between the incidence of bankruptcies and the economic health of the regions.

Since the main causes of business failures have been studied by Baldwin et al. (1997), this paper takes a different approach. It examines the intensity of bankruptcy over the long run, with an additional emphasis on regional differences. The first section contains a national overview of business bankruptcies over time. The second section examines the way in which business insolvency in different regions reacts to economic stress. Lastly, the paper investigates whether business bankruptcy is correlated with the rate of unemployment and whether this differs by region.

This paper examines business bankruptcies, using the number of annual failures and the number of businesses in the market to derive the bankruptcy rate (number of bankruptcies divided by number of businesses).2 Since the number of bankruptcies may change because the number of businesses changes, the incidence of bankruptcies (bankruptcies per 1,000 businesses) is used here to measure the intensity or severity of bankruptcies. Increases in the number of bankruptcies may occur simply because the number of businesses is growing. Defining intensity as the number of bankruptcies divided by the number of businesses allows us to ask whether the probability of failure is increasing or decreasing.

Examining the deficits caused by business bankruptcies in relation to the value of the country’s net assets also is used to assess the severity of business insolvency over time. This measure captures the magnitude of financial losses caused by bankruptcies. The metric against which this is compared is the size of the country’s net assets. Net assets are the difference between the assets and liabilities of a bankruptcy. With few exceptions, liabilities are greater than assets when bankruptcy occurs. Dividing the net assets (or net liabilities) of bankruptcies by the net assets of the entire economy provides a financial measure of the probability of losses due to bankruptcy.

Overview of business insolvency

The recessions in the early 1980s and 1990s were associated with high rates of company bankruptcy (see Table 1). During the early years of each of these decades, bankruptcies rose dramatically (Figure 1). The early 1990s, which accompanied both a recession and restructuring associated with trade liberalization, experienced the highest number of bankruptcies. From 1980 to 1992, the number of bankruptcies more than doubled, climbing from 6,519 to 14,004. But dramatic improvements have occurred since that time. By 2005, the number of bankruptcies was only 7,334, returning to where it was 25 years ago.

Table 1 Bankruptcy Summary, Canada, selected periods from 1980 to 2005

  1980 to 1988 1989 to 1998 1999 to 2005 1980 to 2005
Incidence of bankruptcies (number per 1,000 businesses)        
Average 11.44 13.01 8.98 11.38
Standard deviation 2.31 1.88 1.25 2.46
         
Unemployment rate (%)        
Average 9.59 9.54 7.27 8.95
Standard deviation 1.73 1.31 0.38 1.64
         
GDP growth rate* (%)        
Annual average 7.88 4.30 5.77 5.85
Standard deviation 2.31 2.69 2.55 2.91
         
Net asset growth rate (%)        
Annual average 9.34 7.04 6.36 7.58
Standard deviation 3.43 1.71 2.03 2.68
* Business sector, excluding owner-occupied housing.

Figure 1

Incidence of bankruptcies

As the annual number of bankruptcies gradually increased in the 1980s and 1990s, the number of businesses operating climbed from slightly over 630,000 in 1980 to more than 1,046,000 in 2005, a growth rate of close to 60%. The increase in the number of firms was more pronounced in the 1980s and then began a slow upward trend from 1996 to the present.

The incidence of bankruptcies (the number of bankruptcies per 1,000 businesses) follows the same cyclical pattern as the number of bankruptcies (Figure 1). There are peaks in the early 1980s and 1990s, but contrary to the trend on the number of bankruptcies, the intensity of bankruptcies has a long downward trend. Canada registered 10 bankruptcies per 1,000 businesses in 1980, falling to 7 per 1,000 in 2005. This represents a 30% reduction in the incidence of bankruptcies over the 25-year period. The highest rates of business failure were reached in 1982, with 16 bankruptcies per 1,000 businesses, and in 1992 and 1996, with 15 bankruptcies per 1,000 businesses.

The recovery after the 1991/92 recession was slower than that following the 1981/82 recession. The drop in the incidence of bankruptcies lasted five years in the first case, reaching 9 bankruptcies per 1,000 businesses. This same incidence was not achieved until 2002, some 10 years after the 1990s recession, partly due to a rise in incidence in 1995 and 1996.

Data also show that bankruptcy rates in the 2001 slowdown were far lower than at the start of the 1980s and 1990s. Coincident with the decline of high-tech markets in 2000 and 2001, the incidence of business bankruptcies rose only slightly and then fell steadily. This reaction is contrary to the sharp increases in bankruptcy rates noted in the early 1980s and 1990s.

Bankruptcy liabilities

Despite the perception of failure associated with bankruptcy, some argue that this experience may have beneficial effects in the long run. Armed with knowledge about their mistakes, entrepreneurs have a greater chance of succeeding the next time. But at the time of the bankruptcy, unpaid debts result in a loss for the company. The size of this loss provides a measure of the investment that a society makes in entrepreneurial learning.

Over the last 25 years, net liabilities from bankrupt businesses have increased (Figure 2). With growing liabilities, the net liabilities resulting from bankruptcies jumped from close to $480 million in 1980 to around $3.3 billion in 2005. Not surprisingly, net liabilities peaked in the early 1980s and 1990s. However, despite a decline in the incidence of bankruptcies in the past decade, net liabilities rose sharply from 1999 to 2002. They reached more than $6.6 billion in 2002, a level 72% and 21% higher than in 1984 and 1992, respectively. These data lead to the conclusion that while there were fewer bankruptcies in the early 2000s, they involved large net liabilities.

Figure 2

The losses incurred represented annually between 0.3% and 1.4% of the country’s net assets. In 1980, for example, losses equalled almost $480 million, or 0.32% of Canada’s net assets. This proportion was 0.52% in 2005. On an annual basis, the loss may seem insignificant, but totalled over a 25-year period, the cumulative amount is substantial.

The losses associated with bankruptcy, when calculated as a percentage of the economy’s net assets, also fluctuate with the business cycle, increasing in each of the early 1980s, 1990s and the early 2000 period. Here the financial measure of intensity is no more severe in the early 2000s than in the 1980s. Once again, there is a decline by 2005, but there has been no long-run downward trend as there was when examining the number of bankruptcies.

Bankruptcy by industry

The construction and retail trade industries declared the most bankruptcies every year since 1990 (Table 2). Accommodation and food services has been the third industry for 12 of the 16 years in the period from 1990 to 2005. The top three industries in terms of annual bankruptcies accounted for slightly over half of the total annual bankruptcies in Canada in the early 1990s. This proportion has fallen to 44% in 2005.

It is impossible to ignore a number of unique regional patterns. One of these was the repeated presence in the early 1990s of the primary sector (mostly farming and fishing and hunting) among the three industries with the most bankruptcies in the Prairies and the Atlantic region. The transportation industry was also significant for a few years in the Prairie and the Atlantic region. In addition, the other services industry frequently appears in the top-three ranking for Quebec, the Prairies region and British Columbia.

Table 2 Bankruptcies by industry, 1990 to 2005

  Retail trade Construction Accommodation and food Total number of bankruptcies
         
Canada 36,284 26,149 23,441 174,655
Atlantic 2,927 1,884 1,349 13,298
Quebec 13,848 6,077 9,598 59,510
Ontario 11,193 7,919 7,221 50,457
Prairies 5,847 7,043 3,649 35,754
British Columbia 2,469 3,226 1,624 15,636

Regional differences

Since regional economies differ from one another, the history of bankruptcies differs across regions. First, industry composition differs. Secondly, in the 1990s, competitive forces that arose from the signing of the Canada–United States Free Trade Agreement in 1989 varied across regions. Thirdly, specific events such as the disappearance of the cod fishery in the Atlantic region and mad cow disease and the closure of the Canada–United States border to beef exports affected some regions more than others.

Each region responds in its own way both to the national economy forces and to unique regional circumstances. Despite the diversity of their business insolvency history over the past 25 years, most regions have displayed similar fluctuations in bankruptcies (Figure 3). But while there were substantial differences early in the period, there has been a marked convergence in recent years. Quebec’s bankruptcy rate was over 25 per 1,000 businesses in 1982 while it was around 6 in the Atlantic region—a difference of almost 20 between the largest and smallest rate. Only a difference of 3 bankruptcies per 1,000 businesses separated the regions in 2005, with incidences ranging from 5 bankruptcies per 1,000 businesses in BC to 8 on the Prairies.

Figure 3

In the 1981-82 recession, all regions saw a rise in their bankruptcy rate, except BC which recorded a slight decrease in 1981. However, after this, British Columbia followed the national trend, with its incidence of bankruptcies tripling from 5 to 15 bankruptcies per 1,000 businesses in 1984. The introduction of the free trade agreements and the onset of another recession in Canada in the 1990s appear to have had no significant impact on the solvency of businesses of British Columbia, which continued to record a drop in the incidence of bankruptcies until 2005. In 2005, British Columbia had the lowest rate of business failures of all regions at 5 per 1,000 businesses.

Quebec had by far the highest incidence of bankruptcies up until 2001. Quebec experienced its worst performance in 1982, with 25 bankruptcies per 1,000 businesses. This incidence fell by almost half to 12 bankruptcies per 1,000 businesses in 1987. Even in 1987, a period of growth across Canada, its bankruptcy incidence remained higher than that of the other regions. However, in 1992 and 1996, increases were observed, bringing the incidence rate close to 1982 levels. This makes Quebec the only region intensely affected by both recessions. Since then, Quebec’s bankruptcy rate decreased by 18 bankruptcies per 1,000 businesses to its lowest level in 25 years at 7 bankruptcies per 1,000 businesses, the largest decrease in the country.

The 1980s and 1990s recessions also affected Ontario. Its trend was similar to that of Quebec. However, its businesses were affected to a lesser degree in 1981 and 1982 as its bankruptcy rate rose only by 3 bankruptcies per 1,000 businesses. While all regions saw their incidence of bankruptcies begin to rise again after a period of decline, Ontario’s (like BC) continued to decline until 1989. The recession in 1991/92 drove its bankruptcy rate to 14, less than the significant increase in Quebec. In 2005, Ontario’s incidence was 7 bankruptcies per 1,000 businesses, the result of a general decline that began in 1993.

During the 1980s, the incidence of bankruptcies in the Atlantic region was the lowest in the country, with between 3 and 7 bankruptcies per 1,000 businesses. Bankruptcies increased in the 1990s, as the fishing industry went through traumatic adjustments to declining fish stocks. The Atlantic region registered a 400% increase in its incidence of bankruptcies from 1988 to 1992, reaching 16 bankruptcies per 1,000 businesses. The increase was caused mainly by Nova Scotia. This province generally had a higher insolvency rate than its three neighbours, but the difference widened disproportionately from 1989 to 1998, mainly because of the fishing industry. If not for this drastic rise in the incidence of bankruptcies, the Atlantic region would have experienced a significantly lower incidence of business bankruptcy in the 1990s. By 2005 Atlantic bankruptcies declined to 7 bankruptcies per 1,000 businesses.

Figure 4

The business sector in the Prairie region also generally followed the national trend. The incidence of bankruptcies rose from 6 in 1980 to 11 in 1982. The region had not returned to the 1980 rate when the recovery ended in 1988, and the incidence of bankruptcies rose slowly to around 15 bankruptcies per 1,000 businesses in 1992, 1995 and 1996. The incidence of bankruptcies then fell until 2005 (except for a slight increase in 2002 due to mad cow disease and the ban of beef shipments to the US). Alberta largely defined the pattern for the Prairie region (Figure 5). Business solvency in that province was adversely affected at different times than in Manitoba and Saskatchewan; specifically, from 1983 to 1986, from 1994 to 1997 and in 2002. Construction and other services accounted for much of the increase in bankruptcies in 1995 and 2002.

Figure 5

Bankruptcies and regional economic fluctuations

To what extent are business failures related to the economic health of a region? If a strong economy produces a better economic environment for businesses, should we expect to see a decline in the incidence of bankruptcies? To examine this issue, we compare the trend in the intensity of bankruptcies to the regional unemployment rate.

The relation between the unemployment rate and the incidence of bankruptcies varies widely by region across Canada (Table 3). Overall, there is a high correlation (0.77) between these two measures for Canada. Considered individually, Ontario, Quebec and British Columbia show a strong correlation between the unemployment rate and the incidence of bankruptcies. The correlation between the two variables is 0.94 in British Columbia, followed by 0.80 in Quebec and 0.79 in Ontario. The Atlantic and Prairies regions show a weak correlation, at 0.32 and 0.49 respectively.

The Spearman correlation coefficient provides values quite similar to these Pearson linear correlation coefficients, except in the case of the Atlantic region and British Columbia where the correlation is much lower. The Spearman coefficient uses the ranking of the values of the unemployment rate and incidence of bankruptcies rather than the values themselves, which are used to calculate the Pearson correlation coefficient. The Spearman correlation coefficient is more appropriate when dealing with a non-linear relation between two variables.

Table 3 Correlation between the unemployment rate and the bankruptcy rate

Regions Correlation coefficient (Pearson) Correlation coefficient (Spearman)
Canada 0.77 0.74
Atlantic 0.32 0.18
Quebec 0.80 0.83
Ontario 0.79 0.74
Prairies 0.49 0.47
British Columbia 0.94 0.83

There is a strong correlation between the unemployment rate and the incidence of bankruptcies for the entire period from 1980 to 2005 among the large provinces, while the relationship is weaker for the Atlantic and Prairie provinces. The reason for the weaker correlation in these two regions is that there were a few years when the incidence of bankruptcies did not move closely with the unemployment rate. Figures 6 to 11 show the comparison between the unemployment rate and the national and regional incidences of bankruptcies.

Figure 6

Figure 7

Figure 8

Figure 9

In the Atlantic region, after 1989, the incidence of bankruptcies increased faster than the unemployment rate. The incidence of bankruptcies then fell sharply for two years before climbing again until 1996. The unemployment rate, for its part, decreased slightly from 1993 to 1995. During this period of time, the fishing industry went through dramatic restructuring.

The Prairie region also experienced years where the incidence of bankruptcies diverged from the movement of the unemployment rate. While the unemployment rate fell from 1994 to 1996, the incidence of bankruptcies rose quickly and remained high (largely due to construction and other services) before returning to a more normal level in 1997. Farming on the Prairies experienced unique events that contributed to these peculiarities.

Figure 10

Figure 11

The comparison of the two measures clearly reveals that only a few years altered the correlation coefficient for the Atlantic and Prairies regions. If these years are excluded, the overall correlation between the unemployment rate and incidence of bankruptcies for these two regions is similar to that of the other regions. It should be noted that the 1981/82 recession does not appear to have significantly affected the two measures, since the correlation remained strong during that period.

Conclusion

The intensity of business bankruptcies in Canada has changed a great deal over the last 25 years. Recessions in the early 1980s and 1990s, and the coming into force of free trade agreements in 1989 and 1994 were associated with significant increases in bankruptcies in Canada both in terms of numbers and intensity relative to numbers of businesses. By contrast, the economic slowdown in the early 2000s did not produce the same marked increase in bankruptcies.

In more recent years, the number of bankruptcies fell to 25-year lows. By 2005, the absolute number of bankruptcies returned to the levels of the early 1980s. The rate of bankruptcy declined steadily, returning in 2005 to levels below those in the early 1980s.

But while the number of bankruptcies has declined over time (both absolutely and relative to the total number of firms), financial losses have not. In 2005, they were higher than in the early 1980s. In addition, while less numerous, bankruptcies produced larger losses in the 2000s. Improvements in survival therefore have been concentrated primarily in smaller firms. While there are fewer firms going bankrupt, the average size of the bankruptcies has been increasing.

Over time, regional bankruptcies have not only generally declined, they have also converged. Quebec’s incidence was once higher than that of other regions and its rate rose and fell drastically with the economic fluctuations of the 1980s and 1990s, but its businesses now register an incidence of bankruptcies similar to that of the other regions. The difference between the bankruptcy rates of the different regions has recently fallen to 25-year lows.

The response of regional bankruptcy numbers to fluctuations in regional economies (as measured by the unemployment rate) has been similar for Quebec, Ontario, and British Columbia. It was less responsive in some of the smaller provinces, where specific circumstances associated with fisheries or construction affected the regional economies. In the Atlantic region, for example, the events of the 1990s had a major impact on the insolvency of businesses, particularly in Nova Scotia. Similarly, the Prairies registered a sharper increase in its incidence of bankruptcies from 1995 to 1997, primarily in Alberta.

Reference

Baldwin, J., T. Gray, J. Johnson, J. Proctor, M. Rafiquzzaman and D. Sabourin. 1997. Failing Concerns: Business Bankruptcy in Canada. Catalogue no. 61-525-XIE. Ottawa: Statistics Canada.

Office of the Superintendent of Bankruptcy Canada (OSBC). 2002. Report on the Operation and Administration of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act. Catalogue no. Iu4-3/2002. Ottawa: Industry Canada.

Office of the Superintendent of Bankruptcy Canada (OSBC). 1980 to 1998. Annual Statistical Report for the calendar year. Consumer and Corporate Affairs Canada.

Office of the Superintendent of Bankruptcy Canada (OSBC). 1999 to 2005. Annual Statistical Report for the calendar year. Industry Canada. Internet adress: http://strategis.ic.gc.ca/epic/internet/inbsf-osb.nsf/en/h_br01011e.html (accessed March 10, 2006).

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Notes

* Micro-Economic Analysis Division, (613) 951-2183.
1 Most bankruptcies examined in this paper involve businesses but some are personal bankruptcies of the self-employed. According to the Office of the Superintendent of Bankruptcy Canada, self-employed individuals whose commercial debt represents more than 50% of their total debt declare business bankruptcy instead of personal bankruptcy (OSBC, 2002).
2 The data on bankruptcies and net liabilities presented in this paper relate to the business sector and exclude educational, health care and public administration services.


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