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Why Share Companies Fail in Ethiopia

January 1, 2022

By Habtamu

Share companies are one form of business organization that often issue shares to raise capital for operational and strategic reasons. In other countries, shares of public companies are traded on regulated stock exchanges. In the stock exchange process, investors can place orders to buy and sell shares. Shares can be a valuable part of an investment portfolio. Owning shares in different companies can help build savings and protect money from inflation and taxes. It’s one option of maximizing income from the investments to the individual. When we see it from the company’s side, managing shares has become a central task.

The fundamental component of most investment portfolios is the issuing and managing of shares. Corporate governance is the system by which companies are directed and controlled so that they meet the objectives they set out to achieve.

Wealth maximization is a primary objective of any corporate or share company. The board and management work hard to achieve this, and their successes and failures are measured accordingly. The board, as the primary tactical leader of the company’s strategic aims, has a focus on maximizing wealth, or what in accounting is termed as making a profit. The success pages of share companies in Ethiopia are just a few; of course, the finance industry is an exception.

Leadership failure
Poor leadership makes any business fail. The presence of strong corporate governance is important in share companies. The board, management team, and particularly the general manager must be able to make the right decisions to make the company effective. From financial management to employee management, leadership failures will trickle down to every aspect of the company’s performance. The most successful entrepreneurs learn, study, and reach out to mentors to improve their leadership skills.

A lack of foresight by a board will eventually bring disastrous failure to a company. This is because the board is the primary stakeholder that has a strategic role to impact corporate governance. Though board directors are elected by shareholders or appointed by other board members to represent the shareholders of the company, the transparency of nomination directly affects the quality of the board.

According to greatboards.com, the most important qualities of an effective board member are: dedication and commitment, ability to lead and influence others, straightforwardness and impartiality, being knowledgeable and an insatiable learner, and valuing discretion and confidentiality.

The lack of commitment and dedication among the board members of any company take the lion’s share as a primary reason for the leadership failure of share companies in Ethiopia. The revised Commercial Code that introduced board of supervisors (Article 331-336) states that a board of supervisors can be established by a Memorandum of Association, is directly accountable to the general assembly, and has the responsibilities of ensuring proper supervision and inspection in the company.

In addition to commitment and dedication, the board member’s knowledge about the industry the company operates in; the organization’s operations, mission, and vision; the organizational culture and the roles and responsibilities of the board as well as the basic principles of good governance contribute immensely to the success of any share company.

The revised commercial code allows non-shareholders to be selected for a board of directors position. This may be a good measure in an attempt to fill the knowledge and experience gaps that companies suffer from. However, the code limits the number of elected non-shareholders of a board to one-third.

The future of any company depends on having capable and insightful leadership that has the ability to rise above daily business and organizational challenges and is capable of leading and influencing others to pursue and meet futuristic aims of the company. The presence of a consistent spirit towards organizational goals and the drive to set the right sense of direction to common agreed-upon business goals is instrumental.

Weak financial management
Except for financial institutions, news regarding several share companies in Ethiopia having multiple cases of poor financial management is frequently heard. Stories about share companies failing to start operations because of gross financial mismanagement at early stages are not new in Ethiopia. Such problems find their roots in poor corporate culture where knowledge-based financial management is missing.

Indeed, financial management problems create disputes among different parties in an organization. Although such problems are not unique to share companies, the situation leads to a broad range of corporate failure that may reach company dissolution. Installing a functional mechanism in the corporate governance system, one that explains and resolves issues among shareholders, principals, and executives, is one of the available solutions to address such issues. The installation and practice of management accounting with financial accounting could also offer solutions to solve weak financial management problems that share companies in Ethiopia are frequently known for.

The reason why auditing the very formation process of a company is required, according to the revised commercial code, is because financial management problems often happen at that stage. According to Article 261, when subscribers assemble, they have the right to hear an external auditor’s report on the formation process. If the founders fail to register the company in the commercial register, repayment of shares contributed by subscribers is also included (Article 254/3). Liability of the founders, found in Article 250 of the same document, mainly focuses on the financial matters of the formation stage of share companies. Article 395 of the Commercial Code gives the right to sanction transactions valued more than 10Pct of the company’s capital and have a conflict of interest nature to the general assembly of shareholders.

Capital Shortage and Lack of Profit
Entrepreneurial asset and capital are important ingredients that a business needs to succeed. When we look at businesses in Ethiopia the issue of capital is a recurring theme. Raising capital from potential shareholders or accessing loan facilities upon establishment is not easy for businesses that have to prove their financial sustainability. Even after accessing some loans, the very high cost of capital and loan interest exacerbates their risks of failure.

Before applying for a business license and joining the commercial battle field, it is advisable to secure sufficient capital. In reality, especially in sole proprietorships and private limited companies, the registered capital and overall business operations explicitly show the problem of capital registration. In present day Ethiopia, a new restaurant may register a capital of just ETB3,000, while it can actually require in excess of a hundred thousand Birr to operate. A sizable number of companies prefer not to show the whole capital in use in the financial system. We can see this in capital management. In any case, the lack of capital that a business needs in adequate amounts is a serious problem that share companies face, especially in their formative years.

Indeed the lack of capital is an alarming sign of sound business performance and sustainability. It shows that a business might not be able to pay its bills, loans, and other financial commitments. Lack of capital makes it difficult to grow the business and it may jeopardize day-to-day operations.

It significantly contributes to the failure of company initiatives during the formative phase, and later at the operational stage. This leads to an eventual lack of profit even while revenue grows. Shareholders usually focus more on short-term profitability than long-term sustainability.

Except for a few cases, most share companies are categorized as small business. And according to Small Business Trends, only 40Pct of small businesses are profitable, while 30Pct break even. The rest, 30Pct of small and medium enterprises, report losses. When a company reports losses year after year, it sends a message of demotivation to shareholders, staff, management, board members, and others. This would ultimately take the company to a stage of liquidation.

10th Year • Jan 2022 • No. 103

  • is Deputy General Manager of CHAMPiON Communications, publisher of EBR & Addis Maleda. He has served as a member of the board of directors of several share companies.
    He can be reached at habtamu.k@championethiopia.com

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