1.

0 Introduction
This paper illustrates three particular concepts, namely, portfolio diversification strategy,
strategic divestment policy and corporate collapse or failure. Firstly, portfolio diversification has
been the trend among investors since the 30s. Until the introduction of the modern portfolio
theory in 50s, the diversification strategy by many firms used to follow a simple risk and return
comparison analysis. However, following the unsystematic risks and declined returns from the
portfolio assets led the investors consider the modern portfolio theory and take the correlation
among different assets into account. Secondly, corporate strategic divestment is a two decades
old trend that came into practice after the conglomerates failure of 70s and 80s. The strategic
divestment policy reveal that whereas, firms may look for expansion strategy such as, mergers
and takeovers to grow bigger, divestment policy such as, sell or spin off a particular business unit
can be profitable for some other kind of firms. Thirdly, corporate failure is a regular phenomenon
had happened to a number of renowned companies worldwide due to several internal and
external factors which have been described in the paper.
The paper consists of two sections. The first section provides comprehension to the executive
summary of a management consultant of Brad Limited the reasons behind strategic divestment.
The second section illustrates reasons of corporate failure and recommendations to overcome it.

(Answer to Question 1)
2.0 Portfolio Diversification Strategy
2.1 Description of Key Terms
2.1.1 Portfolio Theory
Portfolio theory, also known as modern portfolio theory (MPT) and introduced in 1952 by Harry
Markowitz, attempts to select an optimal portfolio from a set of possible portfolios
(Levisauskaite, 2010; Marling & Emanuelsson, 2012). Portfolio is defined as a collection of
securities with diversified risk and expected return. According to MPT, an optimal or best
portfolio can be selected by composing portfolios of assets determined by risks, returns,
covariance and correlation with other assets (Kierkegaard, 2006). The theory also states that on
1

order to choose an optimal portfolio, an investor would either choose the portfolio with higher
return for the same level of risk or with lower risk for the same level of expected return;
nevertheless, investors are assumed as risk-averse (Atzberger, 2010; Kierkegaard, 2006).
2.1.2 Unsystematic Risk and Systematic Risk
Unsystematic risk is the type of risk that is resulted from the difference in the corporate financial
decision among the firms (Kierkegaard, 2006). However, this risk is firm-specific and can be
minimized by following diversification strategy (Modigliani & Pogue, 1973). That is why it is
often called diversifiable risk. Unsystematic risks include R&D failures, unsuccessful marketing
or losing major contracts and all other events affecting a firm solely (Kierkegaard, 2006).
However, there is another type of risk which cannot be minimized by diversifying the portfolio.
This is the risk that affects all or a large number of firms in an industry and that is why called
systematic risk (Hotvedt & Tedder, 1978). Systematic risk include risk arisen from business
cycle, inflation, changes in interest rates and exchange rates (Kierkegaard, 2006).
As mentioned earlier, through diversification of the portfolio assets the unsystematic risk can be
eliminated and at a point when unsystematic risk becomes zero, the portfolio return becomes
perfectly correlated to the market (see Figure 1 below) and thus, if any uncertainty in the market
resulted as systematic risk affects the portfolio assets, even the best diversification portfolio may
not stay safe from the consequences (Modigliani & Pogue, 1973).

Figure 1: Unsystematic risk and Systematic risk

2.1.3 Risk Profile of a Business

A risk profile of a company ensures that the risk management process is aligned with the
corporate objectives and investor expectations (Lopatina, 2012). According to Kellysears
Consulting Group (2015), the risk profile of a business or organization should include several
elements. Firstly, it should address the key risk areas such as, strategic decisions, operations and
projects. Secondly, it should address the strengths and weaknesses of each department and
branch. Thirdly, it should also indicate major opportunities and threats related to the business.
Fourthly, it should indicate the risk tolerance levels and characteristic of the business,
particularly whether the investors are risk-averse or risk-seeker. Fifthly, it should also illustrate
the capacity of the business to manage and mitigate different types of risk associated with the
business. Sixthly, it should demonstrate linkages between different types of risk and also between
the risks and risk management process.
2.1.4 Coefficient of Correlation
Coefficient of correlation, also known as correlation coefficient and denoted by

(rho), is a

numerical value that summarizes the direction and closeness of linear relations between two or
more variables, i.e. investments in portfolio (Shen & Lu, 2015). The values of correlation
coefficient ranges between -1 to +1. When the value of correlation coefficient is greater than zero
( >0 ), there is a direct relationship between two variables; hence, if one variable increases,
the other one increases accordingly. However, a negative value of correlation coefficient (
<0 ), the relationship between two variables is inverse and if one variable increases, the
other one decreases (Shen & Lu, 2015).
While investors tend to reduce risk by diversifying their portfolio assets, they prefer two or more
assets with very low or negative correlation ( Philips, Walker & Kinniry, 2012 ). On the
contrary, a high or positive correlation between assets does not reduce risk when portfolio is
diversified.
2.1.5 Comprehension of the Executive Summary

As mentioned earlier, the executive summary reported by the management consultant consists of
two sentences. For reading convenience, the explanation as well has been divided into two parts
following each sentence.
Firstly, the management consultant stated that portfolio theory indicates that your ability to
spread the unsystematic risk by developing a portfolio of shares of companies in two industries
can only benefit the risk profile of your business.
The essential terms, such as, portfolio theory, unsystematic risk and risk profile of a
business have been discussed in the previous sections. A revision of the discussion may help
readers better understand the following comprehension.
Herein the consultant has indicated that since Brad Limited intends to diversify their portfolio by
investing in shares of companies both in property development industry and construction
industry in order to spread the unsystematic risk (the inherent risk of each industry), this
diversification strategy will only benefit the company in relation to the risk profile (such as, key
risk areas, risk tolerance level and characteristics, risk management capacity) of the company.
For example, if the shares of companies in property development industry are exposed to more
unsystematic risks than the shares of companies in construction industry, it will affect the risk
profile of Brad Limited as well as the risk management process and corporate objectives.
Consequently, Brad Limited management will have different risk management strategy for the
companies in two different industries; i.e. they will be more cautious in managing risks
associated with shares of companies in property development industry due to higher risk.
Accordingly, they will be risk-seeker in investing in the shares of companies in property
development industry and risk-averse in investing in the shares of the companies in construction
industry.
Secondly, the consultant also stated that however, the concern is in relation to the extent to
which risk can be diversified, as the coefficient of correlation between the property development
and construction industries stands at plus (+0.8).
The essential terms mentioned herein, such as, coefficient of correlation have also been
discussed in the previous sections. Nevertheless, according to the discussion, the aforementioned
statement indicates that since the correlation coefficient is positive (+0.8), both the industries are
4

likely to move along with each other in terms of financial prospective. Meaning to say, the
consultant pointed out a different scenario, regardless of the previous statement of comparative
advantage from diversification strategy, and that is, if for example, the risks associated with the
shares of companies in property development industry increase, the risks associated with shares
of companies in construction industry will also be increasing and vice versa following a similar
trend.
However, it has been discussed earlier that in order to benefit from portfolio diversification and
unsystematic risk spread, investors seek negative correlation. A negative correlation between the
two industry shares indicates that if risks inherent in property development industry increase, the
risks associated with construction industry shares will move inversely to the other side and will
decrease.
It is also important to note that coefficient correlation of +1 (perfect positive correlation)
implies that the two industry shares follow similar trend equally; in this case, no benefit from
diversifying the two assets. However, in our case, the value of coefficient correlation is +0.8
which is very close to +1. Hence, the risk spread and advantage from portfolio diversification in
the two industries would be very minimal, financially unsecured and unprofitable.
Therefore, the extent of risk diversification is minimal and not in line with the companys risk
profile and expectation from its risk diversification strategy. If Brad Limited really desires to
diversify their portfolio in order to spread risk, they should not invest in shares of construction
industry, rather invest in shares of companies in an industry which has negative correlation with
the investment in shares of companies in property development industry.

2.2 The Policy of Strategic Divestment

Strategic divestment policy simply refers to sale, closing or spinning-off of a business unit,
operating division and product line of a business (Thomas, 2015; Benito, 2003). It became a
trend to divest a portion of the company business in the United States in 90s due to the
unsuccessful Mergers & Acquisitions in the earlier two decades (Haynes, Thompson & Wright,
2000). Divestment once, whereas, was a short-term tool for firms to raise cash or pay debts, have
now become a strategic factor for long-term growth and strategic competitiveness (EY, 2014).
5

However, divestment is never the first and foremost goal of a business, rather it only comes into
investors thought to be undertaken due to continuous failure of a particular unit to raise sales or
earn expected profit, smaller market share of the business unit and the need for increasing
investment in other business units or product lines. Thus, there are several reasons due to which
companies around the world divest a portion of their business.
2.2.1 The Reasons of Strategic Divestment: Real-life Examples
2.2.1.1 Too Small Market Share
Strategic divestment policy may be undertaken if the market share is too small for the firm to
stay competitive or market is too small to provide its expected rate of return (Thomas, 2015). As
such, firms may consider divesting a brand or business unit when a particular product is found to
be off-trend with decline in demand for it and consequently, losing market share.
According to the broad-scale EY Global Corporate Divestment Study surveyed on 720 corporate
executives worldwide and released in 2014, 58 percent of the executives consider divesting if a
particular unit or product line is found to be off-trend and more than 40 percent would consider
selling if there is decline in the product demand as well as the market share (EY, 2014).
Following this trend, Glaxo SmithKline sold its Ribena brands and Lucozade to Suntory
Beverage & Food, a Japanese company, since Glaxo found its products were not well-recognized
in its business focus area, the emerging markets (EY, 2014). Unilever has divested its lowergrowth food brands, such as, Skippy peanut butter and Wishbone dressings in order to focus on
higher-growth market share (EY, 2014). Campbell Soup Company sold its European soups and
sauces division to CVC Capital Partners due to slower demand, sales and growth in the division
in the recent years.
It also happened to Levi Strauss & Co. which found a decline in its market share with almost half
in its 14-19 years old male target group and no introduction or development of a new or
successful product in recent years (Thomas, 2014). Therefore, the company decided to shut down
29 factories in North America and Europe with a retrenchment of over 16,000 employees since
1997 (Thomas, 2014).
2.2.1.2 Availability of Better Alternatives
6

Divestment policy may be influence by the availability of better investment opportunities, such
as a particular line of business, focus on which can have great impact on the firms profitability
by divesting the other certain business line(s) and diverting the limited resources into the
intended business product line (Thomas, 2014).
IBMs divestment strategy can be an appropriate illustration in this context. Though the PC
business of IBM was still profitable in 2004, there was an internal debate in the company that the
PC division may not accommodate any more sustainable innovation (Sheffer, 2012). Actually,
the company was intending to invest in other sectors than PC division such as, consulting
services to IT firms, though the main reason was reported by the CEO of IBM, Samuel J.
Palmisano that IBM that it was looking for an opportunity to establish in a new market that is
vibrant and lucrative, i.e. China (Sheffer, 2012; Badenhausen, 2005). Eventually, it sold its PC
Division to Chainas Lenovo Group.
2.2.1.3 Need for Increased Investment
The need for increasing investment in other sectors such as, machinery, marketing, research and
development can be more beneficial and viable for a firm rather than investing in monetary or
management resources (Thomas, 2014).
Zhu (2014) reports that Merck, the pharmaceutical titan announced divestment of its RNA
interference (RNAi) business line, Sirna in January, 2014 it was not aligned with the core
business of Merck. It was only back in 2006, when Merck acquired Sirna for US $1.1 billion;
however, when Sirna was sold to Alnylam Pharmaceuticals, the value was under-priced to as low
as US $290 million (Zhu, 2014). Mercks Head of Business Development Team, D. Dukes states
that it was the R&D that Merck wants to focus on and Sirna lacks it very much, this made Merck
prioritize its divestment decision even with a big difference in selling from its original price
(Zhu, 2014).
2.2.1.4 Lack of Strategic Fit: Failure in Mergers & Acquisitions
As mentioned earlier, divestment policy was common in companies within United States in the
90s due to Mergers & Acquisitions failure. Hence, firms may undertake strategic divestment
policy if the acquired firms objectives and strategies are not in line with the acquiring firm.

Firms may then divest the business line by restructuring if selling process of becomes difficult or
otherwise by selling it off to other potential buyers.
There are numerous examples of this scenario worldwide. Abbotts decision to spin-off its
research-based pharmaceuticals business, AbbVie in 2011 for US $4.5 billion and Pfizers
divestment of its animal health business, Zoetis in 2013 for US $12.4 billion were resulted from
their failure in expansion strategy facing less profitability in the aforementioned divisions (KY,
2014). The aforementioned Mercks divestment of Sirna in 2014 after acquiring it in 2006 can
also be a good example of lack of strategic fit.
2.2.1.5 Legal Pressure to Divest
Legal pressures may also force firms to undertake strategic divestment policy (Thomas, 2015).
Regulatory changes can sometimes be the major factor for companies to decide for divestment
which is revealed by the global EY study that 57 percent of the executives identified regulatory
change as the major factor in the decision of divestment (EY, 2014).
The divestment policy of Service Corporation Inc., a large funeral home chain, can be a good
example in this context. Service Corporation Inc. acquired many of its competitors in some areas
that made the company to monopolize the industry regionally. However, in order to restrain its
monopolistic trade, the Federal Trade Commission informed the company to divest some its
operation in order to avoid penalties (Thomas, 2014). Eventually, the company had to divest
some its operation.
RJR Nabisco had also suffered from legal constraint due to the law-suits on its tobacco business
line. R.J. Reynolds, the manufacturer of Winston, Camel and other cigarette brands, purchased
Nabisco brands in 1985 (Thomas, 2014). However, due to the law-suit, RJR Nabisco had its
domestic tobacco operations divested into a separate company and overseas tobacco operations
sold to Japan Tobacco.
2.2.1.6 Capital Needs
Besides the aforementioned scenarios and reasons, strategic divestment policy could also be
undertaken facing need for capital. As such, divestment may be done to increase shareholder
returns, pay-off debt and stabilize leverage ratio (Zhu, 2014).
8

Chemtura, a global manufacturer of specialty chemicals decided to divest its Consumer Products
Unit in 2013 that were used to produce pool and spa chemical and it was subsequently sold to
KIK Custom Products for US $300 million (Zhu, 2014). The main reason articulated by the
Chariman, President and CEO, Craig A. Rogerson that the divestment decision was taken to
provide a substantial and increased amount of return to the shareholders (Zhu, 2014).

(Answer to Question 2)
3.0 Corporate Collapse or Failure
With the emergence of globalisation and increase in mergers and takeovers, contemporary
companies, their strategic decisions and operations are becoming more and more complex.
Besides, the occurrence of unsystematic crisis related to renowned companies makes the existing
companies either vulnerable or cautious for a potential collapse.
Corporate failure or collapse is defined as a short-term, undesired, unfavourable and critical state
in a company which is derived from both internal and external causes and further the existence
and growth of the company (Dubrovski, 2007).
According to Mbat and Eyo (2013), a corporate failure is recognized when a company is found
to have lower returns, be insolvent or bankrupt. As such, a firm having lower returns would be
unable to grow further, being insolvent would face tremendous difficulties in paying off debt or
credit to its creditors, and being bankrupt would need government support to sustain its business
(Mbat & Eyo, 2013). Hence, simply saying, corporate failure is an indication that a company is
unable to generate positive cash flows, achieve its strategic goals and comply with legal
requirements.
3.1 Reasons behind Corporate Collapse, Real-life Examples and Recommendations
The causes of corporate collapse have been discussed in numerous papers from different
perspective and hence, the opinions of researchers in relation to illustrating causes have differed
from each other. For example, Dubrovski (2007) argued that a corporate failure is affected by
both internal and external causes. Internal causes are the scenarios that emerge within the
environment of the company, such as, improper competences of the management, uncompetitive
9

market position, over-expensive production and inefficient information system; whereas, the
external causes emerge in the outside environment of the company, such as, sudden economic or
regulatory changes.
However, according to Mellahi and Wilkinson (2004), an organizational failure may be caused
by environmental factors (regulatory and economic changes), ecological factors (density, firm
size, industry life-cycle), organizational factors (succession planning and historical performance
of the firm) and psychological factors (managerial perceptions). In another research, Hamilton
and Michlethwait (2006) suggested six main causes of a corporate collapse, namely, poor
strategic decisions, over-expansion, dominant CEOs, greed and desire for power, failure of
internal controls and ineffective boards. Nevertheless, this section of the paper will discuss major
reasons of corporate failure illustrating real-life examples and subsequently my own
recommendations to help firms avoid corporate failure.
3.1.1 Managerial Misconduct
Managerial inefficiency and ineffectiveness seems to be a major cause to corporate collapse, as
has been suggested by Mbat and Eyo (2013). Managerial expropriation and abuse of
compensation may lead to mismanagement and ultimately leading to corporate failure.
Enrons (a US-based natural gas pipe line company) corporate failure in the past decade have
been widely discussed due to its unnecessary managerial expropriation and compensation policy.
Enrons senior managers used to be paid with performance-based compensation and stock
options through which they could control the company internally and expropriate property even
when the business was underperforming (Mehta & Srivastavaare, 2009). Last but not least, the
board permitted its employees to suspend the companys own code of conduct that led to create
principal-agent conflict of interest (Nakayama, 2002).
3.1.2 Poor Financial, Operational and Risk Management Strategy
Firms affected by poor overall management strategy may be resulted into corporate failure.
According to Mehta and Srivastavaare (2009) the corporate failure of Tyco had been caused due
to inability of management in identifying potential and inherent risks and setting up an effective
financial, operational and risk management policy.

10

This type of corporate failure is prevalent in mergers and acquisition cases as well. When AOL
and Time Warner merged in 2001, the company management were unable to predict the financial
fortune effectively and as well had weaker management strategy. Even knowing the failure of
Lycos-USA Networks merger, AOL and Time Warner went for merger deal in 2001 and wrongly
forecasted the future stock value (Ghaly & Rotaba, 2013). As after the failure of Lycos-USA
Networks merger, the share price started to decline which affected AOL-Time Warner
tremendously; as such, the US $350 billion worth stock value came down to US $205 billion
subsequent to the execution of the merger deal (Ghaly & Rotaba, 2013).
3.1.3 Low Productivity and High Production Cost
Firm management may sometimes show inefficiency in forecasting customer demand, managing
supply chain, purchasing inventories at high cost which may lead to higher production cost,
lower productivity and decline in the market share making it difficult for the firm stay
competitive (Mbat & Eyo, 2013).
3.1.4 Corporate Governance Failure
This is the most contemporary cause to corporate collapse that may result from non-compliance
to disclosure of corporate governance framework. As argued by Haat, Rahman and Mahenthiran
(2008), transparency and accountability are seen as the two major elements of corporate
governance framework, however, when these elements are violated and companies fail to
disclose transparent, reliable and accurate information in relation to both corporate and financial
reporting, it may lead to flow of information asymmetry to its stakeholders, inaccurate decisions
by the shareholders and eventually a corporate collapse.
Perwaja Steel Sdn. Bhd., a Malaysian company fell into corporate collapse due to directors
misconduct as well as reporting failure. It started when the directors of Perwaja paid RM74.6
million to Japans NKK Corporation without the approval of Perwajas board of directors over
the period of 1992 to 1995 (Norwani, Mohamad & Chek, 2011). It was further followed by
omission of the transaction from Perwajas financial report and weaker internal control
mechanism that led to its ultimate collapse.
Another Malaysian company, Transmile suffered from corporate governance failure when it
overstated its revenue by RM522 million and fabricated its property, plant and equipment
11

account by RM341 million in the financial report for the period of 2004 to 2006 (Norwani,
Mohamad & Chek, 2011).
Enrons fraudulent accounting and disclosure practice should not be forgotten. Enron fell into
corporate collapse when it overstated its net income by US $545 million and equity capital by
US $828 million in its financial statement (Norwani, Mohamad & Chek, 2011).
3.1.5 Capital Inadequacy
The most prominent reason of a corporate failure would probably be the inadequacy of capital in
a firm. As capital is theoretically assumed as the backbone of financial support against high
leverage ratio, a firm may collapse when adequate capital is not found to pay off its liabilities
and no financial assistance from the last resort is obtained.
3.1.6 Economic Instability
Economic instability is an external or exogenous factor indicated by Dubrovski (2007) may
affect firms when the government announces its fiscal and monetary policy. Firms with poor
strategic fit, mismanagement and inaccurate prediction of environmental changes are more
susceptible to the corporate failure caused by exogenous factor. As such, a single or few firms in
the industry may unsystematically be exposed to interest rate risk and foreign exchange risk.

3.2 Recommendations
As noticed from the discussion above, companies face corporate failure due to non-compliance
to disclosure of corporate governance framework and financial reporting standards, managerial
misconduct, poor management strategy and policy, capital needs and impulsive external changes.
Therefore, some recommendations can be made in order to solve these issues and avoid
corporate collapse.
3.2.1 Enforcement and Monitoring by Legal Entity
Even though disclosure of corporate governance practices have been made mandatory in almost
all the countries, it may still prompt for a corporate failure in the industry. However, if necessary
enforcement and continuous monitoring is undertaken, the unsystematic corporate crisis can be
12

avoided and minimized. It is argued that in case of a company that is well-connected, a person
who is linked to government and possess local and international power may not be adequately
penalized by regulatory commissions (Norwani, Mohamad & Chek, 2011). Therefore, proper
enforcement of corporate governance disclosure by all citizens and firms are to be practiced and
monitoring should be made at least on yearly basis by government-run agency over all the
companies.
3.2.2 Directors with Ethical Values to Ensure Best Corporate Governance Practice
As transparency and accountability are two of the major elements of corporate governance
framework, the best practice of corporate governance would display disclosures of transparent,
reliable, accurate and relevant information in the annual report. In addition, voluntary
disclosures, such as, sustainability disclosures and in case of Islamic firms, Shariah-governance
disclosure can add values to the reporting standard of the company and help investors to take
correct decisions and stakeholders to have a faith on the companys strategy and operations.
Hence, firms need to develop human capital with ethical values in order to ensure the
aforementioned practices.
3.2.3 Ensuring Accountability of Auditors
Since auditors are important stakeholders to a company helping other stakeholders receive
accurate and transparent information and helping the company to better allocate its resources, it
is crucial that the auditors stay accountable to the board of directors of the company and upon
their responsibility in auditing and consultancy. Otherwise, auditors involvement in corporate
scandal will be under investigation and their reliability will be questioned, as what happened to
Enrons case where the same auditing firm used to provide both auditing and consulting services
and notwithstanding, the financial reporting failure had been revealed.
3.2.4 Minimizing Managerial Expropriation, Compensation and Misconduct
Companies should take additional steps to minimize expropriation and high-scale compensation
by its senior managers especially when the firm is underperforming or having a lower sales,
revenue and market share. The board may play an important role here by charging penalties upon
any high-scale compensation being caught.

13

3.2.5 Developing Adequate Managerial Expertise

In order to structure a flexible and organised financial, operational and risk management policy,
companies need to focus on developing adequate corporate expertise who are equipped with
talents, skills, experience and trainings.

4.0 Conclusion
As discussed in the section of portfolio diversification policy, Brad Limited can only gain from
the portfolio diversification, if the shares of investment have negative correlation between each
other; otherwise, the risk of one investment may affect the other one.
Understood from the section of corporate strategic divestment policy, companies sell or spin off
their non-profitable business units in order to get immediate cash flows, higher returns and stay
in line with strategic goals. However, the consequence of a strategic divestment may not always
bring glory to a firm regardless of the growth in market share or higher expected return. Rather,
it usually comes with lay-offs of a lot of employees and in some cases, results into defaming the
divestment strategy undertaker, as what happened to Robert Haas, the CEO of Levi Strauss &
Co. as he was questioned for his divestment decision that resulted into layoffs of over 16,000
jobs (Thomas, 2015).
The last section on corporate failure discuss major causes of and some recommendations to the
failure. The major causes of corporate collapse have been presented are managerial misconduct,
corporate governance failure, capital needs and external (economic, regulatory, legal and
environmental) factors. The recommendations as remedies presented are enforcement of
corporate governance mechanism and monitoring by legal entity, such as, government agency,
developing directors with ethical values and management with adequate expertise and training,
ensuring accountability of auditors and minimizing managerial misconduct.

(4,614 words)

14

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