An Examination of Trajectory Analysis: the Case

of Air New Zealand Limited

A thesis submitted

in partial fulfilment for the Degree

of

Master of Commerce in Accountancy, Finance and Information

Systems

in the University of Canterbury

by

Hugh Warrick Jory

University of Canterbury

2002
 1

Table of Contents

Table of Contents ......................................................................................................... i

Abstract ....................................................................................................................... ix

Acknowledgements ...................................................................................................... x

Chap ter 1: Introduction ..............................................................................................1

Chapter 2: Review of the Literature .......................................................................... 4

2.0 lntroduction ............................................................................................ .. ............ .4
2.1 Argenti's explanations of corporate collapse ............. ,.......................................... 5
2.1.1 Causes and symptoms of company failure as seen by Argenti .................... 6
2.1 .2 The A-score ....................................................................... ......................... 10
2.1.3 Argenti 's failure trajectories ...................................................................... 13
2.2 Argenti's impact on subsequent researchers up to 1997 ..................................... 18
2.2.1 Research into the A·score ............................... ...... ...... ............................... 19
2.2.2 Research into failure trajectories ............................................................... 22
2.3 McRobert and Hoffman's (1997) update of the theory for the 1990s ................ 24
2.3.1 McRobert and Hoffman's (1997) causes and symptoms of corporate
failure ................................................................ ........................................................... 25
2.3.2 The failure trajectories ............................................................................... 29
2.4 Argenti, McRobert and Hoffman's impact on research after 1997 .................... 32
2.5 The gap in the literature ....... .... ................................... ... ..... .... ............................ 33

Chapter 3: Res~arch Methodology ........................................................................... 35

3.0 lntroduction ................................................................................. ........................ 35
3. 1 Research aim ......................................................................................... ..............35
3.1.1 Research questions ........ .......... ... ................. ........................... " .................. 36
3.1.2 Period of study ............. ....... .... .......................... ..... ......................... ........... 37
3.2 Data source .... ,......... ,......................... ....... ,................................. ......................... 38
3.3 Summary ..................... .............................. ..... .................................................. ... 39

t. E~ laD) 0
 11

Chapter 4: Evaluating Argenti, McRobert and Hoffman's Failure Trajectory

Theory ......................................................................................................................... 40
4.0 Introduction ........................................................................................................ .40
4 .1 The difference between Argenti's (1976a) description and McRobert and
Hoffman's (\997) description ofthe theory .............................................................. ..40
4.2 The subparts of Argenti, McRobert and Hoffinan's theory of corporate failure
..................................................................................................................................... .44
4.3 Evaluating the trajectory analysis portion ofthe theory of corporate failure .... .45
4.5 Summary ........................................................................................................... ..48

Chapter 5: Trajectory Analysis for a more Complex Age .................................... .49

5.0 Introduction .................................................. ...................................................... .49
5.1 Definitions of undefined tenns .............. , .............................................................. .49
5.1.1 Definition for financial health (corporate wellbeing) ............................... .49
5.1.2 Distinguishing the five states of company health ...................................... 50
5.1.3 Definition of indicators (factors) ............................................................... 52
5.1.4 Summary .................................................................................................... 53
5.2 Contradictions in trajectory analysis ................................................................... 53
5.2.1 The definition of failure ............................................................................. 53
5.2.2 The number of failure trajectories ............................................................. ,54
5.2.3 Should corporate indicators shape the trajectory? ..................................... 56
5.2.4 Summary .................................................................................................... 57
5.3 Developing trajectory analysis to be operational. ..................... " .................. " .... 58
5.3.1 What will measure the trajectory? ....................... ,..................................... 58
5.3.1.1 Corporate indicators ....................................................................... 58
5.3.1.2 Market indicators ........................................................................... 59
5'.3.1.3 Non-financial indicators ....................................... " ......................... 60
5.3.2 How Ito measure each indicator .................................................................. 61
5.3.3 How to calculate the trajectory .................................................................. 62
5.3.4 Summary .................................................................................................... 64
5.4 Summary ......................................................................................... :............. :..... 64

Chapter 6: A Brief History of Air New Zealand Limited ...................................... 66

6.0 Introduction ......................................................................................................... 66
 III

6.1 The early years of Air New Zealand: 1940 - 1989 ............................................. 66
6.1.1 Air New Zealand's beginnings .................................................................. 67
6.1.2 The merger and its aftennath ..................................................................... 69
6.1.3 The privatisation of Air New Zealand ....................... ................................ 7 1
6.2 Air New Zealand under private ownership ................................. ........................ 73
6.2.1 Growth through Expansion: 1989 - 1995 .................................................. 73
6.2.1.1 Air New Zealand's trading environment: 1989 - 1995 ................. 74
6.2. I. 1.1 Factors affecting Air New Zealand ................................. 74
6.2.1. 1.2 Financial results ......... ...... ............................................... 76
6.2.1.2. Changes in ownership and contro!... ................................. ............. 78
6.2.2 Consolidation and Stagnation: 1996 - 2000 .... .......................................... 79
6.2.2.1 Air New Zealand's trading environment: 1996 - 2000 ................. 79
6.2.2. 1.1 Factors affecting Air New Zealand ......... ........................ 79
6 ..2.2.1.2 lnvestment into Ansett Holdings Limited ....................... 82
6.2.2. 1.3 Alliances ................................. ........................................ 84
6.2.2.1.4 Financial results ...... ... ..................................................... 85
6.2.2.2 Changes in ownership and control.. ........................................ ....... 87
6.2.3 The Collapse: 2001 .................................................................................... 89
6.2.3.1 The collapse of Ansett ... .................... ..... ....................................... 89
6.2.3.2 Factors affecting Air New Zealand during 2001 ........................... 91
6.2.3.3 Financial results for Air New Zealand during 2001 ....... ............... 92
6.2.3.4 Changes in ownership and contro!... .............................................. 94
6.3 Summary ..................................................................................... ........................ 96

Chapter 7: Removing the Sheen from Air New Zealand's Financial Statements ....
......................................................................................................................................99
7.0 Introduction ..... ............................................................................................... .....99
7.1 Air New Zealand's disclosure of leases ............... .. ............................. .............. 100
7. 1.1 Summary of accounting for leases as per SSAP- 18 (1990) .................... .100
7.-1.2 Discussion of Air New Zealand's leases ................................................ .102
7. 1.3 Should non~cance llable operating leases be recognised as a liability? .... 103
7. 1.4 Treatment of non-cancellable operating leases ~n trajectory analysis ..... 105
7.1.5 Leveraged Leases ................................................. ............... ..................... 106
7.2 Air New Zealand's asset revaluation policy ................................... ..... ............. 109
 IV

7.2. 1 Summary of New Zealand accounting standards regarding revaluation .109

7.2.2 Air New Zealand's asset revaluation policy ........................ .................... III
7.2.3 Treatment of the undervaluation of Air New Zealand's assets ....... ......... 115
7.3 Air New Zealand 's tax accounting policy ......... ................... ...... ................ ,.... .116
7.3. 1 Summary of New Zealand tax accounting standard (SSAP-12) .............. 116
7.3.2 Air New Zealand 's tax accounting disclosure ......................................... 11 8
7.4 Other disclosure issues ...................................................................................... 120
7.4.1 Market value of investments ............................... " .. " ..... ,....... " ................ 120
7.4.2 Deferred charges ...................................................................................... 121
7.4.3 Financial instruments .. ,.. ........ , ,., .............................................................. 122
7.5 Summary ........................................................................................................... 123

Chapter 8: Air New Zealand's Trajectory ............................................................ 125

8.0 Introduction ...................... ............................................................ ...................... 125
8.1 The indicators of company health ..................................................................... 125
8.1 .1 The market indicators .............................................................................. 126
8. 1.2 The corporate indicators .................................................... ...................... 128
8. 1.2. 1 Operating Cash Flows after Interest and Dividends (OCFAlD) .. 128
8. 1.2.2 Return on Capital Employed (ROCE) ......................................... 130
8.1.2.3 Debt to Equity ratio .......... ................................................ " ... " ..... 132
8.2 Air New Zealand 's trajectory ............................................................................ 134
8.2. 1 Different versions of the trajectory .......................................................... 140
8.2. 1.1 Sensitivity analysis ....................................................................... 140
8.2. 1.2 Corporate and market trajectories ................................................ 141
8.2.2 The completed trajectory for Air New Zealand ........ " ..... " ... " .............. ".l42
8.3 Summary ........................................................................................................... 143

Chapter 9: -Limitations and Further Res ea rch ..................................................... 145

9.0 Introduction .................................................................... ................................... 145
9. 1 Research limitations ............................................................................. .. ........... 145
9.1.1 Non·financial infonnation ....................................................................... 145
9.1.2 Financial model........................................................................................ 146
9.1.3 Choice of indicators ................................................................................. 146
9.1.4 Air New Zealand data " .. .................... " ............................... ............. " .... " 147
 v

9.2 Recommendations for further research ............................................................. 147

9.2.1 Research into the actual theory .............. ...................... ............... ............. 147
9.2.2 Research into the case study ..... .............................. ............... ... ............. .. 149
9.3 Summary ................................................ ........ ..... ....... .. ........ ............................. 149

Chap ter 10: Summary and Conclusions ................................................................ 150

References .................................................................................................................153

Appendices ................................................................................................................ 164

Appendix I: Ai r New Zealand Information: 1989 - 2001 .. ................................... .164
Appendix 2: Breakdown of changes made to create the worst-case scenario ........ 178
Appendix 3: Workings to create the trajectory ........................... ...................... ..... .1 81
Appendix 4: Sensitivity analysis results .... ,.. ,............ ........................... ..... ......... .... 196
Appendix 5: Market and corporate indicators ......... ................. .. ..... ............ .. ......... 205
 VI

List of Tables

Chapter 2: Literature Review.....................................................................................4

Table 2.1: Major definitions made by Argenti (I 976a) ............................................. 5
Table 2.2: Summary of Hall and Young's (1991) results ......................................... 20
Table 2.3: Summary of Morris' (1997) results ......................................................... 22
Table 2.4 Major definitions made by McRobert and Hoffman (1997) ........ ............. .25

Chapter 3: Research Meth odology ........................................................................... 35

Table 3.1: Research Objectives ........................................................... ...... ................ 37

Chapter 4: Argenti, McRobert and Hoffman's Theory of Corporate Failure.... .40

Table 4.1: Differences between Argenti (19760) and McRobert and Hoffman's
( 1997) theories .................................................................................................... .41 - 42
Table 4.2: Sixteen criteria for theory evaluation ............... .............. ......................... 47

Chap ter 5: T r ajectory Analysis fo r a mor e Complex Age .................................... .49

Table 5. 1: Distinguishing each state of company health .......................................... 51

C bapter 6: A B rief Histor y of Air New Zealand .................................................••.. 66

Table 6.1: Ansett profitability and contribution to Air New Zealand.
1997 - 2000 ................................... ................... ......................................................... 84
Table 6.2: Financial results of Ai r New Zealand ...................................................... 93
Table 6.3: Air New Zealand directors during 2001 calendar year ............................95
Table 6.4: Chailltlen and Chief Executive Officers of Air New Zealand, 1989 -
200 1................................................................................................................... ...........97

Chapter 7: Removing the Sheen from Air New Zealand's Financial Statements ....
..•~ ..................................................................................................................................99
Table 7.1: Value of the Air New Zealand Group leases from 1989 ·- 2001 ........... 103
Table 7.2: Value of Group and Parent operating leases commi tments ................... I07
Table 7.3: Book and market values of select Air New Zealand Group assets ........ I 13
 Vll

Table 7.4: Difference between market and book values as a percentage of Group
total aod fixed assets ....................... ,.... .. ........... ........... ..... ................................... .. ... .114
Table 7.5: Value of Air New Zealand 's Group deferred taxation 1989 - 2001 .... . 119
Table 7.6: Reduction in Group profit to reflect use of the Comprehensive Basis .. 120
Table 7.7: Value of Air New Zealand 's Group interest in Equaot N.V .................. 121
Table 7.8: Fair and carrying values of selected Air New Zealand Group financial
assets aod liabilities ............. ... ..... ....... .. ... ................................................................... 123

List of Figures

Chapter 2: Literature Review .....................................................................................4

Figure 2.1 : Scorecard for the A-score ................................ ,.. ..... ............................ ... 12
Figure 2.2: The Type I trajectory ................................ .... .. ....................................... 15
Figure 2.3: The Type 2 traj ectory ...... ............................ ........ ............ ...................... .16
Figure 2.4: The Type 3 trajectory ........................................................................ .. .. .1 7

Chapter 5: Trajectory Analysis for a more Complex Age ..................................... 49

Figure 5. 1: Hypothetical Type 4 fail ure traj ectory ................................................... 55

Chapter 6: A Brief History of Air New Zealand ..................................................... 66

Figure 6.1: Air New Zealand profitability: 1989 - 1995 ............ .. ............................ 76
Figure 6.2: Air New Zealaod shareholder's funds: 1989 -1995 .. ............................ 77
Figure 6.3: Air New Zealaod share prices: October 1989 - December 200 1 ...........77
Figure 6.4: NZ$ versus the US$ and TWI: 1989 - 200 1 .......................... .. .............. 81
Figure 6.5 : Air New Zealaod profitability: 1996 - 2000 .................................... ...... 86
Figure 6.6: Air New Zealand shareholder's funds, total assets and turnover: 1996 -
2000 ........................................ ...... ................ .. ........................ ...... .. ............ .. ................ 87

Chapter 7: Removing the Sheen from Air New Zealand's Financial Statements ....
......................................................................................................................................99
Figure 7.1: Possible leases used by Air New Zealand .. .............. ............................ 109
 VIlI

Ch apter 8: Air New Zealand 's Trajectory ............................................................125

Figure 8. 1: Air New Zealand's share prices March 1990 - December 2001 ......... 126
Figure 8.2: Air New Zealand's market capitalisation March 1990 - December 200 1
.................................................................................................................................... 127
Figure 8.3: OCFAID best-case scenario ................................................................. 129
Figure 8.4: OCFAID worst-case scenario ............................................................... 129
Figure 8.5: ROCE best-case scenario ..................................................................... 131
Figure 8.6: ROCE worst-case scenario .................................................... ......... ...... 131
Figure 8.7: Debt to Equity ratio best-case scenario ................................................ 133
Figure 8.8: Debt to Equity ratio worst-case scenario .............................................. 134
Figure 8.9: Standardised Indicators best-case scenario .......................................... 135
Figure 8.10 Standardised Indicators worst-case scenario ............................ ........... 136
Figure 8.1 1: Best-case and worst-case trajectories: Equally Weighted Ind icators .137
Figure 8. 12: Air New Zealand's trajectory March 1990 - December 2001 ........... 138
Figure 8.13: Air New Zealand's trajectory after the invesbnent into Ansett Holdings
..................................................... ..... .......................................................................... 138
Figure 8. 14: A switch from a non-fai ling trajectory into a Type 2 failure trajectory
.............................................................................. .. .................................................... 139
Figure 8.15: Trajectory of Air New Zealand: 1990 - 2001 .................................... 143
 IX

Abstract

Many studies have addressed the issue of company failure and the pioneering work
done by John Argenti in 1976. Twenty one years later, Andrew McRobert and
Ronnie Hoffman provided an update of Argenti's work for the 1990s. Their
cumulative work involved a failure model and the failure trajectory theory (trajectory
analysis). The failure model examines the defects, mistakes and symptoms that
companies exhibit as they near failure. In contrast, trajectory analysis proposes three
different pathways that companies can follow when they fail. Additionally. because
of the particulars of each pathway, trajectory analysis should have considerable value
in company failure classification. However, the limited examination of trajectory
analysis provides considerable scope for further research into their propositions.

This thesis provides an examination of trajectory analysis. The examination involves

firstly, an evaluation of the theory and discusses any deficiencies in trajectory
analysis. Secondly, it produces a trajectory for a New Zealand case study: Air New
Zealand Limited. Air New Zealand is a large. important New Zealand company that
could have failed in 2001 if not for the intervention of the New Zealand Government.
Thus. the case study chosen is a timely example of a large company collapse. Finally,
the thesis detennines the extent to which trajectory analysis is a failure classification
model.

The results show that it is possible to create a trajectory that generally follows Air
New Zealand's financial perfonnance over time. However, in this particular case, it
seems that trajectory analysis is not a failure classification model, but instead has
potential as an early warning system to prevent failure.
 x

Acknowledgements

I wish to thank the following people who have assisted me in the completion of my
thesis. With their support, it has made the production of this work much easier than
what it might have been.

Firstly, I would like to thank my supervisors, the two Alan's in the AFIS department,
Alan Robb and Alan Roberts. Both have offered their time, experience and
understanding of all things accounting in general and company failure in particular.
Secondly. I would thank members of the Department of Accountancy. Finance and
Infonnation Systems for their aid in a wide range of topics. Special thanks goes out
to Gary Ling, Jenne Wong and Karen Lewis, who reminded me that there was more to
this year than just completing this thesis.

Finally, I would like to thank: my family for their encouragement and assistance
(financial and otheTWise) over the course of this year, and throughout my years of
study. Especially, my parents, Diane and David lory, my brother Dale, and Nonie
Smart, who were in the unenviable position of reading the initial drafts of my work.
 I

Chapter 1: Introduction

The last thirty years have seen a dramatic gr~wth in the research examining corporate
failure. Specifically, researchers have concentrated upon two major areas, the causes
and symptoms of corporate failure, and failure classification models that classify
companies as either failed or non-failed.

In 1976, John Argenti published a small book, which some researchers have seen as
the beginning of the organisational approach to business failure (Van Caillie, 1999).
Argenti produced a theory of corporate failure that covered both aspects of corporate
failure research. He summarised the views of the leading writers, experts and
academics in the area of company failure and examined two major failures of the
19708, Rolls-Royce and Penn Central. This culminated in the production of a list of
twelve causes and symptoms of corporate failure that Argenti felt best discriminated
between failed and non-failed companies. Additionally, the research reviewed by
Argenti suggested three major pathways to failure, which he described as failure
trajectories. He believed that these failure trajectories should have considerable value
as a failure classification model.

Subsequent research into Argenti's theories is sparse, with many researchers

concentrating on the failure models first produced by Altman (1965) and Beaver
(1966). However, this changed in the late 19905 when McRobert and Hoftinan
(1997) published Corporate Collapse. McRobert and Hoftinan (1997) in effect
modernised Argenti (1976a), using recent company examples to illustrate the various
causes and symptoms of corporate failure, and the three failure trajectories, However,
both Argenti's, and McRobert and Hoffman's theories suffered from one major
,
limitation: they , did not empirically test their research, Specifically, they never
produced a failed company's trajectory, to determine firstly whether it could be done,
secondly whether the company's trajectory matches one of their hypothesised failure
trajectories and thirdly, whether the trajectory does have considerable predictive
value.
 2

This study presents an examination of the cumulative work of Argenti, McRohert and
Hoffman on failure trajectories. Broadly, this thesis has two major research
objectives. By meeting these objectives, it will provide a greater understanding of the
usefulness of failure trajectories as a failure classification model The first objective
is to evaluate the failure trajectory portion of their theory of corporate failure. The
second objective is to evaluate the application of the failure trajectory theory using a
New Zealand case study. Four specific research questions are as follows.

• Does trajectory analysis meet a set of criteria to evaluate business research?

• How must trajectory analysis he changed so it meets the criteria?
• Does Air New Zealand exhibit a failure trajectory in the period 1989 - 2001?
• Can trajectory analysis be used as an early warning system of failure or can it
predict company failure?

The New Zealand case study is that of Air New Zealand Limited during the period of
1989 - 2001. During those years, Air New Zealand was a publicly owned company
whose majority shareholder was Brierley Investments Limited. Under Brierley's
leadership, Air New Zealand went from a regional Australasian airline to one of the
twenty largest worldwide airlines, after the takeover of Ansett Australia in the first
half of 2000. However, in 2001 , Ansett Australia and its Australian subsidiaries
failed, which, ifnot for the intervention of the New Zealand Govenunent, would have
brought down the parent company. Air New Zealand is chosen because it was an
important New Zealand company and because of the availability of information with
which to create its trajectory.

The thesis is set out as follows. Chapter "2 sununarises the relevant literature with
respect to Afgenti's research. It tracks the development of his theories over ten years,
the contribution made by McRobert and Hoffinan (1997), and discusses the comments
made in, and tests done by, other studies. Following this, Chapter 3 outlines the
research methodology used in this thesis. Additionally, it discusses the research
objectives, the research questions and the data used to calculate Air New Zealand's
trajectory.
 3

Chapters 4 and 5 examine the failure trajectory portion of the theory produced by
Argenti (1976a) and McRobert and Hoffman (1997), Chapter 4 evaluates it against a
range of criteria, designed to measure business research theories. Chapter 5 attempts
to develop parts of the theory, which did not meet the criteria discussed in chapter 4.
The objective in chapter 5 is to produce a simple methodology with which to create a
trajectory.

After producing a theory that is capable of being evaluated using a New Zealand case
study, Chapter 6 introduces the case study, Air New Zealand. The chapter
commences with Air New Zealand's beginnings as the Tasman Empire Airways
Limited and the National Airways Corporation to their subsequent merger in 1978 and
sale by the New Zealand Government in 1989. It then outlines the major internal and
external factors that affected Air New Zealand's operations from 1989 - 2001. Where
possible, it also dis~usses the major changes in ownership and control during the
period.

By comparison, Chapter 7 investigates Air New Zealand's accounting policies and the
notes to the financial statements, in an attempt to identify any creative accounting
techniques. Briefly, creative accounting techniques reduce the reliability of
accounting infonnation. This is done to ensure that the accounting infonnation used
to measure the trajectory is accurate. After evaluating the company's financial
statements, the chapter produces a set of data tenned the 'worst-case' scenario. This
is compared with the 'best-case' scenario, which is the data contained in Air New
Zealand's financial statements.

Chapter 8 presents the results for this thesis. The chapter first outlines the individual
indicators that collectively measure the trajectory. Secondly, it uses the indicators to
calculate the best-case and worst-case trajectories. Finally, these trajectories are
merged into the final trajectory, Air New Zealand's trajectory.

Chapters 9 and 10 provide the limitations and conclusions of this ·thesis and the
avenues for further research. Chapter 9 concentrates upon both the methodological
and data limitations as well as suggesting several areas of new research for interested
readers. Chapter 10 presents the major conclusions of this study.
 4

Chapter 2: Review of the Literature

2.0 Introduction

In 1976, John Argenti published Corporate Col/apse. Responding to the lack of

systematic research into company failure, he examined a range of sources that led him
to produce a method to evaluate failing companies. Argenti proposed using both
financial and non-financial data when evaluating a company for causes and symptoms
of company failure. The final task in predicting failure would be to create the
company's trajectory, which would graphically represent the company's performance
over time. If the trajectory followed one of three hypothesised trajectories, the
company would be more likely to fail.

Twenty years later, Andrew McRobert and Ronnie Hoffman (1997) published another
book also called Corporate Collapse. This publication was essentially a re-
examination of Argenti's (1976a) work, with a particular emphasis on company
failures in Asia and Australasia. As is the case with Argenti (1976a), McRobert and
Hoffman (1997) concentrated on the causes and symptoms of company failure and the
usefulness of the company trajectory. However, they were equally concerned with the
processes that interested parties use to turnaround collapsing companies.

This chapter will sununanse the literature emanating from Argenti's (1976a)
publication exami~ing the causes and symptoms of company failure ~d company
failure traje~tories. Section 2.1 discusses Argenti's explanations of his causes and
symptoms of company failu re and the failure trajectories. Section 2.2 summarises the
research following Argenti's research and prior to the publication of McRobert and
Hoffman. Section 2.3 will discuss the developments of Argenti's ideas by McRobert
and Hoffinan (1997). Section 2.4 outlines the impact of their theory since McRobert
and Hoffman's publication. Finally, section 2.5 provides a summary of the chapter,
identifying the gap in this area of research that the present thesis will examine.
 5

2.1 Argenti's explanations of corporate collapse

Argenti (1976a) began his book with an argument as to why company failure was a
proper subject for study. He argued that the management Hterature and research
focused too much on success. He stressed that the avoidance of failure is as much the
job of managers as the achievement of success. Argenti's reasoning for examining
failure was that if certain factors were present in all company failures, then they could
be avoided to prevent failure. His aim was to produce body of knowledge about
corporate collapse.

Argenti's (1976a) research was a systematic study of corporate failure. He firstly

summarised the views of the leading writers on failure. Secondly. Argenti recorded
the opinions of twelve leading experts in corporate failure. These included receivers,
investment analysts; managers and journalists. Thirdly, he reviewed the findings of
Altman (1965) and discussed Altman's 'Z Score', a model "designed to estimate a
company's propensity to fail' (Argenti, 1976a, p. 10). Finally, he examined two
major failures of the time, Rolls-Royce (failed on 4 February 1971) and Penn Central
(failed on 21 June 1970), with the intention of testing the conclusions reached by
writers and experts of the time. In his words. "[the companies] pass the test with
flying colours and a really clear picture of how companies enter the path offailure
begins to appear" (Argenti, 1976a, p. 10). Argenti (1976a) defined several terms,
which table 2.1 reproduces.

Tonn Defined in Argenti (1976a) as:

Collapse .. When a company, which has hitherto been operating successfully, first begins to falter
and then has to fight to remain profitable" (p. 5). "A company can be a failure without
,ever having been a success but it can only collapse if it was once successful but now is
not'~, (p. 6).
Failure "Refer[s] to a company whose performance is so poor that sooner or later it is bound to
have to call in the receiver or cease to trade or go into voluntary liquidation, or which
isjust ahout to do anyone ofthese, or has already done so" (p. 6).
Insolvency "Cannot pay debts as they fall due or ... net assets are ofnegative value" (p. 5).
Trajectory "A line on a graph, which is intended to represent the general health ofa company" (p.
153).
..
Table 2.1: Major defiOlbons made by Argenb (1976a)
 6

2.1.1 Causes and symptoms of company failure as seen by Argenti

From the above diverse sources on failure, Argenti (I 976a) produced a list of twelve
items he tenned causes and symptoms of company failure. His initial proposition
involved a simple two-stage process evolving from the presence of management
defects. The management defects and other causes related to inherent problems in the
company's operational structure. Argenti argued that they were present before
company failure began. The symptoms related to observable factors that became
apparent as company failure approached, These causes and symptoms will he
summarised below; all page references in this section refer to Argenti (1976a).

Causes a/Corporate Failure

Management: Generally, a failing company has poor management illustrated by six

top management structural defects: one-man rule, a non-participating board, an
unbalanced top team, a weak: finance function, a lack of management depth and a
combined chairman and chief executive. Each one of these defects is described in
detail below.

1. One-man rule: "describe[s] chief executives who dominate their

col/eagues rather than lead them" (p. 123).
2. Non-participating board: "functional directors who sit on the main boards
... [but] take little part in discussions on matters affecting the company as
a whole" (p. 124).
3. Unbalanced top team: Lack of a wide range of ski lls amongst the top team
(p. 125). "The top team includes directors, and very senior executives and
advisors below director lever' (p. 124-25).
4. 'Weak finance function: HA special case of unbalance in the top team" (p.
125). This includes the situation where there is no finance director on the
board, or when the board only meeting with the chief accountant when the
budget is being discussed (p. 125).
5. Lack of management depth: Argenti (1976a) was "less convinced that this
defect is a useful indicator of possible failure", since he would not know
 7

how to recognise it unless it was obvious (p. 125). Argenti (1976a) did not
define this defect.
6. Combined chainnan and chief executive: Argenti (1976a) believed this is
the most important management structural defect. A combined chairman
and chief executive is at the top of the management hierarchy. "There is
no one above him to shake him awake or divert him or warn him or
dismiss him" (p. 126).

Accounting Information: There is an absence of the foHowing four types of

accounting information: budgetary control, cash flow forecasts, costing systems and
valuation of assets.

1. Budgetary control: Refers to creating and using budgets to plan the

company's performance over the following yeaTes). WithO\l:t any
budgetary control, "managers may not have the slightest idea whether
the company is doing well or badly" (p. 127).
11. Cash flow forecasts: Cash flow forecasts are used to outline known
cash inflows and outflows to detennine when a company will have
cash shortages. If management ignore cash flow forecasts, a cash
crisis can unexpectantly arrive (p. 127).
Ill. Costing systems: to detennine how much each product costs and the
effect it has on profit (p. 127). This process distinguishes high yield
products from their low yield counterparts. Failing companies
generally do not produce any costing information.
IV. Valuation of assets: Argenti (1976a) was "sceplical of this alleged
defect" (p. 127), because of loose accounting rules and the influence of
inflation when valuing assets (p. 127). Note that the A-score (Argenti
1977; 1983; 1984) ignored this alleged accounting infonnation defect.

Change: Argenti (1976a) argued that poor management (as detailed above) will
not adequately respond well to change. The only relevant changes are those that
"strike at the core of a company's business" (p. 128). There are five main groups:
competitive, political) economic, social and technological environment.
O'
,r: 8

a. Competitive Trends: including the emergence of low-cost producers, the

merger of competitors, the announcement of new products and the entry of
a new competitor (p. 129)
b. Political Change: Argenti (1976a) emphasised political attitudes towards
business in general and industries in particular. Political change may
affect a company's production resources, raw materials, markets and
financing (p. 129).
c. Economic Change: all major macro-economic factors including foreign
exchange movements, inflation, interest rates and the economic cycle (p.
129).
d. Changes in Society: including, but not limited to, changes in life-styles,
attitudes to pollution and consumer protection (p. 129 - 130).
e. Changes in Technology: Argenti (197§0) believed this to be true in only
certain i~dustries. He noted "it is sometimes a perfectly valid response to
decide not /0 follow a change but to move into an area of lower
technology, or a diflerent one - or, indeed, to adopt any of the dozens of
possible responses to a given technological change" (p. 130).

Constraints: Generally imposed by external parties on how the company trades or

more importantly, how it wants to respond to change (p. 130-32).

Overtrading: Argenti (1976a) was more interested with overtrading as it relates to a

company that "in an attempt to expand, increases turnover at the expense of profit
margins" (p. 133). The other major type is overtrading that forces the company to
over-borrow to finance the continued overtrading (p. 132-133).

The Big Project: "Any undertaking or obligation that is large compared with the
resources of the company" (p. 134). Failure of the project happens when "costs and
times are underestimated or revenues overestimated" (p. 134).

Gearing: Increasing the amount of debt beyond the prudent limit (this amount
differs for each business). A company with high debt may only be able to cover the
interest payments and thus create a burden on the company's resources if the
economy suffers a decline (p. 135-136).
 9

Normal Business Hazards: defined as "certain events which by common consent do

cause the failure of companies but which, being normal hazards of any business,
ought not /0 cause it and ... do so because the company is already too weak to survive
the blow" (p. 137). Examples include a fire at the company's warehouse, a strike at a
supplier's premises, or movements in market share.

Symptoms a/Corporate Failure

Financial Ratios: These can be useful symptoms of failure but Argenti (1976a) had
serious doubts for three reasons. Firstly. ratios may show something is wrong, but
they do not provide enough evidence to predict collapse. Secondly. inflation can
seriously erode their effectiveness. Thirdly, "ma!lagers will start creative accounting.
thus hiding the telltale symptoms/rom everyone" (p. 137-140).

Creative Accounting: Argenti (1976a) felt this is one of the most useful symptoms of
failure. Managers use creative accounting techniques to hide the extent of their
company's problems, which reduce the effectiveness of financial ratios. Argenti
(1976a) described a number of creative accounting techniques that are intended to
make a company's results better than what they actually are (p. 140-4).

Non-financial Symptoms: There are many non-financial symptoms In failing

companies, although companies that are not failing may also display them. He did not
construct a long list, "because they will be different for each industry alld even each

company" (p. 145). Examples provided by Argenti (1976a) include low morale, the
demeanour of the top managers, decline in service or quality. and marking down of
the company share price (p. 144-145).

The Last Few Months: The "number and severity of the symptoms rapidly increase"
(p. 145). Argenti (1976a) suggested that the last few months would be of academic
interest only, since it is far too late to take effective action to save the company from
failure (p . .146).
 10

2.1.2 The A-score

Later that year, Argenti (in 1976c) created his failure sequence. Instead of just causes
and symptoms of corporate failure, he argued that failure could be analysed in three
stages: (l) defects that exist in the management structure, which result in (2) mistakes
made by management and finally. (3) symptoms of failure that become apparent. In
effect. Argenti (1976c) described a failure model: defects led to mistakes that led to
symptoms, which led to failure. This failure model fonned the basis of his failure
prediction model. the A-score (Argenti. 1977). provided in figure 2.1. Note that
Argenti discarded one of the accounting information defects (valuation of assets) and
two causes of corporate failure (constraints and normal business hazards) from both
his failure model and the A-score.

Argenti (1977) assigned a numerical value to items in the A-score allowing a total of
- 7.0. Each value shown
, in figure 2.1 is the maximum allowed for each item, the
minimum value is zero. To calculate a score for each item, one would first have to
determine how severe the item is. For example, when valuing an autocratic chief
executive, you could provide a maximum value of -0.5. However, if you believed that
the chief executive is autocratic, but not extremely autocratic, you may only provide a
value of -0.3, or -0.25 and so on. This makes the whole process very subjective.
Most likely, two people evaluating a company with this version of the A-score would
not get the same results. Argenti (1977) argued that a company with an overall A-
score score of - 1.0 should make the person scoring the company worry, whereas a
score of - 3.0 would mean only a major change would save the company. The A-
score is a scorecard for bad management; therefore, most non-failing companies will
score zero.

In later publications (Argenti. 1983; 1984). Argenti changed the values of the
different factors that made up the A·score. The grand total was 100, instead of - 7.0.
Figure 2.1 also provides these different values. Argenti tenned the 'pass mark' as 25
out of 100: if a company scores more than 25, than "that company may well be
dangerously far down the path to failure" (Argenti. 1984. p. 14). Argenti (1983)
suggested that most companies at no risk of failure will score between 0 - 18.
 11

Additionally, he stated that there was a danger mark of 10 for defects and 15 for
mistakes (Argenti, 1983). If a company scored more than 10 for defects, "the
observer is entitled to feel some anxiety lest these management defects lead the
company into maldng [oj mistake [leading] to Jailure" (Argenti, 1983, p. 21). If the
score is grffater than 15 for mistakes and less than 10 for defects, then management is
running the company at some risk.

This version differed from his first version in that the value shown in figure 2.1 is the
actual value allocated for each item. Argenti (1983) recommended that the scores
should be given only if the item is clearly visible in the observed company.
Therefore, if there were an autocratic chief executive, the A-score would increase by
eight; the severity of the item is irrelevant. This removes one aspect of subjectivity
(the perceived severity) from the A-score; however, one other aspect remains
(detennining whether the defect, mistake or symptom exists).

Finally, Argenti (1983) acknowledged he had not empirically tested the A-score to
detennine its predictive value. However, he stated that "tests wilh approximately
[1,OOOJ accountants, managers and bankers in seven different nations over the past
flve years suggest a misclassification rate oj 5%" (Argenti, 1983, p. 21). This is an
unsubstantiated claim, as he does not provide any references for this research.

One problem with Argenti's (1977; 1983; 1984) A-score is the weightings given to
each item. He allocated points in accordance with his own personal opinion of their
importance, thus creating a SUbjective weighting system. He stated that the weighting
system is arbitrary and subjective, although he argued that the A~score is only
composed of the factors that are widely .accepted in the process of failure (Argenti,
1983). However, Argenti did not mention using different weightings to check the
models sensitivity to ensure that the weighting's he chose were the most appropriate,
that is to best discriminate between failing and non-failing companies. Thus, if
Argenti's values are wrong, in that either his opinion of their persona.! importance is
wrong, or that his values do not discriminate well between failing and non~fai1ing

companies, the A~score may well be a fruitless exercise in detennining whether

company failure occurs.
 12

Depending upon the Points Score

Defects perceived severity, (Argenti,
score up to a maximum 1984)
of(Argenti, 1977):
Management
1. Autocratic chief executive who dominates his
colleagues and will hear no advice. -0.5 8
2. The cruef executive is also the chainnan. - 0.3 4
3. The skills on the board are unbalanced e.g. there are
too many engineers. - 0. 15 2
4. There is no strong finance director. - 0.1 5 2
5. Most members of the board do not actively
participate in the big decisions. - 0. 15 2
6. There is no depth of professional management below
the board. - 0. 15 1
Aceountlng
I . There is no budgetary control system - there may not
even be a budget. - 0.2 3
2. There is no cash flow plan - if there is it is out of
date - 0.2 3
3. There is no costing system, no one knows what each
product really costs nor know its contribution. -0.2 3
Response to Change
The company exhibits some clear and vital example of
fai ling to respond to change - an ageing product, old
fas hioned plant, out·of·date attitude to employees, etc.

Total for Defects

Pass marks for defects
Mistakes
Leverage
The capital gearing or the income gearing of the
company is noticeably high. - 1.0 15
Overtrading
The turnover is rising at a much faster rate than profits or
cash flo w. - 1.0 15
Projects
The company bas launched a project of such a size that if
it goes wrong it will more than exceed any possible cash
available from all its sources. 12
Total for Mistakes ~
Past marks for mistakes 15
Symptoms
Financial Signs
The traditional ratios will deteriorate and cash will be
extremely scarce. The share price will fall versus the
Index. - 0.25 4
Creative Accounting
The Accounts will show evidence of window dress ing to
"improve" profits. - 0.25 4
Non~nnancia l signs
The office needs painting, quality and morale falls, etc.
- 0.25 3
Nose-dive
It becomes impossible to hide the last-gasp scramble for
cash. - 0.25 1
Total for Symptoms ;;..lJl Jl
Total Overall maximum possible ;.J.Ji. .Il!!l
Pass mark -3.0 25
Figure 2.1: Scorecard for the A-score
 13

Another point of note concerning the A-score is that it contains both financial and
non-financial infonnatioll. Using the 1983 and 1984 weightings, financial
information makes up 62 of the possible 100 marks!, Thus, later researchers (Keasey
and Watson, 1987; Hall and Young, 1991; Elliott and Elliott, 2001) who presented
Argenti's A-score as a non-financial model to classify failure are wrong as his model
uses a range of financial and non-financial information.

Some articles written by Argenti subsequent to the production of the A-score (e.g.
Argenti 1979a; 1979b; 1980; 1986a; 1986b) do not specifically mention the A-score.
However, they do discuss Argenti's failure model (defects, mistakes and symptoms
leading to failure) in some detail.

2.1.3 Argenti's failure trajectories

Argenti (l976a) took the twelve causes and symptoms of company failure and
combined them into what he called a 'story-line of failure', provided in the following
quotation:

"Companies which display certain defects in management structure

associated with one-man rule tend to make two errors of omission and three
of commission. The two of omission are the neglect of accountancy
information systems and, worse, the failure to respond adequately to long-
t.erm changes in their environment. The three of commission are a tendency
to overtrade or to launch a big project that is beyond their resources or to
allow their gearing to increase so that even normal business hazards are a
constant threat. Some companies, even quite well managed ones, can now
be severely damaged by constraints upon their choice of response to
change. As a company slides down the path to insolvency its financial
ratios deteriorate, it begins to employ creative accounting, certain non-
financial symptoms appear. and it finally enters a dramatic last few months"
(Argenti, 1976a, p. 148).

I Financial information includes the accounting defects, the three mistakes, fmaRcial signs and creative
accounting. An observer would have to use some type of financial infonnation to determine these
defects, mistakes and symptoms.
 14

Additionally, Argenti (1976a) argued that "1101 allfailillg companies display allihese
fealures nor do Ihey all follow exactly Ihe same roule 10 insolvency" (p. 149).
Specifically. he suggested three such story lines: two were applicable to newly fanned
companies whereas the third applied to mature companies. The trajectory types
follow a different sequence and "each is marked by a different combination of causes
and symptoms, which, [Argenli} believe[dJ, are unique 10 Ihe type" (Argenti, 1976a,
p. 152). Thus, a trajectory diagram with its different sequence of causes and
symptoms would have very considerable predictive value (ibid .. p. 152). Finally,
Argenti (1976a) stated that failure takes time, a few years at least. As such, these
items are dynamic and should be viewed over a time period (ibid. , p. 149). Figures
2.2 - 2.4 provide the graphs of the three different trajectories with time shown on the
horizontal axis and' general health' (left undefined) measured on the vertical axis.

Argenti (1976a) sta.ted that the trajectory does not represent anyone indicator (such as
profit or turnover) for several reasons. Firstly. profit andlor turnover are subject to
annual fluctuations. Secondly. creative accounting techniques affect profits and
tUrnover. Thirdly. there are other indicators of general health including stock market
share value, return on capital. employee morale, reputation with customers and
suppliers (Argenti, 1976a, p. 153). Argenti (1976a) argued for the use of these latter
indicators, Finally. there are five states of general health: failure (where the receiver
is called in), poor, good, excellent and fantastic (Argenti, 1976a, p. 153).

Argenti (1976a) noted that not all of the different indicators of general health
mentioned above could be measured accurately, As the measurement of each
indicator is not unifonn, they cannot be amalgamated mathematically into a
composite indicator (ibid., p. 153). The line therefore is a "somewhat subjective
constmction/rom all these individual indicators, plotted against time" (ibid., p. 153),

A point to note is that Argenti (1976a) did not suggest that any of his causes and only
two of his symptoms of company failure measure the trajectory. Return on capital is a
financial ratio/sign, whereas the latter three indicators are non-financial symptoms.
Possibly, this means that he believed that the two parts of his theory (causes and
symptoms of failure and failure trajectories) should be applied separately or in
tandem. That is the conclusion reached after reading Argenti (1977); whilst Argenti
 IS

provided the three trajectories in that article, he did not discuss them with respect to
the A-score. Nor did a later study (Argenti, 1979a) refer to the A-score when
outlining the trajectories. A detailed description of the three failure trajectories is
provided in the following paragraphs.

A Type 1 failure only happens to newly formed companies. Generally. the company
trades between two to eight years 2 before failure. The company starts with many
causes of company failure listed by Argente, which he states are typical of all new
companies. The company trades for several years, albeit unprofitably or by making
very small profits, until the problems with the operational structure become too severe
and the company fails. Argenti describes the main feature of Type 1 failures as being
that they "never got off the grounr!' (Argenti, 1976a, p. ISO). Furthermore, this type
is the most common of the three types, with 50 - 60% of aJl failures being Type 14.
Figure 2.2 shows a graph of this type of failure.

General
Health

Fantastic

Excellent

Good

Poor

Failure
2 to 8 years

Figure 2.2: The Type 1 trajectory

Source: Argenti (1976a), Exhibit 8.2, p. 154.

Argenti's Type 2 failures also happen to young companies, although these companies
operate . from four to fourteen years (shortest and longest Type 2 failures known by

1 Argenti cited Altman as describing a fai lure of two years, and A.F.L. Deeson, who described another
company (Lanchester Engine Company) lasting eight years, from 1896 - 1904 (Argenti, 1976a, pp. 18
- 19, 154).
1 He stated that all management and accountancy information defects will be present, as will high
fearing and the big project when a company begins operations (Argenti, t 976a, p. 154, 15S).
Argenti (1976a; 1979a) asserted these figures, although no evidence is given.
 16

Argenti, 1976a). A Type 2 company begins with the same causes of failure as the
Type 1, with one major difference: this being that the proprietor has an 'outstanding
personality'. As Argenti says, "Type 2 proprietors are super-salesmen; they are
leaders of men, flamboyant, loquacious, restless and bubbling with ideas" (1976a, p.
158). In the beginning, the proprietor mitigates the major managerial defects and
allows the company to become extremely successful, extremely quickly. Indeed, it
seems that the major factor for these companies is that they expand too quickly; when
the company should be consolidating its position, it continues to grow at a rate
expected by its stakeholders. This rate is not sustainable and the company begins to
collapse faster than it grew, especially because the company cannot hide its problems
from its hanks or shareholders. An important point concerning Type 2 failures is that
they are extremely rare; Argenti (1976a) suggested only one or two of them in the
United IGngdom for a given year. However, "'hey al/ract al/ention ... because of the
squeals of delight from the press on the way up the trajectory - and again on the way
down" (ibid, p. 160). Figure 2.3 provides the graph of the Type 2 failure.

General
Health

Fantastic

Excellent

Good

Poor

Failure
4 to 14 years

Figure 2.3: The Type 21rajectory

SoUrce: Argenti (1976a), Exhibit 8.3, p. 157.

The Type 3 failure occurs in companies that have been trading for a number of years
or even decades. However, Argenti (l976a) claimed the company only remains
operational for two to twenty years after it enters the trajectory. The Type 3 company
is a successful, profitable company, which begins to exhibit many of Argenti's causes
 17

of company failure. The company experiences a major downturn and will either
overtrade or launch a big project that fails. However, the company itself does not fail
because the company is too stable financially for the first downturn to cause failure.
As the graph of a Type 3 failure suggests (see figure 2.4), the company reaches a
plateau. The company is waterlogged at the plateau with high levels of debt; its
profits will just cover the debt repayments. The company may remain on the plateau
for several years, although it is also possible that this will be only a couple afmaDth's
duration. In an attempt to lift the company off the plateau, the managers will attempt
something to improve the company: possibly a project greater than the company can
afford. This second attempt fails; the company's situation worsens and failure
follows soon afterward. Argenti claimed that the number of Type 3 failures is around
20 - 30% of all failures'.

General
Health
Fantastic

Excellent

Good

Poor

Failure
2 to 20 years

Figure 2.4: The Type 3 trajectory

Source: Argenti (1976a), Exhibit 8A, p. 161.

Argenti (1976a) concluded his discussion offailure trajectories by acknowledging that

companies can move from one of the three trajectories to a non-failing trajectory or
vice-versa. For example. managers may rescue a Type 3 company after its initial
collapse. Alternatively. a non-failing company may experience rapi~ growth before a

S Argenti's reasoning was that 20% of all failures are of companies older than ten years, which would
all be Type 3 failures. Additionally. some Type 3 failures are companies between five and ten years of
age (Argenti, 1976a. p. 161).
 18

rapid coUapse, typical of Type 2 companies. However, he believed that the analysis
only needs three trajectories to explain the vast majority of company failures (Argenti,
1976a, p. 166). He also stated that it would be odd if there were only thuee ways a
company could fail: "many willfail without ever displaying any of the signs at all and
never having moved down any of the three trajectories" (ibid., p. 168).

In subsequent articles, Argenti reinforced his arguments concenung the failure

trajectories (Argenti 1976b; 1976c; 1979a). These articles emphasised that the
trajectories were all variants of one theme, the failure model (Argenti, 1979) and that
along the trajectories someone could stop the failure if they saw the signs (see
Argenti,1976b). Additionally, two of his articles (Argenti, 1976b; 1977) suggested
that failure trajectories could be calculated using financial numbers. The three graphs
provided to illustrate the trajectories had years on the horizontal axis and "profits,
turnover, etc" (see the graphs in each article) on the vertical axis. This suggestion
ignores his own discussion of general health (see above) and his argument not to rely
on this type ofinfonnation (see above, p. 14). Whatever his reasons for changing the
vertical axis, a later article used the original axis, financial health (Argenti, 1979a).

This section discussed the importance of Argenti's initial research into both the A-
score of causes, mistakes and symptoms of failure, and failure trajectories. One
general conclusion from the above discussion is that Argenti never empirically tested
his theories, alternatively relying of anecdotal evidence. Instead, he meant for his
propositions to be the starting point for further research into both part of his theory.
The following section examines the research upon each part during the following
twenty years, until the research of MeRobert and Hoffman (1997).

2.2 Argenti's impact on subsequent researchers up to 1997

This section splits the research into two parts. The first part is the research into
Argenti's A Score '(Argenti, 1977; 1983; 1984). The second subsection will discuss
the research concerning failure trajectories (Argenti, 1976a; 1976b; 1979).
 19

2.2.1 Research into the A-score

Early work by researchers into the A-score only sununarised Argenti's failure model
(see Shanna and Mahajan, 1980; Whetten, 1980; Slatter, 1984). Shanna and Mahajan
described Argentj's A-score as a subjective attempt to analyse both the causes of
failure and the performance indicators. The causes of failure are Argenti's defects
and mistakes, the perfonnance indicators Argenti' 5 symptoms (see Sharma and
Mahajan, 1980). Slatter (1984) empirically derived his own list of causes of failure,
after examining a sample of 40 UK turnaround companies. He noted that this list was
very similar to Argenti's (1976a); however, he did not examine Argenti's suggested
symptoms of failure. Robb (1986a), in discussing Argenti's (1977) model, noted that
it was both arbitrary and subjective: a point discussed in Argel1.ti (1983) (see section
2.1.2). Storey, Keasey, Watson and Wynarczyk (1987) noted that although Argenti
(1976a) provided no empirical evidence, he suggested several testable propositions,
which they examined (see below).

Several studies have examined both Argenti's A-score specifically (Robertson, 1984;
Mearns, 1991; Robertson and Mills, 1991a) or more generally his failure model
(Keasey and Watson, 1987; Storey el al., 1987; Hall and Young, 1991; Morris, 1997).
Robertson (1984) and Mearns (\991) each evaluated the A-score using their
respective case studies, Laker Airways and Lesney Products and Co Ltd. Both studies
found evidence for Argenti's mistakes, although Mearns (1991) rejected the defects
and symptoms portion of the score. In Lesney, none of the defects and all bar one
symptom (the terminal signs) were apparent. Mearns (1991) concluded that only the
mistakes portion of the A-score has predictive power. However, Mearns results were
criticised by Robertson and Mills (1991a), who did not agree with his analysis. They
showed that many of Argenti's symptonis were present and provided a more detailed
analysis of how to detennine when a company is overtrading or has high gearing.
Robertson and Mills (1991a) concluded that the A-score still had power to predict
collapse6 .

6 Using Argenti's (1983; 1984) weighting, a company can be in the danger zone (i.e. over 25) by
meeting two of the mistakes. Lesney Products met all three mistakes, scoring at least 45. The A-score
predicted Lesney's failure: therefore, Argenti's model had some predictive power.
 20

Keaseyand Watson (1987), provided an in-depth examination of Argenti's (1976a)

work. The objective of their paper was to detennine whether a model using non-
financial variables (e,g. the different causes and symptoms discussed in section 2.1.1)
could predict failure more accurately than one using financial ratios. They did not test
the A-score; instead, they used a number of proxies meant to measure the different
causes and symptoms of failure. Their sample used 73 failed and non-failed English
single plant companies that operated from 1970 - 1983. They also used a holdout
sample of another 10 failed and non-failed firms.

Keasey and Watson (1987) showed that in both failing and non-failing companies
non-financial information differed in many respects. However, in testing whether
these differences were enough to discriminate between failing and non-failing
companies any better than ratio analysis, they only found that marginally better
predictions could be ,obtained from the non-financial data. Furthermore, their results
also generally supported Argenti's hypothesis concerning the process of corporate
failure. Their conclusions are tempered by their choice of proxies: it is questionable
whether the proxies are actually measuring Argenti's non-financial causes. For
example, their management structure proxies examined only one type of management
defects, the one-man rule. Keasey and Watson (1987) ignored the other five
management defects.

Cause of Collapse Managers Receivers

perception (N=231) perception (N=247)
. Gearing 57 132
Accounting Information 44 68
Management 93 33
Other 37 14
,
Table 2.2: Summary of Hall and Young s (1991) results
NB The results in the table condense Hall and Young's results into four groups. Hall and
Young (199 1) had 36 primary reasons for why the company failed.

Hall and Young (1991) provided an indirect test into Argenti's work. They surveyed
247 small firms that failed from 1973 - 1983, examining management and the

7 Note that this study summarised the work done by Storey et al. (1987).
 21

receivers' views as to why the companies failed. Generally, the major reason for
failure suggested by management or the receiver was one of those suggested by
Argenti, see table 2.2.

It seems, even with this limited research, Argenti's ideas were becoming accepted by
academics. Whetten (1987), and Keasey and Watson (1991 a, 1991 b) cited Argenti
(1976) as an example of bankruptcy prediction. The latter researchers described
Argenti's work as a "dynamic model of business failure which did not rely upon
financial ratios but rather on the fundamentals of the business and its management
structure" (Keasey and Watson, 1991b, p. 20). This article stated that research had
generally supported Argenti's failure model, although they only quoted Keasey and
Watson (1987) and Storey et at (1987). Sheppard (1994) and Tobin (1996) noted that
Argenti's work was anecdotal and lacked empirical evidence, although Argenti
provided an "understanding oj the road to bankruptcy" (Sheppard, 1994, p. 814).
Sheppard also speculated that certain variables should become more important than
others, as the finn becomes more likely to fail.

Finally. Morris (1997), in a comprehensive review of various methods to classify

failing companies, provided an indirect test of Argenti's A-score. Under case-study
research, Morris evaluated several studies (including Argenti 19760; 1983; 1984)
which suggested a range of causes of company failure. Morris ( 1997) used two
samples of failed companies: the first sample contained 25 companies that failed
between 1973 and 1983; the second sample contained 21 companies, which failed
during 1988 - 1993. He acknowledged that both failure samples were during
prolonged recessions in the UK. His research in particular to the A-score is
summarised in table 2.3. Generally, Morris (1997) found that many of Argenti's
causes are present in his samples, the most important being autocratic management,
lack of response to change and high gearing. However, Morris (1997) found other
factors not ackDowledged by Argenti, to be as important in determining failure as
Argenti's factors, including a declining industry (18 and 14 in the two respective
samples), undeurading (17,18) and an acquisition strategy that fails' (13,13). This
cast doubt on whether the A-score includes all the causes that are widely accepted in

I Other researchers (e.g. Slatter, 1984; Tobin, 1996) included this cause as part of Argenti's big project
that fails.
 22

failure (see section 2.1.2). To summanse, Morris (1997) also provided limited
support for Argenti' sA-score,

Cause of company failure tested Equivalent to Argenti's: Number of Companies

by Morris (1997) exhibiting cause
Sample 25 Sample 21
Narrow Ownership Management defect 21 15
(autocratic leadership)
Big Project Fails Big Project mistake 5 0
Relatively High Borrowing Leverage mistake 17 16
External Environment Changed Change defect 17 19
Inadequate Controls Accounting defect 7 7
Overtrading Overtrading mistake 1 1
.,
Table 2.3: Summary of Moms s (/997) results
Source: Morris, 1997: Tables 15.1 and 15.2, pp. 325 - 334.

This section has summarised the major studies that have discussed Argenti's failure
model until McRohert and Hoffman's publication in 1997. According to Keasey and
Watson (1991b), most company failure research in this period focused on the
statistical models (e.g. Altman, 1968); many more studies examined neural networks9
(e.g. Jain and Nag, 1997; Wong, Wang, Goh and Quek, 1992). However, some
conclusions are apparent from the research. Firstly, the limited testing into his work
generally supports his conclusions. Secondly, even though his work was anecdotal
(Sheppard, 1994), subjective (Robb, 1986a) and provided no empirical evidence
(Storey et at., 1987), it was becoming accepted by 1997.

2.2.2 Research into failure trajectories

In comparison to research on A-score, there is very little discussion of Argenti's

failure trajectories. Whetten (1980) provided an early evaluation of Argenti's work.
He described the failure trajectories as "success breeds failure" and "failure
stimulates further failure" organisational decline models (p. 157), The term 'success

9 Neural networking is a type of 'black box' model, whereby only the inputs and outputs are
identifiable, how the inputs become outputs is not easily observable. The process involves examining
the interaction of the inputs with other inputs and outputs, until the model converges upon a result (see
Morris, 1997, pp. 159 - 164, for a greater explanation of neural networking).
 23

breeds failure' describes the Type 2 and 3 failure trajectories; the other term describes
the Type 1 trajectory. Whetten (1980) suggested two areas of further research. The
first area was to examine whether the trajectories should be identified and studied
over time to determine whether trajectories predict performance. The second area
related to management's attitude to irmovation: does too much or too little innovation
lead to failure, as suggested by Argenti, or does high innovation lead to high
perfonnance?IO,

Later researchers did examine Whetten (1980)'s suggested research. Laitinen (1991)
found evidence of Argenti 's three failure types. Laitinen used a sample of 80 Finnish
companies (40 failed and non-failed) and six ratios", although he only examined the
companies six years out from failure. He detected three types of faiJure: the 'chronic
failure firm' where the ratios were consistently poor four years out from failure, the
'revenue financing failure firm' where debt and liquidity remained at an average level
every year before failure, and the 'acute failure finn' where aU the ratios dramatically
worsened in the year before failure. The chronic failure finn is similar to the Type 1
since it is involves company with poor performance. The Type 2 trajectory matches
the acute failure fmn as both types collapsed just before failure. Finally, the revenue
financing failure firm is Argenti's Type 3 failure; this group nicely describes a
waterlogged company.

Hambrick and D'Aveni (1988) examined Whelten's (1980) second area of future
research. One of their research questions was whether large business failures were
typified by either too much or too little change, or a combination of the two just
before failure. This level of change was in comparison to survivor firms. They used a
sample of 124 US companies (62 failed and non-failed) with a mean turnover of $404
million and an average age of 56 years. Hambrick and D' Aveni (1988) found strong
evidence for Type 2 and 3 failures at least five years out from failure. The standard
deviations of 'new domains' (any new area of operations the company entered into)

10 The reasoning here is that, leading up to failure, Type 2 companies are highly hmovative, tbal is
endlessly changing. By comparison, Type 1 and Type 3 companies are not innovative and do not
change much. Yet all three types fail.
II The ratios used were return on investment, rate of growth in total assets, net sales divided by total
assets, cash flow divided by net sales, total debt divided by total assets and the current ratio. He stated
that the results remained the same even when he used twenty (unnamed) ratios.
 24

were significantly different from non-failing companies, which suggested that failing
finns were at the extremes (either too much or too little change).

None of the above studies produced a trajectory. instead determining whether three
trajectories exist. Indeed, researchers generally summarised Argenti 's failure
trajectories, but did not attempt to produce a trajectory (Bibeault, 1982; Robb, 1986b;
Buttery and Shadur, 1991; Tobin, 1996). For example, Bibeault (1982) summarised
the three different trajectories similar to the summary in section 2.1.3, although he did
not try to test Argenti's propositions or analyse them in any way. In comparison,
Buttery and Shadur (1991), in summarising the trajectories, discussed them with
respect to two (then) recent collapses, Bond Corporation and Cougar-Air. Buttery and
Shadur stated that Cougar-Air represented a Type 1 failure and seemed to suggest that
Bond Corporation was a Type 3 failure 12 . They did not do an in·depth study of either
company and did riot attempt to reproduce either company's trajectory.

Buttery and Shadur (1991) commented that Argenti's work needed to be revisited to
develop a better understanding of collapse trajectories. However, no other known
publication or study has examined failure trajectories until McRobert and Hoffinan
published their book in 1997.

2.3 McRobert and Hoffman's update of the tbeory for the 1990s

McRobert and Hoffinan (1997)'s aims in their work differed from Argenti (1976a).
Their aim was "to provide a simple framework ill which the causes of failure are
itemised, the symptoms are listed, the ground-rules for diagnosis are set out and ... a
prognosis and treatment may befound' ~ (McRobert and Hoffman, 1997, p. 16). They
achieved this by setting out the causes and symptoms of corporate failure and
suggesting procedures for avoiding and dealing with collapse. McRobert and
Hoffman (J 997) defined several terms; table 2.4 reproduces them.

12 Buttery and ShaduT stated, that "most of these six items in trajectory 3 were present in the collapse of
Bond Corporation" (Buttery and Shadur, 1991 , p. 42). However, the six items are the first six causes
discussed in section 2.1.1. Thus, they are on1y saying that Bond Corporation exhibited many of
Argenti's causes of corporate collapse.
 25

Term Defined By McRobert and Hoffman (1997) as:

Failure A general definition is an inability to achieve a viable and sustainable economic
mandate (p. 4). Their concise and ongoing definition is as follows: "failing to
provide, from its main operating business, a sustainable return, at least equal to
that which is required of the enterprise by its sponsors, without a requirement for
continual injections of additional fundini' (p. 4). McRobert and Hoffman (1997)
included two groups of borderline failures within this definition: businesses in the
private sector that do not achieve an acceptable return and are not liquidated, and
businesses in the public sector that either do not or cannot achieve an acceptable
financial return (p. 4).
Insolvency The company either cannot meet its debts as they fall due because it is chronically
illiquid or, has an excess ofliabilities over the current value of its assets (p. 4~5).

Trajectory "Is a story-line, represented by a simple diagram. It is a single line on a graph. yet
it represents the general allvround wellbeing ofan organisation" (p. 106).
..
Table 2.4: Major defirultons made by MeRobert and Hoffman (1997)

2.3.1 McRobert and Hoffman's (1997) causes and symptoms of corporate failure

Since Argenti (1976a; 1976c) had already determined the most important causes and
symptoms of corporate failure, McRobert and Hoffinan (1997)'s discussion was only
a summary of them. In saying that, Argenti's and McRobert and Hoffman's causes
and symptoms were not exactly the same; McRobert and Hoffman discussed several
more causes and symptoms than Argenti. This section summarises McRobert and
Hoffinan's (1997) causes and symptoms of corporate failure; all page references in
this seeti·on relate to McRobert and Hoffman (1997).

Causes of Col/apse - People

Management: F~ilure is caused by the following eight important management

structural defects. It is wrong to attach similar significance to the eight defects. The
least important is "management dl!pth, which tends to be a sign of potential rather
than actual weakness. The loudest warnings come from the presence of an autocratic
chief executive" (p. 34).
 26

1. One-man rule: Occurs where the "chief executive dominates rather than
leads colleagues" (p. 24).
2. A non-participating board: "The functional directors ... on the board take
little part in mal/ers that affect the company as a whole" (p. 28).
3, An unbalanced top team: Includes the directors, senior executives and
advisors. Generally means they all have the same skil1s Of expertise (p.
29).
4, Combined chairperson/chief executive: This person answers to no one
because helshe is at the top ofthe management structure. By holding both
positions, a combined chairperson and chief executive is not accountable
to anyone inside the company (p. 29-30).
5. Inadequate strategic understanding: A lack of understanding with regard to
the business environment, including markets and competitors (p. 31).
6. A weak finance function: Where the finance function is not represented on
the board or is disregarded at board levels. This defect overlaps with an
unbalanced top team (p. 31-2).
7. Lack of management depth: Not enough experienced senior and middle
management with the necessary expertise to recognise and correctly
respond to trouble (p. 32).
8. Success in any business: Management believes that SInce they have
succeeded once, they will always succeed in any industry or economic
situation (p. 32-34). This arrogance leads to other defects including
inadequate strategic understanding.

Causes of Collapse - Circumstances

Accountancy Infonnation: Specifically, four defects in the company's accounting

information:-budgetary control, the cash flow forecast, costing systems, and a system
of internal controL They are each discussed in detail below:

l. Budgetary control: Budgets plan the company's perfonnance over

time. Without these controls, "no manager will Jalow with any
certainty whether the company is doing well or badly" (p. 37).
 27

11. The cash-flow forecast: Cash flow forecasts calculate periods of cash
shortages to provide knowledge of when extra borrowings are needed.
Without this type of forecast, there will be no advance warning of any
cash crisis (p. 37).
Ill. Costing systems: Provides infonnation on how much each product
costs and what affect it has on profit (p. 37).
IV. A system of internal controls: "companies which col/apse are
companies which lack an effective control system" (p. 38).

Change: McRobert and Hoffinan (1997) believed that change in this context is
not the small day-to~day variation in demand or supply but instead a major social or
economic change (p. 40). Major social or economic change includes a new political
regime, a new national alliance or the adoption ~f an entirely new socic-economic
policy. It will affect all the aspects of the company's operations, including suppliers,
customers and competitors (p. 39-42).

Constraints on Business: Imposed by external parties upon the company's trading

activities, and how well they respond to change (p. 42-45),

Overtrading: There are two relevant types of overtrading suggested by McRobert and
Hoffinan (1997). Firstly, overtrading leading to over-borrowing to finance it (a badly
managed borrowing process). Secondly, "a company decides to increase turnover at
the expense ofprofit margins" (p. 47).

The Big Project: "Projects that are big in relation to the size of the company
managing them have caused an enormous number of failures" (p. 148). Generally,
this is caused by poor estimation of the' budgetary and cash flow forecasts for the
project (p. 48-9).

Gearing: Increasing debt amounts to a level where the company cannot

reasonably keep up with the interest payments at all times (p. 49-53).

Failure of the Lenders: By not keeping a close eye on the company operations. It
also involves failing to recognise fraud and bank incompetence (p. 54-6).
 28

Nonnal Business Hazards: McRobert and Hoffman (1997) believed that nonnal
business hazards only bring failure to "a company which is too weak to survive an
everyday blow" (p. 57). Examples provided include a big customer moving to a
competitor, the destruction of the company's stock in a fire and new technology that
makes the company's process or product obsolete.

Signs of Collapse - Watch the Activities

Non-financial Signs of Collapse: McRobert and Hoffman (1997) suggested these

signs indicate corporate failure: personal conduct, the salvation illusion, executive
conduct, executive invisibility. selling the family heirlooms, financial statements,
public perceptions, cosmetic accounting, pressure gauges, conunon sense and the final
fling. Specific non-financial signs for trading bankers include rounded-off sums,
post-dated cheques, the overdraft pattern, priority clearance, payments missed and
detective work. Some of these signs are only applicable for specialised people. That
is, not everyone will have the same access to company records to detennine everyone
of the above signs. The more signals seen, the more advanced the state of
deterioration (p. 66-81).

Signs oj Col/apse - Look at the Books

Financial Signs: Are examined using key financial indicators/ratios. McRobert and
Hoffman (1997) discussed the following general types of financial ratios:
capitalisation, assets, management, earnings and liquidity ratios (p. 83-85). They note
that there are no. "specific measures which highlight the deterioration of the
company's ability to sustain a viable business" (p. 85). Management will only
employ creative accounting when all is not well with their company (p. 85).

Cosmetic Accounting: McRobert and Hoffman (1997) distinguished cosmetic

accounting from creative accounting. They used the term creative acc~unting to refer
to acceptable accounting techniques that provide more infonnation regarding the
performance and position of the company (p. 87). However, cosmetic accounting is
"when the intention is less innocent and when the technique is used to distort the
 29

matter, to mislead the observer" (p. 87). Finally, they stated, "cosmetic accounting is
one of the most reliable symptoms of impending doom" (p. 89).

Cash-flow Analysis: A lack of cash causes crises in company affairs. A cash-flow

analysis can provide a reliable early indicator of failure (p. 90, 92).

2.3.2 The failure trajectories

McRobert and Hoffman discussed Argenti's failure trajectories by examining their

theory and practice (McRobert and Hoffman, 1997, p. 5). In fact, they only discussed
the theory of failure trajectories. McRobert and Hoffman (1997) discussed a dozen
items that occur in a large number of company failures. The following quotation
reproduces their description of the storyline or traj~tory. A point to note concerning
their storyline is tht!t they have separated non-financial symptoms and the last few
months; McRobert and Hoffman (1997) included the last few months in their
definition of non-financial symptoms (see section 4.3.1)

"Companies which (1) display certain defects in management structure

(usually associated with one-man rule) show two errors of omission and
three of commission. The two errors of omission are: (2) the neglect of
accountancy information systems and, worse, (3) the failure to respond
adequately to long-term changes in their environment.

"The three errors of commission are: (4) a tendency to overtrade or (5) to

launch a big project which is beyond the company's resources, or (6) to
allow their gearing to increase so that even normal business hazards are a
constant threat. The process of decline i~ accelerated as cash flow (7)
deteriorates rapidly.

"Some companies at this stage, even though competently managed, can be

severely damaged by (8) constraints which are placed upon their ability to
respond to change. Then, as a company slides down the path to insolvency
and its (9) financial ratios deteriorate, it begins to (10) employ creative
accounting. At the same time, certain non-financial symptoms (J J) start to
.,
.,:..
::{~
7:" ~"y,
w
 30

appear and the company begins to (12) enter its dramatic last few months"
(McRobert and Hoftinan, 1997, p. 104)

With respect to the above quotation, McRobert and Hoffman (1997) went on to say,
"The list is dynamic, and not merely static. So it should be viewed and measured
against a time frame" (p. 104). Additionally. "Not every troubled organisation
displays the same features, in the same sequence, and at the same time. Nor will they
follow the same route /0 insolvency. But, their trajectory shapes show a depressing
similarity" (McRobert and Hoftinan, 1997, p. 105). Therefore, the failure trajectories
should be very reliable predictors, depending upon the type of organisation, its
situation and the circumstances in which it operates (ibid. , p. 106).

In measuring the trajectory, McRobert and Hoftinan (1997) argued that the trajectory
does not represent 'a nyone corporate indicator, for example profits or turnover.
Instead, the trajectory is a far more broadly based indicator and therefore more
reliable. There are several reasons for the greater reliability of the trajectory. Firstly,
it is not subject to strong annual fluctuations. Secondly, cosmetic accounting does not
affect the trajectory. Thirdly, factors including stock-market share value, return on
capital, employee morale, reputation with customers and relationship with suppliers
measure the trajectory. These factors maybe more difficult to determine; however,
they are also difficult to conceal (McRobert and Hoftinan, 1997, p. 106-7).

They continued by stating that not all of the above factors can be measured accurately
to some internationally agreed scale. Thus, they cannot be amalgamated to a
universally accepted formula (for example, Altman's Z score method). Specifically,
Altman's (1~65) approach may not be useful as it moves away from where he created
it, the United States (McRobert and Hoftinan, 1997, p. 107). Altman's (1965)
approach was for a specific industry, company size and time period. Examining a
company that does not fall within the criteria will produce invalid results.

Their graphs of each trajectory differed slightly from those shown in figures 2.2 - 2.4:
the vertical axis on McRobert and Hoffman's graphs measured 'corporate wellbeing'
(left undefined) instead of general health. Finally, they had the sarne five states of
 31

corporate wellbeing: failure (where the receiver is called in), poor, good, excellent,
and fantastic (which is a very rare state) (McRobert and Hoffman, 1997, p. 105).

The discussion of the three trajectories is similar to that in section 2.1.3 and will not
be summarised here. Suffice to say that they claimed that the average Type 1 failure
has a life of about five years. Figures provided by McRobert and Hoffman (\997)
show that the proportion of Type 1 companies to all company failures is at least 50%,
to 70% in Australia and as high as 80% in Britain 13 ,

With respect to Type 2 failures, McRobert and Hoffman (1997) suggested that the
greater the annual growth experienced by a given country, the more likely the
occurrence of Type 2 failures. Therefore, only mature economies will experience one
Of two Type 2 failures a year. Finally, McRobert and Hoffman, unlike Buttery and
Shadur (1991), viewed the Bond Corporation as "[t]he best available example of a
company on a Type Two trajectory" (1997, p. 114).

McRobert and Hoffman (1997)'5 discussion of Type 3 companies was practically the
same as that done by Argenti. The only differences relate to the company examples
used to illustrate the trajectory. McRobert and Hoffman concentrated more on Asian
and Australasian failures whilst Argenti (1976a) used British and American failures.

McRobert and Hoffman (1997) ended their discussion of failure trajectories in the
same way as Argenti (1976a), in an examination of the number of trajectories. They
noted that companies could slide into trouble but not fail, and be visible on one of the
trajec.tories, thus mpvrng from one to another (McRobert and Hoffman, 1997, p. 125).
Additionally, companies will not conform precisely to one of the three curves.
However, u~he,! the story -of a failure is observed as a whole (rather than a
succession of incidents), the three-trajectory theory withstands most attacks" (ibid.).
Interestingly, McRobert and Hoffman (1997) seemed to disregard Argenti's research
after his initial 1976 publication. Whilst they did discuss Argenti's failure model
(McRobert and Hoffman, 1997, p. 64), their discussion of the causes and symptoms of

\3 The general and Australian failure figures come from undisclosed research projects (McRobert and
HotTman, 1997, p. 108). The British figures come from Cressy and Storey (1995).

\.
 32

company failure only summarised Argenti (1976a). Furthennore, they included two
causes of failure (constraints on the business and normal business hazards) that
Argenti (1976c; 1977) discarded in his failure model and A-score. McRobert and
Hoffinan (1997) ignored Argenti's A-score, instead using a format similar to Argenti
(1976a); they also did not explicitly discuss any of the research done into Argenti's
work.

McRobert and Hoffinan (1997) illustrated the causes and symptoms using company
failures that had happened in the 19805 and early 19905. This evidence was
anecdotal, with no empirical tests into the different causes and symptoms of company
failure, or the failure trajectories. A general conclusion of McRobert and Hoffman's
(1997) work is that it is just a summary of Arg~nti (1976a). Consequently, their
research, apart from modernising Argenti's work, added very . little since their
conclusions generally matched Argenti's (1976a).

2.4 Argenti, McRobert and Hoffman's impact on research after 1997

McRobert and Hoffinan's (1997) have had no impact on subsequent writers. No

known study discussed their work, instead concentrating on the older work done by
Argenti. The research itself is descriptive, with no actual testing of either the A-score
or the failure trajectories.

Van Caillie (1999) and Van Caillie and Arnould (2001) described Argenti as the
starting point for the organisational approach to business failure. These two studies
and others (van Witteloostuijn, 1998; Liu and Wilson, 2000; Perrin, 2000; Mellahi,
Jackson and Sparks, 2002; Dizdarevic, Larrafiaga, Sierra, Lozano and Pena, 1997)
described Argenti's work in varying degrees. However, several studies noted that
Argenti's work was anecdotal (perry, 2001), restrictive in the choice of defects and
mistakes (perrin, 2000), or that he did not provide any empirical evidence to prove his
propositions (Van Caillie, 1999; Quantum Finance Enterprise, 2000; Van Caillie and
Arnauld, 200 I).
 33

Nonetheless, it does seem that, allowing for the lack of research, Argenti (1977; 1983;
1984)'5 theories concerning the A-score have become widely accepted. At least one
undergraduate accounting textbook has discussed Argenti's A-score in some depth
(see Elliott and Elliott, 2001). Additionally, seminars have examined the A-score as
an example of business risk analysis (see Terrapinn, 2002).

2.6 The gap in the literature

Before discussing the gap in the literature, a general conclusion is apparent from the
above literature; all of Argenti's theories have had very little empirical testing. Most
research into business failure has either concentrated on quantitative methods (e.g.
Beaver, 1966; Altman 1965; 1968; Taffler, 1982) or, in the 1990s, neural network
analysis (for a summary of research. see Morris, 1997; Abouzeedan and Busler, 2002;
Abouzeedan, 2002). Indeed, much of the discussion into Argenti's work is in the
management field of organisational decline, not the field of business failure
classification. This explains why there are a number of untested propositions
concerning the A-score and failure trajectories.

In the empirical work done on Argenti's theories, researchers have concentrated on

the causes and symptoms of corporate failure (or the A-score), including several case
studies. However, they have tended to concentrate on the mistakes portion of the A-
score and ignored the defects and symptoms (see Robertson, 1984; Mearns, 1991).
Largely the research tends to support Argenti's propositions, especially those in
relation to the mistakes made by management (Robertson, 1984; Mearns, 1991;
Robertson and Mills, 19913).

In comparison, the research into the failure traJectories is rather sparse. There is
evidence to sh~w the existence of Argenti's tmee trajectories (Hambrick and
D'Aveni, 1988; Laitinen, 1991). However, there is a range of undefined tenns,
including what the vertical axis of the trajectory is. Further, no known study has
taken an actual company and produced its trajectory. Argenti (l976a) came closest
with his discussion of the failure of Penn-Central and Rolls-Royce, yet he also did not
produce those companies' trajectories. There are several untested propositions. For
 34

example, are there only three failure trajectories, and is it possible to calculate a
company's failure trajectory?

This thesis wi1l begin to fill this gap by examining more closely Argenti's failure
trajectories. This involves evaluating the theory as summarised in sections 2.1 and
2.3, and creating the trajectory of a company that collapsed, but has not failed. The
following chapter will summarise the research methodology used in this thesis.
 35

Chapter 3: Research Methodology

3.0 Introduction

Chapter 2 has shown that there is a lack of research into the theory produced by
Argenti (primarily 1976a), and updated by McRobert and Hoffman (1997)14. Whilst
there has been some research into Argenti 's (1977; 1983; 1984) A-score, little or no
research has occurred into the hypothesised three-failure trajectories that a company
will follow when it collapses and fails. This chapter will outline the methodology
used for an in-depth examination of the three failure trajectories, including evaluating
the theory using a case study.

Section 3.1 produces the research questions answered in the remaining chapters. It
will outline the questions and the specific ways they will be answered. Section 3.2

discusses the data sources used in the thesis. This section shows that while the
number of data sources is small, the information contained in them is complex. A
summary will follow in Section 3.3,

3.1 Research Aim

Buttery and Shadur (1991), in discussing Argenti's work, suggested that, "[it} needs
to be revisited to develop a better understanding of collapse trajectories" (Buttery and
Shadur, 1991, p. 38). McRobert and Hoffman (1997), although possibly unaware of
Buttery and Shadur's comments, followed their suggestions when they updated
Argenti's work with examples drawn from Australasia and Asia. However, McRobert
and Hoffman's (1997) update was just that, an update. They did not adequately test
Argenti's propositions, instead relying on anecdotal evidence from many various
company failures. hnportantly, McRobert and Hoffman did not .test Argenti's
hypothesis of failure trajectories using a sample of failed companies.

14 For the remainder of the thesis, the acronym "AMH" will be used when discussing the cumulative
work of Argenti, as summarised in chapter 2, and McRobert and Hoffman (1997).
 36

The research aim is to provide a thorough examination of failure trajectories as

discussed by AMH. The following chapters will expand on the work done by AMH
and evaluate their work using a New Zealand case study. More specific research
questions and objectives are in the following subsection.

3.1.1 Research Questions

There "are two major research objectives. The first research objective is to evaluate
the failure trajectory portion of AMH theory. Chapter 2, in outlining previous
research into their work, also summarised their theory of corporate failure. Part of
this theory relates specifically to failure trajectories. The first research question is:
does trajectory analysis meet a set of criteria to evaluate business research? The
thesis uses several criteria to evaluate trajectory analysis; these are discussed in
greater detail in chapter 4. If the theory does not meet all the criteria, the second
question is the following: how must trajectory analysis be changed so it meets the
criteria? Basically, this thesis will develop the theory to correct any areas of the
failure trajectory portion that do not meet the criteria. It is this developed theory that
will be applied in the second research objective.

The second research objective is to apply a practical example to the failure trajectory
portion of AMH's theory. This thesis will use a New Zealand company, Air New
Zealand Limited, as the practical example to evaluate the usefulness of failure
trajectories as a failure classification model. Air New Zealand is chosen, not because
the company failed, but because it is a recent collapse of a large, vitally important
New Zealand company. This thesis will use various data sources to measure the
indicators or financial health, which are then used to measure the trajectory.
Furthermore? as some of the indicators involve accounting infonnation. this thesis will
evaluate Air New Zealand's accounting policies for two reasons, to ensure
consistency and to identify creative accounting techniques. Chapter 5 expands on the
process used to evaluate accounting policies. Finally, the resulting trajectory will be
subjected to a sensitivity analysis. The analysis will check the robustness of the
trajectory and analyse changes in the trajectory caused by changing the relative
weights of the indicators.
 37

There are two further research questions for this research objective. Firstly, does Air
New Zealand exhibit a failure trajectory in the period 1989 - 2001? The type 3
failure trajectory is the logical choice as the trajectory Air New Zealand will exhibit
since the company is a mature company that has been trading since the 19405.
However, since companies can move from non-failing to failing trajectories, Air New
Zealand could exhibit one of the other two trajectories instead (see above, pp. 17,31).

Secondly, can trajectory analysis he used as an early warning system of failure or can
it predict company failure? An early warning system of failure will suggest whether a
company is more likely to fail; a failure predictor model predicts whether a company
will fail. Thus, the distinction between the two is that there is a sense of fmality with
the latter type: if the model states a company will fail, it cannot be saved.

The following table will outline the respective research objectives and their
corresponding questions:

Research Objective Research Question

Evaluate failure trajectory portion of theory of Does Trajectory Analysis meet a set of criteria to
corporate failure evaluate business research?
How must trajectory analysis be cbanged so it
meets the criteria?
Evaluate application of the failure trajectory Does Air New Zealand exhibit a failure trajectory
theory using a New Zealand case study in the period 1989 -200 1?
Can Trajectory Analysis be used as an early
warning system of failure 01 can it predict
company failure?
Table 3.1: Research ObjectIVes

3.1.2 Period of Study

For the purposes of the case study, this thesis will measure the trajectory of Air New
Zealand over the period March 1989 - December 2001. It does not seem relevant to
include in the period the company's perfonnance before March 1989, when the New
Zealand Government owned the company. During the study period, the New Zealand
Govenunent did not have a majority equity stake in Air New Zealand. After the

,
•
38

privatisation of Air New Zealand in 1989, the Govenunent had no active participation
in the company's operations. A consortium led by the minority owner, Brierley
Investments Limited, controlled the company. Thus, to all intents and purposes, Air
New Zealand was a new company from 1989, with new owners and new objectives.
The period ends at December 2001 when the Government took an 82% equity stake in
the company.

The following section will outline the various data sources used in this thesis.

3.2 Data Source

The data sources used in this thesis relate to the New Zealand case study, Air New
Zealand Limited. There are three major data sources for Air New Zealand. The first
source is Air New Zealand's annual and half-yearly reports. The annual reports cover
the entire period from March 1989 - June 2001 (in 1991, the company changed its
year-end from 31 March to 30 June). Air New Zealand released half-yearly reports
throughout the period. When the company changed its year-end in 1991, it also
changed the half-year period end from 30 September to 31 December.

The second source is Air New Zealand's market information, primarily share price
data. Whilst there are many databases that hold share price information. this thesis
uses the DATEX CD-Rom database. This database provides, amongst other things,
New Ze'aland share price data and company announcements from January 1990
onwards. Air New Zealand's shares began trading publicly on the New Zealand
Stock Exchange from October 1989; however, DATEX does not include the share
price data from October - December 1989. The share price data produced by a New
Zealand newspaper, the National Business Review, is used to collect the shortfall
fromDATEX.

The third source includes newspaper articles, company announcements and other
media concerning Air New Zealand. Occasionally, the thesis will use these sources to
elaborate parts of the discussion concerning the company during the period.
Consequently, this source is of minor importance compared to the other two sources.
 39

3.3 Summary

This chapter has outlined the research involved in a thorough examination of AMH's
failure trajectory theory. There are two main research objectives including firstly, to
assess the failure trajectory portion of their theory using a set of criteria for evaluating
a theory. The second objective involves using a case study, Air New Zealand, to
evaluate the application of trajectory analysis. From these two general objectives,
there are also a series of specific research questions.

The period of study for creating Air New Zealand's trajectory is from March 1989,
the first financial year the company operated under the new owners, to December
20ot, when the New Zealand Government took a majority shareholding because of
the company's financial problems. Additionally, the major data sources are Air New
Zealand's published financial reports and share price information.

The following five chapters will resolve the above research objectives and questions.
Chapter 4 will evaluate the fai lure trajectory portion of the theory using a set of
criteria described in that chapter. Chapter 5 provides additional development to the
theory, to resolve some of the criteria found lacking from the theory evaluation.
Chapter 6 provides a brief history into Air New Zealand. Chapter 7 wi ll examine Air
New Zealand's accounting policies contained in the company's annual reports.
Finally, Chapter 8 creates Air New Zealand's trajectory using the revised theory
discussed in chapter 5 and incorporating the changes made in chapter 7.
 40

Chapter 4: Evaluatiug Argenti, McRobert and Hoffman's

Failure Trajectory Theory

4.0 Introduction

Chapter 2 outlined the theoretical developments made by Argenti (primarily 1976a)

and McRobert and Hoffman (1997). They described a theory of corporate failure,
which has had very little empirical testing. Therefore, this chapter will theoretically
evaluate the theory, by firstly, discussing the differences between the description of
the theory provided by the above authors. Secondly, it will evaluate the theory
produced by these authors, to decide whether it needs any further development, before
testing it using Air New Zealand,

Section 4.1 outlines the major differences between the description of the theory by
Argenti (1976) and McRobert and Hoffman (1997). Section 4.2 splits AMH's theory
of corporate failure into two subparts. This is an important step as it limits the
amount of AMH's theory the thesis addresses. Section 4.3 evaluates the trajectory
analysis portion of the theory of corporate failure using Zaltman, Pinson and
. Angelmar's (1973) 16 criteria for theory evaluation. A summary follows in Section
4.4.

4.1 The Differences between Argenti's (1976a) description, and

McRobert and Hoffman's (1997) description of the theory

Section 2.3 mentioned that McRobert and Hoffman's (1997) description of the theory
was very simiJar,to Argenti's (1976a). However, there are some differences between
the two. Table 4.1 swnmarises the differences between the two theories. Some of the
important differences wil l be discussed in detail below.

There are two major differences between the terms defined by AMB. Firstly, their
failure definitions differed. Argenti (1976a) provided a narrow definition whereby
failure occurred when the company went into liquidation or receivership, or ceased to
 41

trade. By contrast, McRobert and Hoffman's (1997) provided a broader definition

(see above, p. 25). Chapter 5 will discuss these definitions further. Additionally, the
authors each use the tenn's 'health' and 'well-being' in the trajectory definition.
However, it seems that both tenns mean substantially the same thing l S,

W~at Argenti (1976a) Says What McRobert and HoUman (1997) Says
Definitions
Failure equated with receivership Failure equated with not meeting the stakeholders
minimum return
Uses the term 'general health' in the Trajectory Uses the lenn 'corporate well-being' in the
Definition Trajectory Definition
Provides a defmition of 'collapse' Does not define 'collapse'
Causes and Symptoms a/Corporate Failure
Has only six management structural defects H" .n additional two: 'inadequate strategic
understanding' and 'success in any business'
Does not define ' lack ofinanagement depth' Provides a definition for 'lack of management
depth '
Accounting information defect includes 'valuation Accounting information defect includes 'a system
of assets' ofintemal controls'
Emphasises five different types of change: social, Emphasis two differe~t types of change: social
economic, political, competitive. technological and economic
Emphasises one type of 'overtrading' (increasing Both types of overtrading are equally important
sales at the expense of profit margins) as being
more important in failing companies than the
other type (overtrading leading to over borrowing)
Only provides • couple of 'non·fmancial Lists many 'non·fmancial symptoms', although
s~ptoms' some are specialised
Notes the adverse effect of inflation upon No mention of an inflation effect in texi
financial ratios
'Creative Accounting' hides the extent of 'Cosmetic Accounting' deliberately misleads the
company problems observer
The 'last few months' is a symptom of corporate The ' last few months' is included as a non-
failure in its own right fi nancial symptom
No mention of 'cash flow analysis' Highlights 'cash flow analysis' as a reliable early
indicator of failure
Measurement ofthe Trajectory
'Normal Business Hazards' is included in the 'Deterioration in Cash Flows' is included in the

IS Chapter 5 discusses further this concept.

 42

Siory-line of failing companies story-line of failing companies

No mention of management manipulation (or lack Notes that indicators of corporate well-being are
of it) for general health indicators more difficult to manipulate by management
The Trajectory line is a subjective construction Does not mention how to construct the Trajectory
line, except it is not constructed mathematically
Application a/Trajectory Analysis
There maybe more than three types of failure There are only three types of failure trajectories
trajectories
,
rable 4.1: Differences between Argent, (1976a) and McRobert and Hoffman (1997) s
theories

Many of the differences in table 4.1 relate to the causes and symptoms of corporate
failure. McRobert and Hoffinan (1997) have provided a greater amount of
information concerning management defects. They included two additional
management defects, ' inadequate strategic understanding' and 'success in any
business', and defined 'lack of management depth'. These additions have aided the
breakdown of management defects, which is the most fundamental and important
cause of corporate collapse.

The lack of accounting infonnation defect has only one difference between the
authors: Argenti (1976a) emphasised 'valuation of assets' whereas McRobert and
Hoffman (1997) suggested 'a system of internal controls' as information defects in
collapsing companies. Of the two, McRobert and Hoffinan (I997) provided the
appropriate type of accounting information. Poor asset valuation is not in itself a
cause of corporate collapse. It can be used to manipulate accounting information, and
is more appropriately included in the creative accounting symptom. Poor internal
controls however, ·can allow management to circumvent company procedures and
increase their own effective control of the company. Theft and fraudulent activities
are very possibl.e in a company with poor internal controls. Therefore, internal
control systems are a valid cause of corporate collapse.

Argenti (I976a), and McRobert and Hoffinan (1997) provided a different discussion
of non-financial symptoms. Argenti (1976a) provided very few symptoms, and then
commented that every company collapse will have different non-financial signs of
collapse. McRobert and Hoffinan (1997), by contrast, discussed at least a dozen types
 43

of non-financial symptoms; many are only usable by people in specialised positions.

Some signs are also financial symptoms of collapse!'. Here, Argenti (1976a) had the
more appropriate reasoning. He suggested that interested parties should examine a
company for any relevant non-financial sign of collapse. McRobert and Hoffman
(1997) provided a distinct group of non-financial signs; however, concentrating on
these signs may cause the omission of a sign that the McRobert and Hoffman (1997)
did not contemplate.

Both separate theories highlight the importance of identifying creative accounting.

However, they provide different names for this symptom. Argenti (1976a) stated that
all types of creative accounting can be used to hide company problems. McRobert
and Hoffinan (1997) distinguished between creative and cosmetic accounting (see
above pp. 28 - 29). In this case, it is just the cas~. of calling the same symptom by a
different name; both authors are only interested in accounting techniques that
somehow mask the actual perfonnance or position of a company.

Argenti (1976a) did not mention cash flow analysis as a symptom of company failure.
McRobert and Hof'finan (1997) highlighted cash flow analysis as a reliable early
indicator of failure, and provided their own method of analysing cash flow 17 •
Possibly, Argenti (\976a)'s lack of interest stems from the difficulty of measuring the
cash flows when he wrote his book; cash flow statements only became standard
practice from 1987.

There are very few differences between the authors trajectory analysis portion of the
theory. In many circwnstances, they are very vague in the application of this portion
of the theory, although chapter 5 covers this in more detail. The major difference is
on how the trajectory line is constructed. Argenti (\976a) argued for a subjective
construction. McRobert and Hoffman (1997) stated that the trajectory line should not
be constructed objectively. but did not expressly discuss how to construct the

16 Two mentioned by McRobert and Hoffman (1997) are ' financial statements' and ' cosmetic

aCcOlUlting' .
17 McRobcrt and Hoffman (1997)'s method involves the use of a spreadsheet. This is an analysis
calculating the operating cash flow using the indirect method, listing finance and investment needs,
listing how the company funds its needs, and calculating the actual cash increase or decrease over the
year in question.
 44

trajectory line. Since McRobert and Hoffman (1997) discounted an objective

construction, this only leaves some type of subjective construction. By not stating
this, McRobert and Hoflinan (1997) left a question mark on how a person will
construct the trajectory.

The last difference is on the number of failure trajectories. McRobert and Hoffman
(1997) are adamant that only three trajectories exist. Argenti (1976a) contradicted
himself by firstly stating that three trajectories will explain all company failures and
then suggesting that some companies will fail after never following any of the fai lure
trajectories. Ignoring Argenti (1976a)'s apparent contradiction, the authors are both
stating a similar idea: that three trajectories explain all company failures.

The are many differences between Argenti (1976a) and McRobert and Hoffman's
(1997) description of the theory. However, the general propositions of their theory is
clear. The following section will introduce the two parts of AMH's theory of
corporate failure.

4.2 The subparts of Argenti, McRobert aud Hoffman's theory of

corporate failure

Philosophers (for example, O'Hear, 1989) have argued that there are two major types
of theories: explanatory and predictive. Explanatory theories explain why certain
events happen; they do not try to predict when it will happen. By contrast, predictive
theories will state whether an event will happen, or what needs to happen for the event
to occur. It is not necessary for a predictive theory to explain why the event happens;
its only interest is· whether it happens 18• These types of theories are not independent;
a theory can have both predictive and explanatory power.

II O'Hear (1989) provided a simple example of a predictive theory in terms of an owl sitting on a
flagpole and looking at a mouse. He noted that, by using Pythagoras' Theorem, one can predict the
distance from the mouse to the owl. when we know how far the mouse is from the flagpole the owl is
on. Thus, Pythagoras ' Theorem has predictive power. It has very little explanatory power; we would
not say that the theorem explained the distance of the mouse to the owl (O'Hear, 1989, p. 9).
 45

AMB's theory of corporate failure seems to have both explanatory and predictive
power. Indeed, we can split the theory into two particular sub-theories: one that
predicts which companies fail, the other predicts when companies fail.

Sub-theory 1 identifies what makes a company fail; that is, the causes inherent in the
company's business structure and the symptoms that the company exhibits as it moves
towards failure. This theory proposes the most likely causes and symptoms that best
discriminate between companies that fail and those that do not. All causes and
symptoms stem from one major cause, defects in the company's management
structure. This sub-theory has both explanatory and predictive power; it states how
and why a company fails and it predicts which companies will fail. However, it does
not predict when companies fail.

Sub-theory 2 conce:ns the trajectory analysis portion of the theory of corporate

failure. AMH proposed three types of trajectories companies can follow when they
fail. All of the trajectories are measured over time; the relevant period is from when
the company begins to collapse to when the company fails. The theory uses several
indicators to illustrate the trajectories; these indicators are qualitative, quantitative,
financial and non-financial. This is a predictive theory. It predicts if a company will
fail; it does not explain how or why it fails.

The remainder of thi s chapter will discuss sub-theory two. The objective of this thesis
is to examine AMH's failure trajectory portion of their theory. The following section
will evaluate whether this portion of their theory needs further development before
being applied to Air New Zealand.

4.3 Evaluating the failure trajectory portion of the theory of

corporate failure

This section will evaluate how testable trajectory analysis 19 is in its current fonn. As

was mentioned in chapter 2, AMH did not create a trajectory using actual data (real or

I'Hereafter, when discussing Argenti (I976a), and McRobert and Hoffman's (1997) failure trajectory
portion of their theory of corporate failure, this thesis will use the term "trajectory analysis".
 46

hypothetical). Instead, they retied on anecdotal evidence to illustrate each trajectory.

Therefore, it seems appropriate to evaluate trajectory analysis, as summarised in

sections 2.1 and 2.3, to dctcnnine whether it can he applied to create a company's
trajectory.

Table 4.2 reproduces Zallman et al. 's (1973) 16 criteria for theory evaluation. They

detennined their criteria from an examination of the literature, although they based

their criteria largely on work done by Bunge (1967a; 1967b). One point of note is

that Zaltman et aI's (1973) subject area was consumer research. However, because

they drew their criteria from the literature, their criteria are sufficiently broad enough

to be used to evaluate trajectory analysis. From their discussion of each criterion,

Zaltman et al. (1973) viewed these two criteria as absolutely necessary for a good
theory: internal consistency and empirical interpretability. The following paragraphs

wi1l expand on some of the criteria to evaluate trajectory analysis (assume that a given
criterion is met if it is not discussed).

The second criterion is internal consistency. A theory should contain no logical

contradictions. AMH's trajectory analysis theory contains three contradictions. One

contradiction involves their definitions of failure. Each author has defined failure

differently; however, they both contradicted themselves when defining the failure

state of general health (corporate wellbeing) as when a receiver is appointed. This

differs from both their definitions. The second one involves Argenti's (I 976a) belief

that ·three trajectories explain all failures, whilst also stating that many failures will
happen without moving down the trajectories. The final contradiction involves the

measurement of the trajectory. AMH state that corporate indicators (such as profit

and turnover) do not represent the trajectory. However, one of their indicators is

calculated using a profit figure (return on capital). These contradictions mean that

trajectory analysis does not meet criterion 2.

 47

Formal Criteria
I. Well-fonnedness The theory obeys the rules of "fonnation" and "transformation"
(elementary logic).
2. Internal Consistency The theory contains no logical contradictions.
3. Independence The theory has primitive-concepts independence and axioms
independence.
4. Strength The theory entails other theories.
Semantfeal Criteria
5, Linguistic exactness The theory exhibits nummum intensional and extensional
vagueness.
6. Conceptual unity The components of the theory refer to the same set of behavioural
phenomena.
7. Empirical interpretability The theory is operationalisable (interpretable in empirical tenus).
8. Representativeness The theory deals with deep mechanisms.
Methodological Criteria
9. Falsifiability The theory is fa lsifiable - that is, confrontable with reality (facts).
10. Methodological simplicity The theory is easy to build and test.
Epistemological Criteria
11 . Confmnation The theory coheres with facts.
12. Originality The theory increases knowledge by deriving new propositions.
13. External consistency The theory is consistent with existing knowledge.
14. Unifying power The theory connects previously unconnected items.

15. Heuristic power The theory suggests new directions for research.
16. Stability The theory is able to accommodate new evidence.

Table 4.2: Suteen crllertafor theory evaluatwn

Source: Zaltman, Pinson and Angelmar (1973), table 5.3, p.I04.

AMH have not defined several tenns. Firstly, they have not defined 'general health'
or 'corporate wellb.eing' . what the trajectory is measured against. Additionally, there
are five different states of financial health or corporate wellbeing. Only one of these
states (failur:e) has been defined and distinguished from the others. Secondly, they
have not defined 'indicators' or 'factors'. the items that are meant to measure the
trajectory. A sub-set of indicators and factors is 'corporate indicators'. which should
not be used to shape the trajectory. All these undefined terms mean that the theory
does not meet criterion 5, linguistic exactness.
 48

Criterion 7 expects the theory to he empirically interpretable. In other words, a theory

must he able to be tested in some way, whether it is by experiment, case study or in
some other way. As trajectory analysis currently stands, this is not possible. Let us
assume to satisfy criterion 2, return on capital is not used to shape the trajectory, only
the other four indicators could he used. Furthermore, assume that the company
evaluated using the trajectory does not have a share price (that is, it is not publicly
tradable) and thus, no stock market share value. Thus, the three non-financial
indicators would evaluate this company's trajectory. The problem here is how to
measure the non-financial indicators using publicly available information. If they
cannot be measured using publicly available infonnation, nothing suggested by
trajectory analysis can shape the trajectory. Even if the non-financial indicators could
be measured, how are they combined into the trajectory? AMH only stated that the
trajectory would be subjectively merged; this comment provides no real guidance on
how to do so. Therefore, trajectory analysis does· not meet criterion 7, because the
theory is not currently operational.

The trajectory analysis theory did not meet three criteria, including two that are very
necessary for a good theory. Clearly, trajectory analysis needs further development
before it can used to evaluate whether a company is failing and what trajectory the
company is travelling on as failure approaches. Specifically, the theory has to have
the contradictions removed, it needs several tenus defined, and finally, it needs to be
made operational.

4.4 Summary

This chapter has evaluated AMH's trajectory analysis. There are many differences
between the respective authors description of the theory of corporate failure. Some of
these apply to trajectory analysis, and cause problems when evaluating trajectory
analysis using Zaltman, Pinson and Angelmar<s (1973) criteria. In evaluating
trajectory analysis against the sixteen criteria, it was found to be lacking in three
criteria. Consequently, trajectory analysis needs further development before it can be
empirically used. The following chapter will develop trajectory analysis to satisfy the
three criteria. Thus, chapter 5 will resolve the inherent contradictions in trajectory
analysis, provide definitions for the tenus left undefined by AMH, and make
trajectory analysis operationaL
 49

Chapter 5: Trajectory Analysis for a more Complex Age

5.0 Introduction

The previous chapter evaluated trajectory analys is. It found that AMH's trajectory
analysis theory did not meet three of the sixteen criteria in applying Zaltman et ai's
(1973) theory evaluation test. As two of the three criteria are necessary to produce a
good theory, they all have to be corrected before a trajectory can be produced. This
chapter will develop trajectory analysis to satisfy the criteria found lacking in
app lying Zaltman e/ aI's (1973) theory evaluation test.

This chapter is structured to discuss the three criteria the theory did not meet:
linguistic exactness, ~nternal consistency and empirical interpretability. Thus, Section
5.1 wi1l provide definitions for the terms undefined by AMH. Section 5.2 evaluates
the number of failure trajectories and whether corporate indicators should be used to
shape the trajectory. Section 5.3 develops trajectory analysis into an operational
theory. A summary fo llows in section 5.4.

5.1 Definitions for undefined terms

AMH did not define several terms. In doing so, they made trajectory analysis so
vague that it would be difficult to use. This section provides definitions for the
fo llowing terms: ' general health' or 'corporate wellbeing ', the five states of general
health or corporate wellbeing, the ' indicators' or 'factors' that shape the trajectory,
and 'corporate indicators'.

,
5.1.1 Definition for financial health (corporate wellbeing)

The authors have not defined either one of these terms in their texts. In the previous
chapter, it was suggested that they both meant the same thing. Possibly, AMH meant
the every-day use for these terms. For each of these terms, dictionary definitions have
been provided:
 50

• Health: the overall condition of an organism at a given time, freedom from

disease or abnormality. A condition of optimal wellbeing .
• Wellbeing: the state of being happy, healthy or prosperous20.

From the above definitions, the idea of what the authors mean by health or wellbeing
is becoming apparent. For the purposes of the present di scussion, we can equate
general health with the general condition of the company; corporate wellbeing relates
to the state of being healthy and prosperous. Since the term's "health" and
"wellbeing" are synonyms, the belief that AGM were discussing the same concept is
correct. Therefore. company health 21 relates to the general prosperity of the company.
The more prosperous a company is, the healthier the company, and the more positive
the trajectory.

5.1.2 Distinguishing the five states of company health

There are five states of company health: failure, poor, good, excellent and fantastic.
However, AMH provided little detail on how to distinguish between any of the states.
AMH distinguished only the state of failure. Company failure only happens when the
receiver is appointed in (Argenti, 1976a, p. 153; McRobert and Hoffman, 1997, p.
105). The state of failure would also include the situation occurring when the
company is placed into liquidation or made insolvent (the terms differ depending
upon the legal system) . McRobert and Hoffman (1 997, p. 105) also asserted that the
state of fantastic is very rare. Nevertheless, how can one distinguish the other states?

There are two logical methods of distinguishing between the states of company
health. One method would be to distinguish them based upon a company' s
performance in relation to its competitors and/or applicable industry averages. The
second method would distinIDJish the different states of company health based upon a
company's actual performance over time.

20These definitions are taken from Dictionary.com

11 The remainder of this thesis will use the term "company health" when discussing the
health/wellbeing ofa company.
 51

The second method is useful when the company does not have major competitors or
industry averages. Companies in this situation include large domestic monopolies or
finns that dominate their market. A New Zealand example is Telecom Corporation of
New Zealand Limited, which has at least an 80% share of the market.

Table 5.1 sets out how to distinguish each state of company health using the two
suggested methods 22 . As in the case of the definition of company health, AMH
probably refer to the common meanings for each state of company health. The table
has applied the common meanings when distinguishing each state of company health.

State of Company Health Distinguishing Characteristics

Failure Occurs when the receiver ;, appointed. Alternatively. when a
stakeholder places a company into liquidation or it is discontinued in
some other way.
Poor The company perfonnance is worse than major competitors or industry
averages. Alternatively, it has negative cumulative cash flows or profits
and share market perfonnance is worse than the stock market.
Good Company perfonnance ;s on po< mth competitors and industry
averages. It has stable perfonnance: return on capital is consistent over
time, share market perfonnance is similar to the market index, and
cumulative profits and cash flow will be positive.
Excellent The company exceeds industry averages or competitors. Company
growth (measured by profits, cash flow, turnover, etc.) is greater than
inflation. Return on capital increases compared to previous periods.
Share market performance exceeds the market index
Fantastic The company's perfonnance seems unreal compared to ;ts
competitors/industry. For example, the company enjoys profits and
positive cash flow whilst its competitors in the industry make losses.
Alternatively, the company breaks and continues to break their
perfonnance records.

Table 5.1: D.lStmr:ulshmg each state of company health

Notwithstanding McRobert and Hoffman's comments, it is clear that every state

(apart from failure) of company health is reachable many times. Companies exist in a

22 For the purpose of these examples, each state of health is distinguished using financial information,
The nature of how financial performance is used to distinguish good performing companies from poor
perfonning companies makes it the obvious choice to distinguish each state of health.
 52

cyclical economIC environment and during the booms and recesSIOns, their
performance will change. A company may enter the fantastic state during a boom,
fall to a lower state during the subsequent recession and recover to reach the fantastic
state again in the following boom.

5.1.3 Definition of indicators (factors)

Argenti (1976a) used to term 'indicators' to describe the items that should shape the
trajectory. By contrast, McRobert and Hoffman (1997) used two terms, indicators
and 'factors' , Obviously, while not defining either term, McRobert and Hoffman's
(1997) interchange ofthe terms suggest that they mean the same thing.

AMH mentioned five items that are indicators: return on capital, stock market share
value, employee morale, relationship with customers and reputation with suppliers.
These items include accounting, market and non-financial information. Expanding on
these items, 'indicator' seems to relate to anything that can measure company health.
It would therefore include the financial results (summarised in their annual reports),
market information (such as share prices and market values), and any non-financial,
qualitative, infonnation concerning the operations of the company. Because of its
generality, indicators should include both publicly available and private infonnation,
although only publicly available infonnation will be available to analysts.

McRobert and Hoffinan (1997) introduced 'corporate indicators'. Examples provided

for this sub-set of indicators included profits and turnover. It seems what they
referred to here w~uld be accounting information: data created by accountants and
affected by .changes in accounting policies. Thus, following this reasoning, all
corporate indicators would be created by accounting information, most likely
summarised in their rumual reports.

Additionally, tWo other sub-sets of indicators are possible. The first sub-set is market
indicators, made up of all share market information. The second sub-set is non-
financial indicators, which includes all non-financial, qualitative infonnation.
 53

,
,
f' 5.1.4 Summary

This section has dealt with improving the trajectory analysis theory' 5 linguistic
exactness. It defined several teons, including company health (what the trajectory is
measured against) and indicators (what measures the trajectory). Finally. the five
states of company health have been detailed to provide a blueprint to determine when
the trajectory moves into a new state of company health.

5.2 Contradictions in trajectory analysis

This section deals with the contradictions contained in AMH's theory. The first
contradiction involves the definition of failure. The second one regards how many
failure trajectories are needed to explain all failures. The third contradiction concerns
whether corporate indicators shape the trajectory.

5.2.1 The definition of failure

As discussed in chapter 4, Argenti (1976a), and McRobert and Hoffinan's (1997)

definitions of failure differed. Their contradiction occurred when AMH stated that
the failure state of company health happened when the receiver was appointed (which
differed from both definitions). This subsection will resolve the contradiction by
detennining which definition of failure is most appropriate in the theory.

Tobin (1996) noted that different studies have defined failure at different points in the
corporate distress process.
, These definitions included periods of poor profits, falling
market share and bankruptcy (see Tobin, 1996, pp. 14 - 15; Altman, 1968; Hambrick
and D'Aveni, 1988; Morris, 1997). Morris (1997) went as far as to include the
,
resignation of directors, a cut in dividends or the reporting of profits below forecast in
his meaning of failure. Therefore, definitions vary from the very narrow (that is,
b~ptcy) to the broad (Morris',1997, definition).

It seems appropriate to define failure in a way that it is generally consistent with other
studies. Thus, it would be the narrow definition of bankruptcy (Tobin, 1996).
 54

Bankruptcy can be equated with the appointment of a receiver, since in both cases the
company can continue to trade, restructure or be liquidated (ibid.). Thus, the
definition of failure for the purposes of trajectory analysis is at the point of
appointment of a receiver or when a company becomes bankrupt. The definition
would also include liquidation, Of a discontinuation in some other way. As such, the
definition is similar to Argenti's (I 976a) than to McRobert and Hoffman's (1997).

The choice of this definition also removes the contradiction mentioned above. This is
the same definition given to distinguish the failure state of health from the other states
(see section 5.1.2).

5.2.2 The number of failure trajectories

Chapter 2 outlined AMH's view to the number of trajectories that a company can
fcHow when it fails. They stated that there are only three trajectories; however,
Argenti (1976a) contradicted this view when he stated that companies would fail
without following any of the trajectories. To resolve this contradiction, this
subsection will examine whether more than three trajectories could exist, and
therefore whether the theory is falsifiable (criterion 9 ofZaltman el a/ 's, 1973, criteria
for theory evaluation).

Trajectory analysis states that there are three, and only three, failure trajectory types.
Two of. them involve newly formed companies, whereas the final trajectory type
concerns mature companies (see above. pp. 14 - 17). Given this simplistic view, it
seems apparent that there would be many more failure trajectories. For example, any
mature company that suddenly fails without experiencing an initial collapse will not
follow any of the proposed trajectory types. This mature company certainly does not
conform to a Type I or Type 2 trajectory since it is not a young company; it does not
conform to a Type 3 trajectory because there is not an initial collapse before failure.
This could be a 'Type 4' failure trajectory.

However, the trajectory does not have to conform precisely to one of the types (see
above, pp. 17, 31). What this means is that any company that looks to follow a
trajectory is on that trajectory. All companies that suddenly fail, regardless of their

•
.,f,
'''''. 55
"

age, will follow a type two trajectory. Any company that remains upon a plateau
before failing is a type three trajectory. The above example of a 'Type 4' trajectory is
only an offshoot of the Type 2 trajectory.

Nevertheless, the comments in the preceding paragraph are not entirely correct. For a
company to fal1ew a type two trajectory, the company must be incredibly successful
immediately before the downslide towards failure. Not all mature companies will fail
this way; neither will they all follow the Type 3 failure company. This leads us to the
question of the mature company that has been reasonably successful yet collapses.
Figure 5.1 provides an example of this type of failure. Does this mean that the theory
is wrong, and another failure path exists? It is possible, however to include a fourth
trajectory type, a company would need to fail in a way similar to that given in figure
5.1.

The purpose of Argenti's (1976a) contradiction was to ensure that trajectory analysis
was falsifiable and stable (criterion 16). The discussion above indicates that there
may be more than three failure trajectories. His contradiction was to explicitly state
that the number of trajectories could grow. If a fourth trajectory existed, the theory is
stable enough to include that additional evidence. A less confusing way to state that
the theory is falsifiable is summarised in the following paragraph.

General
Health
Fantastic

Excellent

Good

Poor

Failure

Time

Figure 5.1: Hypothetical Type 4 failure trajectory

 56

Based on the current evidence (Hambrick and D'Aveni, 1988; Laitinen, 1991), only
three failure trajectories exist. However, while more trajectories may exist, there is no
actual evidence to prove the existence of another trajectory type. Therefore, the
theory needs only to include the currently known trajectory types.

5.2.3 Should corporate indicators shape the trajectory?

The third contradiction concerns the usefulness of corporate indicators to shape the
trajectory. AMH stated that no COlporate indicators shape the trajectory, although
they then use one (return on capital). Section 4.3 suggested that, ignoring corporate
indicators that measure the trajectory. no indicators would shape the trajectory in
some situations2J , This subsection will resolve this contradiction.

Why are corporate indicators excluded from trajectory analysis? According to AMH.
this is because they are subject to annual fluctuations and affected by creative
accounting techniques (see above, pp. 14, 30). If each problem can be resolved,
corporate indicators can shape the trajectory.

Firstly, in examining annual fluctuations, contrary to AMH's beliefs, annual

fluctuations should add to the analysis. The trajectory changes based upon changes in
company health, which is affected by annual fluctuations in the perfonnance of the
comp~y. Annual fluctuatio~s indicate a change in the state of company health; an
upward trend in annual fluctuations would indicate a positive change to company
health and vice-veq;a. In effect, annual fluctuations create the shape of indicators, and
therefore, the trajectory.

The second problem with corporate indicators is how creative accounting techniques
affect them. AMH argued that a cQmpany would employ creative accounting to mask
falling performance (Argenti, 1976a, p. 142; McRobert and Hoffman, 1997, p. 89).
Can analysts identify and adjust for creative accounting techniques?

23 Companies affected include ones that do not trade on a stock exchange and do not release any
information concerning the non-financial indicators.
 57

Smith (1996) seems to think so. Terry Smith wrote a book, targeted to non-
accountants, which identified particular creative accounting techniques and suggested
'survival techniques' to identify creative accounting. He summarised all fOnTIS of
creative accounting into one of the following four categories: inflating reported
profits, reporting profits at the expense of the balance sheet, reporting profits without
an equivalent amount of cash, and lowering reported borrowings.

To identify creative accounting techniques, Smith (1996) suggested reading the

accounts backwards (that is, read the notes to the accounts before the financial
statements) and to read the accounting policies. The second point is interesting; he
does not suggest this to check for compliance with generally accepted accounting
principles, but to see whether any changes in accounting policies increase profits.

To expand on Srnith~s (1996) argument, anyone can examine an annual report and its
financial statements for creative accounting techniques. Instead of concentrating on
just the financial statements, an analyst should read the accounting policies for
changes in policies that increase profits or remove liabilities from the balance sheet.
Additionally, it would involve adjusting these changes by reversing the appropriate
journal entries (for profit policy changes) or creating journal entries to bring them on
balance sheet (for liability policy changes).

The major difficulty with this process is that it negatively affects Zaltman et aI's
(1973) ~riterion 10. An examination of a company's annual report for creative
accounting techniques, and adjusting the data for them, means a much more time-
consuming and difficult theory to build and test. However, it ensures that any
corporate indicators that shape the trajectory can be relied on to be not affected by
creative accounting.

5.2.4 Summary

This section has discussed the three major contradictions in trajectory analysis. The
first contradiction is resolved by redefining failure so that it is broadly in line with
other researchers. In doing so, the general definition of failure is the same as that
given for the failure state of company health. The second contradiction is resolved by
 58

acknowledging that more than three failure trajectories could exist. However, current
evidence (including Laitinen, 1991; Hambrick and D'Aveni, 1988) only suggests the
three trajectories defined by AMH. The final contradiction is resolved by removing
the proposition that corporate indicators will not shape the trajectory. Instead,
corporate indicators will be evaluated and adjusted for any creative accounting
techniques. If the corporate indicators are not affected by creative accounting, they
can be used to measure the trajectory.

5.3 Developing trajectory analysis to be operational

This section detai ls how to make the theory operational, by discussing three areas of
interest. These are the [cHawing (each discussed in their own subsection):
1. what will measure the trajectory;
2. how to measure each indicator;
3. how to create the trajectory.

5.3.1 Wbat will measure the trajectory?

AMH suggested five indicators to shape the trajectory: return on capital, stock market
share value, employee morale, reputation with customers, and relationship with
suppliers. They chose these indicators because they were more difficult to conceal.
This subsection will outline what indicators should shape the trajectory, having regard
to one limiting factor: the indicator must be calculable using publicly available
information. If the indi cator is not calculable using publicly available information,
only certain people who have access to the data to calculate the indicator could create
the trajectory, thereby making trajectory. analysis less operational. The subsection
will deal separately with each major indicator subset and suggest the indicators that
will be used in this thesis to calculate the trajectory.

5.3.1.1 Corporate Indicators

Generally, a company with good performance creates both profits and cash.
However, only a profit measure is currently included as an indicator. This is strange,
 59

considering that AMH argued how useful cash flows are as an early detection of
failure. Furthennore, cash flow is less affected by creative accoWlting teclmiques
(Smith, 1996, p. 189). It is appropriate to include a cash flow indicator, because it is
fundamental to the survival of any company, less affected by creative accounting
techniques and advocated by AMH.

This thesis advocates the Operating Cash Flow after Interest and Dividends
(OCFAID) method (Robb, 1999; Robb and Lewis, 2001) to measure both the cash
flow and profit changes. This process involves calculating the profits and cash flow
retained by the company; effectively, adjusting for any distributions made to the
stakeholders. To allow for trend analysis, the process cumulates cash flows and
profits over time.

The third advocated corporate indicator is the debt to equity ratio. This ratio
evaluates the financial risk of the company. Generally, a company with more debt is
riskier than a comparable finn with less debt is, as the fOlmer have to earn more to
meet their interest payments. The fonnula is the simple total debt divided by total
equity version, because in a failure situation "it does not matter whether the debt is
long or short - only the overall amount ofdebt" (Robertson, 1983, p.26).

Return on capital employed (ROCE) is the final advocated corporate indicator. This
indicator is calculated by dividing profits before interest and tax by capital employed
(the formula suggested by Argenti, 1983; 1984). This indicator uses an operating
profit measure, rather than the consolidated after-tax profit measure used by the
OCFAID analysis . .

5.3.1.2 Market Indicators

AMH advocated using the stock market share value (SMSV) to shape the trajectory.
To calculate SMSV, simply multiply the share price with the total n~ber of shares
issued. Other possible market indicators are the share price (which is not influenced
by the number of issued shares) and the Price to Earnings (PIE) ratio (calculated by
dividing the share price by the earnings per share (EPS)).
 60

The reasoning behind the use of SMSV and the share price is simple: an increasing
share price (SMSV) means that the market believes that the company is improving,
and vice-versa. However, this is not always the case: share price dilution can occur
because of bonus shares and share splits, the SMSV may not show major decreases in
the share price, precisely because of increases in issued shares. Therefore, this thesis
advocates using both SMSV and the share price to measure the trajectory. SMSV will
provide the total market value of the company and the share price will evaluate the
market's rating of the company without the influence of the number of shares issued.

This thesis does not advocate the use of the PIE ratio for two reasons. Firstly, there
are differing opinions regarding what the ratio measures: it has been described as a
measure of future performance or the time it will take the company to recover the
shareholder's investment (McKenzie, 1998). Secondly, the ratio can become very
large: for example, i.f a company's EPS is close to zero and the share price remains
unchanged, the PIE ratio will approach infinity. Based on how the trajectory is
calculated (see section 5.3.3), this would produce a spike in the trajectory.

5.3.1.3 Non-financial Indicators

AMH advocated three non-financial indicators. However. the major problem with
non-financial indicators is in their measurement. If they cannot be measured with
publicly available information, we effectively cannot measure them. Publicly
available proxies are available to estimate these non-financial indicators; however,
they will not provide exact measurements of these indicators, simply because they are
only proxies.

This thesis does not advocate the use of non-financial indicators for the following
reasons. Firstly, they are too problematic and difficult to measure. It is too time
consuming to individually measure each non-financial indicator, negatively affecting
criteria 7 and 10. Secondly, the best measurement of non-financial indicators requires
the use of privately available infonnation, Thirdly, non-financial indicators are
difficult to interpret. For example, what does good morale mean? It is definitely not
that clear-cut: Argenti (1976a) discussed this by pointing out that low morale is a
 61

symptom of a failing company. but can also exist in a successful company. However,
even a company close to fai lure can have high morale (Argenti, 1976a, p. 144).

In summary, there are six indicators advocated in this thesis to shape a company's
trajectory. These are the following: cumulative OCFAID, cumulative retained
earnings, ROCE, debt to equity ratio, stock market share value, and the share price.

5.3.2 How to measure each indicator

The indicators discussed above can be calculated in a variety of ways. This

subsection will outline the methods used in this thesis to calculate each of the
indicators. Obviously, for the corporate indicators, the financial reports produced by
the company will contain most of the needed information. The market indicators are
obtainable from databases that contain historical share pnces. A database that
contains most New Zealand companies share prices from 1990 is DATEX.

With respect to the financial indicators (debt to equity ratio, cumulative retained
earnings, cumulative OCFAID, and ROCE), there are two available techniques for
measurement: using the information contained in the fmancial statements, or to use
24
that infonnation plus the infonnation disclosed in the notes of the accounts • This
thesis advocates using both teclmiques. Firstly, calculate the indicators using only the
financial statements. Secondly, calculate the indicators using the financial statements
after adjusting for information contained in the notes to the accounts. Using both
measures will allow us to capture the difference between the company's "best-case"
position (assumed to be what is reported in the financial statements) and the possible
"worst-case" position (after making the changes for off-balance sheet items).
Unfortunately, this method adversely affects Zaltman e/ af's (1973) criterion 10,
making the theory more difficult to test.

The market indicator (SMSY and the share price) is easy to calculate if the company's
shares are publicly tradable on a stock exchange. The company's .primary stock

H This information may be additional disclosure required by accounting standards, or voluntary

disclosure made by the company. Typical disclosure includes market values of assets or off-balance
sheet items that could be termed liabilities.
 62

exchange should be used to calculate the indicators if the company trades on more
than one exchange. However, what happens if the company's shares are not publicly
tradable? Only a small percentage of companies are publicly tradable on a stock
exchange. The remainder are either privately held companies or owned by the
Government. These companies do not have any market share price data and cannot
easily produce the market indicators.

This thesis proposes two solutions to this problem. The first is to use finance
techniques to calculate a proxy about the company. The process involves firstly,
finding a comparable publicly traded company to the non-traded company. Then
calculating certain finance variables from the publicly traded company. Finally,
adjusting the variables for the non-traded company's risk factors, and use those to
calculate a proxy share price. The process is well covered elsewhere (for example,
Damodaran, 1997). -:rhe second solution is to discard the market indicators altogether
and concentrate on the corporate indicators. This thesis advocates the second solution
only if the other indicators are well measured, or if calculating the proxy proves too
difficult.

This section outlines the major methods used to measure the indicators. Financial
information is straightforward to obtain, as it is available from the annual reports.
However, for each corporate indicator, there is a best-case and worst-case scenario.
Market information is easy to detennine as long as the company is publicly tradable;
if it does not trade on the market, the calculations can be very difficult.

5.3.3 How to calculate the trajectory

Trajectory analysis stated that the trajectory is subjectively created from all the
measurers of cOJ)1pany health. The trajectory cannot be objectively created using
some type of universal mathematical fonnula. This subsection describes the process
used in chapter 8 to create Air New Zealand's trajectory.

The first step will be to calculate the indicators as described in the previous
subsection. This will result in three sets of data: the market indicators, the best-case
corporate indicators and the worst-case corporate indicators. Because there are two
 63

sets of corporate indicators, it will be appropriate to create two interim trajectories.

The first trajectory will be the "best-case" scenario, calculated using the market and
best-case corporate indicators, The second trajectory will use the market and worst-
case corporate indicators to calculate the "worst-case" scenario. A mid-point between
the two extremes will be the final trajectory. How to calculate the trajectory line is
provided below.

The second step will be to create the trajectory line. This process will involve
standardising the indicators. Firstly, standardise all the indicators to one base year.
The standardised amount is 100. The base year should be the first period that every
indicator is calculated. Secondly, for · each period, calculate the average of the
indicators: the graph of the resulting amounts will be either the best-case or worst-
case scenario trajectory line. Thirdly, calculate the average of the two interim
trajectory lines. Th~ resulting amounts will be the final trajectory.

Whilst this is a simple way of calculating the trajectory, the process discussed above
suffers from a major fault. The process ignores the possibility that certain indicators
are more important than the others as failure approaches (Sheppard, 1994). For
example, cash flow is fundamental to company survival; if a company cannot create
cash, it will ultimately fail. Therefore, it seems appropriate that OCFAID (the cash
flow measure) would be the most important indicator.

A weigJ1ting system for the company indicators would eliminate the fault discussed in
the previous paragraph. Weighting each indicator will adjust them for their relative
importance. A higher weight can be given to a more important indicator, which
would allow that indicator to have more influence on the trajectory.

The weights would have to be detennined subjectively. There are two reasons for
subjectively created weights. Firstly. it would satisfy the requirement in the theory
that the trajectory is subjectively created. Secondly, any objective method used to
create the weights has validity problems. The weights would be valid only for the
period they were created for. For example, Altman's Z score model used data from
1946 - 1965 to calculate his model (Altman, 1965). The weights used in his model
 64

are valid for investigating failure only during the period 1946 - 1965. The weights
cannot be generalised to other periods, and are not valid outside of the United States:
Altman's (1965) period of study. There are several other problems with an objective
method, which have been discussed elsewhere (Robertson and Mills, 199Ib).

It is not an aim of the thesis to produce universal weights for calculating the
trajectory. It falls outside of the scope of the thesis. To provide these types of
weights would require the use of a sample of failed and non-failed companies.
Nevertheless, a sensitivity analysis, contained in chapter 8, wilt investigate the affect
of different weights on Air New Zealand's trajectory.

S.3.4 Summary

This section improves trajectory analysis's empirical interpretability. Six indicators

. shape the trajectory; each is measurable from publicly available infonnation. The
three non-financial indicators advocated by AMH were removed because of the
difficulty of measuring them using non-financial data. A method to calculate each
indicator is suggested. resulting in two sets of data: a best-case and a worst-case
scenario. Finally, this section provides a method to measure the trajectory. This
method involves standardising the indicators to a common amount and averaging
them to produce the trajectory.

5.4 Summary

This chapter re-examined AMH's trajectory analysis theory to correct the portions of
the theory that did not meet Zaltman et ai's (1973) criteria. The criteria were
linguistic exactness, internal (:onsistency and empirical interpretability.

The chapter improved the theory's linguistic exactness by defining several tenns and
by providing a method to distinguish the five states of company health. Internal
consistency was resolved by removing these contradictions from the theory: allowing
for the increase in the number of failure trajectories and allowing the use of corporate
indicators in calculating the trajectory. Finally, providing a new list of indicators to
 65

measure the trajectory helped refine empirical interpretability. Additionally. this

chapter suggested methods to measure the indicators and calculate the trajectory also
improved empirical interpretability.

The theory outlined in chapter 2, adjusted for the comments in this chapter, is the
theory tested in chapter 8 using Air New Zealand as a case study. However, before
the trajectory can be calculated, the accounting infonnation that calculates the
corporate indicators has to be examined for creative accounting.

Therefore, this seems to be an appropriate time to introduce the case study, Air New
Zealand Limited. Chapter 6 will provide an overview of the company, concentrating
upon the period of study, 1989 - 2001. Chapter 7 will examine Air New Zealand's
accounting policies, to meet the requirements discussed in the previous paragraph.
 66

Chapter 6: A Brief History of Air New Zealand Limited

6.0 Introduction .

To allow for the examination of AMH's trajectory analysis, this thesis will use a New
Zealand company, Air New Zealand Limited, as a case study. This chapter will
provide a brief history of Air New Zealand. This is done primarily to provide a
comparison between the slope and direction of the trajectory and the actual events as
they happened. If the trajectory closely matches the actual events, it implies that the
trajectory is a faithful presentation of the performance of the company.

Section 6.1 will discuss the early years of Air New Zealand, from its inception in
1940, to the merger with the National Airways Corporation in 1978, and finally its
privatisation by the New Zealand Government in 1989. This section will concentrate
only on these major events of the company during the first fifty years of its existence.
Section 6.2 will discuss the company whilst it was under the ownership of private
enterprise, and wi ll cover the period 1989 - 2001. It will have a broader application
than section 6.1, discussing the major factors that affected Air New Zealand's trading
environment, its financial results and the major changes in ownership and control.

6.1 The early years of Air New Zealand": 1940 - 1989

This section wi ll outline three major events of the company history during the period
before the Government privatised the company in 1989. Section 6.1.1 will outline the
creation of the airline under its pre-merged names: Tasman Empire Airlines Limited
and the National Airways Corporation. Section 6.1.2 will discuss the merger of the
two companies in 1978 and the immediate results of the merger. Finally, Section
6.1.3 will outline the reasoning for the privatisation of Air NZ.

2S Hereafter, this thesis will refer to Air New Zealand as Air NZ.

,
.,
.
 67

3.1.1 Air New Zealand's beginnings

Air NZ began operations in April 1940 under the name Tasman Empire Airways
Limited (TEAL). TEAL was a joint operating company owned by four separate
entities: Qantas Empire Airways (with a 23% equity stake), British Overseas Airways
Corporation (BOAC; 38%), Union Airways of New Zealand (19%) and the New
Zealand Govenunent (20%) (Thomson, 1968; Rennie, 1990). Qantas was tbe
Australian Government's representative in the venture, BOAC represented British
interests. Union Airways, the largest private carrier operating in New Zealand at the
time (Rennie, 1990, p. 7), was the New Zealand nominee. Union Airways originally
held a 39% stake in the company, but the New Zealand Government took its stake to
ensure that private enterprise did not have the majority of New Zealand shares in
TEAL (Renni e, 1990). However, when the New Zealand Government nationalised
Union AilWays in 1945 - 47, it became the major shareholder in TEAL.

The company, as the name suggests, was set up primarily to cater for trans-Tasman
flights between New Zealand and cities on the East Coast of Australia. Indeed, its
first flight on 30 April 1940 was between Auckland and Sydney. TEAL did not
operate domestically; this was the domain of private enterprise, until tbe passing of
the New Zealand National Airways Act on 28129 November 1945 (Aimer, 2000).
Tbis Act authorised the National Airways Corporation (NAC) to operate the domestic
and overseas routes excluding trans-Tasman routes, which TEAL serviced.

The National AilWays Act nationalised three privately owned companies (Union
Airways, Air Travel (NZ) Ltd and Cook Strait Airways) and the RNZAF Air
Transport Service into NAC (patterson and Wallace, 1997, pp. 22-23). NAC did not
begin operations until 1 April 1947, 15 months after the passing of the Act, to allow
for the transition from private to State control. NAC, after its launch, serviced both
islands and several regional routes to South Pacific Islands (including Fiji, Norfolk
Island, Tonga, Samoa and the Cook Islands) (Rennie, 1990, p. 34). By 1948, it held a
monopoly on the domestic routes (Rendel, 1975, p. 39). which it kept until its merger
with Air NZ in 1978.
 68

TEAL experienced many changes after its creation. NAC, which was told by the New
Zealand Government to concentrate only on domestic routes, relinquished their
international routes to· TEAL in 1951 (the Pacific route, renamed the Coral Route) and
1954 (Norfolk Island route) (Aimer, 2000, chapter 4). TEAL expanded into other
routes that provided services to other countries. Excluding the Pacific routes
discussed above, the first non trans-Tasman route serviced by TEAL was the
Auckland - Los Angeles route on 14 February 1965 (Rennie, 1990, p. 176).

The first change in TEAL's ownership occurred in 1949. This change acknowledged
the British Govenunent's withdrawal from Pacific routes. The New Zealand
Government still was the majority owner (with 50%), Qantas's stake increased to
30%, whereas BOAC's fell to 20% (Thomson, 1968, p. 64). Five years later the
British Government decided to withdraw from participation in the South Pacific.
Consequently, the New Zealand and Australian Governments became equal
shareholders in TEAL, after the Qantas and the BOAC holdings was transferred to the
Australian Government in December 1954 (Rennie, 1990, p. 173). The two
Governments continued to be joint controllers of TEAL until April 1961 . when the
New Zealand Government purchased the Australian Government's share for $1.6
million (ibid. , p. 162). This deal also signalled the end of TEAL's monopoly on
trans-Tasman flights, with Qantas receiving 30% of trans-Tasman routes from
October 1961 , which increased to 40% the following April (Thomson, 1968, p 164).
In 1965, the now wholly owned New Zealand company renamed itself Air NZ, which
would reflect better the company's origins (Rennie, 1990, p. 176).

NAC consolidated from its early beginnings. The domestic routes increased until
1953, when they remained stable until the failure of South Pacific Airlines of New
Zealand (SPANZ) in 1965 (Aimer, 2000, p. 68). NAC carried over 90% of passenger
traffic up 10 the creation ofSPANZ, in 1960. SPANZ, NAC's first major competitor
was 49% owned by Ansett Airlines. The company had the potential to be a major
competitor to NAC, but was not allowed to fly on the profitable main trunk routes and
consequently failed in 1965 (Aimer, 2000, pp. 144 - 159).

Another competitor, Mount Cook Airlines, began operations in 1955. It operated the
tourist routes, mainly in the South Island lake regions; however, it also was prohibited
 69

from semcmg the maIO trunk (patterson and Wallace, 1997, Chapter 5). The
company ceased to be a major competitor with NAC when NAC invested in Mount
Cook in 1973 (with a 15% equity stake) (ibid., pp. 70 - 74). Finally, NAC took over
Safe Air in 1972, a freight carrier that operated mainly between Blenheim and
Wellington. Safe Air needed additional funds to purchase new aircraft, which it could
not raise itself. NAC could raise the money and Safe Air had no choice but to join the
state owned company or fail (ibid., chapter 4).

By the start of the 1970s, both companies were well run and efficient (Rendel, 1975).
However. a major change occurred in the 19705, with Air NZ and NAC merging on 1
April 1978.

6.1.2 The merger and its aftermath

Merger talks between the companies began as early as 1952 and agam In 1958.
However, at this time, the New Zealand Govenunent did not wholly own both
companies and the merger talks were shelved (Thomson, 1968). In 196 1, the then
National Government raised the idea of merging the two companies again and went as
far as merging the TEAL and NAC boards of directors in October 196 1. An
independent report (the Barr, Burgess and Stewart report) presented in June 1965
halted the merger. It reported that the two companies had a close relationship that
would not improve if the Government merged them; the report also advocated
separate Boards and Chainnen for each company. The Government implemented
their recommendations and the merger talks subsided until 1972 (Aimer, 2000).

Air NZ reopened the merger talks in 1972. They argued that long~tenn savings would
occur if the two companies merged. However, another reason for the merger was so
Air NZ could use NAC's resources to heJp it compete internationally. The General
Managers report (Keppel-Patterson report) into the merger, completed in 1974, like
the 1965 report, advocated keeping the status quo. The report could see no long-tenn
savings if the companies merged. The Labour Government agreed and the two
companies remained separate for another four years (Aimer, 2000, pp. 223 - 225).
 70

The final merger talks began in 1977. The reasons for the merger, as seen by Air NZ,
included the following: it would provide long-lenn benefits, it was in the National
interest, it would increase staff efficiency and other commercial reasons (Air NZ was
struggling internationally and needed the NAC sales offices to increase revenue)
(patterson and Wallace, 1997, p. 100; Aimer, 2000, pp. 238 - 239). It was also
suggested that the Ministries of Transport and Treasury advocated the merger to
increase their own control over NAC's operations (Aimer, 2000, pp. 230 - 232).
NAC's reasons against the merger were simple and had not changed since the 1960s:
the airlines were already efficient and the two companies had separate aims (NAC as
a short-haul public utility and Air NZ as a long-haul carrier). Additionally, they saw
inherent conflicts if the companies were merged (Aimer, 2000, p. 238). A hastily
completed report compiled in a few months (from September - December 1977) by
the Secretary of Transport found sufficient evidence of significant benefits to public
and nation from th~ merger. The National Government agreed and the merged
company began operations from April 1978. The new company was to be renamed
New Zealand Airlines, but after a public outcry, the Government retained the name
Air NZ (Aimer, 2000).

When the Prime Minister announced the merger, he suggested the following benefits:
savings of $8 - 10 million per annum, increased efficiency of all resources, fewer fare
increases and no staff redundancies (Patterson and Wallace, 1997, p. 97). Patterson
and Wallace (1997) showed that none of these occurred during the three-year period
suggested for the benefits to occur (ibid., pp. 99 - 104). The total losses made during
the merged company's first three years of operations were $52 million, although a
downturn in the aviation industry and high fuel costs severely affected profits. Fares
increased by 148%, at three times the rate ofNAC's fare increases during its last three
years of separate operations. Resource efficiency fell over the three years, as did staff
productivity.- Finally, there was no increase in market share.

Employee morale plummeted, because the NAC staff was concerned about their jobs
after the merger, and Air NZ employees were worried that the NAC staff would take
their employment opportunities. Employee morale was also adversely affected by the
Erebus disaster on 28 November 1979 that caused the deaths of 279 people and the
grounding of the DC-IO fleet. Both events adversely affected Air NZ's market share.
 71

Furthermore, Air NZ was heavily over-staffed, so its employees suspected that many
of them were going to lose their jobs.

The company turnaround began in 1981 with staff cuts of7% (626 positions). Fifteen
percent (1192) more lost employment in 1982". The company implemented several
short-term policies in 1981, including eliminating poor work practices, introducing
incentive fares to increase revenue and eliminating unprofitable routes (Patterson and
Wallace, 1997). Top management also produced a five-year plan in 1982 to return the
company to profitability (Air NZ, 1982). The turnaround was impressive with
cumulative profits of $304 million from 1983 - 1986 compared with cumulative
losses of$142 million from 1979 - 1982 (patterson and Wallace, 1997, p. 116).

6.1.3 The privatisation of Air New Zealand

Now that NAC and Air NZ were one company, discussion inevitably turned to its
privatisation. As markets became less regulated, Governments did not need to own
companies that would be better run under private enterprise. This was the policy of
the Labour Government from 1984 - 1989, that ultimately sold Air New Zealand to
the Brierley consortium made up of Brierley Investments, Qantas Airways, American
Airlines and Japan Airlines.

The sale process began when the Government stated an intention to sell 25% of the
company in its 1987 budget. Offers closed in May 1988, with two major airline
companies, Qantas and British Airways as the leading bidders. Air NZ management
favoured
. the latter .bidder, since they opened up Air NZ to both the European and the
wider Ameri~an markets and since BritisQ Airways itself did not operate in the Pacific
(patterson and Wallace, p. 155). Qantas did not offer the same advantages to the
company. Nevertheless, the Government accepted Qantas' bid on 20 September
1988. The deal was short lived, however, when the Government reopened the bidding
on 18 Octoher for the 100% sale of Air NZ, with a maximum foreign investment of
35%.

26 Air NZ detailed its staff numbers in its tcn-year statistical review provided in its Annual Reports (see
the 1989 Annual Report).
 72

The Government provided several reasons for the sale. Firstly. the reasons for
nationalising air services back in the 19408 were no longer applicable27 , Secondly. as
the company was now profitable. the private sector was ready and able to fund the
services. Thirdly, the Government could not meet the needed capital injection into
Air NZ of $200 - 300 million. Fourthly, the funds from the sale would be available
for use in the social services; the public would benefit from an improved Air NZ with
a more efficient management. Finally, by retaining the 'Kiwi Share', the Government
would always ensure that Air NZ was New Zealand owned (Patterson and Wallace,
pp. 150 - 151). The kiwi share had no voting powers but Air NZ had to get its
holder's consent before it could change certain aspects of its operations (location of
the head office) or ownership (maximum percentage of foreign ownership).

Eventually, two consortiums of potential buyers fonned to purchase Air NZ: the
Brierley consortium made up of Brierley Investments, Qantas, American Airlines and
Japan Airlines, and the British Airways consortium made up of British Airways, EIE
(a Japanese tourist investor) and DFC (acting in a broker's role). On 22 December
1988, the Government announced the sale to the Brierley consortium for $660
million. Each member purchased the following stake: Brierley 65% (with an
agreement to offer 30% for a public float), Qantas 20%, American Airlines 7.5% and
Japan Airlines 7.5%; the New Zealand Government retained ownership of the Kiwi
share.

The Go~ernment chose this consortium because of a "wide range of considerations

which · best suited the overall objectives of Government" (Patterson and Wallace,
1997, p. 159); however, it did not state what these considerations were. Another
possible reason was the fact that Brierley was taking a large share, ensuring that the
company remained in New Zealand hands.

The entire Board of Directors resigned and was replaced by nine members: R.H.
Matthew" (Chainnan), P.D. Collins, SJ. Cushing, J.B Leslie, J.L. Menadue, P.L.

27 These reasons, as detailed by Patterson and Wallace (1997) were the following: govenunent
participation in airlines was a logical approach to the development of New Zealand's trade and tourism,
it fitted in with the government's strategic objectives as a supplement to military and civil defence and
finally, it provided a worthwhile expense in foreign policy terms (to control the country's flag carrier).
2B Matthew was first appointed as a director on I January 1989.
 73

Reddy, T.K. Tamaki (all appointed on 17 April 1989), Sir R. Trotter (12 May) and Dr
J.A. Farmer (26 June) (1989 Annual Report). The board contained four Brierley
nominees, two Qantas nominees, one Japan Airlines nominee and two independents.
Additionally, Tamaki's alternative director was W.G. Kaldahl, the American Airlines
nominee. The consortium officially became the new owners of Air NZ on 17 May
1989, thus beginning the period of public ownership from 1989 - 2001, covered in the
following section.

6.2 Air New Zealand under Private Ownership

This section will outline Air NZ's performance during three distinct periods. Section
6.2.1 discusses Air NZ during the growth years: 1989 - 1995 . Section 6.2.2 will
examine the period 1996 - 2000, the stagnation years. Finally, the period where the
company collapsed, 2001, is outlined in section 6.2.3 29 ,

6.2.1 Growth through Expansion: 1989 -1995

Air NZ began operations under private ownership with the potential for strong
growth. Owned by entities that were prepared and willing to provide funds for
additional aircraft. the company was poised to compete both domestically and
internationally for the passenger dollar. Air NZ's growth through expansion occurred
during this period, which culminated in the record profit of $260.2m reported for the
year ending 30 June 1995.

This section will ,examine many aspects of Air NZ's operations. Section 6.2.1.1
discusses th.e company's trading environment. Additionally, the section will outline
any external factors that affected Air NZ's trading environment. Section 6.2.1.2
discusses any major changes in ownership and control over the six years.

29Unless otherwise stated, all information contained in section 6.2 is taken from Air NZ's publicly
available information: Annual and Six·monthly reports (1989 - 2001), Company Announcements
(1989 - 2001), and a sununary of Air NZ's Company History (2001) and Financial History (2001).
 74

6.2.1.1 Air New Zealan d's trading envir onment: 1989 -1995

This section will discuss the company's trading environment under several sub-
headings. These are the following: factors affecting Air NZ and the financial results.

6.2.1.1.1 Factors affecting Air New Zealand

During the 1990 financial year, two factors indirectly affected Air NZ's operations.
in August 1989, the Australian domestic pilot dispute between the pilots and the
major Australian carriers adversely affected market conditions. The short-tenn
consequence was that it had a major impact on passenger numbers travelling into the
South West Pacific; the dispute particularly affected Air NZ's Japanese, trans-Tasman
and long haul Pacific routes. The other major factor that affected the company's
operations was a dC?pressed New Zealand economy. The fact that New Zealand
economy was in decline affected the outbound New Zealand market, again reducing
travellers on Air NZ's most profitable routes. However, these factors did not stop Air
NZ from experiencing a 30% increase in profits.

One external factor affected the company in the 1991 financial year and continued to
affect the company for several years afterwards. The Gulf War, which began because
of Iraq's invasion of Kuwait in August 1990 and lasted from January - February
1991, significantly affected the airline industry. The war reduced passenger travel
during and after the war; it also led to major fuel cost increases as the war was centred
in the major oil producing regions of the world. Air NZ's fuel expenses came in $40
million over budget. The final consequence of the Gulf War was that many countries
(including NZ and 'its major trading partners: Australia, the UK and the US) went into
recession, adding to the reduced passenger numbers discussed above. It is therefore
not surprisi.ng that Air NZ' s profits declined in 1991 to its lowest level in the 19905.

The downturn in the world econ0n:ty caused by recessions in many wealthy countries
continued into the 1992 and 1993 financial years. Additionally, the aviation industry
suffered its then worst recession in history; this continued into the 1994 financial year.
Thus, the industry (and Air NZ) suffered surplus capacity and depressed passenger
numbers into 1993. By 1994, the industry stili was not enjoying sustainable growth.
 75

However, Air NZ remained profitable throughout this period, partly because of its
expansion into the Asian market.

Air NZ remained profitable for many reasons, three of which are discussed below.
Firstly, the company reorganised into six operating divisions JO effective from 1
January 1991 , each with its own management structure. The restructuring also caused
large-scale redundancies of 1,069 staff in 1991 (10.2% reduction in staff numbers),
582 in 1992 (6.2%) and 510 (5.8%) in 1993 31 which helped keep the labour costs
down. Secondly, the company withdrew in 1990 from several unprofitable domestic
routes and sold its fleet of Fokker Friendships in the 1991 financial year, which were
surplus to requirements. Air NZ's associate Air Nelson, with lower overheads than
Air NZ. took over the unprofitable routes . Thirdly, Air NZ expanded heavily into the
Asian market, introducing seven new passenger routes from 1990 - 1995 32 . Asia was
the fastest growing area of new arrivals into New Zealand; the new routes meant that
Air NZ was well placed to cater for them, These factors contributed to the large
increases in profits in 1994 and 1995 .

By the 1995 financial year, the aviation industry had recovered from the repercussions
of the Gulf War. However, two factors affected Air NZ to differing degrees. The
Kobe, Japan earthquake in January 1995 reduced Japanese passenger traffic, although
growth from other Asian countries easily offset this decline. The second factor was
the grounding of Air NZ's domestic fleet (ten Boeing 737 aircraft) in February 1995 .
The grounding was due to a technical fault not attributable to the company, although
the grounding allowed Ansett New Zealand, Air NZ's major domestic competitor, to
increase its l!1arket share. By the end of.the financial year, the company's domestic
market shar~ was back to nonnal (at around 70%).

30 These six "distinct business units" were the following: international airline, domestic airline, cargo
services, engineering services, catering services and information services. Air NZ added a seventh
business unit, terminal services, from July 1993.
)1 The Managing Director provided this number in his report. Subsequent statistical reviews showed
that staffnumhers only fell by 34 in 1993.
J2 The new routes introduced included Bangkok and Oenpasar (in 1990), Taipei ( 1991), Seoul (1993),
Nagoya and Osaka (1994), and Fukuoka (1995).
 76

6.2.1.1.2 Financial results

As discussed above, Air NZ remained profitable throughout this period. Average

annual growth in the company's consolidated before-tax operating profit was 26.11%
from 1989 - 1995. As the compauy recovered from the recessions caused by the Gulf
War, average growth was even higher at 50.44%33. Growth in Shareholder's Funds
(including minority interests) was impressive, at an average 13.04% per annum,
although a share issue influenced the growth rate, In August 1991, Air NZ issued 140
million shares after a two for one rights issue raising $140 million. Figures 6.1 and
6.2 graph the company's profit and shareholder's funds amounts over the period.

Air New Zealand's Profitability 1989 -1995

$350,000,000
$300,000,000
$250,000,000
$200,000,000
$150,000,000
$100,000,000
$50,000,000
$0
1989 1990 1991 1992 1993 1994 1995

Year

m Consolidated NPAT • Operating Surplus Before Tax

Figwe 6.1: Air New Zealand profitability: 1989 -1995

Air NZ listed its shares on the New Zealand Stock Exchange (NZSE) from October
1989. As part of the deal with the New Zealaud Government, Brierley had to on-sell
30% of Air NZ shares to the New Zealand public and company employees. Initially.
Air NZ liste~ on ~y the A class; the company listed the B class on the NZSE in January
1992 34 , However, as shown in figure 6.3, the share price remained depressed during

II The consolidated net profit average growth was 338.89% and 522.07% for the two respective
f.eriods. These figu[cs were affected by the 2000% growth in net profit in 1992. .
Air NZ had two different classes of ordinary shares. New Zealand nationals, as defmed in the
company constitution, could own the A class. New Zealand nationals broadly meant any NZ citizen,
any NZ government department or local authority, any NZ company, business or trust, or any Air NZ
employee holding shares through a company scheme. Overseas citizens and corporations (other than
airline operators without the NZ government's consent) and NZ nationals could own the B class.
 77

much of the early period, only increasing when the company's results improved in
1993. However, even in 1995 Bob Matthew, Air NZ 's Chairman, was dissatisfied
with the company's share price performance. He stated that the market prices
"represent modest historic Price Earnings multiples substantially below those
attributed to other listed airlines in the Asia-Pacific region ". [and] the average PE
of leading shares on the New Zealand Stock Exchange" (Chainnan Statement, 1995
Annual Report, p. 10).

Air New Zealand's Shareholder Funds 1989 -

1995

$1,400,000,000
$1,200,000,000
$1,000,000,000
$800,000,000
$600,000,006
S400,000,OOO
$200,000,000
$0
1989 1990 1991 1992 1993 1994 1995

Year

Figure 6.2: Air New Zealand shareholder'sfunds: 1989 - 1995

Air New Zealand Share Price: 1989 - 2001

$6.00 .
$5.00 '.
','
.'
-,' " . " .
$4.00 .'
.. ..
$3.00 "\_./'>.
....
$2.00
$1.00
$0.00 +--~-~-_~- _ _ -_~-~- _ _ - :;:
0
m
m
M
m
m
- v
8! 8l 8l 8l ~ 8l 8l 8l 8 8
~ ~ ~ m

- "- a 1::;;; 1::

0

a
-a a a a ~

";;;
~

;;; ~
~
~
~ " " "
" " ";;; ";;; ";;; ";;; " " " "
Year
~
~
~
~
~
~

I--Ashares ..... .. B Shares I

Figure 6.3: Air New Zealand's share prices: October 1989 - December 2001
Source: National Business Review and DATEX share history, 1990 - 200 1.
 78

This period under private ownership, was Air NZ's time of strong growth. Annual
growth and profitability after 1995 never approached that obtained from 1989 - 1995.
The company had cash reserves of $542.3 million in 1995, which it retained for
investing purposes, in either new routes or other companies. In conclusion, Air NZ
was in a good position to continue its strong expansion shown during the early 19908.
As section 6.2.2 will show, this did not happen.

6.2.1.2 Changes in Ownership and Control

During 1989 - 1995, Air NZ's executive management and equity owners remained
stable. Of the original four buyers of Air NZ, American Airlines sold their stake in
February 1992 and Japan Airlines theirs in December 1994. However, Brierley
Investment and Qantas Airways ensured continuity of ownership by owning between
them from 54.7% (reported in the 1993 Annual ' Report) to 84.9% (1989 Annual
Report) of the total shares on issue. Indeed, Brierley's holding never fell below 35%,
making it ~he major shareholder during the first six years. Appendix I provides the
top five shareholders of Air NZ from 1989 - 2001.

Consequently, very few changes occurred for the Board of Directors. Air NZ had
nine directors (increased to ten when James McCrea was appointed managing director
in August 1992). The American Airlines director resigned in March 1991
(permanently replaced by the Japan Airlines director). In 1995, three members
resigned (the Japan Airlines and Qantas contingent). the former because they no
longer had an investment in Air NZ, the latter as they wanted to use independent
directors. However, a core directorship made up of the Brierley and independent
directors remained unchanged over the six years. Appendix 1 lists the Directors of
Air NZ from 1989 - 2001 including their appointment and retirement dates, and the
nominator of the director.

Finally, executive management also remained stable from 1989 - 1995. The group
had 15 members in 1989, increasing to 17 by 1995. The major change in top
management was when Jim Scott resigned as Chief Executive Officer in April 1991.
His deputy, James McCrea, replaced him in August 1991. Other changes in executive
management were small, with seven retirements and nine appointments during the six
years. See Appendix 1 for a list of the company's executive management.
 79

6.2.2 Consolidation and Stagnation: 1996 - 2000

This period is described as the stagnating years, because Air NZ's profits declined and
never reached the amounts enjoyed in 1995. During these years, the company
consolidated its position, faced intense competition from other airlines and entered
into a worldwide airline group. Finally, Air NZ began and completed its foray into
the Australian domestic market with the purchase of Ansett Holdings Ltd.

This section contains two subsections. Section 6.2.2.1 examines Air NZ's trading
environment from 1996 - 2000. Section 6.2.2.2 outlines any major changes in
ownership and control.

6.2.2.1 Air New Zealand's trading environment 1996 - 2000

This section examines four factors that affected Air NZ's operations during the late
1990s. These arc the following: external and internal factors, the investment into
Ansett Holdings, entering the Star Alliance and the financial results.

6.2.2.1.1. Factors affecting Air New Zealand

Many factors affected Air NZ, which it had no control over. However, five factors
stand out. Three were relatively short-tenn, whereas the other two affected the
operations throughout this period and indeed during Air NZ's entire life.

During the 1996 and 1997 financial years, two factors stood out that had a major
effept upon Air NZ's domestic operations. These were the industrial action taken by
Air NZ air t~affic controllers, and the Mount Ruapehu eruptions. During December
1995 and again in September 1996, air traffic controllers went on strike, forcing the
airlines to change their flight-times and affecting thousands of passengers. A
suggestion of the numbers affected by the industrial actions was up to to,OOO people
per day (Evening Post, 1995; Sunday Star Times, 1996; The Daily News, 1996).

The strikes occurred around the same time as the eruptions of Mount Ruapehu. A
major eruption in September 1995 caused the closure of Palmerston North's airport
 80

(Bell, 1995). This closure forced Air NZ to divert flights to other centres and
disrupted main route flights. Furthenmore, ash clouds created by Mt Ruapehu affected
many North Island airports during June and July 1996, stranding many domestic and
international flights (Dunbar, 1996; Samson 1996). The airport closures affected
thousands of passengers (see Saunders, 1996; Waikato Times, 1996).

The third factor that had a major effect on Air NZ's operations was the decline in the
Asian economies from 1997. The Asian Economic Crisis caused many people from
the Tiger Economies to stop travelling, severely affecting Air NZ. From 1989 - 1995,
most of Air NZ's growth occurred through flights offered to and from the Asian
region (see section 6.2.1 ,1.1). International passenger traffic declined 25% or
122,500 visitors, for the 1998 financial year. Air NZ suspended its flights to Seoul
from December 1997 through a lack of demand. The lower demand from Asia
continued into the 1999 financial year, although passenger numbers recovered to 1997
levels. The Asian Economic Crisis contributed to the decline in profits throughout the
period.

The final two factors affecting Air NZ throughout its life are as follows: firstly.
exchange rate pressures, and secondly. oil prices. Foreign exchange (forex)
movements (especially against the US$) are vitally important to the company, since a
major portion of its revenue, expenses and capital expenditure come from foreign
sources. For example, in 1995, Group forex revenue exceeded $1.5 billion for the
first tim<? and continued to do so throughout the 1990s. Thus, more than half of Air
NZ's revenue came from forex. The major forex expenses are aviation fuel, aircraft
leasing costs and interest expenditure; the major capital expenditures are jet aircraft
(purchased in US dollars). Therefore. movements in forex have major effects on Air
NZ's financial results.

Although the company relied on both forex revenue and expenditure, it seems that Air
NZ should want a stronger NZS. A high NZS would reduce revenue, but would also
push down aircraft and equipment costs, and lease, fuel and interest expenditure. For
example, in the 1996 income year, forex revenue fell $100 million because of the
stronger NZS. The strengthening NZ$ continued into 1997, reducing forex revenue
by $70 million (cost savings were not provided in 1995 and 1996). However, as the
 81

NZ$ weakened in the late 1990s, it increased Air NZ's costs by $135 million in 1998
and major increases in 1999 and 2000". Figure 6.4 provides the New Zealand
exchange rate movements against the US$ and Trade Weighted Index from 1989 -
2001. Generally. a weak NZ$ coincided with lowering profitability (see sections
6.2.2.1.4 and 6.2.3.3).

Strength of NZ$ versue the US$ and TWI

0.7500 75.0
0.7000 ,_ ", 70.0
0.6500 65.0
~ 0.6000 60.0 _
en 0.5500 · ' . ",' 55.0 ;:;:
:J 0.5000 "' \ I ''"'1" SO.O ~
0.4500 45.0
0.4000 ': " : - 40.0
0.3500 " - - - - - - - - - - - - - - - - - - - - - ' . 35.0

~~~~#~~~~~~~##~~
)~ -$''\ .? 'f'~ ~o..J, cJ'Q )..s ~-\ .# )'IJ~ ~04 cJ'Q )~
)'IJ<:> ~& cj'Q

Year

USA TWII
Figure 6.4: NZ$ versus the US$ and TW!: 1989 - 2001
Source: Reserve Bank of New Zealand

Increasing fuel costs only became a problem in the late 1990s. Higher fuel prices
increased fuel expenditure by 11.8% in 1997, This was a short-tenn increase, as fuel
cost fell in the following two income' years: by 2.7% in 1998 and 7.1% in 1999 on
re.lativ~ly stable consumption. However, fuel costs increased by 44.0% in 2000 (by
$141.7 million to $463.7 million), because of the historically high oil prices.
Consumption only increased by 2.0% to 327.2 million gallons.

Air NZ initiated many changes to remain competitive. ill 1995, it launched Freedom
,
Air as a budget trans-Tasman carrier, in direct competition with Kiwi IIJ.temational.
Freedom continued after Kiwi collapsed in September 1996 (Dunbar, 1996). Air NZ
transfonned itself when it began the 'Pacific Wave' in April 199~ (completed in

35The 1999 and 2000 AlUlUal Reports do not provide any amounts. The Chairman and Managing
Director's reports only mention that adverse foreign exchange movements affected the company in
both these years.
 82

August 1997), which was designed to increase service quality by implementing a

number of changes including increasing the number of business class seats and
increasing legroom. Air NZ began 'Project Save', a cost-cutting measure, in 1996.
Its aim was to reduce costs by $100 million annually from 1998. Project Save
actually increased costs by $10.4 million in 199736, although it saved $84 million in
1998. Cost savings after 1998 are unknown, as Air NZ's annual reports did not
discuss the project. Finally, Air NZ sold several unprofitable segments of its
operations: Air NZ's catering business in June 1997, the light aircraft operations and
coach touring business in May 1998 and Ansett Express in June 1999. All of these
factors provided short-tenn boosts to Air NZ's profitability and ensured that Air NZ
remained profitable up to 2000.

6.2.2.1.2 Investment into Ansett Holdings Limited

Air NZ made very few investments during the early 1990s, preferring to expand
through growth rather than acquisition. However, the company completed three
acquisitions in the early 1990s: the Mount Cook Group in the 1991 financial year, Air
Nelson in December 1995, and Jetset Travel and Teclmology Holdings in July 1997.
Its largest acquisition was Ansett Holdings, which Air NZ initially invested in 1996.

During the early 1990s, The New Zealand and Australian Government's were
attempting to create a single Australasian aviation market. This would have allowed
carriers to operate domestically in both countries, therefore allowing Air NZ to
operate in the Australian market in direct competition with Qantas Airways and
Ansett. However, the Australian Government suspended the agreement in 1994; if
Air NZ were to enter into the Australian market, it would have to be through one of
the established players.

In 1995. Air NZ began discussions with the shareholders (TNT Ltd and News Corp) .
of Ansett Australia in an attempt to establish closer relations. On 2 September 1996,
Air NZ announced a deal to purchase 50% of Ansett Australia, TNTs stake in the

36 Project Save incurred one-off restructuring costs of$25.4 million in 1997. These were partly offset
by benefits from the project of$15 million.
 83

company. They paid A$47S million, A$32S million direct to TNT and the remainder
as a capital contribution. News Corp took over Ansett NZ, which allowed for
continued competition in the domestic market. Air NZ had both an equal stake with
News Corp in Ansett and an equal number of board members.

Various commentators have described this deal as the worse thing to hit either Air NZ
or Ansett (see Van den Bergh, 2001; Espiner, 2001b; 2001c; Easdown and Wilms,
2002). However, at the time, Air NZ generally had positive things to say about the
deal:

"The Ansett Australia investment is expected to serve the Group's

interests more effectively than any attempt at independent entry to
what is already a mature and highly competitive Australian domestic
market. It provides Air NZ with the advantage of immediate and
comprehellsive access to the much larger Australian domestic aviation
market through Ansell's well·established network.

"The Directors expect that in the medium term Air NZ will enjoy
significant benefits by way of improvements in the earnings of Ansett
Australia and through the cost savings and other benefits available to
each of the two airlines through them working in close cooperation.
However, the firtancial impact of the investment is expected to be
.n eutral ill the current financial year ... " (Chairman's Report, 1997
Annual Report, p. 6).

As part of Air NZ's purchase agreement, the company had a pre-emptive right to
purchase News Corp's stake in the company. This fact only became important when
Singapore Airlines (SIA) became interested in News Corp's stake. SIA made an offer
of A$SOO million in May 1999 for News Corp's stake in Ansett, which News Corp
could not accept because Air NZ objected. Instead, Air NZ made substantially the
same offer to News Corp, who accepted because of Air NZ's right mentioned above.
They announced the sale in February 2000 for $703 million (A$580 million) plus a
deferred consideration equivalent to 10.5% of the market value of Air NZ as at 18
February 2000. The Australian Foreign investment Review Board approved the
 84

purchase in June, making Air NZ one of the world's top 20 airlines. SIA
subsequently invested in Air NZ.

Air NZ did not consolidate Ansett in its accounts until 2000. As Air NZ and News
Corp had an equal equity share in Ansett, neither one controlled it and SSAP-8
(1990). accounting for business combinations, did not require consolidation. Thus,
Ansett contributed to Air NZ's profits during the period as an associate of the airHne.
Table 6.1 outlines Anselt's profits from 1997 - 2000, and Air NZ's share of Anselt's
profits. During this period, Ansett always contributed to Air NZ's own profits, even
in 1997 when it made a loss.

Financial Year Ending Ansett's Pre-Tax Air NZ's share of

Profit; After-Tax Profit Ansett's Profits
(in A$ million) (in $ million)
1997 (11.4); (35 .0) 17.6
1998 82.2; NA 32.3
1999 200.4; 156.9 1Ol.7
2000 NA; 144.4 61.3
..
Table 6.1: Ansett profitablllty and contrlbutron to Alf New Zealand, 1997 - 2000
Source: Chairman and Managing Director's reports, Air NZ Annual Reports

6.2.2.1.3 Alliances

Throughout the ) 990s, Air NZ began entering into alliances and partnerships with
other airlines. Generally, the major partnership type Air NZ entered into was
codeshare services, whereby two airlines established a relationship that allowed them
to sell tickets on each other's flights. These flights are operated by only one of the
airlines, but can be sold by either airli~e. Air NZ entered into many codeshare
agreements including those .with the following airlines: Ansett (from September
1996), United Airlines (May 1997), Singapore Airlines (October 1997) and Luthansa
(July 1998). Codesharing is a simple way of expanding an airline's coverage without
increasing the numbers of flights operated. For example, Air NZ's codeshare
agreement with United Airlines applied to approximately 146 United flights per day
from January 1999, increasing Air NZ's coverage to at least eight US cities.
 85

The culmination of the different partnerships occurred when Air NZ entered into the
Star Alliance in March 1999. The Star Alliance was (and still is) the world's largest
airline alliance and membership "[brought] considerable network and loyalty benefits
to Air NZ's customers" (Chairman's Report, 1998 Annual Report, pp. 6 - 7).
Additionally, it provided Air NZ with exposure and recognition in markets where the
company has a minimal presence 37 •

6.2.2.1.4 Financial results

Generally, Air NZ's profitability fell over the entire period. The company remained
profitable until 2000, when an accounting policy change reduced Air NZ's after-tax
surplus of$184.4 million to a consolidated after-tax loss 0[$600.1 million (Air NZ's
then largest consolidated loss). The company's profitability (as shown by figure 6.5)
declined from 1996 to 1998 at an average rate ofl6.77% (before tax decline 17.91 %).
However, Air NZ's profits improved in 1999 by 48.02% (before-tax increase
17.54%), in part due to the company's share of Ansett's profits. The company's
profits declined again in 2000 by 13.20% excluding the accounting policy change, or
by 380% including it. The accounting policy change was a change in tax accounting
from the partial method to the comprehensive method, which resulted in a one-off
charge of $786.2 million (chapter 7 will discuss this accounting policy in detail). This
period has been described the stagnating period since Air NZ's profitability declined
even though revenue continued to increase (by an average 5.32% per annum; see
figure 6.6).

The continued after-tax profits made by Air NZ, meant that shareholder's funds
continued to increase (see figure 6.6). Shareholder's funds increased at an average
rate of 13.69% [rom 1996 to 1999; it declined 25:21 % in 2000 due to the loss caused
by the accounting policy change. Air NZ made two major share issues, each to fund
the investment into Ansett. The first share issue was in November 1996, this issued
an additional 119.4 million shares, raising $252.2 million. At the same time, the

37When Air NZ entered the Star Alliance, the following airlines were either members or achieving full
membership; Air Canada, Ansett Australia, Lufthansa, Scandinavian Airlines System, Thai Airways
International, United Airlines, Varig Brazilian Airlines, All Nippon Airways (joined October 1999) and
Mexicana (joined in July 2000).
 86

company increased foreign ownership by increasing the proportion of 'B' shares to

49% (previously 35%). The second share issue issued another 189.2 million shares
on 10 November 2000, and this raised $280.2 million.

Air New Zealand's Profitability 1996 ·2000

$250,000,000
$125,000,000
$0
-$125,000,000
-$250,000,000
-$375,000,000
-$500,000,000
-$625,000,000
Year

ID Consolidated WAT • Operating Surplus Before Tax

Figure 6.5: Air New Zealand profitability: 1996 - 2000

Finally, total assets grew at an average rate of 9.32% from 1996 - 1999; however,
total assets doubled in 2000 when Air NZ consolidated Ansett in its accounts (see
figure 6.6). Growth in liabilities accounted for all of the increase in total assets in
2000, with the reported debt ratio increasing to 82.3%38. Thus, from the Ansett
purchase in June 2000, Air NZ was highly geared, which is one of the mistakes
suggested by AMH that lead to failure.

38 The Chairman's report actually reported that the Group's equity ratio declined to 17.7% (from
48.4%).
 87

Air New Zealand financial information: 1996 ·

2000

$9,000,000,000
$7,200,000,000

$5,400,000,000
$3,600,000,000

$1,800,000,000
$0
1996 1997 1998 1999 2000
Year

1111 Revenue _ Total Assets 0 Sharehokler's Funds I

Figure 6.6: Air New Zealand shareholder's funds, total assets and turnover:
1996 - 2000

6.2.2.2 Changes in Ownership and Control

During this period, there were a few major changes in shareholding and management.
Brierley remained the major shareholder with an equity stake ranging from 30.32%
(reported in June 2000) to 47.08% (June 1998) of the total shares on issue. However,
from 1997 - 1999 Brierley's stake was held in several holding companies: Anafi
Investments (holding 'A' shares), Urtica Investments ('B' shares) and Portfolio
Management (a mix of 'A' and ' B' shares). Anafi Investments held Brierley's entire
stake from August 2000, as Brierley sold the ho ldings in the other two companies to
SIA.

Qantas sold its equity stake in March 1997 to a range of international institutional
investors. This probably included Franklin Resources Inc, who was a substantial
security holder from 1997 - 1999, holding at least 5% all shares on offer during this
time. Finally, SIA purchased 8.3% of Air NZ in April 2000, increasing its stake to
25% by August.

There were significant changes in who made up the board of directors. On 30 June
1998, the Chairman, Matthew, resigued from the Board; his deputy, Cushing, replaced
him as Chairnlan. Three other long-serving directors (that is, had been directors from
 88

1989) also retired during the period: Trotter at the same time as Matthew, Reddy and
Collins on 27 October 1999. Another director (Landels) retired in November 1998,
after serving on the board for three years,

When SIA completed its purchase into Air NZ, they were given the right to nominate
three directors; a resolution was passed increasing the board size from nine to thirteen
plus the managing director. Finally, one director (Wareing) retired in November
2000, after servi ng for five years. The makeup of the Board as at 31/12/2000 was the
following: four Brierley directors, three Singapore Airlines directors and six
independents. There was no managing director because Jim McCrea resigned in July
2000.

Until 2000, there were very few changes in the executive management. Air NZ
appointed four exec~tive managers and seven retired during 1996 - 1999, reducing
the total number in the group to fourteen. However, major changes occurred during
2000. Firstly, McCrea resigned on 7 July 2000, with another three senior managers
leaving at the same time. As his replacement, Gary Toomey, did not begin as CEO
until January 2001, Cushing was Executive Chairman for the remaining six months of
2000. In October 2000, Air NZ combined the management structures of Air NZ and
Ansett into a new 21-person group (New Zealand Press Association, 2000). Air NZ
appointed five additional managers to the executive team, three of them former Ansett
employees. The remaining 20 Ansett top management either resigned or Air NZ fired
them (Espiner, 2001b; Easdown and Wilms, 2002).

It is important to note that leadership continuity at a management level did not

continue after McCrea resigned. McCrea had been Scott's deputy when the Board
appointed him CEO in 1991. Cushing,' although a board member and Chainnan,
probably had very little operational control over Air NZ. However, he was expected
to run the combined Ansettl Air NZ airline during the first six months of integration.
In addition, Toomey came from Qantas Airways and had no previous management
experience at Air NZ (although he did serve as an alternative director from 1993 -
1995). At least three of AMH's management defects are present from this time, these
being a combined CEO and Chairman, inadequate strategic understanding and lack of
management depth (the latter two referring to Australian operations).
 89

6.2.3 The Collapse: 2001

The 2001 financial year is undoubtedly Air NZ's worse year ever in its 61-year
existence. Shares, that had traded as high as $2.36 (B class $2.80) at the start of the
year, fell to a low of $0.18 (B class $0.155) on 24 September 2001 (see figure 6.3).
Additionally, the year saw the collapse of Aosett Australia and Air NZ recorded New
Zealand's largest ever corporate loss of$1.4 billion, of which $1.32 billion related to
the write-off of Ansett in Air NZ's books. Air NZ's woes continued when it recorded
a $376.5 million consolidated loss for the six months ending 31 December 2001. That
Air NZ was in financial strife was an understatement.

This section will outline the major problems that faced Air NZ's operations during the
period. Section 6.2.3.1 will discuss the collapse of AnseU. Section 6.2.3.2 discusses
the other major ex~emal factors affecting Air NZ during the period. Section 6.2.3.3
will outline the financial results for the period. Finally. section 6.2.3.4 examines the
changes in ownership and control, including a brief discussion of the New Zealand
Government's rescue plan.

6.2.3.1 The collapse of Ansett

The collapse of Ansett Australia has been the subject of numerous newspaper articles
in both New Zealand and Australia. Additionally. at least one book (Easdown and
Wilms, .2002) has also examined the collapse of the airline in some detail. This
section will discuss the major internal and external factors that led to the demise of
Ansett.

There were · many internal problems with Ansett's jet fleet. Ansett used seven
different jet aircraft from four different manufacturers, each requiring different
engineering facilities and pilots to operate them. Furthermore, Ansett had the second
oldest fleet among the top 50 carriers (Van den Bergh, 2001), which meant that the
aircraft needed very regular (and expensive) maintenance checks. These problems led
to two embarrassing groundings of their fleet: the Ansett Boeing 767-200 aircraft
around Christmas 2000 and their entire 767 fleet in Easter 2001. Although, the
company managed to deliver 95% of passengers to their destinations during the
 90

groundings, the damage was done with many passengers turning to Qantas or the 00-

frills competitor, Virgin-Blue.

This leads onto the second problem leading to Ansett' s collapse, competition. During
the 1990s, Australia had a domestic duopoly between Ansett and Australian Airlines
(later Qantas when the Australian Government merged the two firms in \992).
However, two budget carriers (Impulse and Virgin Blue) began operating in Australia
soon after Air NZ purchased Ansett. Impulse only lasted a couple of months before
Qantas acquired it; however, Virgin Blue was still in operations at the end of 2001.
These airlines changed the face of competition, by lowering prices and margins and
stealing market share 39 . Ansett could not compete, considering the large mismatched
fleet and high operational costs it faced. It did not help when the travelling pubHc
deserted Ansett afler the two fleet groundings (Van-den Bergh, 200\).

Another change in Ansett's operations was the high oil pnces and depressed
Australian Dollar (A$). Fuel prices were at historical highs and the A$ reached
record lows against the US$. This severely affected Ansett's operations since most of
the company's fu el costs, lease payments and loan repayments were denominated in
US$. Thus, thi s caused Ansett to pay more money to cover these expenses.

The final problem was the change in Ansett' s management. Before the takeover by
Air NZ, Ansett had an effective and efficient management structure under the
leadership of its Executive Chairman, Rod Eddington. However, he left just before
the sale, leaving Ansett "rudderless, lacking a permanent CEO and a proper first-line
team of senior management" (Easdown and Wilms, 2001, p. 111). The latter
comment relates to the fact that Air NZ retained only three of Ansett's senior
managers; they also replace~ AnseU' s top 250 commercial, marketing and sales
managers (ibid., p . 114 - \\6). The lack of an effective management exacerbated the
above problems and not-surprisingly led to Ansett losing millions of dollars in cash
per day.

39 Ansett's market share fell from 54% in June 2000 to 39% when it failed: 85% of the loss in market
share went to the budget carriers (Espiner, 200Ie).
 91

The final collapse was relatively swift, although many of the facts were not released
until just before Air NZ placed Ansett in voluntary administration on 13 September
2001. A week before voluntary administration, Virgin Blue's owner Richard Branson
stated that Ansett was losing $1 million in cash a day (Riordan, 2001). This number
was too low, as Air NZ had infonned the New Zealand Government in late August
that Ansett's losses were $1.6 million a day (NZ Press Association, 2001). However,
at times Ansett lost $3 million per day or $21 million a week (Easdown and Wilms,
2002).

The Air NZ board placed Ansett in voluntary administration to prevent the collapse of
the parent company. Ansett contributed $191.8 million in operating losses for the
year ended 30 June 2001 and an additional $129.8 million in losses in the following
three months. It is no wonder that Air NZ wrote-off Ansett, especially after
experiencing its own problems.

6.2.3.2 Factors affecting Air New Zealand during 2001

Air NZ faced an equally challenging trading environment as its subsidiary during

2001. The company faced the same high oil prices and an even lower currency
against the US$, that caused its fuel bill to· increase by $378 million in the 2001
financial year. However. two major events, other than Ansett, affected Air NZ during
the period: the collapse of Qantas New Zealand and the September 11 attacks.

On 21 April 2001, Qantas New Zealand, Air NZ's major competitor on domestic
routes, was placed in receivership. Qantas New Zealand began operations as
Newmans Air; however, when Ansett Australia purchased the company in 1987, they
renamed it Ansett New Zealand (Espiner, 2001a). When Air NZ invested in Ansett in
1996, News Corp purchased Ansett New Zealand, to comply with competition
regulations. News Corp sold Ansett NZ to Tasman Pacific in April 2000, who
renamed the company Qantas NZ. However, the one constant in the ~ompany's life
was that it never made sufficient profits and it eventually ran out of cash in April 2001
(ibid.).
 92

The positive spin-off for Air NZ was that it flew significantly more domestic
passengers in the weeks following Qantas NZ's collapse. In the first week alone, it
flew an extra 25,000 passengers. However, this short-term gain disappeared after the
more profitable Qantas Airways fully entered the market in July (Kennedy, 2001).

The other major effect on Air NZ's operations was the September 11 attacks in the
US. Briefly, terrorists took control of four planes, two of which they flew into the
World Trade Centre in New York, a third was flown into the Pentagon in Washington
DC. A consequence of this was to place the international aviation industry into its
worse recession since the early 19905. Air NZ's international passenger numbers
declined by at least 7.7% after the attacks, which contributed significantly to the loss
made for the six-months ending 31 December 2001.

To summarise, there were three major factors affecting Air NZ's operations. The
first, and most important one, was the collapse of its subsidiary Ansett Australia in
September 2001. The second factor was the collapse of its major domestic competitor
Qantas NZ. This collapse provided short-term benefits, but also allowed Qantas
Airways to enter the market. The final factor was the September 11 attacks, which
severely affected Air NZ's profitability in the last three months of2001.

6.2.3.3 Financial results for Air New Zealand during 2001

Air NZ's .profitability declined substantially during this period. Table 6.2 provides a
breakdown of Air NZ's financial results in six-monthly intervals, covering the six-
months ended 31December 2000 (December 2000),30 June 2001 (June 2001) and 31
December 2001 (December 2001). The June 2001 profitability and cash flow figures
are calculated by subtracting the December 2000 figures from the year ended June
2001 figures, prov:ided in Appendix 1.

During the 2001 calendar year, the company lost a cumulative $342.9 million in
operating losses and a massive consolidated after-tax net loss of $1,805.6 million.
Ansett's operating losses in this period were $386.8 million. This implies that had Air
NZ operated separately, it would have made an operating profit of $43.9 million
during the 2001 calendar year. The consolidated net loss can also largely be
 93

attributed to Ansell: Air NZ wrote-olIits investment in Ansell in June 2001 ($1,320.9

million) and incurred demerger expenses in December 2001 ($389.7 million).

Six-Months Six-Months Six-Months

Ended Ended Ended
31112n000 301612001 31/12n00 1
(in $000,) (in $000,) (in $000,)
Revenue 4,311,489 3,648,636 2,579,354
Operating Expenditure 4,196,940 3,816,850 2,754,086
EBIT (loss) 114,549 (168,214) (174,732)
Earnings Before Tax (loss) (32,890) (1,524,362) (418,033)
Consolidated Net Profit (loss) 3,78 1 (1,429,099) (376,513)

Current Assets 2,886,034 2,791,432 1,386,858

Long-term Assets 6,65 1,5 10 5,322,597 2,695,824
Total Assets 9,517,544 8,114,029 4,082,682
Current Liabilities 3,887,670 3,639,157 2,285,236
Long-term Liabilities 3,727,3 18 3,956,833 1,671,716
Equity 1,902,556 518,039 125,730

Net Operating Cash-flows 189,080 (42,765) (187,401)

Net Investing Cash-flows (210,490) 77, 109 (123,607)
Net Financing Cash-flows 27,280 28,741 17,803
Table 6.2: Fmancta / results ofA,r New Zealand

Because of the large losses, total equity fell significantly. From December 2000 -
December 2001, equity declined to 6.61% of its value, whilst the equity ratio
worsened to 3.1 % (19.99% in December 2000). Finally, the company lost cash in the
2001 calendar year. Operating cash flows were an outflow of $230.2 million during
the 2001 calendar year, which is unprecedented for a company that created cash from
operations in almost every six-monthly period from March 1989 - June 2000 (see
appendix 1).
 94

6.2.3.4 Changes in Ownership and conlrol- 2001

There was no actual change in share ownership during the 2001 calendar year.
However, effectively the New Zealand Government (NZ Govt) controlled Air NZ by
December 2001. The following will sununarise how the NZ Govt ended up in control
of the company.

Both the executives and directors knew that Ansett needed a modem fleet to be
competitive, and that required up to $1.5 billion in extra funding (Van den Bergh,
2001 ; Easdown and Wilms, 2002, p. 129). Two different proposals to fund this
recapitalisation deal became apparent from April 2001: one by Qantas, who would
acquire SlA's stake, the other by SlA and Brierley. Each deal involved allowing
either Qantas or SIA purchasing an equity stake greater than the 25% allowed under
Air NZ's constitution. However, the NZ Govt was unwilling to allow a foreign airline
to increase its stake and both deals soured by September 2001.

Instead, the NZ Govt proposed its own recapitalisation deal on 13 September 2001,
which Air NZ's shareholders accepted in December 200 I. The deal had two stages.
The first stage involved the NZ Govt lending Air NZ $300 million on 15 October
2001. The second stage would have Air NZ repaying the loan to the NZ Govt in the
fonn of preference shares issued at $0.24. These preference shares carry a fixed
cumulative dividend of 5% per annum, have full voting rights and will convert (at one
for one) to ordinary shares on 1 January 2005, or earlier, as the NZ Govt decides.
Additionally, the NZ Govt would invest another $585 million for new ordinary shares
in Air NZ; the company would also reclassify its A and B class into one ordinary class
of shares. The shares were reclassified on the 24 December 2001. However, the
second stage was not complete by the end of December 2001 4 °.

This change in control naturally caused major changes in the directors of the
company's board. Earlier on 29 May 2001, Fanner replaced Cushing as Chainnan.

40 The second stage was completed on 18 January 2002. Air NZ repaid the $300 million loan plus
accrued interest by issuing 1,279,866,438 preference shares. Further, 2,166,666,667 ordinary shares
were issued to the NZ Govt at $0.27 per share. From the recapitalisation date. Air NZ had
4,203,354,290 shares on issue, of which the NZ Govt owned 82%. Brierley and SIA's equity stake fell
to 5.5% and 4.5% respectively (see 2001/02 Interim Report).
 95

Cushing resigned because of a possible conflict of interest regarding the

recapitatisation deal; he was also the Chainnan of Brierley.

The major changes occurred on 4 October 2001. The Board was reduced to eight
directors made up of one nominee of SIA. one nominee of Brierley, four independents
and two directors approved by the NZ Govt. Six directors resigned on that day, whilst
a seventh retired earlier on 20 September 2001. Table 6.3 outlines the directors of Air
NZ 85 at 31 December 200 1 and the directors who retired during 2001 calendar year.

Current Directors as at 31/ 1212001 Retired Directors during 2001

Name Date Appointed Name Date Resigned
John Palmer 29/11/2001 Hon Phillip Burden 4/ 10/2001
Chainnan
Dr James Farmer 26/6/1989 John Curtis 4/ 1012001
Deputy Chairman
Sir Ronald Carter 2)nl I998 Sir Selwyn Cushing 4/ IOI2oo t
Dr Choong K ong Cheong 8/812000 Charles Goode 2019/2001
Elizabeth Coutts 8/812000 Professor Phillip Rose 4/ 10/2001
Roger France 4/ 10/2001 Michael Tan 4/10/2001
Ralph Norris 27/8/1998 Greg Terry 4/ 10/2001
William Wilson 20/12/ 1999
Table 3.3: Alr New Zealand Directors during 2001 calendar year
NB 1 The 2001 annual report states that Dr Cheong was appointed on 10 August 2000. This date
comes from the 2000 annual report.
1 The 2001 annual report states that Ms Coutts was appointed on 7 August 2000. This date
comes from the 2000 annual report.

Finally, the executive management structure changed considerably over the period41 •
The first change occurred when Toomey began as President and CEO in January
2001. Toomey brought with him several executives from Qantas who immediately
,
took up senior positions in Air NZ (Easdown and Wilms, 2002, p. 121). In late
February 200 I, the management structure was reorganised from a business unit
structure to one of functional units. The new management structure had twelve
functional units . At least four executives retired (National Business Review, 2001).

41 In only two years from 1989 - 2001 did Air NZ not disclose who made up its executive management.
These were 1991 and 2001. Possibly, Air NZ did not disclose its management learn in 2001 because it
was so radically changed from that disclosed in 2000.
 96

Top · management remained largely unchanged until Air NZ placed Ansett in

voluntary administration. Roger France replaced Toomey on 9 October 2001, when
he resigned as President and CEO. France became the executive director for the
remainder of the period. The 2001 Annual Report stated that the company had begun
a major management and staff-restructuring programme, which the company
continued into 2002. The restructuring programme resulted in a 17% reduction in
management numbers and a 30% reduction in salary costs. Air NZ announced its new
executive team on 23 October 2001, with six members, plus the CEO. At least eight
senior executives left the company between October and December 2001.

To summarise, Air NZ had continuity of ownership and directors at least through to

September 200 I, when the company placed Ansett in voluntary administration.
However, control (in the fonn of senior management) changed three times, once in
January 2001, again in February, and finally in October. Instability in the top
management would have severely hindered Air NZ's ability to respond to the
problems outlined in sections 6.3.3.1 and 6.3.3.2. Additionally, this is one of AMH's
management defects that cause company failure.

After September 2001, the company was effectively under the NZ Government's
control, which is observable from the major changes in the board of directors.
Furthennore, management changed again as France oversaw the process that reduced
management numbers by 17%.

6.3 Summary

This chapter has provided an overview of Air NZ, concentrating on the period 1989 -
2001. After the privatisation of Air NZ in 1989. the eompany went through three
distinct periods. The first was a period of rapid growth from 1989 - 1995, especially
from 1991 - 1995. The eompany outperfonned many of its eompetitors (Espiner,
2001a) during this period when the aviation industry was in the midst of a harsh
reeession brought on from the fallout of the Gulf War of 1991. From 1991, Air NZ's
profits grew alUlUally, reaching a record profit of $260.2 million in 1995. The
company had good continuity of control, with the Chairman remaining the same
 97

during the period and the CEO only changing once in 1991 (see table 6.4). Finally,
the company had two comer shareholders: the majority owners Brierley Investments
and Qantas Airways.

Chairman Chief Executive Officer (CEO)

Name Date Date Name Position Date Date
Appointed Resigned! Held Appointed Resigned!
Replaced Replaced
R o Matthew 171411989 30/611998 R J Scott CEO 611988 411991
Sir S J 30/611998 291512001 J McCrea CEO & 81199 1 ml2000
Cushing Managing (1992 as
Director Director)
J A Farmer 291512001 2911112001 Sir S J Executive ml2000 31112001
QC Cushing Chairman
] L Palmer 2911112001 GK Toomey President & 311/2001 911012001
CEO
G R W France Executive 10/2001
Director
Table 6.4: Chalrmell and Chief Execut.ve Officers of Air New Zealand 1989 - 2001

From 1996 - December 2000, Air NZ entered a period of stagnation. The company's
own profitability declined over much of this period; Group profit only imprOVed in
1999 because of the equity accounted returns from Ansett Australia. Air NZ entered
into the Australian market by purchasing 50% of Ansett Australia in 1996 and taking
over the company in 2000. However, the Asian Economic Crisis, which began in
1997, adversely affected the company as it dramatically reduced profitability on their
Asian passenger routes.

Leadership from the board remained stable with Matthew retiring in June 1998 and
his deputy. Cushing
, replacing him. More worrying signs were apparent at a
management level when McCrea resigning as CEO in July 2000. Toomey replaced
him in January 200 1; in the interim, Cushing ran the company. Brierley continued as
the majority shareholder during this period. Qantas sold its shareholding in March
1997. SIA replaced Qantas as a comer shareholder when it completed a 25%
purchase of Air NZ in August 2000.
 98

The calendar year 2001 was a difficult one for Australasian airlines. Three airlines
collapsed (Impulse, Qantas New Zealand and Ansett Australia) and one other, Air
NZ, came very close. That year was the final period, the collapse. Ansett struggled to
compete with a radically changed Australian domestic market with two new budget
airlines, an aged fleet and high overheads. By the middle of 2001, the company was
losing at least $1 million in cash per day. The drain on Air NZ's coffers continued
until September 2001 when it placed Ansett in voluntary administration. Air NZ
incurred New Zealand's largest annual corporate loss of $1.425 billion in the 2001
financial year and an additional $376.5 million corporate loss for the six-months to
December 2001.

The New Zealand Government established effective control of Air NZ from

September 2001, when it announced a recapitalisation deal that would see the NZ
Government investing $885 million in the company. The company had three
Chairmen (Cushing, · Fanner and Palmer), one CEO (Toomey) and two executive
directors (Cushing and France) during 2001. Additionally, six directors resigned on 4
October 2001, leaving a much smaller board of eight to run the remnants of Air NZ.
Finally, the executive management changed three times: when Toomey arrived in
January 2001, in February 2001 when the management structure changed, and in the
last three months 0[2001 when France was executive director.

Many of the causes advocated by AMH affected Air NZ. Management defects were
apparent from July 2000 (see above), as was poor responses to changes in the trading
environment (for example, an inadequate response to Ansett's deteriorating situation).
Additionally. Air NZ made two of AMB's three mistakes (high gearing and the
failure of a big project, Ansett), faced constraints (especially with respect to
refinancing) and nonnal business hazards (high oil prices and a weak NZ$). At least
one symptom was observable from 1995,. when Air NZ's finances began to decline.
Furthermore, numerous non-financial symptoms were observable in 2001. as was a
declining sh~re price. Therefore, it seems that Air NZ exhibited nine of the causes
and symptoms of corporate failure advocated by AMH.

The following chapter will investigate another symptom suggested by AMH, creative
accounting. After Air NZ' s financial statements are evaluated for creative accounting
techniques, chapter 8 will produce Air NZ's trajectory.
 99

Chapter 7: Removing the Sheen from Air New Zealand's

Financial Statements

7.0 Introduction

Air NZ (like all New Zealand companies) is required to comply with New Zealand
disclosure requirements. Briefly, these requirements are legal requirements
(summarised in the Financial Reporting Act 1993 and the Companies Act 1993) and
stock exchange requirements (detailed in stock exchange regulations). Air NZ has to
release an annual report, which includes several financial statements. In addition, Air
NZ, in complying with NZSE regulations, also releases half-yearly reports. These
reports are the major publicly released documents released by Air NZ concerning its
perfonnance and position over the period 1989 - 2001.

The annual and half-yearly reports are produced under generally accepted accounting
practice (GAAP). GAAP encompasses specific rules relating to particular
circumstances and broad concepts of general application (Explanatory Forward, 1995,
paragraph 4.1). In New Zealand, this means complying with any source of
authoritative support (section 24(d), Financial Reporting Act, 1993). The major
source of authoritative support is the accounting policies contained in the New
Zealand accounting standards. Broadly speaking, accounting standards are rules that
establish how to recognise, measure and disclose particular transactions and other
events (Explanatory Forward, 1995, paragraph 3.4).

Many changes in GAAP happened over the period 1989 - 2001. Firstly, the
Companies Act 1993 and Financial Reporting Act 1993 replaced the Companies Act
1955. The·Financial Reporting Act 1993 gave statutory backing to all accounting
standards. This meant that non-compliance with accounting standards was a criminal
offence. Secondly, the number of accounting standards increased substantially over
this period. The titles of these accounting standards changed from 'statement of
standard accounting practice' (SSAP) to 'financial reporting standard' (FRS). The
latter title meant that the accounting standard had been issued under the Financial

THE LIBRARY
UNIVERSITY OF CANTERBURY
CHRlSTCHlJHCH , ~J.z.
 100

Reporting Act 1993 and met the requirements of the Statement of Concepts (SOC;
1993). The SOC (1993) is New Zealand's conceptual framework. It outlines the
following: the objectives of general purpose financial reporting, the qualitative
characteristics of useful infonnation and the definitions of the different financial
elements (SOC, 1993, paragraph 1.4). The SOC (1993) is meant to be the core of the
accounting process; although, if there are any conflicts between the SOC (1993) and
an accounting standard, the standard should be followed (Explanatory Forward, 1995,
paragraphs 3.2, 3.8).

This chapter will examme Air NZ's financial statements, and consequently, its
accounting policies. Section 5.2.3 argued for the analysis of a company's accounting
policies and notes to the accounts to minimise creative accounting. The analysis
contained in this chapter follows and expands on Smith (1996), whereby the
accounting polices and notes are examined for changes that increase profit Of remove
liabilities from the balance sheet. Based upon this criteria, the following parts of Air
NZ's accounting polices are discussed in greater detail: operating leases, asset
revaluations, income taxes, market value of investments, deferred charges and
fmancial instruments. Unless otherwise specified, all figures produced in this chapter
relate to Air NZ's group accounts.

7.1 Air New Zealand's disclosure ofleases

This section discusses in detail Air NZ's leases. Section 7.1.1 summarises lease
accounting in New Zealand. Section 7.1.2 outlines the value of Air NZ's leases from
1989 - 2001. It shows that Air NZ changed to leases of an operating nature over this
period. Section 7.1.3 evaluates whether non-cancellable operating leases should be
recognised on the balance sheet. Section 7.1.4 states the treatment of leases for
trajectory analysIs. Section 7.1.5 discusses possible leveraged leases used by Air NZ.

'-' "

7.1.1 Summary of accounting for leases as per SSAP-18 (1990)

The accounting s tandard defines two major types of leases: operating and finance
leases. Operating leases are all leases that are not classified as finance leases (SSAP-
 101

18, 1990, paragraph 3.3). Furthennore, all lease agreements relating to land will be
classified as operating leases if the land does not transfer to the lessee at the end ofthe
lease tenn. This is because land has an indefinite useful life (ibid., paragraph 4.28).

Finance leases are any leases that substantially transfer all the risks and rewards of
ownership to the lessee (SSAP-18, 1990, paragraph 3.2). SSAP-18 provides a more
specific definition of what makes up a finance lease 42 ; this divides leases into finance
and operating leases. The definition of a finance lease makes it possible to structure
the lease agreement in such a way that it does not meet the requirements in paragraph
4.4, and thus is classified as an operating lease. However, whether a lease is a finance
lease or not relates to the substance of the transaction, not the fonn of the contract
(ibid., paragraph 4.3). Therefore. if a lease agreement provides substantially the same
requirements as those given in paragraph 4.4, it should be classified as a finance lease.

The distinction between the two types of leases relates to whether the asset and
liability arising from the lease should be recognised. A finance lease leads to the
recognition of both a liability and an asset in the financial statements, An operating
lease will not lead to the recognition of any assets or liabilities in the financial
statements. Thus, by classifying finance leases as operating leases, a company can
reduce the amount of liabilities shown on the balance sheet.

There are several disclosure requirements required in the lessee's financial statements.
The less.ee must show all the finance lease liabilities classified into several periods:
payable within one year, between one and two years, between two and five years and
more than five years. Furthennore, the lessee's financial statements will separately
disclose the amount of finance lease interest (SSAP-18, 1990, paragraph 5.15).

The lessee should show the rental expense of all operating leases separately in the
financial statements. Additionally, the lessee must disclose all non-cancellable

~2 Briefly, a lease would normally be classified as a fmance lease when: the lease is non-cancellable;
the collection of the minimum lease payments is reasonably predictable; and one of the following: the
lease transfers ownership to the lessee at the end of the lease tenn; the lessee has the option to purchase
the asset at a price less than the fair value and at the time of lease inception; it is reasonably certain that
the option will be exercised; the lease tenn is for a major portion of the useful life (at least 75%); and,
the present value of the minimum lease payments at inception is not less than substantially all (90%) of
the fair value of the asset (SSAP- 18. 1990, paragraph 4.4).
 102

operating lease commitments with a lease tenn of more than one year, classified into
the same periods as finance leases; that is, ranging from lease amounts payable within
one year to amounts payable after five years (SSAP-I8, 1990, paragraphs 5,16, 5,17),

7.1.2 Discussion of Air New Zealand's leases

During the period 1989 - 2001, Air NZ had both operating and finance lease
agreements. Table 7.1 provides the values of non-cancellable operating and finance
leases disclosed by Air NZ from March 1989 - December 2001. From the table it is
obvious that Air NZ changed to leases of an operating nature rather than a financial
nature over the twelve years. Operating leases increased 19-fold over the twelve
years, whereas finance leases decreased by almost 30% during the same period.

There are several consequences from Air NZ's move towards operating leases and
away from finance leases. Firstly. the company recognised fewer liabilities on the
balance sheet. Had Air NZ structured all its lease agreements as finance leases, total
assets and liabilities would have increased by a maximum of $2.965 billion for the
year ending June 2001 (increasing total assets by 37%). Secondly, the recognition of
leases as operating leases reduced the risk of Air NZ using typical risk proxies like the
debt to equity ratio, because the operating leases do not feature on the balance sheet.

Thirdly, the two types of leases are treated differently for tax purposes. The entire
operating"lease payment is tax deductible, whereas only the interest portion of the
finance lease is deductible for tax purposes (sections EO 2A and Fe 80 Income Tax
Act, 1994). However, a finance lessee can claim the depreciation for tax purposes
(sections BD 2( I)(a) and Fe 8G Income Tax Act, 1994), Therefore, there is a
possible tax advantage for recognising operating rather than finance leases, depending
upon the size of the depreciation charge. Nevertheless, the major consequence is that
Air NZ did not have to recognise a large amount of non-cancellable operating leases
as liabilities in the statement of financial position.
 103

Date Finance Leases Non-Cancellable Operating Leases

(in millions)
Total Operating Leases Aircraft Operating
(in millions) Leases (in millions)
3110311989 $355.9 $47.7 $27.4
3 1/0311990 $360.1 $188.2 $109.7
30/06/1991 $543.9 $477.3 $409.4
30/06/1992 $516.5 $610.8 $531.6
30/06/1993 $466.3 $481.6 $373.2
30/06/ 1994 $335 .4 $426.9 $321.5
30/06/ 1995 $336.5 $5 14.2 $407.2
31/ 12/ 1995 $317.8 $528.1 $430.7
30/06/ 1996 $288.1 $503.9 $375.4
31112/ 1996 $262.9 $484.3 $379.3
30/06/1997 $258.7 $509.6 $392.3
31/1211997 $264.6 $579.8 $488.9
30/06/1998 $275.7 $591.5 $452.7
31/ 1211998 $275.7 $661.2 $533.0
30/0611999 $199.2 $582.9 $461.8
3111211999 $196.7 $739.5 $616.4
30/0612000 $428.6 $2,406.1 $l,OlU
31112/2000 $334.1 $2,685.6 $1,374.9
30/0612001 $326.7 $2,965.2 $1,69 1.1
3111212001 $256.0 $912.2 $808.0

Table 7.1: Value oj/he Air New Zealand Group leasesJrom 1989 - 2001
I Air NZ does not stale that their operating leases are non-cancellable. However, it is assumed
that they arc non-cancellable, because that is all that is required by SSAP-18 (1990).
2 The 1992 annual report comparative figure was $672.8 million.
3 The 1992 annual report comparative figure was $596.6 million.
4 The 1995 annual report comparative figure was $389.4 million. From 1995, the deposits
held to payoff finance leases was recorc,led as an investment, instead of being netted against
finance leases.

7.1.3 Should non-cancellable operatin g leases be recognised as a liability?

Notwithstanding what it states in SSAP-18 (1990), is there an argument for

classifying non-cancellable operating leases as a liability and recognising the amount
 104

in the balance sheet? The now discontinued 04+ 143 standard setting body addressed
this issue a number of times. A 1996 document (McGregor, 1996) advocated
accounting for non-cancellable operating leases in the same way as that done for
finance leases. However, to fall under the proposed changes, the non-cancellable
operating lease duration had to be longer than one year. The reasoning behind this is
simple: rights and obligations established under operating leases are the same in
nature as those established under finance leases. Furthennore. it would "enable the
financial statements of lessees to reflect the rights and obligations arising under non-
cancellable leases, thus enhancing the relevance and representational faithfulness of
the financial statement" (McGregor, 1996, p. 17).

The G4+ 1 body revisited the issue in 2000 (Nailor and Lennard, 2000). Under this
paper's advocated approach, the lessee would recognise the rights and obligations
conveyed upon thell? by the lease agreement. The ,lease would be recognised on the
balance sheet in a similar way to that already done for finance leases. Nailer and
Lennard (2000) reasoning for capitalising operating leases is because the current
accounting trcatment is not the most relevant of the available choices, The current
accounting treatment does not provide useful infonnation for the users ' of the
Financial Statements. Nailor and Lennard (2000) provided the example whereby
investment analysts attempt to capitalise operating leases to provide a more
appropriate measure of financial position (Nailer and Lennard, 2000, paragraph 1.18).
Obviously, investment analysts do not agree with the current accounting treatment for
non-cancellable operating leases, Thus, this paper also advocates capitalising non-
cancellable operating leases, subject to materiality,

Nevertheless, the question arises: does a non-cancellable operating lease meet the
definition and measurement criteria of assets and liabilities? If this does not happen,
there seems .to be no reason for capitalising these types of operating leases. Stevenson
(1992) stated thal at least one standard setting board (the UK Financial Accounting
Standards Board) has conceded, Plat, in theory, non-cancellable leases should be
capitalised. McGregor (1993) discussed this in detail and showed that any material

41 The G4+ 1 standard setters was made up of representatives from the New Zealand, Austtalia, Canada,
the United States, the United Kingdom and International Accounting Standards Conunittee accounting
standard setters.
 105

non-cancellable lease would meet the measurement and recognition criteria for assets
and liabilities contained in SAC 444 ,

McGregor's (1993) reasoning was as follows. Non-cancellable leases would meet the
definition of an asset because the future economic benefits provided by the leased
property would be controlled by virtue of the lease agreement. Additionally, non-
cancellable leases would meet the definition of a liability since, under the lease
agreement, the lessee has a present obligation to sacrifice future economic benefits to
the lessor. These leases would meet the recognition criteria as lease agreement
specifies the amounts of the lease payments and it is probable that the lessee will pay
those amounts to the lessor. He concludes by stating,

"The rights and obligations established under operating leases are no

different in nature to those established under finance leases. ... Failure to
reflect the rights and obligations arising under material operating leases in
the financial statements will understate both the resources controlled by
those entities and the financial obligations they have to external parties"
(McGregor, 1992, p. 20).

To summarise, there is an argument for recognising non-cancellable operating leases

in the financial statements. Based upon the definitions given in the SOC (1993), these
types of leases would meet the measurement and recognition criteria of both assets
and liabilities. Thus, they would be recognised as such, if not for the intervention of
SSAP-18 (1990).

7.1.4 Treatment of non-cancellable operating leases in trajectory analysis

The discussion in subsection 7.1.3 shows that non-cancellable operating leases should
be recognised in the balance sheet (ignoring for the moment that SSAP-18, 1990, does
not require it). Furthermore, this thesis assumes that all assets and liabilities
(including off-balance sheet amounts) should be included to evaluate trajectory
analysis.

44 The measurement and recognition criteria for assets and liabilities contained in the SAC 4 are
substantially the same as those contained in the SOC (1993).
 106

The treatment proposed here, is to include the amount (shown in table 7.1) of 000-
cancellable operating leases in the total value of assets and liabilities. The liability
will have a long-term duration, except for the portion repayable in the current year.
The asset will be shown as one fixed/Jong-tenn asset. The lease asset will not be split
into its two separaJe assets (the asset itself and the rights of the asset), because this
would only be possible with a copy of the lease agreement45 . The operating lease will
he treated in a similar manner to that of a finance lease, although the financial
performance effects will remain the same (see subsection 7.1.1).

The one drawback of this method is the use of the total lease payment as the value of
the asset and liability. Generally, the lessee can value leases at the lower of the
present value of the minimum lease payments and the fair value of the asset (SSAP-
18, 1990, paragraph 5.1). None of these values are known, so the recognised amount
may be somewhat la~ger than what might have been Q1e case.

7.1.5 Leveraged Leases

Arising from the 1995 annual report, an interesting phenomenon occurred regarding
Air NZ's operating lease disclosure. Table 7.2 reproduces the value of the group and
parents operating lease commitments over the financial years 1989 - 200 I. For the
years 1989 - 1994 and 200 I, the group values exceeded the parent values for both
aircraft and property leases. However, for the period 1995 - 2000, the parent's
aircraft ~perating leases were greater than the group's aircraft operating leases. Prima
facie, this does not make sense; the group accounts are an aggregation of the parent
and all of its subsidiaries. Generally, one would expect the parent's values to be
smaller (as it is for the property leases over the entire period).

In the operating lease note, Air NZ acknowledged that the parent leased a number of
aircraft from its wholly owned subsidiary, New Zealand International Airlines
Limited46 . Ostensibly, this can explain the difference in the two amounts, as any

4S The lease agreement would show the assets leased, the amount of the lease payments, the lease term.
etc. Without this information, it would not be possible to split the operating lease asset into its separate
l'."rts.
This subsidiary is described as an aircraft leasing and fmancing company in Air NZ's Annual
reports.
 107

related party transactions between the parent and its subsidiary will be eliminated on
consolidation. Two quotes from Air NZ's annual reports may resolve this issue. In
the company's 1994 annual report, it stated:

Group Values (in millions) Parent Values (in millions)

Aircraft Operating Property Aircraft Operating Property
Leases Operating Leases Leases Operating Leases
31/03/ 1989 $27.4 $20.3 $27.4 $20.3
31/03/1990 $109.7 $78.5 S109.7 $72.6
30/06/1991 $409.4 $67.9 $409.4 $67.9
30/06/1992 S531.6 $79.1 $354.2 $70.3
30/0611993 $373.2 $108.4 $355.0 $98.0
30/0611994 S321.5 $105.3 $289.7 $89.7
30/0611995 S407.2 $107.1 $788.4 $103.3
30/0611996 $375.4 $128.5 $529.0 $114.7
30/06/1997 $392.3 $117.3 $592.5 $107.3
30/06/1998 $452.7 $138.8 $965.8 $108.3
30/06/1999 $461.8 $121.1 $966.1 $99.2
30/0612000 $1 ,011. 1 $ 1,395.0 $1,279.9 S105.4
30/06/2001 SI ,691.2 $1,274.0 $ 1,456.3 $103.6

Table 7.2: Value o/Group and Parent operatmg leases commItments

"For the Purposes o/section of the Companies Act 1955 as amended, Air
NZ Limited alld one of its subsidiaries, New Zealand International Airlines
Limited, have agreed to enter into a transaction ... with certain overseas
.banks for the financing of two Boeing B767-319 aircraft .... Certain
directors of Air NZ Limited and New Zealand International Airlines Limited
are 'interes~ed' in this transaction because they are also directors of the
other company involved, or because they are executives of Air NZ Limited"
(1994 Annual Report, Note 21, p. 61).
,

The 1995 annual report disclosed the following infonnation concerning these planes:
"{dJuring the year, the Company transferred two aircraft to .i!s. wholly owned
subsidiary, New Zealand International Airlines Limited for $264,514,000 and
subsequently leased these aircraft on operating lease agreements. All these
transactions are eliminated on consolidation" (1995 Annual Report, Note 16, p. FI6).
 lOS

No other annual report discussed the types of operating lease agreements between Air
NZ and its subsidiary. It would seem that Air NZ has used leveraged leases. SSAP-
18 (1990) does discuss leveraged leases; this is reproduced below:

"Certain finance lease transactions are structured in such a way that they
involve at least three parties, the lessee, the lessor and one or more long-
term lenders who provide part of the acquisition finance for the leased asset
usually without any general recourse to the lessor. These lease transactions
are sometimes known as leveraged leases. In such cases, the lessor records
hislher investment in the lease net of the nOn-recourse debt and of the
related fin ance costs to the third-party long term lender and recognises
finan ce income on the basis of hislher net cash investment outstanding in
respect of the finance lease" (SSAP-IS, 1990, paragraph 4.19).

Here, New Zeal and International Airlines would record the lease transaction net of the
debt used to purchase it. This would be recorded in its accounts, which would also be
consolidated into the group 's accounts. Because of what the standard requires, the
group accounts would not show any of the debt incurred to fund the aircraft purchase.
The only indicator of the possible debt amount is the difference between the parent
and group operating leases commitment. Figure 7.1 provides a possible diagram of
the leases affecting Air NZ throughout the period from 1989 - 200 1. It is a simplified
diagram of a very complicated part of their operations. Since the Air NZ group's
finance leases decreased during the period, it seems that Air NZ appears to have
exhibited an on-going process of removing liabilities from the balance sheet.

Air NZ's use of leverage leases has grim implications, these being that the company
used the accounting standards to remove debt from both the financial statements and
the notes to .the accounts. Any possible leveraged leases have not been included in the
analysis, because of difficulties in ascertaining the true amount of the debt used.
Furthennore, Air NZ may not have used such transactions in their leasing
arrangements. This subsection has been included to bring to the readers' attention a
possible use of the accounting standards to withhold useful information to the users of
the financial statements,
 \09

Air New
Air New
Zealand
Zealand Ltd
Other Group
, ,,
Subsidiaries ... .-.!
,, New Zealand
\ International Airlines
\
\
,, ,
,,,
\
, \
\ ,
,,
,,
,
Finance Lease ~ ,, ,
,, ,
Operating Leases <III. - - II>- ,, ,,,
, ,
Inter-Group
Leases
Possible THIRD PARTIES
Leveraged
Leases

Figure 7.1: Possible leases used by Air New Zealand

7.2 Air New Zealand's asset revaluation policy

This section outlines the effect of Air NZ's asset revaluation policy on trajectory
analysis. Section 7.2.1 discusses the applicable accounting practices during the period
1989 - 2001. Section 7.2.2 outlines Air NZ's revaluation policy. It shows that their
choice of policy materially undervalued assets during many of these twelve years.
Section 7.2.3 provides the treatment for the undervaluation of Air NZ's assets for the
purposes of trajectory analysis.

7.2.1 Summary of New Zealand accounting standards regarding asset

revaluation-

During the period of study, three types of GAAP governed asset revaluations in New
Zealand. Beforc the introduction of SSAP-28 (1990), New Zealand did not have an
accounting standard addressing fixed assets or asset revaluation issues. Consequently,
accounting for asset revaluations could follow any generally accepted accounting
policy.
 110

New Zealand companies began revaluing their assets from the 19505, although, the
only assets generaIly revalued were land and buildings. By 1980, revaluing assets
was a generally accepted policy in New Zealand, However, there were not the same
limitations on revaluations as imposed by SSAP-28 (1990); for example, companies
did not have to revalue systematically or revalue all assets in the same class at the
same time (Leitch, 1997).

From 1990 - 2001, the relevant accounting standard was SSAP-28 (1990). This
standard argued for asset revaluations only when the entity adopted the modified
historical cost accounting system. Revaluation of fixed assets should happen
systematically and preferably on an annual scale. Additionally. all assets within a
class of assets shou ld normally be revalued at the same time (SSAP-28, 1990,
paragraph 4.14).

Asset valuations should only be done by an independent valuer; a necessary

requirement to provide reliability concerning the value (SSAP-28, 1990, paragraph
4.15). The revaluation should be at net current value, and should not result in the net
carrying amount being greater than the recoverable amount 47 (SSAP-28. 1990,
paragraph 4.16). Government valuations (district valuation roll valuations) should not
be used as revalued amounts unless an independent valuer (ibid.• paragraph 4.17) has
confinned the basis of valuation. Finally. a transitional provision (ibid., paragraph
4.27) all.ows an entity to continue to use the carrying values shown in their financial
statements at the date of commencement (I October 1991) for SSAP-28 (1990).

In March 2001, a new accounting standard (FRS-3, 2001) was issued, which
combined SSAP-28 (1990) with SSAP-3 (1984), accounting for depreciation. The
revaluation pro.isions are contained in paragraphs 7.1 - 7.22. Under FRS-3 (2001),
paragraph 7.1, an item of property, plant and equipment can only be revalued if: all
the items within that class of asset. are revalued to fair value; the revaluations happen

47 The accounting standard defined each of these tenns. Briefly, net current value is the price that
might be expected when sold at the operative date,less disposal costs (SSAP-28, 1990, paragraph 3.8).
Net carrying amount is the book value of the asset (ibid., paragraph 3.7). Recoverable amount is the
amount of net cash inflows expected to arise from the assets continued use and eventual disposal, or its
disposal, when the asset is to be disposed in the immediate future (ibid., paragraph 3.9)
 III

on a systematic basis (at a minimum, every five years); and, the revaluation is done by
an independent valuer, or at the fair value detennined by an active market or at the
readily available price48 , Revaluation is not mandatory, but is encouraged to provide
infonnation that is more relevant to users of the reports (FRS-3, 2001, paragraph 7.2).

The frequency of the valuations depends upon movements in the fair value of the
asset. As the volatility in the movements of the fair value become significant, so
should the frequency of revaluations increase (FRS-3, 2001, paragraph 7.5).
Furthermore, a rating valuation (for example, Goverrunent valuations) should not be
used for recording revaluation. unless an independent valuer confinns the basis of the
valuation (ibid., paragraph 7.10). Finally, a transitional provision (ibid., paragraph
12.3) allows an entity to continue to use carrying amounts as at 1 October 1991 , if the
entity did not subsequentl y revalue these amounts in accordance with SSAP-28
(1990). Apart from the transitional provision, FRS-3 (2001) applies from 31 March
2002 (so falls outside of the period of study).

7.2.2 Air New Zealand's asset revaluation policy

Air NZ's asset revaluation policy is quite simple: the company very rarely revalued its
assets. The only times Air NZ revalued their assets was in 1976 (when the company
revalued select land and buildings), in 1985, when the company purchased a majority
stake in the Mount Cook group, and in 2000, when the company consolidated the
Ansett group. The latter two revaluations relate to the assets and liabilities brought in
by the subsidiaries and required under SSAP-8 (! 990), paragraph 4.29. The company
did not revalue any of its other assets. All other assets are valued at depreciated
historical cost.

It seems Air NZ made use of SSAP-28's (1990) transitional policy as stated in section
7.3.1. Air NZ's 1994 annual report stated that H ... certain a/the Group's Land and

.. Of the three tenns discussed in this sentence, two are defined in the standard. Property, plant and
equipment arc tangible assets that are held for continual use in the production and supply of goods,
services, rental or administrative purposes and items held for maintenance of assets (FRS-3, 2001,
paragraph 4.35). "Fair vallie is the amount for which an asset could be exchanged ... between
knowledgeable, willing parties at an arm's length transaction" (ibid., paragraph 4.23). The tenn
"active market" is not defi1led in this standard, but a possible defmition is given in lAS 38 (Intangible
Assets): a market where the items traded are homogenous; willing buyers and seller can be found at
any time; and, prices are available to the market (provided in Roberts, 2002).
 112

Buildings l!re stated at valuation ... the Directors have elected to continue to account
for these assets on the basis of the revalued amounts as at 30 June 1992,,49 (1994
Annual Report, Statement of Accounting Policies, p. 44). In the 1992 report, Air NZ
disclosed that their asset values were shown at cost, except that " ... the Group's
industrial and commercial land and buildings at Mangere were revalued by
independellt valualioll as at 31 March 1976" (1992 Annual Report, Note 9, p. 48). It
seems a reasonable assumption that Air NZ will continue to use these non-revalued
amounts by applying FRS-3' s transitional provision (discussed in subsection 7.2.1).

There are three major consequences of Air NZ's accounting policy. Firstly. fixed
asset values are likely to he undervalued in the statement of financial position,
assuming at least 10 years of land value increase from the company's last revaluation
at the beginning of the analysis. Furthermore, Air NZ's ROCE figure will be larger
because of a smaller denominator. If assets are not revalued, it will reduce both the
asset revaluation reserve and total equity, thereby reducing capital employed.
Secondly, the company has a smaller fixed asset base, and as a consequence, will
recognise a smaller annual depreciation charge in the statement of financial
performance (assuming the same depreciation policies). This has the added bonus of
reducing expenses and increasing net profit. Thirdly, Air NZ will recognise very
large gains on sale, if they sell any of their long-term fixed assets. This is because the
company has a small book value for these types of fixed assets; and all things being
equal, the gain on sale would be smaller if the company used more recent asset
values.

Air NZ's accounting policy raises the following question: are they providing useful
information for the readers' of their finanqial reports? Air NZ does provide additional
disclosure; they disclosed the market value of their jet aircraft and the Government
valuations of their New Zealand land and buildings. Table 7.3 provides the book and
market values of these assets, and the amounts of fixed assets and total assets Air NZ
recognised in the statement of financial position for the period March 1989 - June
2001.

49SSAP-28 (1990) became operative from 1 October 1991. This was during Air NZ's 1992 fmancial
year. The first time it could apply this standard would be from 30 June 1992.
 113

Jet Aircraft (in millions) Land and Buildings Total Fixed

(in millions) Assets Assets
Market Book Diff. Market Book Diff. (in millions)
Value Value Value Value
31/03/1989 $926.6 $780.7 $145.9 $146.4 $89.6 $56.9 $1,681.5 $1,278.0
31/03/1990 $1,174.2 $1,044.3 $129.9 $149.6 $91.3 $58.3 $2,189.2 $1,615.9
30/06/1991 $1,206.2 $1,114.7 $91.4 $149.1 $89.1 $60.0 $2,358.7 $1,726.0
30/06/1992 $1.247.0 $1,102.7 $144.3 $145.3 $81.3 $64.0 $2,409.4 $1,575.4
30/06/1993 $1,300.1 $1,288.1 $12.0 $134.3 $81.4 $52.9 $2,729.0 $1,761.5
30/06/1994 $ 1,21 3.0 $1,247.2 -$34.2 $142.7 $81.4 $61.3 $2,861.5 $ 1,752.9
30/06/1995 $1,226.3 $1,298.0 -$71.7 $144.2 $79.5 $64.7 $3,107.2 $I ,82Q.4
30/06/1996 $1,143.1 $1,190.1 -$47.0 $145.6 $82.4 $63.2 $3,134.8 $ 1,737.6
30/06/1997 $1,244.7 $1,259. 1 -$14.4 $150.4 $82.0 $68.4 $3,346.8 $1,813.9
30/06/ 1998 $1,673 .9 $1,640.3 $33.7 $146.4 $72.8 $73.6 $4,104.0 $2,213.7
30/06/1999 $1,648.7 $1,698.2 -$49.5 $184.7 $66.7 $118.0 $4,390.7 $2,223.2

30/06/2000 $4,735 .2 $4,411.6 $323.6 $735.3 $606.9 $128.3 $8,989.4 $6,027.1

30/06/200 1 $2,037.3 $ 1,931.5 $105.9 $195.9 $74.0 $122.0 $8,114.0 $4,997.7

Table 7.3 Book and market values of select Group Azr New Zealand assets
I Differences are due to rounding errors.

There are some major differences between the book and market values. Over the
entire period, the Government valuations of Air NZ's land and buildings exceeded the
book value by at least $50 million. The jet aircraft valuations are more volatile. For
five years, the book value exceeded the market values of the aircraft (by a maximum
of $71.7 million). The other years were the opposite; the market value exceeded the
book value by a maximum of$323.6 million in 2000.

The jet aircraft vaiuations volatility is because of Air NZ's foreign currency policy.
Air NZ denotes the value of their aircraft in US$, and uses this value as a natural
hedge for US$ denominated loan and lease liabilities. The movements in the market
value are caused by fluctuations in the NZ$ - US$ exchange rate, not major
movements in the valuations (which are also denoted in US$), Thus, the market value
fell when the NZ$ appreciated against the US$ and vice-versa.
This raises the question of whether these values are material. Table 7.4 shows the
sum of the djfferences between the market and book values as a percentage of both
 114

total and fixed assets. As expected, Air NZ's fixed assets were undervalued
throughout much of period. For only one year (1995) did the book value exceed the
market value, although by only a very small amount. The undervaluation of assets
was greater than 5% af total and fixed assets in five years (the years 1989 - 1992 and
2000).

Total value of differences Sum of differences as a

shown in Table 7.4 percentage of:
(in millions) Total Assets Fixed Assets
3110311989 $202.8 12.06% 15.87%
3110311990 $188.2 8.59% 11.64%
3010611991 $151.4 6.42% 8.77%
3010611992 $208.3 8.64% 13.22%
3010611993 $64.9 2.38% 3.68%
3010611994 527. 1 0.95% 1.54%
3010611995 -$7.0 -0.23% -0.39%
3010611996 $16.2 0.52% 0.93%
3010611997 $54.1 1.62% 2.98%
3010611998 $107.3 2.61% 4.85%
3010611999 568.4 1.56% 3.08%
3010612000 $452.0 5.03% 7.50%
30/06/200 1 5227.8 2.81% 4.56%
Table 7.4: Difference between market and book values of select Air NZ
assets as a percentage o/Group total and [lXed assets
I Differences are due to rOllllding errors.

However, is the undervaluation material? According to the SOC (1993), materiality is

a matter of judgement and is concerned with whether the infonnation affects the
perceptions of Ihe users (paragraph 6.6). SSAP-6 (1985), materiality in financial
statements, provides an appendix giving percentage guidelines for what is material.
This appendi"x states that any variation in amount greater than 10% is material and a
variation between 5 - 10% could be material. Finally, there are industry nonns used
by New Zealand auditors to determine materiality levels. These 'rules of thumb'
1 __ •

differ for various financial items, but the total asset materiality figure is 2%.
Based upon auditor benchmark levels of 2%, eight of the annual undervaluation
amounts shown in lable 7.4 are material (1989, 1990, 1991, 1992, 1993, 1998, 2000
 115

and 2001 income years). For these years, it seems appropriate to revalue the assets, to
provide more recent and relevant data. Air NZ did not revalue the assets themselves
because SSAP-28 (1990) did not require them to, and the auditor was probably
satisfied with the additional disclosure of the market values.

7.2.3 Treatment of the undervaluation of Air New Zealand's fixed assets

There are material differences between Air NZ's book values of their major assets
(the jet aircraft and land and buildings) and the disclosed market values. The proposal
here for traj ectory analysis is to revalue to the market values where there are material
differences. Additionally, to remain consistent with SSAP 28's (1990) systematic
M

approach, all immaterial differences will also be revalued to the market values. Thus.
revaluation of assets wi ll occur on an annual basis.

Basically, the approach will be similar to that taken for operating leases. In every
year of the analysis. the market values will replace the book values of the fixed assets
in the calculation of the trajectory. Only the statement of financial position figures
will change; the changes will not affect the profit figures contained in the statement of
financial perfonnance. Air NZ does not separately disclose the market values of the
land and the buildings, so the buildings cannot be depreciated. Furthennore, the
company's disclosure is not clear regarding how the book value of the aircraft relates
to the different assets. The book value of the jet aircraft (shown in table 7.3) does not
equate with the book values of the separate assets disclosed by Air NZ, Therefore, it
is not possible to detennine what effect the revaluation has on the arulUaI depreciation
expense. The major reasoning behind this artificial revaluation is to make use of the
most recent data in detennining the traj ectory. A company should be evaluated on its
most recent data; it should not use data that is twenty years old.

There is one major drawback to this process. The market values quoted in table 7.4
include Government valuations; SSAP-28 (1990) specifically prohibits these types of
valuations as revaluation amounts. Following SSAP-28 (1990). these. figures would
not be used in the analysis. However. Air NZ does not provide any independent
valuations of their land and buildings; thus. as a proxy for the market value, the
Government valuations are the next best provided by the company.
 116

7.3 Air New Zealand's tax accounting policy

The following section outl ines the company's tax accounting policy and its effect on
trajectory analysis. Section 7.3.1 provides a sununary of the applicable accounting
standard relating to income tax. Section 7.3.2 discusses Air NZ's choice of tax
accounting policy. It reveals a major overstating of profit for much of the period
when using one consistent accounting policy.

7.3.1 Summary of New Zealand tax accounting standard (SSAP-12, 1980; 1991)

SSAP-12, accounting for income tax, summarises New Zealand tax effect accounting.
There are two versions of SSAP-12 applicable during the period of study: SSAP-12
(1980), which covered the period up to I October 1991, and SSAP-12 (1991),
applicable after 1 October 1991.

SSAP-12's (1980) prefened tax method was the liability method (paragraph 5.2).
This method recorded outstanding tax differences as either assets (future tax benefits)
or liabilities (income tax payable), with the tax effect of timing differences to be
adjusted annually for any change in the tax rate (SSAP-12, 1980, paragraph 4.7). The
other pennitted method was the deferral method. This method also recorded any
outstanding tax differences as liabilities or assets, although deferred tax already
recognised in the balance sheet was not adjusted to reflect changes in the income tax
rate (ibid., paragraph 4.8).

However, not all tax differences have to be recognised. If three criteria are metSO , the
tax differences and related tax liabilities will not crystallise; therefore, the amounts do
not have to be r~cognised (SSAP-12, 1980, paragraph 5.3). Debit balances in the
deferred tax account are only recognised if there is reasonable certainty of recovery in
future periods (ibid., paragraph 5.4).

so The criteria arc: that the entity is a going concern, that there is reasonable evidence to foresee that no
liability will arise because of a reversal of timing differences for the subsequent three to five years; and,
that there is no indication the situation will change (SSAP-12, 1980. paragraphs 4.11, 5.3).
 117

Under SSAP-12 (1991), only the liability method (detailed above) can be used to
account for income taxes (paragraph 4.8). The standard allows two possible bases to

account for tax under the liability method: the comprehensive and partial bases.
Under the comprehensive basis, the income tax effect of all timing differences is
recognised (SSAP-12, 1991, paragraph 4.10). The partial basis only recognises the
amount of timing differences that will crystallise in the futureS] (ibid., paragraph
4.11). The standard advocates the comprehensive basis over the partial basis (ibid. ,
paragraph 4 .18).

52
Under the partial basis, when three criteria are met, the income tax effect of certain
timing differences do not need to be recognised in the current period (SSAP-12, 1991,

paragraphs 4.16, 4.l7). Therefore, the company ~~ ly recognises tax liabilities when
they will crystallise)n the near future. When timing differences result in a debit
balance (future tax benefits), the future tax benefits is only recognised when there is
virtual certainty" of its recovery (ibid., paragraph 4.20).

Both standard versions required the following (amongst other things) to be disclosed
in the notes to the accounts: the tax method used, the amount of income tax losses
carried forward, and unrecognised timing differences (SSAP-l2. 1980, paragraphs
4.9,4.14 and 5.10; SSAP-12, 1991 , paragraph 5.14). Of the two versions, SSAP-12

(1991) has the more stringent disclosure regime.

)1 The amount of deferred tax crystallising depends on the following: future profits, reversal of existing
timing differences in the future, and that the reversal of timing differences is similar to existing
differences (SSAP-12, 1991, paragraph 4.11).
52 The criteria are: that the entity is a going concern, that there is reasonable evidence that no liability is
likely to result of the reversal of timing differences for a considerable future perio{-and that there is no
indication that after this period the situation will change so to crystallise the liabilities (paragraphs 4.15,
5.2). The criteria are similar to that produced in SSAP-12 (1980) (see footnote 50).
53 There is "virtual certainty" when: future income is sufficient to absorb the debit balance; and the
income will take place in periods to allow the absorption to take place (SSAP-12, 1990, paragraph
4.20).
 118

7.3.2 Air New Zealand's tax accounting disclosure

From 1989 - 1999, Air NZ accounted for tax using the partial basis. In the statement
of accounting policies, Air NZ stated that "no deferred taxation is recorded ... as the
Directors believe that continuing timing differences are not expected to crystallise in
the foreseeable future" (1989 Annual Report, Statement of Accountirig Policies, p.
B37) . Consequently, no deferred tax liability was recognised in the statement of
financial position. In 1993, Air NZ applied the new SSAP-12 (1991) and stated that
they used the partial basis to account for income tax. The accounting treatment
remained the same.

Only in 2000, after the purchase of Ansett Australia, did Air NZ substantially change
its accounting policy. The company changed from the partial basis to the
comprehensive basis for accounting for income taxes. The following quote provides
their reasoning: "the comprehenSive basis is the preferred basis of [SSAP-12, 1991]
and is the basis required by International generally accepted accounting practice.
The change has been made recognising the international nature of the Group
follOWing the purchase of Ansett Australia" (2000 Annual Report, Statement of
Accounting Policies, p. B8)S4. In bringing the liability onto the statement of financial
position, the company incurred a charge to the statement of financial perfonnance of
$786 million. Table 7.5 reproduces the amounts of both recognised and unrecognised
tax liabilities disclosed by Air NZ from 1989 - 2001.

The preferred method under SSAP·12 (1991) is to recognise the deferred liability in
the balance sheet, irrespective of whether the timing differences will or will not
crystallise in the future (paragraph 4.18). Had Air NZ followed this approach from
1991 (when the standard had authoritative support), their perfonnance results would
have been signiijcantly different. Instead of recognising a tax liability of $786 million
in 2000, the company would have recognised a liability of $196 million in 1992 and
adjusted for the changes in deferred taxation in subsequent periods.
,.
 119

Deferred Taxation
(in millions)

Disclosed in the Notes to the

Accounts
31/0311989 S 123.0
31103/ 1990 11 66.0
30/061199 1 $245.8
30/061 1992 1196.1
30/06/ 1993 1222.7
30/06/ 1994 $273.0
30/06/ 1995 $342.5
30/061 1996 $417.5
30/0611997 $436.7
30/0611998 $420.9
30/0611999 1449.1
Recognised in the Statement
of Financial Position
31/03/ 1989 S3.6'
31/0311990 $3.7
30/06/2000 1786.2
3111212000 1772.2
30/06/2001 1446.4
311 12/200 1 1288.1

Table 7.5: Value of Air NZ's Group deferred taxation 1989 - 2001
I The 1992 alUlUnl report comparative figure was $165 . 1 million.
2 The 1998 annual report comparative figure was $418 .0 million.
l'For tbese two years, Air NZ subsidiaries used the comprehensive basis.
4 The 200 1 annual report comparative figure was $761. 5 million.

The treatment of Air NZ's deferred tax liability will be to recognise it as a liability
when this was ij rst possible. From 1989. this thesis will apply the comprehensive
basis to Air NZ's treatment of income taxes. The use of the comprehensive basis will
ensure consistent accounting polices for income tax over 1989 - 2000. This will
cause a reduction in profits for many of the years during the period 1989 - 1999.

54Air New Zealand 's reasoning was not accurate. IAS~12, income taxes, issued in 1996, required the
temporary difference approach to account for timing differences, not the comprehensive basis.
 120

although the reduction in profit for the 2000 financial year will not be as large. Table
7.6 details the reductions in profit for the financial years 1989 - 2000.

Increase (decrease) in
Deferred Taxation
(in millions)
31103/1989 $123.0
31103/1990 $43.0
30/06/1991 $79.8
30/06/1992 ($49.7)
30/06/1993 $26.6
30/06/1994 $50.3
30/06/1995 $69.5
30/06/1996 $75.0
30/06/1997 $19.2
30/06/1998 ($15.8)
30/06/1999 $28.2
30/0612000 $337.1

Table 7.6: ReductlOn in Group Profit to reflect use o/Comprehensive Basis

7.4 Other Disclosure Issues

The previous three sections have examined a number of Air NZ's accounting policies
in some detail. Those accounting policies affected the majority of the period 1989 -
2001. This section will examine three of Air NZ's accounting treatments, which
affected the company for only a specific number of years.

Section 7.4. 1 exam'ines the market value of certain Air NZ investments. Section 7.4,2
evaluates Air NZ's treatment of deferred charges. Section 7,4.3 discusses the
treatment offinancial instruments by the company.

7.4.1 Market Value of Investments

During 1999, Air NZ had an interest in·the company Equant N.V. Equant N.V. is a
company created from a joint venture between airline companies in the late 1940s.
 121

Air NZ interest was held by its subsidiaries and associates, although it did not
immediately record the investment in the statement of financial position. However, it
did sell some of its stake and recognise a gain on sale of $27.4 million in the year
ended 1999 (this amount being the sale of around 25% of its total interest). In the
2000 annual report, the company recorded a book value for this investment; this was
the fair value of Ansett's stake in Equant N.V. Table 7.7 provides the market and
hook values of the Equant N. V. investment.

Equant N .V. Investment Difference as a Percentage

(in millions) of Total Assets (Table 7.3)
Book Value Market Value Difference
30/0611999 $0 $179.1 $179.1 4.08%
30/0612000 $20.8 $69.0 $48.2 0.54%
30/061200 1 $0 $0 . $0 0.00%

Table 7.7: Value ofAlr NZ •s Group mterest m Equant N. V.

For the two years Air NZ owned the shares of Equant N.V., this investment was
undervalued in the statement of financial position. Using the auditor benchmark level
disclosed in section 7.2.2, 1999 difference between the market and book values is
material, as is the 2000 difference (if it is collated with the undervaluation of assets
shown in Table 7.4). The trajectory analysis treatment will be the same as that
discussed in subsection 7.3.3; the market value of the investment will replace the
book value in the calculations. As with the asset revaluations, none of these changes
will affept profit.

7.4.2 Deferred Charges

From 1978 --' 1990, Air NZ recognised all asset called Deferred Charges. This asset
was made up of capitalised interest and commitment fees on loans raised to purchase
aircraft assets and were written off over the loan period (1989 Statement of
Accounting Policies). However, in 1990, Air NZ changed the policy to one of
expensing interest and commitment fees when incurred. Thus, the company wrote off
the amount relating to interest ($ 18.54 million) to retained earnings.
 122

The problem with this accounting treatment is not with the result, but with how the
company wrote off the asset. An alternative treatment would have been to write the
asset off to the statement of financial perfOlmance. The deferred charges were just
capitalised expenses; writing them off to the statement of financial perfonnance
would ensure consistency with other comparable expenses. The company's treatment
actually increased its profits: the company did not incur amortisation of $6,983
million in 1990 because of the write-off of deferred charges to retained earnings.

For the purposes of trajectory analysis, the deferred charges write off will be expensed
in the statement of financial perfonnance in 1990. This is a more appropriate
treatment and applies the reasoning for the change in accounting policy (expensing
interest and commitment fees).

7.4.3 Financiallustruments

A disclosure standard (FRS-31) concerning financial instruments became operative on

31 December 1993. This standard was created to improve disclosures concerning an
entity's exposure to financial instruments (FRS-31, 1993, paragraph 3.1). This
standard requires companies to provide disclosure about any additional risk faced by
having financial instruments. Included in the disclosure are the fair values of
financial assets and liabilities arising from financial instrumentsss .

Air NZ began disclosing financial instruments in 1994. They provided carrying and
fair .values of many financial assets and liabilities including loans, finance leases,
options and a range of swaps. Table 7,8 provides a list of Air NZ's financial
instruments for the period June 1996 - June 2001. Major liabilities (loans and finance
leases) have been excluded from the table, because the carrying values seem more

55 FRS-31 (1993) dermes the terms mentioned in this paragraph, A financial instrument is any contract
that gives rise to both a financial asset of one entity and a financial liability of another entity. These
assets and liabilities maybe either recognised or unrecognised (FRS-31, 1993, pa"ragraph 4.1). A
financial asset is either: cash, a contractual right to receive cash or another financial asset, a contractual
right to exchange financial instruments under favourable conditions, or, an equity instrument (for
example, shares) in another entity (ibid., paragraph 4.2). A fmancialliability is a contractual obligation
to deliver cash or another financial asset to another entity, or, to exchange financial instruments under
Wlfavourable conditions (ibid., paragraph 4,3).
 123

appropriate in the analysis. Air NZ has an obligation to pay only the carrying value of
the liability. not the fair value.

Type of Financial Carrying Value Fair Value Difference

Asset/Liability (in millions) (in millions) (in millions)
30/6/1996 Options $0 $ 19.5 $19.5
30/6/1997
30/6/1998 Options $7.6 $9.9 $2.3
Interest Rate Swaps -$0.005 -$0.9 -$0.895
30/611999 Options $5.3 $6.1 $0.8
Interest Rate Swaps -$0.163 -$0.401 -$0.238
30/612000 Currency Options $1.7 $0.4 $1.3
Fuel Options $6.4 $28.8 $22.4
Interest Rate Swaps $0.5 $13.0 $12.5
Fuel Swaps $0 $15.5 $ 15.5
30/61200 1 Currency Options $ 1. 8 $1.1 -$0.7
Fuel Options $ 19.4 $5.7 -$13.6
Interest Rate Swaps -$2.8 -$3 1.2 -$28.4
Fuel Swaps $0 $ 1.1 $1.1
Foreign Currency Forward
Exchange Contracts $0 $100.2 $100.2

Table 7.8: Fazr and carrymg values of select A,r NZ Group financial assets and
liabilities

The majority of the financial assets and liabilities shown in the table 7.8 are
undervalued, if they are valued at all in the statement of financial position. The
treatment of these values for trajectory analysis, like for that of revaluation of fixed
assets, will be to use the revalued amounts in the analysis. The assets will be
artificially changed for each year. This will not affect the statement of financial
perfonnance.

7.5 Summary

This chapter has examined a number of Air NZ's accounting policies. The objective
of the chapter was to provide a more appropriate valuation of the company's assets,
 124

liabilities and equity, by using the more recent infonnation and various off-balance
sheet items disclosed in the notes to the accounts. Consequently, more assets have
been recognised for the purposes oftrajectory analysis.

The following changes have been made to Air NZ's financial results. Firstly, the
disclosed off-balance sheet operating leases have been included in the analysis. Air
NZ has an obligation to pay these leases, and only the accounting standard stops the
company from recognising them as a liability. Secondly, the company's major fixed
assets (j et aircraft and land and buildings) have been revalued to reflect the current
year market values. Thirdly, Air NZ's accounts will use the comprehensive basis to
account for income taxation over the entire period, rather than only from 2000
onwards. The consequence of this will be to bring the off-balance sheet liability into
the analysis.

Several other changes occurred in this chapter. The company's investment in Equant
N.V. and a select group of financial instruments have been revalued, again to make
use of more recent infonnation. Additionally, an asset write-off to retained earnings
has been more appropriately written-off to the statement of financial performance.

Appendix 2 will sununarise the changes made by this chapter for the period of study
into five tables. This appendix shows the increase in assets from asset revaluations
and capitalisation of operating leases. The increases in liabilities are for capitalisation
of opera.ting leases and increases in deferred taxation. Finally, the appendix shows
the changes made to the asset revaluation reserve, to consolidated profit after tax and
retained earnings. The analysis used in the following chapter will use this information
to adjust Air NZ's financial statements. The adjusted data will be Air NZ's worst-
case scenarIO.
 125

Chapter 8: Air New Zealand's Trajectory

8.0 Introduction

The previous four chapters have now made it possible to create the trajectory for Air
NZ. In chapters 4 and 5, trajectory analysis was evaluated and developed to remove
problems with AMH's version and make it testable. Chapter 6 introduced Air NZ and
provided its financial results from 1989 - 2001. Chapter 7 examined Air NZ's annual
reports to identify and adjust for any creative accounting teclmiques that overstated
profit or understated liabilities.

This chapter will produce three separate trajectories for Air NZ S6 • The first one will
evaluate Air NZ from its best-case scenario, using the information provided in the
financial statements. The second trajectory is Air NZ's worst-case scenario, adjusting
the best-case infonnation for the changes made in chapter 7. The final trajectory is
Air NZ's trajectory. which will take a mid-point between the two extremes.

Section 8.1 will evaluate all the separate indicators. It will show for some of the
indicators that there is a substantial difference between the two scenarios. Section 8.2
will use the indicators to shape the different trajectories. Additionally. this section
provides a sensitivity analysis to check the robustness of the trajectory and shape it
using different weights for each indicator. Section 8.3 wi ll summarise the conclusions
made -in this chapter.

8.1 The indicators of company health

This section wili discuss each of the six indicators of company health. Section 8.1.1
outlines the market indicators, which were unaffected by the changes made in chapter
7. Section 8.1.2 discusses the four corporate indicators. Each of the corporate
indicators has a best-case and worst-case scenario.

56 Appendix 3 shows the figures used to create these trajectories.

 126

8.1.1 The market indicators

As discussed in chapter 3, Air NZ is one of the few companies trading on the NZSE
with more than one type of share. The company classified its shares into two classes
over much of the period of study, the A class and the B class (see footnote 34). The
company combined the two share types back into one share on the 24 December 2001
as part of the New Zealand Government deal to recapitalise Air NZ.

The A class began trading in October 1989, whilst the B class were only publicly
tradable from January 1992. However, for the purposes of calculating the market
value, the B class were valued at the same amount as the A class until the B class
traded separately on the NZSE. Figures 8.1 and 8.2 provide the graphs of Air NZ's
share prices and market value respectively from March 1990 - December 2001. The
period is chosen since March 1990 was the first date after the A class began trading
on the NZSE that Air NZ publicly released either an armual or a half-yearly report.

Air New Zealand Share Prices

$6.00
$5.25
$4.50
$3.75
$3.00
$2.25 ·
$1.50"~_·
$0.'15
$0.00 +----_--~---~--_---,--­
War-90 M:lr-92 War-94 War-96 M:lr-98 fv1ar-OO

Year
A' Shares ___ B' Shares I
Figure 8.1: Air New Zealand's share prices: March 1990 - December 2001

The Share prices both follow a simi lar trend from 1990 - 2001, although the B class
were valued at a higher amount than the 'A' shares. This is because the B class had a
greater demand as fore ign nationals could own them . The A and B classes reached
their historical highs in June 1994 and again in December 1995. From the latter date,
 127

Air NZ's share prices fell consistently (apart from two brief recoveries in December
1996 - June 1997 and June 1998 - June 1999) to a value 0[$0.35 in December 2001.

Stock Market Share Value Indicator

$2,500,000,000

$2.000,000,000

$1 .500,000,000

$1,000,000,000

$500,000,000

$iJ +----_-_--~-_-_--
MoIr-go Mar-92 M:lr-94 Mar-96 Mir-98 MY-OO

Year

Figure 8.2: Air New' Zealand's market capitalisation: March 1990 - December 2001

The stock market share value grew consistently from June 1991 to June 1997 (when it
exceeded $2 billion market capitalisation). Air NZ had three major share issuesS7,
which increased the market value without a similar change in the share price.
Additionally. Air NZ reclassified some of the A class to the B class, increasing
foreign ownership (see chapter 6). This increased the market value since the B class
always had a higher value. However, like the share prices, the market value never
really recovered from its high in June 1997 and ended at an historical low of $265
million.

To summarise, the share prices fell from December 1995, whilst the market value fell
from June 1997. Any recoveries in either indicator never lasted more than 12 months.
Finally, the fall in the indicators after the purchase of remaining share of Ansett in
June 2000 was swift: the A class fell 81 % whereas the market value fell 77%.

j1 These were in August 1991 (issuing 140 million shares), November 1996 (119 million shares) and
November 2000 (189 million shares).
 128

8.1.2 The corporate indicators

This subsection will discuss each of the four corporate indicators. Using the process
outlined by Robb (1999), section 8.1.2.1 will examine cumulative OCFAID and
cumulative retained earnings. Section 8, l.2.2 outlines the company's ROCE
indicator. Section 8.1.2.3 produces Air NZ's debt to equity ratio. Each section will
discuss both the best case and worst-case results.

8.1.2.1 Opcrating Cash Flows aftcr lllterest aud Dividends (OCFAID)

Figures 8.3 and 8.4 provide the graphs of the best~case and worst-case scenarios afthe
OCFAID analysis. There are no differences between cumulative OCFAID in the two
graphs. From Dece~ber 1992 onwards, Air NZ reclassified capitalised interest from
an op~rating activity to an investing activity. However, both scenarios were adjusted
for this change by reducing OCFAID by the amount of capitalised interest from
December 1992, thus ensuring consistency. The differences between the best and
worst-case cumulative retained earnings relate to the changes made in chapter 7.

The important thing to note from figures 8.3 and 8.4 is the fact that cumulative
OCFAID was always positive from 1989 - 2001. It fell in only four six-month
periods (six-months ending June 1991, June 1998, June 2001 and December 2001).
Cumulative OeFAID exhibited strong growth from December 1991 to December
1996 (average six-month growth of 22.7%) and again from December 1998 to
December 2000 (average growth of 6%). The problems caused by Ansett coupled
with high fu~1 prices and a weak New Zealand dollar caused cumulative OCFAID to
fall by 9.5%
. .
over the 2001 calendar year. Nevertheless, cumulative OCFAID
indicates that Air NZ continued to create cash from its operations and was in no
failure situation through a lack of cash creation.
 129

OCFAID : Best-Case

$3,000,000
$2.250,000

..,
0
0
$1,500,000

,•
$750,000
0
0 SO
.<:
.... ·S750,oM' ·89 M3r-91 f¥'ar-93 Mar-95 Mar-97 Mar-99

-$1,500,000
-$2,250,000

Yea r

1-- OJrTlJlative OCFAID ----- Qurulalive Retained Earnings I

Figure 8.3: OCFAJD best-case scenario

The cumulative retained eamings (eRE) differ substantially between the two graphs.
In the best-case scenario, eRE only fell once (in September 1990) before the change
in accounting policy in June 2000. Growth was substantial from June 1991 to
December 1999 with average six-monthly growth of 15%. However, the three major
falls from June 2000 more than removed the eight years growth, reducing eRE by
260% by December 2001.

OCFAID : Worst-Case

$3,000,000,000
$2;250,000,000
$1,500,000,000

$750,000.000
$0 fl"e;;;;;;;q;;::~....=*~:!::~~:;:!:::!::::!::~~:::.,~_
-$750,QOQ,oOda -89 Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Ma 01

-$1,500,000,QOO
.$2,250,000,000
Year

1-- Qmulative OCFAID -+- OJrrutative Retained Earnings I

Figure 8.4: OCFAJD worst-case scenario
 130

Under the worst-case scenario, eRE was negative in March 1989 and remained that
way until June 1992. Average six-monthly growth of 40% was again impressive from
June 1991 to December 1999, even allowing for losses made in the six-months ending
June 1991, June 1995, June 1996 and June 1997 (these were caused by increases in
deferred taxation). The major losses made by Air NZ after Ansett became a
subsidiary sti ll affected the company, reducing CRE by 400% by December 2001 ,

Both graphs show that Air NZ struggled to create similar after-tax profits as they did
cash, A widening gap between the two appeared from June 1991, this never closed
over the following ten years. At eRE's height, the gap between that and cumulative
OCFAID was $ 1.4 billion for the best-case and $1.86 billion for the worst-case
seenano. Using Robb's (1999) terminology, Air NZ was a "cash-cow", a company
that made cash, but not necessarily any corresponding profits.

8.1.2,2 Return all Capital Employed (ROCE)

Figures 8.5 and 8.6 provide hTfaphs of the best-case and worst-case scenario ROCE
indicator respectively. To recap, ROCE is calculated by dividing earnings before
interest and tax (EBIT) by capital employed. There were two major problems in
determining this indicator. Firstly, until June 2001, Air NZ did not produce the EBIT
figure. However, the company provided enough infonnation to produce a proxy
operating profit (or surplus) before tax plus the net interest expense. This proxy was
used from 1989 - 2000 1 to provide continuity of data and a consistent measurement
base (the numerator would be calculated in the same way for each year).

Secondly, until December 1993, Air NZ's half-yearly report did not provide enough
infonnation to determine the proxy EBIT figure (they did not disclose the net interest
expense). Thus, for the fi rst four years ROCE was calculated on an annual basis,
whereas for the remainder of the period it was calculated on a six-monthly basis. To
remove this inconsistent measurement, the EBIT proxy from March 1989 to June
1993 was halve?: half of which was placed in the first six months, the rest in the
second six months. Whilst this is an arbitrary split, it is the best way of ensuring that
the indicator was measured on a six-monthly basis s8.

58 Using the data with either the inconsistent measurement or the arbitrary split did not significantly
change the shape of the trajectory.
 13 1

Return on Capital Employed: Best-Case

15.00%
10.00%

5.00%
0.00% tt:::=::::;:::::::::::::::::::::_:~:::::;::::==::::::::::,=j-._
-5.00$ -89 tvtlr-91 IYBr-93 fv1ar-95 Mar-97 Mar-99 (-01
-10.00%
-15.00%
-20.00%
. -25.00%
-30.00%
-35.00%
Year

Figure 8.5: ROCE best-case scenario

Retu rn on Capital Employed : Worst-Case

10.00%

5.00%

0.00% +-::=::::::;::::::::=:--_...:::::::=:::::::::~=)
"" -89 Wet-91 Ivbr-93 Mar-9S Wer-97 I'v'ar-99
-5.00%

-10.00%

-15.00%

-20.00%

-25.00%
Year

Figure 8.6: ROCE worst-case scenario

The only difference between the best-case and the worst-case scenarios relates to the
value of the denominator, capital employed. Capital employed is calculated by
adding together total equity and total long-term liabilities. After making the changes
in chapter 7. this figure differed for each scenario. Not surprisingly, the two graphs
have the same shape; indeed, the only difference is the percentag~s on the vertical
axis. Therefore, the following discussion will refer to both of the graphs.
 132

Until June 2001 and the problems occurring in that year, ROCE remained positive.
There was, however, very little growth in the indicator over the previous twelve years.
The average return over the positive period (March 1989 - December 2000) was
4.27% (worst-case scenario: 3.5%), which is less than the starting point in March
1989. Only in three half-year periods (periods ending June 1994, December 1994 and
December 1995) did the retum on capital employed exceed that made in March 1989.
Further, the indicator declined from December 1995 with only brief recoveries in June
1997 and December 1999. Thus, the graphs show that the company never regained its
profitability in the latter 1990s.

The losses in June 2001 and December 2001 show that the Ansett debacle severely
affected Air NZ's operations. The respective losses for each period were 32% and
20% (worst-case: 20% and 13%). It seems somewhat illogical that the worst-case
scenario's losses are not as bad as the best-case's. However, this is because the
worst-case scenario created a larger capital employed than the best-case, thereby
spreading the loss over a larger base.

To summarise, Air NZ remained profitable on an operating basis until June 2001.

The decline in return on capital employed coincided with Air NZ's initial purchase
into Ansett Australia, although, only when Air NZ consolidated Ansett did the return
become negative.

8,1.2.3 Debt to Equity Ratio

Figures 8.7 and 8.8 provide the debt to equity ratio for both the best-case and worst-
case scenario. Firstly, for the best-case scenario. the ratio (calculated by dividing total
liabilities by total equity) only exceeded 2:1 once (in June 1991) in the period March
1989 - Decembe, 1999. Indeed, the ratio remained around 1:1 from June 1996 until
December 1999. This indicates that until Ansett became a subsidiary, Air NZ was a
low ,risk company with a relatively .small amount of debt. From June 2000, the ratio
worsened; the ratio was 4.6: 1 in June 2000 and reached a high of 31-~ I -by December
2001. The best-case scenario suggests that Air NZ became considerably riskier
during the last 18 months of the period.
 133

Debt to Equity Ratio: Best-Case

100.0000

10.0000

1.0000 t==:::::::::::=.===::;:==:::::,_-~::;>,J~~-
M3 -89 M:lr-91 M3r-93 t;.tar-95 Wlar-97 f.ler-99 M:lr-01

0.1000
Year

Figure 8. 7: Debt to Equity ratio best-case scenario

The worst-case scenario is significantly different from figure 8.7. As discussed in

chapter 7, the major changes that affected the company's debt and equity were the
capitalisation of operating leases, an early adoption of the comprehensive tax basis
and revaluation of selected assets to market values. During the period up to
December 1999, the ratio never fell below 1.7:1. However, from June 1990 -
December 1997, the ratio exceeded 2:1. The higher ratio over this period suggests
that Air NZ was a lot riskier than was suggested from examining just the statement of
financial position. Like the best-case scenario, the ratio deteriorated from the
consolidation of Ansett; the ratio was 4.5: 1 in June 2000 and worsened to a high of
13:1 in !une 2001. The conclusion from the previous paragraph stands: Air NZ's
riskiness became apparent after the consolidation of Ansett in its accounts,

Why did Air NZ's debt to equity ratio deteriorate to such an extent from JIDle 2000?
From June 2000, Air NZ consolidated Ansett in it~ accounts. As at June 2000, Ansett
contributed ·$4 billion in assets and $3.1 billion in liabilities, but no increase in
equi tY9. Coupled with the loss made because of the change in the tax accounting
policy, it significantly increased debt relative to equity. The consolidated net losses
made in the six-months ended June 2001 and December 2001 increased the ratio even
more, since equity decreased whereas debt remained relatively constant.

S9 Appendix 1 provides a summary of how Air NZ treated the purchase of Ansett in its accounts.
 134

Debt to Equity Ratio: Worst-C ase

100.0000

10.0000

1.0000 .e--~--~--~.--~--~--~-
Mar-8g Mar-91 Mar-93 Mar-95 M3r·97 fv'ar-99 Mar-01

Year

Figure 8.8: Debt to Equity ratio worst-case scenario

A final point concerning figures 8.7 and 8.8: they may not be entirely accurate. From
October 1996, Air NZ held a 50% stake in Aoset!. Air NZ also nominated three of
the six members of AnseU's board of directors. However, Air NZ was not required to
consolidate Ansett in its books until June 2000. An early consolidation of Ansett
from 1996 may have significantly changed the ratio from this time. That is, the ratio
may have deteriorated as early as December 1996, instead of as late as June 2000.

To summarise, Air NZ's debt to equity ratio remained relatively constant over the
period until March 1989 to December 1999. However, with the consolidation of
Ansett, the ratio declined rapidly from June 2000. This shows that Air NZ became
more financially risky over the period of study.

8.2 Air New Zealand's Trajectory

This section will produce Air NZ's trajectory. The first step will be to standardise the
indicators as per the discussion in section 6.3.3. Figures 8.9 and 8.10 provide graphs
of the standardised indicators. All of the indicators were standardised to a base of 100
in March 1990. March 1990 was chosen, as it was the first period that all of Air NZ's
indicators were measurable using publicly available infonnation.
 135

Standardised Indicators: Best-Case Scenario

1000.00

750,00

500.00

-8 ..
..
~
250.00
.!!- -, . -- - :."-'>:.- i*" --}'--l'*

81 0.00
~
r..t3r-92 Iv\3.r-96 Iv1ar-98 P'vtIr-OO
'""
u ""
-250.00
-90 Mlr-94

•
'>-"m" -500.00

•• -750.00
•
"' -1000.00

-1250.00

-1500.00
Year

- - OJrrulative Da'A[) _ _ QJrrulative Retained Earnings

..... -. Return on capital ErrpIoyed -?f- Debito Equity Ratio
~A' Shares -----*-- 8' Shares
--+-- Market Value Equity

Figure 8.9: Standardised Indicators best-case scenario

The assumption here is that as an indicator increases, so will company health and the
trajectory. However, this is not entirely true for all of the indicators. The debt to
equity ratio measures financial risk; a higher ratio suggests a riskier company and a
greater chance of failing. Therefore, to ensure consistency with the other indicators,
the inverse of the debt to equity ratio is used when calculating the trajectory (that is,
the higher the indicator, the lower the risk, which is better for a non-failing company).
Figures 8.9 and 8. 10 include the inverse debt to equity ratio.
 136

Standardised Indicators: Worst-Case Scenario

900.00

600.00

300.00
S
".!l-
~
0.00
,:,-- '"
"

"
0>
.... -90 M21r-92 Mar-94 Mar-96 Mar-98 Mar-DO '
0> -300.00
~

~ -600.00
~
::E
~
~ -900.00
~
>-
~
~ -1200.00
.:l
-1500.00

-1800.00

-2100.00
Year

Currulative OCFA[) _ o'JITlJlalive Retained farnlngs

Return on capital Errployed --)i--- Debt to Equity Ratio
---...-A'Shares ____ B' Shares
-+- Markel Value Equity

Figure 8.10: Standardised Indicators worst--case scenario

The second step is to combine the indicators into one trajectory. Using the method
summarised in chapter 5, a weighted-average is used to create the trajectory from the
individual indicators. Figm-e 8.1 1 provides both the best-case and worst-case scenario
trajectories. These trajectories are created using an equal weighting for each of the
indicators.

As expected, the trajectories follow a similar shape to the indicators. The fallout from
the 1991 Gulf-War, which increased fuel prices and reduced tourism travel, caused
the initial drop from 1990 - 1991. The trajectory improved until December 1995,
whereby it remained reasonably constant until December 1999. The drop in June
2000 was due to both the consolidation of Ansett and the effect of the comprehensive
 137

tax basis on Air NZ's profit. Finally, several factors including the collapse of Ansett,
historically high fuel prices and a general slump in the international aviation industry
caused the drop in 2001.

Six Indicator Trajectory - both scenarios

500.00
400.00
300.00

100.00 ,1' __
200.00 =0""""""""-
0.00 t----~---~---~---~---~-_\_-
_100.!M:I -90 M1r-92 Iv1ar-94 fv1ar-96 fv1ar-98 Mar-OO
-200.00
-300.00
Year

. --+--- Trajectory (Best-Case) _ _ Trajectory (Worst-Case)

Figure 8.11: Best-case and worst-case trajectories: equally weighted indicators

The final step is to merge the above two trajectories into the final trajectory. The
process involves simply taking the average of the two scenarios and placing the
company trajectory in a midpoint between them. Figure 8.12 shows the graph of Air
NZ's trajectory. This trajectory is very similar to the above scenario trajectories.
which is because the scenarios are almost identical in shape.

Does this trajectory meet one of the three hypothesised trajectories? Possibly. Air NZ
followed the Type 3 trajectory of failure. Figure 8.12 could be the Type 3 trajectory
for two reasons. Firstly, Air NZ is a mature company that has been operating for over
sixty .years. Secondly, there is a plateau (of six months) between the two collapses
(June 2000 and iune 2001 - December 2001). AMH did mention that a plateau could
be as short as one or two months, howe\:'er they also believed that such a short plateau
was very unlikely (Argenti, 1976, p. 164; McRobert and Hoffman, 1997, p. 124).
 138

Air New Zealand's Trajectory

500.00
400.00
300.00
200.00

100.00 "_-J
0.00 t------------r--~-T_
-100.Q&t -90 Mar-92 Mar-94 Mar-96 Mar-98 MJr·OO

-200.00
-300.00
Year

Figure 8.12: Air New Zealand's trajectory: March 1990 - December 2001

The reasoning in the previous paragraph that Air NZ is a Type 3 company is based on
the twelve-year trajeCtory. However, Air NZ's operations changed considerably from
December 1996. From then, the company ceased to be a regional New Zealand
airline and instead became an Australasian carrier. Examining the trajectory from
December 1996 (and standardising from this date) shows a different trajectory, more
akin to the Type I. Figure 8. \3 shows that Air NZ's trajectory did not grow from
December 1996; instead, it remained relatively stable until June 2000, when the
collapse began.

Trajectory: December 1996 "December

2001

125.00
100.00 ·
75.00
so.oo
. 25.OQ
0.00
-25.0 ,. Jun- Dec- Jun- Dec- Jun- Oec- Jun- Dec- n- Dec-
6 9 7 9 7 9 8 9 8 9 9 9 9 0 0 0 0 0 01
-so.oo
-75.00
Year

Figure 8.13: Air New Zealand's Trajectory after the investment into Ansett Holdings
 139

This paints a different picture of the company; the Air NZ trajectory may have
transferred from a non-failing trajectory (up to December 1996) to a failing trajectory
(from December 1996). The company's trajectory grew from 1990, which is unlike
the typical Type 3 company. Further, the plateau (suggested from December 2000 ~

June 2001) does not happen at a poor state of health, but actually at the excellent state
of health (see section 8.2.2). The proposition that Air NZ is a Type 3 company is
incorrect. Instead, Air NZ transferred from the non-failing to the Type 2 failing
trajectory. Figure 8.12 is similar in shape to Argenti's (1976a) exhibit 8.8, which
figure 8.14 reproduces. The traj ectory is not the Type 1 trajectory since a company
on that trajectory does not succeed; it is obvious that Air NZ did so until December
1996.

To conclude, Air NZ, although it did not fail, "transferred to the Type 2 failing
trajectory during the period 1990 - 2001. Therefore, the proposition that Air NZ
followed the Type 3 trajectory is incorrect. The following two subsections will
conclude the discussion of Air NZ's trajectory by raising the following questions:
firstly, should equally weighted indicators create the trajectory, and secondly, what
staters) of health was Air NZ in during the period?

General
Health

Fantastic

Excell ent _ - --------

Good

Poo~

Failure

Time

Figure 8.14: A switch from a non-failing trajectory into a Type 2failure trajectory
' ..
SOUIce: Argenti (1976a), Exhibit 8.8, p. 168.
 140

8.2.1 Different versions of the Trajectory

The trajectory produced above is calculated by equally weighting the individual

indicators. However, in chapter 5, it was suggested that the indicators should have
different weights, to reflect their relative importance towards the survival of a
company. This subsection will examine whether tI1e trajectory changes shape as the
indicator weights change,

8.2.1.1 Sensitivity analysis

A sensitivity ana lysis was used to apply different weights to each indicator, to both
check for robustness in calculating the trajectory and to adjust for the relative
importance of each indicator. This process involved calculating the trajectory with
the indicators having different weights, and comparing them with the equally
weighted traj ectories shown in figure 8.1 1. Appendix 4 provides several versions of
the trajectory after applying the sensitivity analysis. Each graph provides both the
appropriate (either best-case or worst-case scenario) trajectory given in figure 8.11
and the adjusted trajectory.

Graphs 1 and 2 (as shown in appendix four) double the weighting of the corporate
indicators whilst leaving the market indicators unchanged. Graphs 3 and 4 do the
reverse, by doubling the weight of the market indicators, whilst the corporate
indicators have a weighting of one. Graphs 5 - 12 weigh the indicators in a random
matter; Appendix 4 provides the ordering of the indicators for each graph. Finally,
Graphs 13 - 26 double each individual indicator only; for example, graphs 13 and 14
double cumulative OCFAID, whilst leaving the others unchanged.

The graphs provi,d ed in the appendix show that the new trajectories are not exactly the
same as those in figure 8.11, although they fo llow a similar shape. All the graphs
show a decline in the traj ectory until June 1991. They all show strong growth until
December 1994. From December 1994, the different trajectories show uncertain and
volatile growth until 1999. Importantly, all the graphs exhibit the major collapse in
the trajectory from December 1999 - December 2001.
 141

These graphs (which are only a sample of the entire analysis) show that creating the
trajectory is robust. Irrelevant of the individual weighting of the indicators, the
resulting graph still shows that Air NZ followed the modified Type 2 failure
trajectory. This does not mean that the use of a weighting system within the
parameters set is less appropriate in creating the trajectory; instead, it means that it
makes no substanti al difference to Air NZ's trajectory.

8.2.1.2 Corporate and Market Trajectories

A specialised version of the trajectories was examined during the sensitivity analysis.
This involved giving the corporate or market indicators a weighting of zero, thus
producing a corporate and a market trajectory. Appendix 5 provides the graphs of the
market trajectory and the best·case and worst-case scenarios corporate trajectories.
Two points are apparent from these graphs.

Firstly, the corporate trajectories more closely match the actual trajectories than the
market trajectory. The corporate trajectories show a steady increase from June 1991 -
December 1999, when the coJlapse began. The market trajectory is more volatile and
shows that it began declining from heights reached in June 1994 and again in
December 1995.

The second point relates to the values each type of trajectory can take. The market
trajector>: cannot become negative, because company shares and market capitalisation
cannot be negative. Thus, the market trajectory will only reach zero when the
company deli sts its shares from thc stock exchange or the company fails. The
corporate trajectory can go below zero, which makes it more difficult to determine
when failure may happen. In other words, the closer the market trajectory gets to
zero, th e closer to failure; the more negative the corporate trajectory is, the greater the
chance of failure.

The impact of the two different types of indicators is as follows. The corporate
indicators can go negative; they will have, of course, a greater negative impact on the
trajectory than the market indicators. Alternatively, the market indicators can only
have a positive impact on the trajectory since they cannot go negative.
 142

The apparent closeness of the corporate trajectory to the actual trajectory may mean
that only the corporate indicators need to be calculated when creating a trajectory.
Thus, an analyst would not have to calculate a share price proxy for a company that
does not trade upon a stock exchange. Instead, the corporate trajectory can be used as
a close approximate for the actual traj ectory. However, additional research would
need to be done to detennine whether this is the case.

8.2.2 The completed trajectory for Air NZ

Using the discussion of the indicators in section 8.1, and the distinguishing
characteristics of the different states of company health in chapter 5, it is clear at what
time Air NZ was in particular states of company h: _alth. Air NZ began the trajectory
in a good state of co~pany health. The corporate indicators were generally positive
but stagnant during the period March 1989 - March 1990. It remained in a good state
of health until December 1993, where the growth in profits, cash and the perfonnance
ofthe company's shares was enough to break into an excellent state of health in June
1994.

Air NZ continued in an excellent state of health until December 1999; the losses made
in June 2000, however were enough to drag the trajectory back to the good state of
company healtll. Finally, the general fragility of the company in 2001 (the collapse of
Ansett, massive company losses, reductions in OCFAID and a woeful share
perfonnance) caused the company to enter the poor state of health, where it stayed
until pecember 2001.

. .
Figure 8.15 reclassifies the traj ectory shown in figure 8.12 into the fonnat suggested
by AMH (the horizontal axis time and the vertical axis the states of company health).
 143

Air NZ's Trajectory

Fantastic

Excellent

Good

Poor

Failure -I--~-~-~-~-~-_-_-_-_-_-_-

1990 1991 1992 1993 \994 1995 1996 1997 1998 1999 2000 2001

Year

Figure 8. 15: Trajectory ojAir New Zealand: 1990 - 2001

8.3 Summary

This chapter has gone through the process of producing a company trajectory. Using
Air NZ as a case study. it has shown that using the six indicators would produce a
trajectory that meets one of the hypothesised trajectories. Specifically, Air NZ
followed a modified Type 2 failure trajectory.

The company's perfonnance was solid until the consolidation of Ansett as a

subsidiary in June 2000. The consolidation plus the change in the tax accounting
policy adversely affected the company to an extent that it did not recover by
De<:ember 2001. Indeed, in that fateful year, Ansett collapsed, causing Air NZ to
record its largest corporate loss. Furthennore. the company struggled to continue in a
radically changing trading environment. By December 2001, Air NZ continued to
lose cash and incur losses, and its share price collapsed. Realistically, only the New
Zealand Govemment remained between it and failure.

The traj ectory faithfully graphs Air NZ's performance, from the heights in the 1990s
to the collapse in 2001. At first glance, the trajectory looks like a Type 3 trajectory,
since it declines, remains on a plateau, and collapses a second time. However, the
company's actual trajectory seems to be a modified Type 2 trajectory (a transfer from
 144

a non-fai ling company to the Type 2 collapse) because Air NZ does not fall to the
plateau at a poor state of health, but instead at a good state of health. The company
only began collaps ing in June 2001; the fall in June 2000 is more of a decline, since it
did not reduce the trajectory markedly.

The following chapter will discuss the limitations inherent in the thesis. Additionally,
Chapter 9 will suggest avenues of future research in the area of trajectory analysis.
 145

Chapter 9: Limitations and Further Research

9.0 Introduction

The preceding chapters have examined trajectory analysis to determine whether, as

AMH have argued, it could be useful as a failure classification model. However,
before stating the conclusions of this thesis, it seems appropriate to discuss both the
research limitations, and to suggest areas of further research. Both of these are
covered in this chapter.

Section 9.1 discusses the limitations inherent in this thesis. Section 9.2 outlines the
major areas of further research. A summary follows in section 9.3

9.1 Research Limitations

There are four major limitations with this thesis. These are the following: non-
financial infonnation. nse of a financial model, choice of indicators and Air NZ's
data. The following subsections discuss each of these.

9.1.1 Non-fi nancial information

One of the innovative parts of AMH's theory of corporate failure is the use of non-
financial information. Many researchers (especially Storey el aI. , 1987; Keasey and
Watson, 1987) commentated that a combination of non-financial and financial
infonnation in classifying failure companies, has a higher success rate than using
either type of information separately. Both Argenti's (1977; 1983; 1984) A·score
model and trajectory analysis (as produced by AMH) made use of non-financial
infonnation when classifying companies as failed or non-fai led. In spite of all this,
the changes made to trajectory analysis removed all of AMH's suggested non-
financial indicators.
 146

Nevertheless, it was appropriate not to use non-financial indicators in the analysis of

Air NZ. AMH did not provide methodology to measure any of their indicators.
Whilst there is a simple way to measure financial infOimation (financial statement
analysis), the same cannot be said with non-financial information. At an early stage
in the development of the trajectory analysis theory, it was decided to use a
methodology that was as simple as possible, so a result could be obtained. That there
was no use of non-financial information is unfortunate, but further research into
including this type of information into the analysis is possible (see below).

9.1.2 Financial Model

Consequently, the indicators used to measure the trajectory were of a financial nature.
Argenti, in particular, was highly critical of using financial information in classifying
failure. Argenti (especially 1976a, 1976c, 1980; 1986b) believed that the use of
creative accounting techniques would erode any usefulness of financial information.
Thus, there is a serious question mark over the usefulness of financial infonnation,
especially as companies in financial distress will employ creative accounting
techniques to mask declines in profitability (Argenti, 1976a, p. 143).

This limitation cannot be avoided when using financial information. However, by

attempting to determine and adjusting for creative accounting techniques, it is hoped
that the scope for unreliable financial information is minimised.

9.1.3 Choice of Indicators

A limitation exists with respect to the choice of indicators. The indicators used in this
thesis were chosen primarily because they were easy to calculate and they could be
applied to any given company. However, it is possible that there are other measures
(either corporate, non-financial or market indicators) that are more appropriate to
measure the trajectory with. The lack of research into trajectory analysis contributes
to this limitation. Since no known study has attempted to produce a company
trajectory, no study, apart from AMH, has suggested what indicators should be used
to measure the trajectory. Therefore, any indicators chosen are subject to a lack of
empirical use in determining company trajectories. Only further research into which
 147

indicators researchers should use to measure trajectories will reduce this particular
limitation.

Even so, it is pleasing to note that the indicators chosen have produced a robust model
that fa ithfully modelled Air NZ's performance. Thus, the indicators seem to be a
good measure for Air NZ's trajectory.

9.1.4 Air New Zealand data

The major limitation here relates to the reliability of the data used to measure Air
NZ's trajectory. Generall y, all publicly available information such as financial
statements has a reliability problem, as the reporting entity can change accounting
policies that reduce internal consistency. Additionally, as financial statements
summarise the detailed internal management account's, a lot of information is lost in
their production. These reliability problems are always present, and are very difficult
to control. However, by evaluating Air NZ's accounting policies, as was done in
Chapter 7, lUlreliable infonnation should be minimised.

9.2 Recommendations for further research

Because of the lack of research into trajectory analysis and the limited scope of this
thesis, there is considerable range for further research in this topic. The following
subsections identi fy and discuss the various types of additional research.

9.2.1 Research into the actual theory

During the evaluation of AMH's trajectory analysis, many methodological issues

presented themselves as worthy for subsequent research. These issues include, the
indicators used to measure the trajectory, the need (if any) for a weighting system, the
effect of creative accounti ng upon the trajectory and an examination of the number of
failure trajectories.
 148

This thesis used only a few indicators to measure the trajectory, none of which were
objectively chosen. An examination into the large number of potential indicators
seems to be appropriate to detennine which indicators are best suited to measure the
trajectory. It may be that different industries have a particular set of indicators to
measure their trajectories after making use of industry-specific infonnation. Included
in the above should be an analysis of non-financial indicators, although the major
difficulty for these indicators is in how to quanti fy them. Finally. any subsequent
research into indicators should investigate the relative importance of the indicators. If
some indicators become more important as failure approaches than others (as
suggested by Sheppard, 1994), then these indicators should have a greater influence
on any company traj ectory.

A second area of potential research relates to the use of a weighting system. The
results of this thesis used an equal weighting system, after a sensitivity analysis
indicated that Air NZ's trajectory shape did not substantially change after using
different weights for the indicators. However, if some indicators are found to be
vitally important in detennining failure, then these indicators should have a greater
weighting in creati ng the trajectory. The weighting would be of necessity, subjective
in keeping with Argenti's "somewh(J1 subjective construction" (1976a, p. 153).
Possibly, the process used by Robertson (1983) would be appropriate to create a
sUbjective weighting system.

The results in this thesis showed that Air NZ's best-case and worst-case scenarios
were very similar. This indicates that the changes made to Air NZ's data to control
for creative accounting did not radically affect the resulting trajectory. Possibly, this
means that Air NZ did not lise creative accounting techniques, or that the process to
control for them failed. Alternatively, creative accounting techniques may not affect
the trajectory. Whichever the case, an examination into the effect of creative
accounting techniques on the trajectory is suitable. If creative accounting does not
affect trajectory analysis, it would be an invaluable company perfonnance
measurement.

Finally, AMH inductively chose the number of failure trajectori es and their individual
shape. Even allowing for the fact that some companies can transfer from failing to
 149

non failing trajectories (as was the case for Air NZ), it seems unlikely that there are
only three or four (including the hypothetical example provided in chapter 6) failure
trajectories. While previous research suggests the existence ,of'three failure
trajectories (see Laitinen, 1991), this has not been investigated using actual
trajectories. New research could examine the trajectories of many failed companies to
detennine whether the three hypothesised trajectories exist, and whether we need
more than three trajectories to explain all company failures. As Argenti (1976a)
argued, once we know in what ways companies fai l, we can try to avoid their
mistakes to ensure that fewer companies fail in the future.

9.2.2 Research into the case study

There is one area of additional research into Air NZ specifically. Air NZ had not
failed by the end of 2001; instead, the New Zealand Government purchased an 82%
equity stake in the company, in an attempt to tum the company around. A valuable
area of further research would be an investigation into the New Zealand
Government's turnaround attempt of Air NZ. The major area of interest would be
whether the new management team can make Air NZ profitable again and if traj ectory
analysis can graphically represent the turnaround over time.

9.3 Summary

This chapter has outlined limitations in this thesis and potential areas of further
research. There were four major limitations discussed, which relate to the research
methodology used to measure company trajectories and Air NZ's data. While these
limitations do reduce the accuracy of the reported results, it is important to discuss
them before concluding the research into trajectory analysis.

As a consequence of this thesis. there are two major areas of additional research.
Since this is an early study into the operations of trajectory analysis, there is still the
potential for further research into various aspects of the theory. Additionally. research
into Air NZ itself is available, with the current New Zealand Government attempt to
tum the company around.
 150

Chapter 10: Summary and Conclusions

The preceding chapters of this thesis have provided the first in-depth study into
AMH's trajectory analysis theory. Whilst Argenti (primarily in 1976a) and McRobert
and Hollinan (1997) provided the theory into how to create the trajectory, neither
study empirically produced a trajectory. instead relying upon anecdotal evidence to
illustrate their three failing trajectories. This study has used a New Zealand case
study, Air NZ, to investigate the potential for using trajectory analysis as a failure
classification model.

There are four major research questions examined in this thesis. The first question,
which evolved from the second research objective, examined trajectory analysis
against a range of criteria suggested by Zallman, Pinson and Angelmar (1973) to
evaluate business theories. AMH's trajectory analysis theory did not meet three
(these being internal consistency, empirical interpretability and lingu istic exactness)
of Zallman ef al. 's (1973) criteria. AMH had developed the theory enough to allow
similar anecdotal evidence to illustrate the three trajectories (see Argenti, 1976a;
Buttery and Shadur, 1991; McRobert and Hoffman, 1997). However, without further
development, trajectory analysis is not empirically testable using actual company
data.

Therefore, chapter 5 attempted to develop the theory to meet all the sixteen criteria
(and answer research question 3). With no guidance provided by AMH, it was felt
that at such an early stage in the development of the theory, simplicity was the key.
Consequently, indicators that are easily calculated were chosen to measure the
trajectory. The trajectory itself was calculated by a straightforward merging of the
indicators. The development made in chapter 5 meant that trajectory analysis met all
sixteen criteria. However, the methodology chosen has several limitations, which
include not using non-financial indicators and subjectively choosing the indicators
that measure the trajectory. The development in chapter 5 did however enable
trajectory analysis to be empirically tested; this was covered in chapter 8.
 151

The final two questions relate to the results seen after creating Air NZ's trajectory and
follow from the third research objective. The first question was concerned with what
failure trajectory Air NZ exhibited during the period 1989 - 2001.· The general
conclusion provided in chapter 8, was that Air NZ exhibited a modified Type 2
trajectory. From 1989 - 1996, Air NZ followed the non-failing trajectory, before it
transferred to the Type 2 trajectory from 1996, after the company invested in Ansett
Holdings Limited.

However, there is one major problem with this conclusion: Air NZ did not fail.
Consequently, Air NZ's trajectory is not complete; the company could continue to
decline or begin to succeed again. There are two other possible conclusions with
respect to the failing trajectory Air NZ exhibited. Air NZ could be at the final stage
of the Type 3 trajectory, after declining to the plateau in June 2000 and collapsing
from the plateau from June 2001. Alternatively, Air NZ could have begun the decline
to the plateau in June 2001, which it reached in December 2001 (note that the original
decline to the plateau is very similar to the modified Type 2 trajectory). Only in
hindsight is it ultimately possible to determine which failure trajectory Air NZ
exhibited. The longer between the collapse in 2001 and the actual date of failure, the
more likely Air NZ exhibited the Type 3 trajectory. Then again, if Air NZ does not
fail, we can say Air NZ was on the Type 3 trajectory, but transferred to the nonMfailing
trajectory after reaching the plateau.

The final research question relates to whether traj ectory analysis can be used as ' a
failure classification model. After creating Air NZ's trajectory in chapter 8, it does
not seem that trajectory analysis is a failure classification model. Apart from the
decline in June 2000, there was nothing to suggest in 2000 that Air NZ was going to
collapse in 2001. Using publicly available infonnation, trajectory analysis only
shows failure once the company has failed. Possibly, trajectory analysis could
forecast failure if either internal management information or budgeted information is
used instead, but the problem remains in determining at what point along the
trajectory line, company failure becomes certain. Remember that Air NZ's trajectory
declined to a value of M212, which was not enough to suggest failure. Therefore,
based upon the case of Air NZ, AMH's assertions concerning trajectory analysis were
incorrect: it does not predict failure.
 152

The conclusion from the previous paragraph may reflect a 'grey area' in trajectory
analysis. For example, in Altman's (1965; 1968) original model, he found that the
model had a grey area, where it did not correctly classify companies as eith~r failed or
non-failed. It may be the same for trajectory analysis, whereby at a certain point in
the trajectory, company failure becomes inevitable. Air NZ's trajectory may not be at
this point, which may explain the difficulty in detennining the type of trajectory that
Air NZ exhibits. A valuable area of further research would be to determine whether a
grey area exists in trajectory analysis or if the above conclusion is correct: that
trajectory analysis has no real predictive value.

In spite of this, trajectory analysis, in the case of Air NZ, does seem to be an early
indicator of company failure. The comment made in chapter 8 was that the trajectory
faithfully represents Air NZ's performance over time. Thus, when Air NZ's financial
performance increased, so did the trajectory and vice versa. Therefore, the trajectory
could be an early warning system of failure. For example, when Air NZ's trajectory
declined in June 2000, this suggested that there was something wrong with the
company's operations. Additionally, the lack of growth in the trajectory from
December 1996 to December 1999 again suggests that Air NZ was not performing at
the same level seen prior to the investment in Ansett. The use of trajectory analysis
should allow us to determine when a company's performance changes and the
direction of the change should provide the user with additional infonnation
concerning possible failure. Certainly, an area of possible further research wou~d be
whether trajectory analysis is, generally, a reliable early warning system of company
failure.
 153

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Appendix 1: Air New Zealand Information: 1989 - 2001

Air New Zealand's TOD Five Shareholders· 1989 . - 2001

Year Largest Shareholder 200 Largest Shareholder 3'" Largest Shareholder 4\D Largest Shareholder 5" Largest Shareholder
3/1989 Brierley Investment 65% I Qantas Airways 19.9%) Japan Airlines 0.5% American Airlines 7.5%)
3/1990 Brierley (35%) Qantas (19.9%) Japan Airlines (7.5%) American Airlines (7.5%) National Provident Fund
I (4.0%)
6/ 1991 Brierley 137.5% I Qantas (20.0% NPF (Equities) Ltd (5.5% Japan Airlines 5.0%) American Airlines (5.0%)
611992 Brierley (42.5%) Qantas (20.0%) Japan Airlines (5 .0%) ANZ Nominees (3 .7%) Australian Mutual Provident
Society (3.7%)
6/1993 Brierley I35.4% antas 19.3% ANZ Nominees (5 .7% AMPS 5.4% Ja an Airlines 5.0%
6/1994 Brierley I37.5% an<as 19.4% National Nominees 6.5% Japan Airlines 5.0%) ANZNominees 3.1%
6/1995 Brierley I41.9% an<as 19.4% National Nominees 6.3%) ANZ Nominees 3.3% AMPS (2.4%)
611996 Brierley (4 1.9%) NZCSD Ltd (22.9%) Qantas (19.4%) First NZ Capital Custodians Air NZ Staff Share Purchase
(1.4%) Scheme (0.9%)
6/ 1997 Anafi Investtnents (27.8%) National Nominees NZ ANZ Nominees (12 .2%) Urtica Investtnents (7.6%) Portfolio Management (6.3%)
1(14.1%)
6/1998 Anafi Investments (27.82%) NNNZ (15.20%) ANZ Nominees (8.89%) Urtica Investments (7.59%) Portfolio Management
I (6.82%)
6/1999 Anafi Investments (33 .10%) NNNZ (13.80%) Urtica Investments (7.58%) Portfolio Management ANZ Nominees (5 .45%)
(6.75%)
6/2000 Anafi Invesnnents(30.32%) SiItRap.ore Airlines (24.99% NNNZ (6.87%) ANZ Nominees (4.5 1%) AMP Life Ltd 0.66%
6/2001 Anafi Investments (30.32%) Singapore Airlines (24.99%) NNNZ (9.32%) ANZ Nominees (2.80%) Westpac Banking Corp
State Street (1.83%)
,
NB: The top-five shareholders are as reported m Air NZ s annual reports.
1996: NZCSD stake is actually split amongst its members who have invested in Air NZ. They did not provide individual holdings.
1997: Substantial Security Holders were Brierley (32.8%) & Franklin Resources (10.6%)
1998: Substantial Security Holders were Brierley (42.23%) & Fraoklin Resources (10.59%); Brierley Investment split into Anafi, Urtica and Portfolio
1999: Substantial Security Holders were Brierley (47.08%) & Franklin Resources (5.82%)
2000: Substantial Security Holders were Brierley (30.32%) & Singapore Airlines (24.99%); Brierley Investment held in Anafi holdings
200 1: Substantial Security Holders were Brierley (30.32%) & Singapore Airlines (24.99%);
-...'"
Directors of Air New Zealand from Aoril1989
Namo Namo
HonP m~
sir R P Cart" 24/7/1989 Qmtas
Dre ,rri,
~
EM :outts '91 '01 NLO (jovt
PD 271' 0/1999 Qm",
S :;urn, loddy 27/10/ 1999
hr : I ' [7/' ~ DrPIBRoso
i{j Di Qantas J A Strong 6/9/1993 31 /5i [2l Qmtas
IAr~=' TK Tomaki

;R Franco
:B Goodo
NZGovt JNTan
dTo",
~ I 22112/1994
I 4/1 0/2"6ii

LlI111998 3l hr R Trott" , 2/5/~c-----t,;S';;'

~~~
L 24/7/1989 , ) 18/ 1993
F~
W ' Qm""
I I I I 11991 SP 30/8/ 1995 I l l: 12000
Loslio [7/4/1989 14, 191 Omtas WM
RH
were

Alternative Directors of Air New Zealand from April 1989

Air New Zealand's Executive Manae:ement·. 1989 2001
Name Position Employed Appointed Resigned Name Position Employed Appointed Resigned
by AirNZ to Position by Air NZ to Position
D Beatson VP Group Public Affairs 2001 212001 T Jenson GGM, Operations 612000 141812000; 101200 1
Technical; SVP Operations (Ansen 212001
1996)
GBiggs OM I.nfonnatioD 1992 1994; 1997 1998 G GM Amett International 612000 141812000 2001
Services; CIO Kingshott (Aasen
1990)
REBirch GM Airline Operations 1958 1986 1992 G R Lilly GM Australia & NZ; GM 197 1 1992; 200 1
Regional Sales and 1997;
Marketing; GM Air NZ 141812000
International
PD Bowe GM Cargo; OM National 1959 211989; 1997 o A List OM Finance 311988 311988 1991
Airline 1992
P Brown OM Human Resources 1993 1993 1996 NA DCED Development & 1982 211989 1991
Macfarlane Industrv Affairs
P) Clark OM Mount Cook Group 1986 1991 1998 JMcCrea DCED Airline; CEO 1956 211989; 7n12000
(MCG) International Airline; 1991;
CEO; Managing Director 811991;
1992
S) Cushing Executive Chairman 7n12000 31112001 GC OM Government & 1960 (check 812000
McDowall Industry Affairs; OM Oovt '88);
& International Affairs; 1991 ;
GM International Affairs 1998
A David CIO 2001 212001 AJMarks OM Passenger 711989 711989; 1998
SaleslMarketing; GM 1991 ;
Sales & Marketing, ]/1997
International; OM
Commercial, International
•
HEDe Director ofHwnan 1967 21 1989; 1993 A Maroney Chief Financial Officer 31112001 212001 21/1210 1
Silva Resources; OM HR. 1991
J Dell ChlefFinancialOfficer 1994 141812000 21200 1 A Miller OM Domestic Airline 411997 411997;
Group; GM Amett 14/8/2000;
Domestic; SVP Sales and 212001;
Marketin2; SVP Strate2Y 1012001
 and Planning
I J Diamond GM Airline Services; 1954 (check 2/2001 R Nazarian Chief Financial Officer 10/1995 10/ 1995 1998
GM Engineering; Group '98); 1991;
GM, oPerations Services 14/812000
WDodge VP Freedom Air 2001 2001 A Patterson GM Commercial; 111999 111999; 2001
Executive GM 14/8/2000
Commercial
P Donovan VP NZ & Southwest 2001 2/2001; A SVP Ventures 6/2001 6/2001 10/2001
Pacific Sales & 10/2001 Pondekas
Distribution; VP
Australia Sales &
Distribution
LF Doolan GM Corporate Affairs; 3/1991 3/ 1991; 212001 TA GM Catering; GM Ansett 1969 1991 ; 812000
GGM Corporate, Govt & 14/812000 Rainham Express; GM Special 1998;
International Affairs Projects 7/ 1999
P El=ly GM Business 1972 2/ 1989; RRosalky GM Australian Regional 6/2000 14/8/2000 2/2001
Development; GM 811992; Airlines (Ansett
Car~o; VP Cargo 2/2001 1994)
R G Elstone Chief Financial Officer 3/ 1991 3/1991 1995 TJRyan GM Information Services 1968 1991 1993
BJ GM Terminal Services; 1993 1993; R J Scott Chief Executive Officer 611988 611988 29/4/ 1991
Fitzgerald Senior VP Worldwide 212001 ;
Airport Services; SVP 10/2001
Customer Services
MFlanagan Director Strategic 1966 1996; 2/2001 WR GM Operations, 1965 1992 8/2000
Planning; GM Strategic 1999; Taxmock International
Planning; GGM ANfNZ 14/812000
Integration
GRW Executive Director 10/2001 N GM NZ Domestic Trans- 1968 14/8/2000;
France Thompson Tasman & South West 212001;
Pacific; VP Australian 10/2001 ,
Sales & Distribution; SVP
Sales & Distribution
G Frazis SVP Strategy, Networks 1/2001 2/2001 10/2001 GK President and CEO 311/200) 3/112001 9110/2001
& Marketing Toomey
RGGates Director of Public 1965 2/1989 1991 C Tremain GM IIR & OC; GGM IIR 1990 111998;
Relations & OC; SVP IIR & OC 14/8/2000;
2/2001
Liliant SVP Customer Services 212001 10/2001 K Turnbull SVP Business 1/2001 212001 10/2001
Performance Enhancement
J L Gribble GM Portfolio Business; 1958 1987; 212001 K Waddell VP Group Finance 2001 2/2001 1212001
GM Group Portfolio 14/8/2000
Business
PHarris VP 1/2001 2/2001 10/2001 RD OM Strategic Planning 1965 1992 1996
GoveromentlInternationa Webster
1 Affairs
W Jacobson OM ANNZES; SVP 1/2000 112000;
Operations & Technical 10/2001
CEO - Chief Executlve Officer eIO - Chief Informanoo Officer
DeEO = Deputy Chief Executive Officer GM = General Manager
GGM = Group General Manager HR. = Human Resources
MeG = Mount Cook Group OC = Organisational Cbange
SVP = Senior Vice President VP = Vice President
1 The resignation dates are when certain people no longer appeared in the executive management as disclosed in Air NZ's Annual Reports, Company
Announcements or National Business Review (200 1). Therefore, at the date, a particular manager may DO longer work for Air NZ; alternatively, the manager may have been
demoted out of the executive management.

-'"
00
AirNew Zea1andShare p.
nce Infoannaf IOn: ocoer
t b 1989 Decemb er 2001
Date 31/10/1989 30/ 1111989 3111211989 3110111990 28/02/1990 30/03/ 1990 30/04/1990 3110511990
Air NZ A-share nrice $2.83 $2.47 $2.55 $2.35 $1.92 $1.78 $1.78 $1.88
Air NZ B-share nrice
Market Value $792,400,000 $691,600,000 $714,000,000 $658 000,000 $537,600,000 $498,400,000 $498,400,000 $526,400,000
Date 29/06/1990 31 /07/1990 31 /08/ 1990 28/09/ 1990 31110/1990 30/ 1111990 28/ 1211990 31 /0111991
Air NZ A-share orice $1.98 $2.07 $1.70 $1.50 $1.30 $1.07 $1.03 $0.93
Air NZ B-share orice
Market Value $554,400,000 $579,600,000 $476,000,000 $420,000,000 $364,000000 $299600000 $288,400,000 $260,400,000
Date 28/02/ 1991 28/03 /1991 30/0411991 31105/199 1 28/06/ 1991 3110711991 30/08/ 1991 30/09/1991
Air NZ A-shar~---;;rice $1.27 $1.48 $1.57 $1.53 $1.33 $1.43 $1.34 $1.60
Air NZ B-share ~rice
Market Value $355,600,000 $414400000 $439,600,000 $428,400,000 $372400000 $400 400 000 $562,800,000 $672 000,000
Date 31110/1991 291111199 1 31112/ 199 1 3110111992 28/0211992 31103 /1992 30/04/1992 29/05 /1992
Air NZ A-shar;;;ice $1.66 $1.65 $1.58 $1.58 $1.76 $1.70 $1.82 $2. 12
Air NZ B-shar;;rice $1.65 $1.70 $1.70 $1.65 $2.20
Market Value $697,200,000 $693,000,000 $663,600,000 $673,890,000 $730,380,000 $714000,000 $739,4 10,000 $902,160,000
Date 30/06/ 1992 3110711992 31 /08/ 1992 30/09/1992 30/10/ 1992 30/ 1111992 3111211992 2910111993
Air NZ A-share orice $2.15 $2.54 $2.57 $2.60 $2.50 $2.48 $2.58 $2.43
Air NZ B-share ~rice $2.20 $2.76 $2.76 $2.76 $2.76 $2.62 $2 .80 $2.60
Market Value $910,350,000 $1,099,140,000 $1, I07,330,000 $ 1,115,520,000 $1,088,220,000 $1,083 ,632,576 $1,138,478,353 $1,066,707512
Date 26/0211993 31103 /1993 30/04/1993 31105/1993 30/06/1993 30/07/1993 3110811993 30/09/ 1993
Air NZ A-shar;;;rice $2.10 $1.90 $ 1.99 $2 .23 $2.27 $2.44 $2.56 $2.68
Air NZ B-shar; ;;;'ce $2 .45 $2.02 $2.20 $2.70 $2 .75 $2.75 $3.22 $3.55
Market Value $952,302,650 $844,333252 $897158427 $1,041,068,986 $1,059981703 $1 108,024,352 $12 13 457,315 $1,297,586298
Date 29/ 10/ 1993 30/1111993 3111211993 3110111994 28/0211994 31103/ 1994 30/04/1994 31 /05/1994
Air NZ A-shar;;;rice $3.10 $3.02 $3.56 $4.10 $3.84 $3.72 $3.72 $3.88
Air NZ B-shar; -;;rice $4.15 $4.20 $4.48 $5 .20 $5.35 $4.70 $4.90 $4.90
Market Value $ 1,507582,673 $ 1,522,482,978 $1,721,607,609 $1 ,989,028,884 $1,937,362,916 $ 1,801,878,340 $1,832,922,269 $1,879,044,678
Date 3010611994 2910711994 3110811994 3010911994 3 111011994 3011111994 3011211994 3110111995
Air NZ A-share price S3.86 S3.83 S3.94 $3.55 S3.65 $3.49 S3.50 $3.45
Air NZ B-share pn'ce $5.30 S5.47 S5.70 $5.00 S4.65 S4.85 $4.90 S4.60
Market Value SI,935367,235 $1,953,106,623 S2,020,516 297 S1,799,439,174 SI,773 938,804 S1,758860,324 $1,769,503,957 $1,708,524810
Date 2810211995 3110311995 2810411995 3010511995 3010611995 31/07/1995 3 110811995 29/09/1995
Air NZ A-share price $3.62 $3.63 $3.90 $3.82 $3.45 $3.63 $3.73 $3.78
Air NZ B-share price $5.10 $5.20 $5.00 $4.95 $4.35 $5.00 S5. 10 $5.15
Market Value $1,835139,692 $ 1,853 ,544,307 $ 1900 33 1 943 $1,869,509,757 $ 1,669,719,899 $ 1,822 500,378 $1,866,848,848 $1,889,023,083
Date 3111011995 3011111995 2911211995 3110111996 2910211996 2910311996 3010411996 3110511996
Air NZ A-share price $3.89 $3 .90 $3.80 $3.48 $3.50 $3.57 $3.77 $3 .27
Air NZ B-share price $5.22 $5.35 $5 .20 $4 .70 $4.75 $4.85 $5.10 $4,45
Market Valu e $1,931,597,615 $1954658819 $ 1 902549,367 $1732,694,726 $1,746221010 $1781921528 $1,878379451 $1633372 568
Date 2810611996 3 110711996 3010811996 3010911996 3 111011996 2911111996 3111211996 3110111997
Air NZ A-share price $3.19 $3.05 $3.18 $3.01 $2.50 $2.68 $2.73 S2.68
Air NZ B-share price $4.65 $4.05 $4.33 $4.00 $3.45 $3.70 $3.84 $3.78
Market Value $1641 355,383 $1,507864 983 $ 1 588801 853 $ 1488,573 181 $1 ,256184578 $1 802,346 695 $ I 855 683 642 $ 1,824,565,699
Date 2810211997 2710311 997 3010411997 3010511997 3010611997 3110711997 2910811997 3010911997
Air NZ A-share price $2.74 $2.59 $2.85 52.95 $3.08 $3.14 S2.81 $2.80
Air NZ B-share price 53.77 $3.92 $4.17 $4.29 $4 .50 $4.69 $4.23 $4.02
Market Value S 1,839, 132,75 I $1,837,432316 $1 982 025 889 $2,044,261,774 $2,140,166252 $2,210,280,815 $1987, 127, 191 SI,925,911,566
Date 3 111011997 2811111997 3 111211997 30/0111998 2710211998 31103/ 1998 3010411998 2910511998
Air NZ A-share pn'ce $2.50 $2.30 $2.34 S2.14 $2.06 $1.87 $2.08 $1.95
Air NZ B-share price $3.40 $3.30 $3.45 $2.72 $2.55 $2.50 $2.55 $2.48
Market Value $1666,992,147 $158 1403635 $1,634,627 219 $1,374,064,047 $ 1,303,722,760 $123491 1,864 $ 1,309 504 236 $ 1,252,483,015
Date 30/06/1998 3110711998 3 110811998 3010911998 3011011998 3011111998 311121 1998 1910111999
Air NZA-share price $1.83 $ 1.84 $1.70 $1.42 S2.00 $2.12 $2.55 $2.69
Air NZ B-share price $2.07 $2.04 $1.90 $1.58 S2.50 $2.45 $2.98 $3 .10
Market Valu e $1 103,921,764 $ 1,098480375 $1019,126787 $849,310,110 $ 1272 491,456 $ 1 293,293 432 $ 1,564,796,063 $1 638,594,899
Date 26/0211999 31103/1999 30/04/1999 3110511999 30/06/ 1999 30/07/ 1999 31/08/ 1999 30/09/1999
Air NZA-share price $2.68 $2.85 $2.86 $3.10 $3.05 $3.00 $2.74 $2.63
Air NZ B-share price $3.16 $3 .25 $3 .75 $3.90 $3.90 $3.78 $3.50 $3.10
Market Value $1,652368415 $1,726,507,338 $1,868,349,257 $1979910359 $1,965,538,870 $19 18,162776 $1765 149850 $1,622175208
Date 29/ 10/ 1999 30/1111999 30/ 1211999 3110112000 29/0212000 31 /03/2000 28104/2000 31105/2000
Air NZA-share price $2.69 $2.52 $2.36 $2.08 $1.92 $1.92 $1.99 $1.84
Air NZ B-share price $2.92 $2.85 $2.80 $2.35 $2.13 $2.33 $2.51 $2.19
Market Value $1,590,250,968 $1,521 ,595,612 $1,461,587,606 $1,255,424,098 $1 , 147944,412 $1,203,556,893 $1,273,866,982 $1,141,475,177
Date 30/0612000 31107/2000 31/0812000 29/09/2000 31/ 10/2000 30/ 1112000 29/ 1212000 31101/2001
Air NZ A-share price $1.84 $1.80 $1.80 $1.88 $1.61 $1.43 $1.57 $1.60
Air NZ B-share price $2.17 $2.38 $2.46 $2.84 $2.25 $1.90 $2.25 $2.10
Market Value $1 135 963 972 $1 182,782650 $1 205,028,622 $1,333,850989 $1 091 834666 $1 256458,897 $1,440,381,926 $1,396,334,974
Date 28/0212001 30/03 /2001 30/0412001 31105/2001 29/0612001 3110712001 3110812001 27/0912001
Air NZ A-share price $1.38 $1.03 $1.06 $1.05 $1.09 $1.10 $0.95 $0.40
Air NZ B-share price $1.82 $1.40 $1.51 $1 .44 $1.45 $1.34 $1.15 $0.40
Market Value $1207583,784 $916,737,418 $969,109,426 $939,290685 $958438,267 $921,505,421 $793,148,557 $302,728,474
Date 31110/2001 30/ 1112001 31112/2001
Air NZ A-share price $0.29 $0.32
,
$0.35
Air NZ B-share pn·ce $0.29 $0.33 $0.00
Market Value $219,478 144 $245 ,891,201 $264,887,415
NB. The reported Share Pnces were the closmg pnces for a partlcular day. The reported days were the last days the NZSE were open for a parttcular month.

--'"'
Parent Companv Financial Information
Financial Year Ending; Mar 1989 Mar 1990 Jun 199 1 Jun 1992 Jun 1993 Jun 1994 Jun 1995 Jun 1996 Jun 1997
Statement of Finantial Pel"fol'" mance $000s) ($000s) ($000,) ($000,) (SOOOS) $000,) ($000,) ($000s) ($000s)
Turnover 1,719876 1 898440 2440266 2,208649 2,338, 150 2598412 2887,605 2,999,556 2,930,737
Ooeratin2 Costs 1,524,006 1,690986 2,225,462 1,908,968 2,023,995 2215,281 2,436,913 2,596,440 2,599,706
Depreciation and Amortisation 95280 89172 137016 107,414 119 716 133674 138463 145499 144 396
Net Interest Charges 18604 56308 92,258 57,%8 54, 132 50477 26036 3,725 14,492
Operating Profit 8 1 986 61974 -1 4470 134,299 140,307 198,980 286 193 253,892 172 143
Abnormal Items -3,455 28707 64,345 -13 ,140 3,745 0 0 0 -25,422
Tax Paid -13,800 9224 8 141 0 0 -7500 -25462 -25,083 -3 102
Subsidiaries and Associates 1,227 1049 -4,094 -6053 -4 517 -815 -569 -3,582 6,577
Extraordinary Items -551 0 -48,425 0 0 0 0 0 0
Consolidated Net Profit After Tax 72 3 17 100 954 5,497 115 106 139535 190665 260,162 225,227 150 196
Statement of Financial Position
Issued Capital 280000 280000 280000 420,000 434775 443485 443485 443,490 725,274
Reserves 338,657 468448 461 673 564 963 679,322 754 832 830698 956885 947438
Minority Interests 12315 12 7 12 70 85 75 3,442 4 599 2,492 2,532
Total EoWty 630972 761 160 74 1,743 985,048 1,114172 1 20 1 759 1,278782 1402 867 1,675,244
LonJl:-Term Liabilities 459,623 744074 833942 842825 938697 887085 1013434 774646 809639
Other Liabilities 83154 90474 74401 5179 4382 3753 3167 1986 1158
Current Liabilities 507,783 593,539 708,658 576,3 10 671,774 768853 8 11 ,826 955,331 860,746
Total Liabilities 1,050560 1 428,087 1,617 DOl 1424,314 1,6 14,853 1,659,691 I 828 427 1,73 1,963 1,671,543
Fixed Assets I 278,022 1,615,888 1726,012 1,575,404 1,761,453 I 752932 1,820,435 1,737678 1,813,889
Long-Term Assets 73,608 77,004 53,428 181,31 1 210,439 192,745 208,384 212,636 777, 11 8
Current Assets- 329,902 496355 579,304 652,647 757133 915773 1078390 1,184 5 16 755780
Total Assets 1,681532 2,189,247 2,358,744 2,409,362 2,729,025 286 1450 3,107,209 3,134,830 '3346,787
CasbOow Statement
Net Cashflow from ()perarin.l!; Activities 178628 231 958 45,965 298,132 258 150 425016 412 937 425,845 291590
Net Cashflow from Invesrin.l!; Activities -77 746 -197,350 5 1,259 -18,395 -310,592 -285,455 -371,297 -142,072 -823,337
Net Cashflow from FiDancin.l!; Activities - 10799 1 -2765 1 -103 592 -150,3 76 130,150 -77 162 103855 -177,338 113,592
Net Increase (Decrease) in Cash Holdin.l!; -7 109 6957 -6368 129,361 77,708 62,399 145 495 106,435 -418, 155
Closin.l!; Cash Balance 246 7013 127,330 256,691 334,399 396,798 542293 648728 230573
 Financial Year Ending: Jun 1998 Jon 1999 Jon 2000 Jun 2001
Statement of Financial Performance ($000,) ($000,) ($000,) ($000,)
Turnover 3 088 801 3,359,012 3723687 7960, 125
I Operating Costs 2748624 2961,752 3,302088 7481,326
Depreciation and Amortisation 169,768 196,679 185,830 532,464
Net Interest Char~es 40702 50,248 72 170 226,568
I Opera,"", P<ofit 129,707 150,333 163 599 -280,233
Abnormal ltems 0 0 0 -1,277019
Tax Paid -17838 -37,428 -37,340 148,470
Subsidiaries and Associates 32956 110,227 59824 -16,536
Extraordinarv Items 0 0 -786227 0
Consolidated Net Profit After Tax 144825 214,371 -600,144 -1,425,318
Statement of Financial Position
Issued Capital 725274 725,852 727026 1,007,485
Reserves 1264 075 1,398, 108 861 275 -491 230
Minority Interests -470 2,208 1784 1,784
Total Equity 1,988 879 2,126 168 I 590085 518,039
Long-TermLiabilities 1 208642 13 10691 3799452 3,956833
Other Liabilities 0 0 0 0
Current Liabilities 906510 953,839 3,599,882 3639, 157
Total Liabilities 2, 115 152 2,264,530 7,399,334 7,595,990
Fixed Assets 22 13709 2,223,242 6027055 4,997,659
Long-Term Assets 909,196 970,2 19 498044 324,938
Current Assets 981 126 1,197,237 2,464 320 2,791,432
Total Assets 4104 03 1 4,390698 8989419 8 11 4,029
Cashflow Statement
Net Cashflow from~rating Activities 160033 331,583 39 1,821 146,315
Net Cashflow from InvestW2 Activities -164,849 -257,105 -670552 -133 381
Net Cashflow from Financing Activities -28,382 20,468 681,904 56,021
Net Increase (Decrease) in Cash Holding -33 198 94946 403,173 68955
Closing Cash Balance 197375 292,32 1 695 494 764,449
NB. In the 199 1 Annual Report, Arr NZ mcluded short-term. deposlts as part of Its cash balance. This accounts for the apparent disparity in the table. The Accounting
Policy change is included as an extraordinary item in the period ending June 2000.
 Period Ending Mar-90 Sop-90 Joo-91 Dec-91 Jun-92 Dec-92 Jun-93 Dec-93 Jun-94
Statement of Financial Performance ($000,) ($000,) ($000,) ($000,) ($000,) (SOOO,) ($Ooo,) ($ooo,) (SOOOs)_
Turnover 1898440 940080 1500186 1089210 1119439 1163981 1174169 1267478 1330934
I Operating Costs 1690986 1087394 1127887
Depreciation and Amortisation 89172 64948 68726
Net Interest Charges 56308 27317 23160
I ()pera~Profit 61974 -7285 -7185 65565 68734 70124 70183 87819 111161
Abnormal Items 28707 18160 46185 -7296 . -5844 -8173 11918 0 0
Tax Paid 9224 0 8141 0 0 0 0 0 -7500
Subsidiaries and Associates 1049 437 -4531 -2194 -3859 -1014 -3503 280 -1095
Extraordinary Items 0 -37967 -10458 0 0 0 0 0 0
Consolidated Net Profit After Tax 100954 -26655 32152 56075 59031 60937 78598 88099 102566
Statement of Financial Position
Issued Capital 280000 280000 280000 420000 420000 428483 434775 443485 443485
Reserves 468448 407387 461673 531270 564963 65 1810 679322 729793 754832
Minority Interests 127 12 12604 70 84 85 85 75 2155 3442
Total EQuity 761160 699991 741743 951354 985048 651895 1114172 1175433 1201759
LoD.£-Term Liabilities 744074 703476 833942 964913 842825 1017166 938697 987203 887085
Other Liabilities 90474 89821 74401 0 5119 0 4382 3858 3753
Current Liabilities 593539 5485 15 708658 712528 576310 715436 671774 765 155 768853
Total Liabilities 1428087 134 1812 1617001 1677441 1424314 1732602 1614853 1756216 1659691
Fixed Assets 1615888 1554765 1726012 175 1918 1575404 2001820 1761453 1869816 1752932
Lonsz-TermAssets 77004 75854 53428 526 15 181311 32931 210439 182940 192745
Current Assets 496355 411184 579304 824262 652647 778209 757133 878893 915773
Total Assets 2189247 2041803 2358744 2628795 2409362 28 12960 2729025 293 1649 286 1450
Cashflow Statement
Net Cashflow from Operating Activities 231958 62352 -16387 190141 107991 126819 13 133 1 215013 210003
Net Cashflow from Investing Activities -197350 48485 2774 -14437 -3958 -254233 -56359 -209019 -76436
Net Cashflow from Financing Activities -27651 -114713 11 12 1 13654 -164030 181853 -51703 6030 -83 192
Net Increase:JQecrease) in Cash Holding 6957 -3876 -2492 189358 -59997 54439 23269 12024 50375
Closing Cash Balance 7013 35 14 127330 316688 256691 311130 334399 346423 396798
 Period Ending Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 Jun-98 Dec-98
Statement of Financial Performance $OOOs ($000, $000,) $OOOs ($000,) $OOOs ($000, ($000,) $000,)
Turnover 1472432 1415173 1500138 1499418 1462430 1468307 1534330 1554471 1628355
_Operating Co,ts 1219281 1217632 1266118 1330322 1319418 1280288 1370969 1377655 1454094
Depreciation and Amortisation 69139 69324 72728 72771 7 1580 72816 86421 83347 87537
Net Interest Charges 16597 9439 6072 -2347 6815 7677 16304 24398 26055
Operating Profit 167415 118778 - 155220 98672 ·64617 107526 60636 69071 60669
Abnormal Items 0 0 0 0 0 -25422 0 0 0
Tax Paid -27746 2284 -18875 -6208 -593 -2509 -10287 -755 1 -17050
Subsidiaries and Associates 790 -1359 -1209 -2373 11527 -4950 31690 1266 39160
Extraordinary Items 0 0 0 0 0 0 0 0 0
Consolidated Net Profit After Tax 140980 119182 135136 90091 76737 73459 82039 62786 82779
Statement of Financial Position
Issued Capital 443485 443485 443485 443490 566811 725274 725274 725274 725274
Reserves 797199 830698 952628 956885 1081925 947438 1122360 1264075 1307600
Minority Interests 3472 4599 2465 2492 2476 2532 3856 -470 -1388
Total Equity 1244 156 1278782 1398578 1402867 1651212 1675244 1851490 1988879 2031486
Long-Term Liabilities 918286 1013434 872690 774646 730757 809639 1020746 1208642 1415441
Other Liabilities 3180 3167 2697 1986 1567 1158 0 0 0
Current Liabilities 865097 811826 996821 955331 946911 860746 982925 906510 1099318
Total Liabilities 1786563 1828427 1872208 1731963 1679235 1671543 2003671 2115152 25 14759
Fixed Assets 1756795 1820435 1818059 1737678 1666574 1813889 2113720 2213709 2466183
Long-Term Assets 214600 208384 2 15585 212636 813296 777118 822397 909196 846940
Current Assets 1059324 1078390 1237142 11 845 16 850577 755780 919044 981126 1233122
Total Assets 3030719 3107209 3270786 3134830 3330447 3346787 3855161 4104031 4546245
Cashflow Statement
Net Cashflow from Operating Activities 242280 170657 269935 155910 196808 94782 135628 24405 183 162
Net Cashflow from Investing Activities -214829 -156468 -87854 ·54218 -665122 -158215 -146162 -1 8687 -311958
Net Cashflow from Financin~ Activities 58606 45249 -89369 -87969 58707 54885 -14765 -136 17 268201
Net Increase (Decrease) in Cash Holdin.l!: 86057 59438 92712 13723 -409607 -8548 -25299 -7899 139405
Closing Cash Balance 482855 542293 635005 648728 239121 230573 205274 197375 336780
 Period Ending Jun·99 Oec-99 Jun-OO Oec.()() Jun-Ol Dec..{) 1
Statement of Financial Performance ($000,) ($000,) ($OOOs) (SOOO,) ($000,) ($000,)
Turnover 1730657 1803921 1919766 4311489 3648636 2579354
Operating Costs 1507658 1556712 1745376 398 1839 3499487 2595629
Depreciation and Amortisation 109142 88851 96979 246881 285583 158457
Net Interest Chare.es 24193 31411 40759 115659 110909 60293
OoeratiDi~ Profit 89664 126947 36652 ·32890 . ·247343 ·235025
Abnormal Items 0 0 0 0 · 1277019 -183008
Tax Paid -20378 -51601 14261 29472 118998 41520
Subsidiaries and Associates 71067 51878 7946 7 199 -23735 0
Extraordinary Items 0 0 -786227 0 0 0
Consolidated Net Profit After Tax 131592 127234 -727378 3781 ·1429099 -37651 3
Statement of Financial Position
Issued Capital 725852 726982 727026 1007485 1007485 999733
Reserves 1398108 1507209 861275 893287 -491230 ·874003
Minoritv Interests 2208 22 19 1784 1784 1784 0
Total EQuitv 2126168 2236410 1590085 1902556 518039 125730
Lo02- Term Liabilities 1310691 1359261 3799452 3622149 3956833 1671716
Other Liabilities 0 0 0 0 0 0
Current Liabilities 953839 1034901 3599882 4017692 3639157 2285236
Total Liabilities 2264530 4630572 7399334 763984 1 7595990 3956952
Fixed Assets 2223242 2451 365 6027055 6074968 4997659 2495900
Long-Term Assets 970219 920793 498044 576542 324938 199924
Current Assets 1197237 1258414 2464320 2890887 2791432 1386858
Total Assets 4390698 4630572 89894 19 9542397 8114029 4082682
Cashflow Statement
Net Cashflow from Operating Activities 148421 157915 233906 189080 -42765 -187401
Net Cashflow from Investing Activities 54853 -11 9003 -551549 -210490 77109 -123607
Net Cashflow from Financing Activities -247733 -58673 740577 27280 28741 17803
Net Increase (Decrease) in Cash Holding -44459 -1 9761 422934 5870 63085 -293205
Closing Cash Balance 292321 272560 695494 701364 764449 471244
NB. See the notes for the preVIOUS table.
 177

Effect of Air New Zealand's acquisition of Ansett

The following formed part of Air NZ's 2000 Annual Report, Note 13 CP, B23):

On 23 June 2000 the Group acquired the remaining 50% of the shares in Ansett
Holdings Limited for a cash consideration of A$580,000,000 with an additional
obligation to make a second payment by way of shares or cash equivalent to 10.5% of
the value of Air New Zealand shares on issue on 18 February 2000.

Ansett Holdings Limited has been consolidated from 30 June 2000. Therefore 50% of
the earnings have been equity accounted for the year and the financial position
consolidated as at 30 June 2000.

Consolidated
2000
$000
Summary of the effect of acquisition of Ansett Holdings Limited
Assets - Increase/(Decrease)
Fixed Assets 3,409,855
Investments (575,165)
Other Term Assets 118,437
Bank balances 203,077
Finance Lease Receivable 62,357
Other Current Assets 860,416
Liabilities - (Increase)lDecrease
Loans and Capitalised Leases Obligations (1,456,470)
Employee Entitlements (309,398)
Trade and Other Creditors (1,435,317)
Minority Interest (1,784)

Purchase Price 876,008

Deferred Consideration (116,541)

Net Cash outflow to the company 759,467

Cash acquired with subsidiary (203,077)
Net Cash outflow to the Group 556,390

No subsidiaries were acquired during the year ended 30 June 1999

Appendix 2: Breakdown of changes made to create the worst-case scenario

in

Decreases in Profit $196,148,000

-
.....
oc
 :urrent Asse~ 170,
'ixed Asse~
t:ili' 100
IF ~74 000

Increases in ARR j ,
Decreases in P~fit $272,998,000 $342,492,000

~
, in ROo' JQ_
Net
Table Three: Changes In FIgures 3111211994 - 31112/1996

Decreases ,orlmm

in Figures JW'VU "7

LT Liabilities

$449,078,000 $0

En

1 ARR stands for Asset Revaluation Reserve.

2 REs stands for Retained Earnings.

-
00
o
Appendix 3: Workings to calculate the trajectory

Best-Case Scenario
Period Endin 3 I103/1989 3I109/1989 3 I103/1990 3010911990 30106/ 1991 311 1211991 30106/1992
Operating Cash Flow $178,628,000 $23 1,958,000 $62,352,000 -$16,387,000 $190,141,000 $107,991,000
Less Int. and Divs. Received $5,552,000 $6,509,000 $0 $18,765,000 $0 $0
Less Interest Paid 518,511,000 $52,842,000 $0 $107,278,000 $0 $0
Less Dividends Paid 526,237,000 $32,290,000 $0 $18,493,000 $0 $16,800,000
Less Capitalised Interest $0 $0 $0 $0 $0 $0
OCFAID $139,432,000 $0 $ 153,335,000 $62 352,000 -$123,393,000 $ 190,141,000 $91 191,000
Cumulative OCF AID $139,432,000 $139,432,000 $292,767,000 $355,119,000 $231,726,000 $421,867,000 $513,058,000
After-Tax Profits $72,317,000 $100,954,000 -$26,655,000 $32,152,000 $56,075,000 $59,031,000
Less Dividends Proposed $28,000,000 $32,200,000 $0 $0 $16,800,000 $25,200,000
Less Capitalised Interest $0 $0 $0 $0 $0 $0
Retained Earnings $44,3 17,000 $0 $68,754,000 -$26,655,000 $32,152,000 $39,275,000 $33,831,000
Cumulative Retained
Earnin2S $44,3 17,000 $44,317,000 $113,071000 $86,4 16,000 $118,568,000 $157,843000 $191,674,000
EBJT $132,697,000 $118,282,000 $77,788,000 $192,267,000
Long-term Liabilities $459,623,000 $744,074,000 $833,942,000 $842,845,000
ToW Equity $630,972,000 $761,160,000 $741,743,000 $985,048,000
Capital Employed $ 1,090,595,000 $1,505,234,000 $1,575,685,000 $1,827,893,000
Return on Capital 0.1217 0.0393 0.0393 0.0247 0.0247 0.0526 0.0526
Total Liabilities $1,050,560,000 $1,428,087,000 $ 1,341,812,000 $ 1,617,001,000 $1,677,441,000 $1,424,3 14,000
Total Equity $630,972,000 $761,160,000 $699,99 1,000 $741,743,000 $951 ,354,000 $985,048,000
DebtJEQuitv Ratio 1.6650 1.8762 1.9169 2.1800 1.7632 1.4459
Period Eodin 31 /03 /1990 30109/1990 30106/ 199 1 31 / 1211991 ,010611992
Cumulative OCFAID $292,767,000 $355, 119,000 $231,726,000 $421,867,000 $513,058,000
Cumulative Retained Earnings $113,071,000 $86,416,000 $118,568,000 $157,843,000 $191,674,000
Return on Capital 3.93% 2.47% 2.47% 5.26% 5.26%
Debt/Equity Ratio 1. 8762 1.9169 2.1800 1.7632 1.4459
A 'Shares $1.78 $1.50 $1.33 $1.58 $2.15
B'Shares $1.78 $1.50 $1.33 $1.58 $2.20
Market Value Equity $498,400,000 $420,000,000 $372,400,000 $663,600,000 $910,350,000
 $170,657'~
31 /1992 31 11993
Operating Cash Flow $126,819,000 $131,331,000 $215,013,000 $210,003,000 $242,280,000 $269,935,000
Less Int. and Divs. Received $0 $0 $0 $0 $0 $0 $0
Less Interest Paid $0 $0 $0 $0 $0 $0 $0
Less Dividends Paid $4,598,000 $5,195,000 $5,531,000 $26,610,000 $35,479,000 $35,478,000 $53,218,000
.'a, oon
~' Interest $2,647,000 $ 17RaMO ;1,911,000 $1,955,000 <7 . . 000 "a'OM

~oi: ~ ~ooo
$12~~
$~ ~
'AlI
$756,: ,
$78,598,000
,nM
ti: $
$ 102,566,000
, ;,000
$140,459,000
$1 Yo'
$135,136,000

:!~ $35<1~i
Less Dividends Proposed

~
$~;:~;~,::
$26,609,000 "'" 'M"
I "'h'~ $~ $65~
Less ' . . 11
$49,879,'
Retained

~
=
$5" ,., f)()(l
'Oh~~ <40""
$57;~
"., "f)()(l f)()(l ; f)()(l
.
ng·term L'bili'
la nes $1,017,166,000 ~~87,203,000 $887:oi~:~~ $9 18,286,000 $1,013,434,000 $872,690,000
I Total Eauity $1,0'0 '7'
MO $1,114,172,000 $1,17<'" MO <1 '0' 7<a non <""" ' " non <1 ' " 7"non <1,,a, '" non
, ,
$2,27 0.0710
1 C, n;'. ' 0.0458 0.0479 0.0532 0.0643 $2,10.0851 0.0559
.. . ,
~1,:
~:';;~'~i~'~~ ~:,~~
$: ,000
Total Equity $1,114,1;2~~ :
$1'2:~;:~ $1'2::;:~
$1,080,378,000 $1,244,156,000 $1,398,5;8
, Ratio 1.6037 ' , 1.4941
I.~ 3
P,rio' 3111 3111Vl ' 13 31

IA'; ';n ty Ratio

~
~
$2.58
• L.4494
$2.27
-* ~
5.32%
1.4941
13.56
,
6.43%
1.3811
13.1
$fsll
8.51%
..4360
13.50
$~ 5.59%
L.4298
;3.45
~5J2:OOO

•
7.10%

~
~ ~
$2.80
~ ~
'.48 14.90
, $: $1, $1 $: $1

-
00
N
Period EndinlZ 30/06/1996 3111211996 30/06/1997 3111211997 30/06/1998 311 1211998 30/06/1999
Operating Cash Flow $155,910,000 $196,808,000 $94,782,000 $135,628,000 $24,405,000 $183,162,000 $148,421,000
Less Int. and Divs. Received $0 $0 $0 $0 $0 $0 $0
Less Interest Paid $0 $0 $0 $0 $0 $0 $0
Less Dividends P.aid $35,479,000 $53,219,000 $45,345,000 $68,017,000 $45,345,000 $45,435,000 $33,919,000
Less Capitalised Interest $848,000 $2,220,000 $4,119,000 $3,788,000 $3,014,000 $3,403,000 $2,086,000
OCFAlD $119,583000 $ 14 1,369,000 $45,3 18,000 $63 ,823,000 ·$23,954,000 $134,324,000 $112,416,000
Cumulative OCFAID $1,82 1,095,000 $1,962,464,000 $2007,782,000 $2071,605000 $2,047,651,000 $2,181975,000 $2,294 391 000
After-Tax Profits $90,091,000 $76,737,000 $73,459,000 $82,039,000 $62,786,000 $82,779,000 $131,592,000
Less Dividends Proposed $53,219,000 $45,345,000 $68,017,000 $45,345,000 $45,345,000 $34,009,000 $51,031,000
Less Capitalised Interest $848,000 $2,220,000 $4,119,000 $3,788000 $3,014,000 $3,403,000 $2,086,000
Retained Earnings $36,024,000 $29,172,000 $1,323,000 $32,906,000 $14427,000 $45367000 $78,475,000
Cumulative Retained
Earnings $712,230,000 $741,402,000 $742,725,000 $775,631,000 $790,058,000 $835,425,000 $913 900,000
EBIT $96,325,000 $71,432,000 $1 15,203,000 $76,940,000 $93,469,000 $86,724,000 $113,857,000
Long-term Liabilities $774,646,000 $730,757,000 $809,639,000 $1,020,746,000 $1,208,642,000 $1,415,441,000 $1,310,691,000
ToW Equity $1,402867000 $165 1 212,000 $1,675,244,000 $1,851,490,000 $1,988,879,000 $2,031,486,000 $2,126,168,000
Capital Employed $2,177,513,000 $2,381,969,000 $2,484,883,000 $2,872,236,000 $3,197,521,000 $3,446,927,000 $3,436,859,000
Return on Capital 0.0442 0.0300 0.0464 0:0268 0.0292 0.0252 0.0331
Total Liabilities $1,731,963,000 $1,679,235,000 $1,671,543,000 $2,003,671,000 $2,115,152,000 $2,5 14,759,000 $2,264,530,000
Total Equity $1,402,867,000 $1,65 1,212,000 $1,675,244,000 $1,851,490,000 $1,988,879,000 52,031,486,000 $2,126,168,000
DebtlEauitv Ratio 1.2346 1.0170 0.9978 · 1.0822 1.0635 1.2379 1.0651
Period En . 30/0611996 3111211996 30/0611997 3111211997 30/0611998 3111211998 30/0611999
Cumulative OCFAID $1,821,095,000 $1,962,464,000 $2,007,782,000 $2,071,605,000 $2,047,651,000 $2,181,975000 $2294391,000
Cumulative Retained Earninzs $7 12,230,000 $74 1,402,000 $742,725,000 $775,631,000 $790,058,000 $835,425,000 $913,900,000
Return on Capital 4.42% 3.00% 4.64% 2.68% 2.92% 2.52% 3.31%
DebtlEQuity Ratio 1.2346 1.0170 0.9978 1.0822 1.0635 1.2379 , 1.0651
A 'Shares $3.19 $2 .73 $3.08 $2.34 $1.83 $2.55 $3.05
B'Shares $4.65 $3.84 $4.50 $3.45 $2.07 $2.98 $3.90
Market Value Equity $1,641,355,383 $1 855,683,642 $2,140,166,252 $1,634,627,219 $1,103,921,764 $1,564,796,063 $1965,538,870
Period Endine 31112/1999 30/06/2000 31/1212000 30/06/2001 31112/2001
Operating Cash Flow $157,915,000 $233,906,000 $189,080,000 -$42,765,000 -$187,401,000
Less Int. and Divs. Received $0 $0 $0 $0 $0
Less Interest Paid $0 $0 $0 $0 $0
Less Dividends Paid $51,031,000 $34,050,000 $51,075,000 $30,273,000 $0
Less Capitalised Interest $1,511,000 $522,000 $347,000 $15,000 $0
OCFAlD $105,373,000 $199,334,000 $137,658,000 -$73,053 000 -$187,401,000
Cumulative OCFAID $2,399,764,000 $2599,098,000 $2,736,756,000 $2,663,703,000 $2,476,302,000
After-Tax Profits $127,234,000 -$727,378,000 $3,781,000 -$1,429,099,000 -$376,513,000
Less Dividends Proposed $34,050,000 $51,075,000 $0 $30,273,000 $0
Less Capitalised Interest $1,511,000 $522,000 $347,000 $15,000 $0
Retained Earnings $91,673,000 -$778,975,000 $3,434,000 -$1,459,387,000 -$376,513 000
Cumulative Retained
Earnin2s $1,005,573,000 $226,598,000 $230,032,000 -$1,229,355,000 -$1,605,868,000
EBIT $158,358,000 $77,411,000 $82,769,000 -$1,413,453,000 -$357,740,000
Long-term Liabilities $1,359,261,000 $3,799,452,000 $3,622,149,000 $3,956,833,000 $1,671,716,000
Total Equity $2,236,410,000 $1,590,085000 $1,902,556,000 $518039,000 $125,730,000
Capital Employed $3,595,671,000 $5,389,537,000 $5,524,705,000 $4,474,872,000 $1,797,446,000
Return ou Capital 0.0440 0.0144 0.0150 -0.3159 -0.1990
Total Liabilities $2,394,162,000 $7,399,334,000 $7,639,841,000 $7,595,990,000 $3,956,952,000
Total Equity $2,236,410,000 $1,590,085,000 $1,902,556,000 $518,039,000 $125,730,000
DebllEauitv Ratio 1.0705 4.6534 4.0156 14.6630 31.4718
Period Endin 31112/1999 30/06/2000 311 1212000 30106/2001 3111212001
Cumulative OCFAID $2,399 764,000 $2,599,098,000 $2,736,756,000 $2,663,703,000 $2,476,302,000
Cumulative Retained Earnimls $1,005,573,000 $226,598,000 $230,032,000 -$1,229,355000 -$1 ,605,868,000
Return on Capital 4.40% 1.44% 1.50% -31.59% -19.90%
DebtlEouitv Ratio 1.0705 4.6534 4.0156 14.6630 31.47 18
A 'Shares $2.36 $1.84 $1.57 $ 1.09 $0.35
E'Shares $2.80 $2.17 $2.25 $1.45
Market Value Equity $1,461,587,606 $1,135,963,972 $1,440,381 ,926 $958,438,267 $264 887,415
Calculation of the Traiectorv
Period Endin. 31 /03/1990 30/09/1990 30/061199 1 311 12/199 1 30/06/1992 31/12/1992 30/061 1993
Cumulative CF 100.00 121.30 79. 15 144. 10 175.24 2 16. 17 258.35
Cumulative Retained
Earninfls 100.00 76.43 104.86 139.60 169.52 206.12 250.23
Return on CaDital . 100.00 62.82 62.82 133.86 133.86 116.62 121.91
Debt/EQuf~Ratio 100.00 97.88 86.06 106.41 129.76 116.99 l29.45
A Sha re Price 100.00 84.27 74.72 88.76 120.79 144.94 127.53
B Share Price 100.00 84.27 74.72 88.76 123.60 157.30 154.49
Markd Value Equity 100.00 84 .27 74.72 133. 15 182.65 228.43 212.68
Trajectory 100.00 87.32 79.58 119.23 147.92 169.51 179.23

Peri 31/12/1993 30/0611994 31/12/1994 30/0611995 31/12/1995 30/0611996 31/12/1996

Cumulative CF 329.47 39 1.45 461.42 507.33 581.18 622.03 670.32
Cumulative Retained
Earninf!S 303.47 361.12 452.23 510.33 598.04 629.90 655.70
Return on Caoita/ 135.50 163.66 216.58 142.37 180.74 11 2.59 76.33
Debt/Equity Ratio 125.57 135.85 130.65 131.22 140.16 151.97 184.49
A Share Price 200.00 216.85 196.63 193.82 2 13.48 179.21 153.37
B Share Price 251.69 297.75 275.28 244.38 292.13 261.24 215.73
Market Value Equity 345.43 388.32 355.04 335.02 381.73 329.32 372.33
Traiectorv 241.59 279.29 298.26 294.92 341.07 326.61 332.61
Period Ending: 30/06/1997 31/ 12/1997 30/06/ 1998 3111211998 30/06/ 1999 31/ 1211999 30/06/2000
Cumulative CF 685.80 707.60 699.4 1 745 .29 783.69 819.68 887.77
Cumulative Retained .
Earnings 656.87 685.97 698.73 738.85 808.25 889.33 200.40
Return on Cavital 118.00 68.18 74.40 64.04 84.32 112.09 36.56
Debt/Equity Ratio .
188.04 173.37 176.42 151.56 176.16 175.26 40.32
A Share Price 173.03 131.46 102.81 143.26 171.35 132.58 103.37
B Share Price 252.81 193.82 116.29 167.42 219.10 157.30 121.91
Market Value Equity 429.41 327.97 221.49 313.96 394.37 293 .26 227.92
Trajectory 357.71 326.91 298.51 332.05 376.75 368.50 231.18

Period Endin 3111212000 30/06/2001 31112/2001

Cumulative CF 934.79 909.84 845.83
Cumulative Retained
Earnings 203.44 -1 087.24 -1420.23
Return on Capital 38.13 -803.93 -506.56
Debt/EQuity Ratio 46.72 12.80 5.96
A Share Price 88.20 61.24 19.66
B Share Price 126.40 81.46
Market Value Equity 289 .00 192.30 53. 15
Traiect~ry 246.67 -90.51 -167.03

-'"
00
Worst-Case Scenario
Period Endim~ 31103/89 30/09/89 31103190 30/09190 30/06/91 31112191 30/06/92
Operating Cash Flow $178,628,000 S231,958,000 S62,352,000 -$ 16,387,000 S I90,141,000 SI07,991,000
Less Int. and Oivs. Received S5,552,000 S6,509,000 SI8,765,000 SO SO
Less Interest Paid SI8,511 ,000 S52,842,000 SI07,278,000 SO SO
Less Diyidends Paid S26,237,000 S32,29O,000 SI8,493,000 SO SI6,800,000
Capitalised Interest SO SO SO SO SO
OCFAID S139,432,000 SO S153 335 000 S62,352,000 -S I23,393,000 S190141 ,000 $91 19 1,000
Cumulative OCFAlD S139,432,000 S139,432,000 S292,767000 S355,119,000 S23 1 726,000 $421867000 S5 13,058,000
After·Tax Profits $72,3 17,000 SI00,954,000 -S26,655,000 S32,152,000 S56,075,000 S59,031,000
Less Deferred Taxation SI23,000,000 S43,000,000 S79,800,000 -S49,652,000
Less Dividends Proposed S28,000,000 S32,200,000 SO SO SI6,800,000 S25,200,000
Less Capitalised Interest SO SO SO SO SO SO
Less Deferred Char~es S18 540000
Retained Profits -S78,683,000 SO S7 214 000 -S26,655 000 -S47,648,000 S39275,000 S83 483 000
Cumulative Retained
Eamin2$ -S78,683,000 -S78,683 000 -S71,469,000 -S98,124,000 -SI45,772,000 -S I06497,000 -S23,014,000
EBIT S132,697,000 SI18,282,000 S77,788,000 SI92,167,000
Long-term Liabilities $459,623,000 $744,074,000 $833,942,000 $842,845,000
Total Equity S630,972,000 $761,160,000 S74 1,743,000 S985,048,000
Add Increase in Capital
Employed S202,762,000 $323,017000 S495,161,000 S671,322000
Capital Employed SI,293,357,000 SI ,828,251,000 S2,070,846,000 S2,499,215,000
Return on Capital 0.1026 0.0323 0.0323 0.0188 0.0188 0.0385 0.0385
Balance Sheet Liabilities $1,050,560,000 $1,428,087,000 $ 1,34 1,8 12,000 SI,617,OO I,000 $ 1,677,441,000 $ 1,424,3 14,000
Add Extra Liabilities SI70,700,000 SI70,700,000 S354,137,000 S354,137,000 S723,075,000 S723,075000 $806,924,000
Total Liabilities $ 1,221,260,000 S170,700,000 SI,782,324,000 SI,696,049,000 S2,340,076,000 $2,400,5 16,000 S2,23 1,238,000
Balance Sheet Equity S630,972,000 SO S761,16O,000 S699,991,000 S741,743,000 S95 1,354,000 S985,048,000
Add Extra Equity S79,762,000 S79,762,000 S22 154000 S22, 154,000 -S94,373,000 -S94373,000 SI 2,119,000
Total Equity S7 10,734,000 $79,762,000 S783,3 14,000 S722, 145,000 S647,370,000 S856,981 ,000 S997,167,000
Debt/Equity Ratio 1.7183 2.1401 2.2754 2.3486 3.6147 2.8011 2.2376

-'"
....,
Period Endin2 31112192 30/06/93 31112/93 30/06/94 31112/94 30/06/95 31112/95
Operating Cash Flow $126,819,000 1131,33 1,000 1215,013,000 1210,003,000 1242,280,000 1170,657,000 1269,935,000
Less Int. and Divs. Received . 10 $0 10 $0 10 10 10
Less Interest Paid 10 $0 10 $0 $0 10 10
Less Dividends Pidd 14,598,000 $5,195,000 $5,531,000 126,610,000 $35,479,000 $35,478,000 $53,218,000
Capitalised Interest $2,394,000 $2,647,000 $ 1,289,000 $1,911,000 $1,955,000 $788,000 $491,000
OeFAID 1119,827,000 1123,489000 1208,193 000 1181,482,000 $204,846,000 $134391 000 1216,226,000
Cumulative OCFAlD 1632,885,000 1756,374,000 1964,567,000 11,146,049,000 $1,350,895,000 $1,485,286,000 $1,701,512,000
After-Tax Profits $60,937,000 $78,598,000 $88,099,000 $ 102,566,000 1140,459,000 $119,703,000 $135,136,000
Less Deferred Taxation $26,572,000 $50,278,000 $69,494,000
Less Dividends Proposed $17,139,000 $26,088,000 $26,609,000 $35,479,000 $35,479,000 $53,218,000 $35,479,000
Less Capitalised Interest $2,410,000 $2,631,000 $1,289,000 $1,911,000 $1,955,000 1788,000 $49 1,000
Less Deferred Charges
Retained Profits 141,388,000 123,307,000 160,201,000 114,898,000 $ 103,025,000 -13,797,000 $99, 166,000
Cumulative Retained
Earnin2s 118,374,000 141,681,000 $101,882,000 $116,780,000 $2 19,805,000 $216008000 $3 15174,000
EBIT $96,109,000 $98,330,000 $115,136,000 1134,321,000 $184,0 12,000 $128,217,000 $161,292,000
Long-term Liabilities $1,017,166,000 $938,697,000 $987,203,000 $887,085,000 $918,286,000 $1,013,434,000 $872,690,000
Total Equity 11,080,378,000 $1,114,172,000 $1,175,433,000 $1,201,759,000 $1,244,156,000 $1,278,782,000 $1,398,578,000
Add Increase in Capital
Employed $671,322,000 $410,888,000 $410,888,000 $320,795,000 $320,795,000 $336,801,000 $351,463,000
Capital Employed $2,768,866,000 $2,463,757,000 $2,573,524,000 $2,409,639,000 12,483,237,000 12,629,017,000 $2,622,731,000
Return on Capital 0.0347 0.0399 0.0447 0.0557 0.0741 0.0488 0.0615
Balance Sheet Liabilities $1,732,582,000 $1,61 4,853,000 $ 1,756,216,000 11,659,691,000 SI,786,653,000 11,828,427,000 1 1,872,208,000
Add Extra Liabilities $806,924,000 $704,292,000 $704,292,000 $699,784,000 $699,784,000 $856,739,000 1870,559,000
Total Liabilities 12,539,506,000 12,319,145,000 $2,460,508,000 $2,359,475,000 52,486,437,000 12,685,166,000 12,742,767,000
Balance Sheet Equity 11,080,378,000 11,1 14,172,000 $1,175,433,000 $1,201,759,000 $ 1,244,156,000 11,278,782,000 $ 1,398,578,000
Add Extra Equity $12,1 19,000 -$157,869,000 -1157,869,000 -$245,946,000 -$245,946,000 -$349,527,000 -$349,527,000
Total Equity $1,092,497,000 $956,303,000 $1,017,564,000 $955,813,000 $998,210,000 1929,255,000 $1,049,051,000
DebtJEquity Ratio 2.3245 2.4251 2.4180 2.4686 2.4909 2.8896 2.6 145

-
00
00
Period Endini!: 30/06196 31112196 30/06197 31/ 12197 30/06198 31/ 12198 30106199
Operating Cash Flow S155,91O,OOO S196,808,OOO S94,782,OOO S135,628,OOO 524,405,000 S183,162,OOO S148,421,OOO
Less Int. and Divs. Received SO 50 SO 50 SO SO SO
Less Interest Paid 50 50 SO 50 50 SO SO
Less Dividends Paid S35,479,OOO S53,219,OOO 545,345,000 568,017,000 $45,345,000 $45,435,000 133,919,000
Capitalised Interest 5848,000 S2,220 000 54, 11 9000 $3,788,000 $3,014,000 53,403,000 $2,086,000
OCFAD) $ 11 9,583,000 $ 141369000 545318000 $63,823,000 -$23,954 000 $ 134 324000 $ 11 2416,000
Cumulative OCFAID $ 1 821 095000 S1,962 464 000 $2,007,782,000 52,07 1,605,000 $2,047,651,000 $2 181 975000 $2,294,391,000
After-Tax Profits 590,09 1,000 $76,737,000 573,459,000 $82,039,000 S62,786,OOO 582,779,000 513 1,592,000
Less Deferred Taxation 574,976,000 519,227,000 -$ 15,781,000 $28,164,000
Less Dividends Proposed $53,219,000 $45,345,000 $68,017,000 545,345,000 545,345,000 534,009,000 $5 1,031,000
Less Capitalised Interest $848,000 52,220,000 $4, 119,000 $3,788,000 $3,014,000 53,403,000 $2,086,000
Less Deferred Charges
Retained Profits -538,952,000 529 172,000 -$17 904,000 $32,906,000 $30,208000 $45367000 $50,3 11,000
Cumulative Retained
Earnin2s $276,222,000 S305 394,000 5287 490,000 5320,396,000 5350,604,000 $395971 000 5446,282,000
EBIT $96,325,000 17 1,432,000 $ 115,203,000 S76,940,OOO 593,469,000 $86,724,000 $ 113,857,000
Long-tenn Liabilities 5774,646,000 $730,757,000 $809,639,000 $1 ,020,746,000 51,208,642,000 51,415,44 1,000 5 1,3 10,69 1,000
Total Equity 51,402,867,000 1 1,65 1,212,000 51,675,244,000 $1,85 1,490,000 $1,988,879,000 52,03 1,486,000 52, 126,168,000
Add Increase in Capital
Employed S361,267,OOO S364,289,OOO 5400 33 1,000 $42363 1,000 5475,635,000 S545 989 000 $603,664,000
Capital Employed 52,538,780,000 52,746,258,000 12,885,214,000 53,295,867,000 53,673,156,000 53,992,916,000 $4,040,523,000
Return on Capital 0.0379 0.0260 0.0399 0.0233 0.0254 0.02 17 0.0282
Balance Sheet Liabilities 51,731,963,000 51,679,235,000 $ 1,67 1,543,000 52,003,671,000 $2, 11 5,152,000 $2,5 14,759,000 $2,264,530,000
Add Exua Liabilities $921,365,000 5901,730,000 5946304 000 $ 1,016,449,000 5 1,012,436,000 51,082,081,000 5103 1 985000
Total LiabilitieS $2,653,328,000 52,580,965,000 $2,617,847,000 $3,020,120,000 $3, 127,588,000 $3,596,840,000 53,296,515,000
Balance Sheet Equity $ 1,402,867,000 5 1,65 1,2 12,000 SI,675,244,OOO 51,85 1,490,000 5 1,988,879,000 $2,031,486,000 $2, 126, 168,000
Add Extra Equity -$38 1 704,000 -538 1,704,000 -5382,640,000 -$382,640,000 -53 12,203,000 -$3 12203 000 -$201,030,000
Total Equity $ 1,021,163,000 $1,269,508,000 $ 1,292,604,000 $ 1,468,850,000 $1,676,676,000 $ 1,719,283,000 51,925, 138,000
DebtlEquity Ratio 2.5983 2.0330 2.0253 2.0561 1.8654 2.0921 1.7 124

-
00

'"
Period Endin 31112/99 30106/00 31/12/00 30106/01 31112101
Operating Cash Flow S157,915,000 S233,906,000 1189,080,000 -142,765,000 -$187,401,000
Less Int. and Divs. Received 10 10 10 SO 10
Less Interest Paid 10 10 10 10 10
Less Dividends Paid S51,031,000 134,050,000 151,075,000 130,273,000 10
Capitalised Interest 11,511,000 1522,000 1347,000 115,000 10
OCFAID 1105,373,000 S199334,000 S137,658,000 -173 053 000 -S187 401000
Cumulative OCFAID 12,399,764,000 12,599,098,000 12,736,756,000 S2,663,703,000 12,476,302,000
After-Tax Profits 1127,234,000 158,849,000 S3,78 1,000 -11,429,099,000 -1376,513,000
Less Deferred Taxation $337,149,000
Less Dividends Proposed 134,050,000 151,075,000 10 130,273,000 10
Less Capitalised Interest $1,511,000 1522,000 1347,000 115,000 10
Less Deferred Charges
Retained Profits 191 673,000 -1329,897,000 S3,434,000 -11,459,387,000 -1376,513,000
Cumulative Retained
Earnin2.s 1537,955,000 1208,058,000 1211,492,000 -11,247,895000 -11,624,408,000
EBIT 1158,358,000 177,411,000 182,769,000 -11 ,413,453,000 -1357,740,000
Long-term Liabilities 11,359,261,000 13,799,452,000 13,622,149,000 13,956,833,000 11,671,716,000
Total Equity $2,236,410,000 11,590,085,000 11,902,556,000 15 18,039,000 1125,730,000
Add Increase in Capital
Employed 1750,303,000 12,562,480,000 $2,811,539,000 12,711,908,000 1908,465,000
Capital Employed 14,345,974,000 17,952,017,000 18,336,244,000 17,186,780,000 12,705,911,000
Return on Capital 0.0364 0.0097 0.0099 -0.1967 -j).1322
Balance Sheet Liabilities 12,394,162,000 17,399,334,000 17,639,841,000 17,595,990,000 13,956,952,000
Add Extra Liabilities 11,188,596,000 12,406,133,000 12,685,603,000 12,965 158,000 19 12,232,000
Total Liabilities 13,582,758,000 19,805,467,000 110,325,444,000 110,561,148,000 14,869,184,000
Balance Sheet Equity 12,236,410,000 11,590,085,000 11,902,556,000 15 18,039,000 1125,730,000
Add Extra Equity -1201,030,000 1551,806,000 1551,806,000 1286,399 000 1286,399,000
Total Equity 12,035,380,000 12,141,891,000 $2,454,362,000 1804,438,000 14 12,129,000
DebtlEquity Ratio 1.7602 4.5779 4.2070 13.1286 11.8147
Calculation of the Trajectory

Period Endin 31103190 30109190 30106191 31112191 30106192 31112192 30106193

Cumulative OCFAID $292,767,000 $355,11 9,000 $231,726,000 $421,867,000 $513,058,000 $632 885,000 $756,374,000
Cumulative Retained
Earnings ·-$71 469 000 -$98, 124,000 -$145,772 000 -$106,497,000 -$23,014,000 $18,374,000 $4 1,68 1,000
Return on Capital 0.0323 0.0188 0.0188 0.0385 0.0385 0.0399
Equity/Debt Ratio 2.2754 2.3486 3.6147 2.8011 2.2376 2.3245 2.425 1
Share Price: 'A' Shares $1.78 $1.50 $1.33 $1.58 $2.15 $2.58 $2.27
Share Price: '8' Shares $1.78 $1.50 $1.33 $1.58 $2.20 $2.80 $2.75
Market Value Equity $498,400 000 $420,000,000 $372,400,000 $663,600 000 $910350000 $1 138 478353 $1059 981 703

Cum ulative OCFAID 100.00 12 1.30 79. 15 144.10 175.24 216.17 258.35
Cumulative Retained
Earninzs 100.00 62.70 -3.97 50.99 167.80 225.71 258.32
Return on Capital 100.00 58.06 58.06 118.91 118.91 107.30 123.38
Debt/Equity Ratio 100.00 96.88 62.95 81.23 101.69 97.89 93.82
A Share Price 100.00 84.27 74.72 88.76 120.79 144.94 127.53
B Share Price 100.00 84.27 74.72 88.76 .
123.60 157.30 154.49
Market Value Equity 100.00 84.27 74.72 133.1 5 182.65 228.43 212.68
Trajectory 100.00 84.54 60.05 100.84 141.53 168.25 175.51

--
'"
Perinrl Endin 31/12193 30/06194 311 12/94 30/06195 3lil2195 30/06/96 3lil2i96
Cumulative OCFAID 5964,567,000 $1 146049000 $1 350,895,000 $1 485 286,000 $1 ,701512000 51 ,821095000 51 ,962,464,000
Cumulative Retained
Earnings $101,882,000 $116780,000 $219 805,000 $216,008,000 $315 174000 $276222000 $305,394,000
Return on Capital 0.0447 0.0557 0.0741 0.0488 0.0615 0.0379 0.0260
EquitylDebt Ratio 2.41 80 2.4686 2.4909 2.8896 2.6145 2.5983 2.0330
Share Pn'ce: j4' Shares $3.56 $3 .86 $3.50 $3.45 $3.80 $3.19 $2.73
Share Price: 'B'Shares $4.48 $5.30 $4.90 $4.35 $5.20 $4.65 $3.84
Market Value Equity $1,721,607,609 $1935,367235 $1 769 503 957 $1669719,899 $1,902549,367 $1641355,383 $1,855,683,642

Cumulative OCFAID 329.47 391.45 461.42 507.33 581.18 622.03 670.32

Cumulative Retained
Earnings 342.55 363.40 507.55 502.24 640.99 586.49 627.31
Return on Capital 138.30 172.32 229.07 150.76 190.11 117.29 80AI
Debt/Equity Ratio 94.10 92.17 91.35 78.74 87.03 87.57 1l1.92
A Share Price 200.00 216.85 196.63 193.82 213.48 179.21 153.37
B Share Price 251.69 297.75 275.28 244.38 292.13 261.24 215.73
Market Value Equity 345.43 388.32 355.04 335.Q2 381.73 329.32 372.33
Trajectorv 243.08 274.61 302.33 287.47 340.95 311.88 318.77
Period EndiIJg 30/06/97 31 / 12197 30/06/98 31112198 30/06/99 31112/99 30/06/00
Cumulative OCFAiD $2,007,782,000 $2 071 605 000 $2,047,651,000 $2,181975000 $2,294,391,000 $2,399764,000 $2,599,098000
Cumulative Retained
Earnings $287,490,000 $320,396 000 $350,604,000 $395,971,000 $446 282,000 $537,955,000 $208,058,000
Return on Capital 0.0399 0.0233 0.0254 0.0217 0.0282 0.0364 0.0097
Equity/Debt Ratio 2.0253 2.0561 l.8654 2.0921 1.7124 l.7602 4.5779
Share Price: 'A' Shares $3.08 $2.34 $l.83 $2.55 $3.05 $2.36 $l.84
Share Price: 'B'Shares $4.50 $3.45 $2.07 $2.98 $3.90 $2.80 $2.17
Market Value Equity $2140,166,252 $1,634,627,219 $1 , 103,921,764 $1,564 796,063 $1,965,538,870 $1461587,606 $1,135,963,972

Cumulative OCFAID 685.80 707.60 699.41 745.29 783.69 819.68 887.77

Cumulative Retained
Earnings 602.26 648.30 690.57 754.05 824.44 952.71 491.12
Return on Capital 123.43 72.17 78.66 67.14 87. 11 112.64 30.09
DebtiEqui~Ratio 112.35 110.66 121.98 108.76 132.88 129.26 49.70
A Share Price 173.03 131.46 102.81 143.26 17l.35 132.58 103.37
B Share Price 252.81 193.82 116.29 167.42 219.10 157.30 12l.91
Market Value Equity 429.41 327.97 22l.49 313.96 394.37 293.26 227.92
Traiectorv 339.87 313.14 290.17 328.55 373.28 371.06 273.13
Period Endi 31/12/00 30/06101 31 /12/01
Cumulative OCFAID $2 736 756,000 $2663,703000 $2476302,000
Cumulative Retained
Earnings S211,492,000 -$1,247,895,000 -$1,624,408,000
Return on Capital 0.0099 -0.1967 -0.1322
EQuity/Debt Ratio 4.2070 13.1286 11.8147
Share Price: 'A' Shares $1.57 $1.09 SO.35
Share Pn·ce: 'B'Shares $2.25 $\.45
Market Value Eouitv $1,440 38 1,926 $958 438267 $264 887 4 15

Cumulative OCFAID 934.79 909.84 845.83

Cumulative Retained
Earnings 495.92 -1546.06 -2072.88
Return on Capital 30.69 -607.99 -408.70
Debt/Equity Ratio ·54.09 17.33 19.26
A Share Price 88.20 6\,24 19.66
B Share Price 126.40 8 1.46
Market Value Equity 289.00 192.30 53.15
Trajectory 288.44 -127Al -257.28
Calculation of Air NZ's Trajectory

Period Endin.!?: 31103/90 30109/90 30/06191 31/12/91 30106/92 31112192 30106/93

Best-Case Traiectorv 100.00 87.32 79.58 11 9.23 147.92 169.5 1 179.23
Worst-Case Traiectorv 100.00 84.54 60.05 100.84 141.53 168.25 175.51
Air NZ's Traiectorv - 100.00 85.93 69.81 110.04 144.72 168.88 177.37
.

Period Endine: 31/1 2/93 30/06/94 31/12194 30/06/95 31112195 30106/96 31/12/96
Best-Case Trajectory 241.59 279.29 298.26 294.92 341.07 326.61 332.61
Worst-Case Trajectory 243.08 274.6 1 302.33 287.47 340.95 3 11.88 318.77
Air NZ's Trajectory 242.33 276.95 300.30 291.20 341.01 319.24 325.69

Period Endin!! 30106/97 31112197 30106/98 31/ 12/98 30/06/99 31112199' 30106/00
Best-Case Trajectory 357.7 1 326.9 1 298.5 1 332.05 376.75 368.50 23 1.1 8
Worst-Case Trajectory 339.87 313 .14 290. 17 328.55 373.28 37 1.06 273. 13
Air NZ's Trajectory 348.79 320.02 294.34 330.30 375.01 369.78 252.15

Period Ending 31112100 30106/01 31/12/01

Best-Case Traiectorv 246.67 -90.51 -1 67 .03
Worst-Case Traiectorv 288.44 -127.41 -257 .28
Air NZ's Traiectorv 267.56 -108.96 -212.16

-'"
v.
 196

Appendix 4: Sensitivity Analysis Results

Trajectory: Best-Case Scenario

750.00

250.00
500.00
0,00
~:!'=~~~~::::~::::::~~:~~\-_
~250.!Ml -90 Mar-92 Mlr-96 Mar-98
-500.00
-750.00
Year

-----+---- Adjusted Trajectory -..- Base-Case Trajector y

Graph 1: Corporate Indicators weighting doubled

Trajectory: Worst-Case Scenario

750.00

250.00
500.00
0.00
~':!""'~~~~:::~:~::~:~~:~~~_
-250.00:1 -90 Mar-92 tv'ar-96 Mlr-98 tier-DO
-500.00
-750.00

Year

-+- Adjusted Trajectory _ Wors t-Case Trajectory

Graph 2: Corporate Indicators weighting doubled

Trajectory: Best-Case Scenario

600.00

4oo.00b~~~
200.00
cwo
.200.<1&' ·90 Mar-92 Mar-94 Wer-96 Mar-98

-400.00
Year

-+- Adjusted Trajectory _ _ Base-Gase Trajectory

Graph 3: Market Indicators weighting doubled

 197

Trajectory: Worst-Case Scenario

600.00
400.00

-20 .dt!'
200.00
0.00
90 War-92 Mar-94 I'Ier-96 War-9S

-400.00
Year

I--+----- Adjusted Trajectory - - - Worst-Qtse Trajectory )

Graph 4: Market Indicators weighting doubled

Trajectory: Best-Case Scenario

800.00

600. 00k~====~
400.00
200.00
0.00
-2oo.cM3 -90 fvt:lr-92 War-94 Mar-9S Mar-9S Mar-GO
-400.00
Year

-----+- Adjusled.Trajeclory ___ Base-Gase Trajectory

Graph 5: OCFAID weighting 2.0; CRE and ROCE weighting 1.5; DIE weighting 1.0;
'A 'Shares, 'B ' Shares and Market Value weighting 1.3

Trajectory: Worst-Case Scenario

800.00

600.00~~=====~
400.00
200.00
0.00
-200.<Ma -90 War-92 Mar-94 Mar-9S War-98
-400.00
Year

--+- Adjusted Trajectory ___ Worst· Case Trajectory

Graph 6: Weighting the same as Graph 5

 198

Trajectory: Best-Case Scenario

600.00

400.00
200.00
0.00
-200.dd' 90 Mar-92 foIar-94 ""'-96 Mar-98

·400.00
Year

I-+- Adjusted Trajectory - - - Base-Gase Trajectory!

Graph 7: OCFAlD weighting 1.5; CRE and ROCE weighting 1.0; DIE weighting 1.3;
'A' Shares, 'B' Shares and Market Value weighting 2.0

Trajectory: Worst-Case Scenario

600.00

400,00~e:=:::::::~
200.00
0.00
-200.dd' -90 M3.r-92 ~r·94 Mar-96 Mar·98 ""'-00

·400.00
Year

j---+-- Adjusted Trajectory - - - Worst-Case Trajectory I

Graph 8: Weighting Same as Graph 7

Trajectory: Best-Case Scenario

750.00
500.00
250.00
0.00
-250. 90 Mar·92 M3r-94 Mar-96 Mar-98
-500.00
·750.00 .
Year

-+- Adjusted Trajectory ___ Base-Case Trajectory

Graph 9: OCFAID weighting 1.4; CRE and ROCE weighting 2.2; DIE weighting 1.8;
'A 'Shares, 'B' Shares and Market Value weighting 1.0
 199

Trajectory: Worst-Case Scenario

750.00

5°O.00b~~==:::=:::~r-
250.00
0.00
-2S0.00a -90 Iv'ar-92 Wer-94 Wer-96 Mlr-98 War-DO
-500.00
-750.00
Year

-----+--- Adjusted Trajectory _Worst-Qlse Trajectory

Graph 10: Weighting the same as Graph 9

Trajectory: Best-Case Scenario

600.00

0.0
4oo,oob~===~
200.00

-2oo.cMa -90
-400.00
Mar-92 f.Aar-94 Mar-96 Mar-98

-600.00
Year

-+- Adjusted Trajectory ___ Base-Case Trajectory

Graph 11: OCFAID weighting 1.0; CRE and ROCE weighting 1.4; DIE weighting
2.2; 'A' Shares, 'B' Shares and Market Value weighting 1.8

Trajectory: Worst-Case Scenario

600.00

200.00
400.00
0.00
~~==£!:!:::=::::::=::::::::::~~_
-200,003 -90 ' 'tv1ar-92 Mar-94 Mar-96 M:lr-98
-400.00
-600.00

Year

-+- Adjusted Trajectory ___ Worst-Case Trajectory

Graph 12: Weighting the same as Graph 11

 200

Trajectory: Best-Case Scenario

600.00

200.00
400.00
0.00
-200.~ -90
t::::!=!:~~~~:::~:~~~~~~~~~J~.
Wer-92 Mar-94 Mar-96 Mar-9S

-400.00
Year

---+---- Adjusted Trajectory ___ Base-Case Trajectory

Graph 13: OCFAID Indicator weighting doubled

Trajectory: Worst-Case Scenario

600.00

400'00~~~~
200.00
0.00
-200.<fd:l -90 M:lr-92 Mar-94 Mar-96 Wer-9S

-400.00
Year

-+--- Adjus ted Trajectory _ _ Worst-CasEI Trajectory

Graph 14: OCFAID Indicator weighting doubled

Trajectory: Best-Case Scenario

750.00

250.00
500.00
0.00
l::!:=!:::!";~~~:~~=~::~:::::~~,..
-250.cM3 -90 Mar-92 Mar-94 Wer-96 Mar-98
-500.00
-750.00
Year

-+- Adjusted Trajec tory ___ Base-Case Trajectory

Graph 15: CRE Indicator weighting doubled

 201

Trajectory: Worst-Case Scenario

750.00

250.00
SOO.OO
0.00
~:!:=o:::!:;:~~~:~~~:~:~~::::~~;:--
-250.{M:I -90 IY1ar-92 tv1ar-94 Mar-96 WElr-OO
-500.00
-750.00

Year

---+- Adjusted Trajectory ___ Worst-Gase Trajectory

Graph 16: CRE Indicator weighting doubled

Trajectory: Best-Case Scenario

600.00

400.00b~~::::::::=~~
200.00
0.00
-200,dij3 -90 tv'er-92 Mar-94 tv1ar-96 fv1ar-98

-400.00
Year

--+- Adjusted Trajectory ______ Base-Gase Trajectory

Graph 17: ROCE Indicator weighting doubled

Trajectory: Worst-Case Scenario

600.00

200.00
400.00
0.00
l::!==!::~~~~::::::::::::~:jlr--
-200,cf'd3 -90 Mar-92 Wer-94 War-98

-400.00
Year

--+- Adjusted Trajectory ___ Worst-Gase Trajectory

Graph 18: ROCE Indicator weighting doubled

 202

Trajectory: Best-Case Scenario

600.00

4OO'OOb~===~
200.00
0.00
-200.Qd3 -90 tv'er-92 Mar-94 Mar-96 Mar-96 Mar-DO

-400.00

Year

---+-- Adjusted Trajectory _ Base-Case Trajectory

Graph 19: DIE Indicator weighting doubled

Trajectory: Worst-Case Scenario

600.00

4oo,00b~==~
200.00
0.00
-200.Q&I ·90 f'ler-92 Mar-94 Mar-96 Mar-98 M1r-DO

-400.00

Year

I---+- Adjusted Trajectory - I I - Worst-Gase Trajectory I

Graph 20: DIE Indicator weighting doubled

Trajectory: Best-Case Scenario

600.00

20 .0 ~~='!:~~~~::::::::::==~::~~
400.00
0.00
-zoo.Qd3 -90 . Wlar-92 Mar.-94 Mu-96 Mlr-98 Mar-DO

-400,00
Year

-+- Adjusted Trajectory ___ Base-Case Trajec tory

Graph 21: 'A' Shares Indicator weighting doubled

 203

Trajectory: Worst-Case Scenario

600.00

200.00
400.00
0.00
i~=:!::~~~~::::::::::::::J\----
-ZOO.Qda -QO M3r-92 MJr-94 M'lr-96 Mar-98 M3r-OO

-400.00

Year

I--+-- Adjusted Trajectory - - Worst-Gase Trajectory I

Graph 22: 'A' Shares Indicator weighting doubled

Trajectory: Best-Case Scenario

600.00

4°O'OOb~:::::::~
200.00
0.00
-200.~ -90 War-92 fv1ar-94 War-96

-400.00
Year

---+---- Adjusted Trajectory ___ Base-case Trajectory

Graph 23: 'B' Shares Indicator weighting doubled

Trajectory: Worst-Case Scenario

600.00

200.00
400.00
0.00
i~=:!::~~~~::::::::::::::J\--
-200.iM' -90 fv'ar-Q2 Mar-94 tv'er-96 Mir-98

-400.00

Year

--+-- Adjusted Trajectory _ _ Worst-case Trajectory

Graph 24: 'B' Shares Indicator weighting doubled

 204

Trajectory: Best-Case Scenario

600.00

400.00t~~~~~~~::::::::::::::::::::::~~~_
200.00
0.00
-200.Qda -90 Mar-92 Mu-94 Mar-96 Mar-98

-400.00
Year

--+- Adjus ted Trajectory _ Base-Case Trajectory

Graph 25: MV Indicator weighting doubled

Trajectory: Worst-Case Scenario

600.00

400, OOt~~~~~~~::::::::::::::::::::::::~~
200.00
0.00
-200.eM" -90 Mar-92 Mar-94 Mar-9S Mar-98

-400.00

Year

I-+- Adjusted Trajectory ---- Worst-Gase Trajectory I

Graph 26: MV Indicator weighting doubled

Notes to Abbreviations

OCFAID = Operating Cash Flows after Interest and Dividends

eRE = Cumulative Retained Earnings
ROCE ~ Return on Capital Employed
DIE ~ Debt to Eq,u ity Ratio
MV ~ Stock Market Share Value
Unless otherwise stated, each indicator has a weighting of 1.0
 205

Appendix 5: Market and Corporate Indicators

Market Trajectory

350.00

280.00

210.00
140.00
70.00 .r<'"-or
0.00 +---_--_--_--_--_--
Mar-gO M3r-92 Mar-94 f.ler-96 Mar-98 Mar-DO

Year

Graph J,' Equally Weighted Market Trajectory

Corporate Trajectory: Best-Case

600.00

400.00

200.00
0.00
l:~~::::::~--
+ _____--_J\__
Ma -90 M:lr-92 tvlar-94 Mar-96 Mar-98
-200.00

-400.00
Yea r

Graph 2: Equally Weighted Corporate Trajectory: Best-Case Scenario

Corporate Trajectory: Worst-Case

600.00

200.00
400.00
0.00
t:!:~~;::'::::::::==:=- r--

_200.Q:6l-90 Mar-92 Mar-94 Mar-96 Mar-98 ' Mar-OO

-400.00
-600.00

Yea r

Graph 3: Equally Weighted Corporate Trajectory: Worse-Case Scenario