Vanishing act: Why there were fewer insolvencies even as number of businesses decreased

Tens of thousands of businesses have pulled a vanishing act during the pandemic, a statistical mystery created by duelling data and the unprecedented turmoil of the coronavirus crisis.

Data from the federal Office of the Superintendent of Bankruptcy show a marked decline in the number of business insolvencies since the start of the pandemic, an unusual sign of stability given the magnitude of the economic downturn this year.

But a different, and much more gloomy, picture emerges from Statistics Canada data that track the opening and closing of companies. The number of active businesses had been stable for years, rising just 2.9 per cent from January, 2015, to February, 2020.

That stability turned on its head in March, when the number of active businesses, defined by Statistics Canada as having employees on the payroll in a given month, started to tumble. (To count those businesses, the agency uses payroll deduction forms that companies must submit to the Canada Revenue Agency.) The number of active businesses declined by 85,690, or 10.7 per cent, between February and July, rebounding slightly from a nadir in June.

The decline is even more pronounced for continuing businesses, which Statscan defines as having at least one employee for at least two consecutive months. The number of continuing businesses fell by 102,496 between February and July, a decline of 13.4 per cent.

Whichever of Statscan’s measures is used, large numbers of companies have shut down operations and have stopped paying their employees since the onset of the pandemic, likely a sign of deep financial distress.

So far, that distress has not translated into a rise in business insolvencies. Far from it – according to monthly data from the Office of the Superintendent of Bankruptcy, bankruptcies and proposals were down 35.3 per cent in September from a year ago, a year-over-year pattern of decline that began in March.

The bankruptcy superintendent warns that monthly figures are volatile. But the pattern since March is well established, showing a consistent decline from the previous year. For the 12 months ending in September, 2020, insolvencies were down 19.2 per cent compared with the 12 months ending in September, 2019.

What could explain the difference? One explanation could lie in what is being measured. The Statistics Canada data capture the opening and closing of companies, including temporary shutdowns. The agency also measures, on a less frequent basis, the entry and exit of companies from the economy. An exit, unlike a closing, is permanent; Statscan deems a business to have exited if it is closed for 12 months. That measure would compare more directly to insolvencies.

Historically, the two data sets, company closings and company exits, have been closely correlated. Both fall when the economy is expanding, Statscan says, and rise when it contracts. But the federal government’s fiscal interventions may have disrupted that historical relationship, with the agency saying that equating the high rate of closings this year to an eventual high rate of business exits “likely overstates” the impact of the economic downturn since March.

Still, Statscan says the issue requires further investigation; the agency is planning to examine insolvency data to see how it compares with its data on business closings.

For the head of the Canadian Federation of Independent Business, the answer is already obvious. Dan Kelly, the CFIB’s president and chief executive officer, says thousands of businesses have shut down and are effectively bankrupt, but are holding off on a formal filing on the faint hope that federal relief programs might be enriched, or that they can outrun their debts long enough to survive the pandemic.

He calls them “zombies,” not-quite-dead corporations that may linger a few more months before formally expiring. Mr. Kelly has run into this first-hand, as the CFIB is finding it difficult to contact a significant number of its companies about membership renewals. He said as many as 15,000 of 110,000 members are at risk of going under.

The sectoral breakdown of corporate closings from March to July gives some weight to his theory. The arts and entertainment sector, along with the accommodation and food sector, experienced much larger declines than most of the rest of the economy. The number of continuing businesses fell by 24.5 per cent in both of those sectors, much higher than the 13.4-per-cent decline for the entire economy.

Those two sectors are, of course, among the hardest hit by the public-health measures to fight the coronavirus and the associated change in consumer spending patterns. A third sector – “other services” – also saw an above-average decline of 16.5 per cent. That catch-all category includes hair stylists and beauticians, another sector savaged by the coronavirus crisis. All three are dominated by small businesses.

Mr. Kelly says it’s not too late for Ottawa to save at least some of the zombie businesses, pointing to the paradox of federal wage and rent subsidies becoming less generous this fall and winter compared with the spring and summer, even though the pandemic rages on. “These businesses are weaker than they were in March,” he says.

In addition, he says, Ottawa should immediately change the rules to allow newly formed companies to access aid programs. Whatever the changes, the federal government needs to act quickly to ensure that aid dollars arrive in the bank accounts of those business owners teetering on the edge, Mr. Kelly says. “Every day that ticks by, more business owners make the decision to hang up the towel.”

Tax and Spend is a weekly series that examines the intricacies and oddities of taxation and government spending.