Transaction Cost Economics and Why Businesses File Dormant Company Accounts

Sometimes a business will continue to be registered even though it is not actively trading. This could be seen mainly as an administrative decision; however, once you apply the principles of transaction cost economics developed by Ronald Coase and later elaborated on by Oliver Williamson, the reason for staying registered becomes clearer.

The main purpose of transaction cost economics is to explain how companies organize their activities in order to reduce the costs of participating in the market, negotiating and executing contracts, and administering them. An example of this is when companies file dormant company accounts instead of closing down and then reopening a company; by remaining registered, they are saving on their overall costs by having the option to remain dormant and still have a company registered.

What Defines a Dormant Company

A dormant business does not carry out any significant transactions during an accounting year and therefore has not traded, generated revenue, or incurred any operational expenditure.

Only limited transactions can be made by inactive companies, such as penalties for failure to file with Companies House. As a result, dormant company accounts typically consist of a simplified set of financial statements, including a basic balance sheet and a declaration confirming that no transactions took place.

Even if there has been no activity during the year, dormant companies are required to file dormant company accounts annually. This confirms compliance and provides an official record of the company’s inactivity.

Transaction Costs and the Decision Not to Dissolve

From an economics viewpoint, dissolving a business has costs associated with doing so. There are expenses associated with the administrative procedures, the legal documents needed to dissolve the business, and, potentially, loss of intangibles (like your brand name or business history). Re-establishing a business at a later point in time incurs some additional costs:

the cost of registering with the secretary of state and having to do any legal work associated with that registration
the administrative delay in establishing a new business again
the potential to lose your name or reputation due to this type of inactivity

According to transaction cost economics theory, companies will try to avoid these costs where they can. Filing dormant company accounts instead of dissolving your business may be the best way to minimize your total business cost by maintaining your current business structure, and there won't be as much money spent on trying to get back into the market if you had to establish a new business entity.

Preserving Scarce Assets: Names, Brands, and Legal Identity

A company name is an economic resource that is scarce. Once a company ceases to exist, there will be other companies competing to use the name.

If a company files its dormant accounts, it has effectively kept the use of the company name as an option. The existence of such an option relates to the principles of property rights and opportunity cost; that is, if a company loses the use of a company name, that loss may be greater than the relatively small cost of keeping the accounts in a dormant state.

This applies in particular to companies that have valuable branding or established trademarks, or that have an established market position

Dormant Companies as Real Options

Another way to analyze dormant status is through real options theory. This concept basically states that companies have options (the right, but not the obligation) to reinstate activity at some future time, and that this flexibility is deemed to be of value in uncertain circumstances, such as:

A firm may choose to hold off on launching a new product until market conditions improve.
A subsidiary of a company may be put on hold while the parent company restructures.
A company may be waiting for either regulatory approval or technological advancements before pursuing an opportunity.

Instead of making an actual closure of the business, many companies choose to keep filing dormant company accounts so they can retain this level of strategic flexibility at what is typically a low cost.

Holding Assets Without Active Operations

A company can be created to exclusively hold assets (such as property and/or items of intellectual property). These types of entities do not engage in daily transactions yet serve an easily defined economic function.

A company can be the owner of an asset (e.g. a piece of land), which will be developed, and while developing an asset, the company would record very few (if any) transactions; however, the company directors would employ dormant accounts in order to provide evidence of continued ownership of the asset while avoiding continuing to incur significant administrative costs.

This illustrates the efficiency of resource allocation since the company maintains control of its asset without incurring unneeded operating costs.

Simplified Reporting and Cost Minimization

Reduced reporting requirements are available for dormant companies. In addition to confirming that they do not have significant accounting transactions, dormant companies have minimal asset values on their balance sheet and meet the qualification for dormant status. The reduction in reporting burden decreases administrative costs, so these companies align with a broader economic objective of minimising costs.

Although reducing the reporting burden is an advantage of being a dormant company, compliance with legislation still applies to these companies. Dormant companies will still be required to file dormant company accounts and submit confirmation statements each year to remain legally active.

Avoiding Unnecessary Market Exit

From an economic perspective, dissolving a company can be seen as an exit from the market, whereas being dormant is viewed as a temporary exit from the market.

By dissolving and then re-entering the marketplace, companies may incur substantial costs and be inefficient when doing so. In addition, companies that face barriers to entry or rely heavily on their brand to gain customers will find the process of re-entering to be challenging. Filing dormant accounts provides companies with a way to reduce their market exposure without completely leaving the marketplace.

This is consistent with the rational decision-making of firms when making decisions under uncertainty.

Conclusion

From an economic perspective, dissolving a company can be seen as an exit from the market, whereas being dormant is viewed as a temporary exit from the market.

This is consistent with the rational decision-making of firms when making decisions under uncertainty.