The collapse of Carillion raises concerns not only about corporate governance at the firm and KPMG’s audit, but also how the directors were able to get changes to their pay passed the vote. Speaking in The Guardian on Saturday (20-Jan-18), British Prime Minister Theresa May signalled her government’s frustration with the slow pace of change: “Boardroom excesses can no longer be tolerated “ (20-Jan-18)
Carillion, the FTSE 250 construction firm and public sector service provider, went into liquidation on Monday (15th January) and the Insolvency Service has been asked to fast-track their investigation into Carillion’s directors and broaden its scope to include past directors. Additionally, it called on the Financial Reporting Council to conduct an investigation into the preparation of Carillion’s accounts past and present, as well as the company’s auditors.
The FRC stated: “We have been actively monitoring this situation for some time in close consultation with other relevant regulatory bodies. We have powers to investigate the circumstances relating to the audit of Carillion as well as the actions of the relevant accounting professionals.”
Manifest identified audit and remuneration governance problems
Manifest’s pre-AGM analysis for May 2017 noted that although KPMG had been the company’s auditor since 1999 there was no disclosure of any audit tendering plans. The UK Statutory Auditors and Third Country Auditors Regulations 2016, which implemented the EU’s audit directive and the audit tendering requirements of the UK Competition and Markets Authority meant that its audit committee knew it needed to put the contract out to tender.
As well as concerns about audit, the spotlight has also turned to Carillion’s remuneration arrangements. Manifest’s say on pay analysis identified very weak clawback provisions; specifically, Manifest had identified that there were no claw-back provisions applied to share-based awards; the provisions only applied to the cash portion of the bonus awards.
Other issues highlighted were a significant overlap of performance measures for bonus and LTIP and historic payout levels suggested that stretching incentive plan targets had not been set. Additionally, the then chief executive, Richard Howson had received a significant salary increase and his pension benefits were seen as particularly generous.
Confused voting signals?
Voting on Carillion’s remuneration policy is interesting. For some years there had been a strong vote against the backward looking, non-binding pay implementation report. At last year’s AGM, overall dissent was 20.78%, down from 54.1% in May 2016. However, the forward looking binding vote on the remuneration policy passed with 98.73% approval, up from 88.9% in 2014. Had the policy vote not passed, the amended clawback provisions could not have been implemented.
Additionally, the company had a 20.64% vote against a resolution to grant a general authority to issue shares without pre-emption rights of up to 5% and a 23.32% vote against its resolution to grant an additional general authority to issue shares without pre-emption rights of up to 5%. However, this was in-line with the Pre-Emption Group guidelines, which recommend a 5% general authority and a 5% additional authority to be only used in connection with an acquisition, or specified capital investment.
Looking more generally at Carillion’s governance Manifest’s analysis also identified poor progress at achieving board gender diversity and a lack of a gender diversity target.
Roger Barker, head of corporate governance at the Institute of Directors, said: “We are still in the early stages of finding out what went wrong at Carillion. However, it is clear that major providers of public services must be governed in a prudent manner. Today’s outcome suggests that effective governance was lacking at Carillion, and we must now consider if the board and shareholders have exercised appropriate oversight prior to the collapse.
“There are some worrying signs. The relaxation of clawback conditions for executive bonuses in 2016 appears in retrospect to be highly inappropriate. It does no good to the reputation of UK business when top managers appear to benefit in spite of the collapse of the organisations that they are responsible for.”
Action by government and regulators
The Financial Conduct Authority had previously notified Carillion that it was beginning an investigation into the timeliness and content of announcements made by Carillion between 7th December 2016 and 10th July 2017. In July, following a profit warning, Howson resigned. Keith Cochrane, previously its senior independent non-executive director had taken over and a new chief executive, Andrew Davies, had been due to start later this month.
Carillion’s importance as a construction firm for public projects as well as a provider of basic public service and its use of local sub-contractors meant the government held talks with leading business and construction trade bodies, representing those firms as well as trade union representatives.
The business secretary, Greg Clark, said: “It is important we quickly get the full picture of the events which caused Carillion to enter liquidation, which is why I have asked the Insolvency Service to fast-track and broaden the scope of the Official Receiver’s investigation.
In particular, I have asked that the investigation looks not only at the conduct of the directors at the point of its insolvency, but also of any individuals who were previously directors. Any evidence of misconduct will be taken very seriously.”
As well as the concern about construction projects, public services, employees and sub-contractors there are 27,000 members of the company’s defined benefit schemes which were already in deficit. These members are likely to be transferred to the Pension Protection Fund (PPF). PricewaterhouseCoopers (PwC), which was appointed to assist the Official Receiver in the liquidation said the situation was complicated by the number of schemes. It reported that a team of PwC specialists together with the trustees, the PPF and the Department of Work and Pensions had been formed.
Expert believes there is a case for workers on company boards
Prem Sikka, Professor of Accounting at the University of Sheffield and Emeritus Professor of Accounting at the University of Essex, wrote that Carillion’s collapse may have been prevented if it had had workers on the board who may have highlighted concerns about the company’s practices. He said the independent directors that were on its “audit, ethics, social responsibility and other committees did little to check the company’s reckless expansion, low equity base, excessive leverage; raise questions about dubious assets, or the pension scheme deficit.“
He added that workers on the board may have prevented the company paying out dividends to shareholders while the pension funds were in deficit.
Sikka also wrote: “Carillion’s auditors KPMG have some serious questions to answer. For the financial years 2016, the firm collected £1.4m for auditing and another £0.2m for tax advice. The accounts do not disclose why the tax bill is so low. The pre-tax profits for 2015 and 2016 were £155.1m and £146.7m respectively. Carillion paid corporation tax of only £7.5m and £4.2m respectively. What exactly was the role of KPMG in constructing tax transactions?
“It is hard to recall cases when auditors raised red flags about a company’s practices. Carillion’s accounts for the year to 31 December 2016 received a clean bill of health from KPMG on 1 March 2017. To reach its conclusion KPMG should have examined Carillion’s cash flow forecasts, correspondence with major lenders, the state of major contracts and ability to raise additional resources. Yet barely four months later on 10 July 2017, the company issued a profit warning. Its chief executive was sacked.”
Following meetings earlier in the week with business and trade union representatives the government established a task force which met for the first time on Thursday (18th January). The government said the task force was set up to monitor and advise on mitigating the impacts of Carillion’s liquidation on construction firms, particularly SMEs and those working in the sector. The government added that the task force would act as a means to work together to ensure the impact of the Carillion insolvency on the firm’s employees in the private, as well as public, sector was minimised and to help them recover.
The TUC’s general secretary Frances O’Grady welcomed the group’s establishment following her earlier calls for a task force to be set up. Attendees at the meeting included representatives from leading business bodies, the construction trade sector, unions, banks and government. Among the issues the TUC said it would use the meeting to press for were the transfer of private sector contracts to alternative providers with jobs, pay and pensions protected; protection for agency and zero-hours workers on Carillion contracts to ensure they can recover unpaid wages and an urgent risk assessment on other large outsourcing firms to avoid another crisis, and a moratorium on future outsourcing.
To find out more about Manifest’s Say on Pay rating framework please contact email@example.comLast Updated: 18 January 2018