January 19, 2018

Carillion’s collapse – a corporate governance failure?

Financial investigation

Let's recap: what happened to Carillion?

Having suffered staggering losses on contracts and under the weight of debts of around £1.5bn, including a £590m pension deficit, its market capitalisation fell from £2bn in 2016 to just £61m last Friday. As attention turns to the cause of the spectacular demise of the industry giant, stakeholders and the wider public are questioning the decisions taken by the directors in the months preceding the collapse including how they justified directors' remuneration packages and paying ever growing shareholders dividends, which reached over £80m in 2016.

It is now remarkable to read former chairman Philip Green’s statement of 1 March 2017 (available here) which references the Board's "focus on overseeing and developing the Group's strong governance and management framework" and reports that "the Group continues to have substantial liquidity with some £1.5bn of available funding".

Just over three months later Carillion was issuing profit warnings and writing down contract values by £845m. Second and third profit warnings followed in September and November respectively. At one point during the summer of 2017, 25% of Carillion's shares were shorted, the greatest proportion of any company on the London stock exchange. It seems remarkable that the directors appeared to have such little inkling of what was round the corner and yet the hedge funds had a considered (and as it turned out) realistic view of Carillion's prospects.

IoD raises issues

The Institute of Directors (IoD) has accused directors of failing to provide "appropriate oversight", with Roger Barker, head of corporate governance at the IoD commenting: "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."

The reference to clawback conditions relate to a change in pay policy at Carillion that took place in 2016. The changes restricted the circumstances in which the company could demand the repayment of executive bonuses. Previously, deferred bonuses could be recouped in certain insolvency scenarios. Following the changes, the clawback provisions only apply in the event of gross misconduct or if financial results have been misstated. With it being reported that the directors took home bonuses of £4m last year, it is hard to see how this decision can be reconciled with the directors' corporate governance responsibilities given the events of the past 6 months.

Further, on 3 January the Financial Conduct Authority announced an investigation into the "timeliness and content" of market updates by Carillion during the period prior to the first profit warning.

Are the directors to blame?

As directors, the individuals involved were subject to a broad range of duties and obligations towards Carillion and its stakeholders. Given the position that Carillion and its stakeholders are now in, there are serious questions to be answered, particularly in light of some of the circumstances detailed above. The financial decisions taken by the directors in relation to executive remuneration, dividend payments and the broader corporate strategy look at best ill-judged and not in accordance with good practice and at worst in breach of statutory obligations. Whatever the rationale, it now seems clear that the directors stunningly misjudged the company’s predicament and prospects on multiple occasions. We wait to see the outcome of the Official Receiver's investigation into the directors' conduct with interest.

As a wider point, boards of directors of all companies should be aware of their duties and responsibilities. The consequences of a breach range from disqualification from acting as a director to criminal fines.

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