Carillion, the second largest building contractor in the UK and the lead on a number of key public service contracts, entered into liquidation last week. Various commentators have highlighted poor governance at the company but would the revised UK Corporate Governance Code recently announced by the Financial Reporting Council (FRC) have prevented its collapse?
What caused the collapse?
There are differing views as to what caused Carillion’s problems but many have pointed at internal failings and a poor governance culture. Roger Barker, Head of Corporate Governance at the Institute of Directors said “it is clear that major providers of public services must be governed in a prudent manner”. He suggested that the collapse highlights a lack of effective governance at Carillion and questioned whether the board and shareholders acted appropriately before the collapse.
The Government has acknowledged these worrying signs and has ordered an investigation into the conduct of Carillion’s directors. Executives at the company are said to have tweaked rules in the firm’s bonus scheme to make it harder for those bonuses to be clawed back if the company failed. This sounds like the executives were trying to preserve their own position at the expense of shareholders’ interests. The bonuses have been branded ‘exorbitant’ in the House of Commons.
Further concerns related to the excessive pay of former chief executive Richard Howson who received £1.5 million in 2016. Carillion also agreed to continue paying his remuneration until October this year, handing him a £600,000 salary.
Many believe that the directors of Carillion did not follow responsible internal processes. Recognising the crippling debt, and other significant problems the company was facing, they should have acted in the best interests of the company and looked to minimise the risk of collapse, which eventually became unavoidable.
The revised corporate governance code
Poor corporate governance, particularly excessive executive pay, has been a hot topic for reform in the last 12 months. Back in September 2017, we wrote about the proposed changes to the existing corporate governance code which applies to all premium listed companies, including Carillion. Since then, the FRC has opened a consultation on those proposed revisions after undertaking a ‘comprehensive review’ of the code.
In the consultation document, the FRC highlights the heightened public scrutiny faced by the country’s largest companies and the impact poor internal governance can have on a wide range of stakeholders. So could the proposed changes help to prevent another Carillion failure?
The revised, ‘shorter and sharper’ code aims to encourage high standards by being clearer and more concise. It focuses on the application of principles relating to stakeholders, integrity, corporate culture and diversity.
A significant change, introduced in an attempt to tackle excessive levels of executive pay, relates to shareholder dissent and the percentage of votes against a resolution. So when more than 20% of shareholders vote against a resolution, the company should: explain the actions it intends to take following the vote; publish an update on the position within six months of the vote; and provide a final summary in the company’s annual report setting out the steps taken as a result of the vote.
To increase transparency, the Investment Association has introduced a public register that lists companies which have experienced high levels of shareholder dissent. The first published list shows that, at their last AGMs, 24 FTSE All-Share companies received significant shareholder votes against their remuneration policies and 43 had 20% or more votes against their remuneration report.
The new code should give shareholders more say in how company executives are remunerated. The excessive pay levels at Carillion may have been tackled earlier had the directors had a greater responsibility to address shareholder concerns.
The new code will require boards to establish a mechanism by which they can engage with the company’s workforce and gather its views. The collapse of Carillion will have serious repercussions for its 20,000 employees whose jobs are now in limbo. Perhaps if the board had engaged more directly with those employees and been required to listen to their concerns, steps could have been taken to safeguard their position.
Section 172 duty and stakeholder engagement
The Government intends to introduce legislation which would oblige companies to explain how they have complied with the requirements under section 172 Companies Act 2006 to take account of stakeholder interests when making decisions. This is needed to increase transparency and ensure the internal processes adopted by a company promote its success and are for the benefit of its members as a whole, whilst also taking account of wider stakeholder interests.
Carillion’s supply chain is thought to include up to 30,000 small businesses who had already suffered persistent late payments before the firm’s final collapse. The changes to the section 172 duty are intended to highlight that it’s not just the shareholders who are affected by the decisions of a company’s board of directors.
The future of governance
Whilst a range of factors contributed to Carillion’s collapse it is right that poor governance practices are being highlighted as a key contributor. But whether the new corporate governance code would have prevented the collapse is unclear. Ultimately, the new requirements will only bite if shareholders and investors are prepared to step in and hold boards to account.
The new code should help to increase transparency in a number of key areas, helping stakeholders to understand what is going on behind closed doors. Preventative action could then be taken to stabilise any struggling company before it reaches the point of no return as Carillion did earlier this month.