Carillion: a one-off or a symptom of a wider malaise?

Last week’s House of Commons report on Carillion is damning. Frances has an excellent summary of it here but the key points are these.

In the words of the report, the company was borrowing without investing. Its debt increased but the value of its assets remained the same and, as its revenue declined, Carillion found it ever more difficult to service the debt.

Carillion was also ‘aggressively accounting’, which is a way of making a corporate conjuring trick sound macho:

‘Aggressive accounting’ is the practice of declaring revenue and profits based on optimistic forecasts, before the money has actually been made. All is well if the forecasts are correct. But if costs rise and revenues fall (say, because of delays and defects), expected profits turn into actual losses.

If you then pay dividends on those expected profits but the profits don’t come in, you run up even more debt.

In the eight years from 2009 to 2016, Carillion paid out £554 million in dividends, almost as much as the cash it made from operations. In the five years from 2012 to 2016, Carillion paid out £217 million more in dividends than it generated in cash from its operations.

Over the eight years from December 2009 to January 2018, the total owed by Carillion in loans increased from £242 million to an estimated £1.3 billion – more than five times the value at the beginning of the decade.

When times were good, Carillion was paying as much in dividends as it could, when things went bad, it carried on paying dividends with money it didn’t have.

And when you’re in that sort of fix, all it takes is for two or three projects to fail and you’ve had it. Which is what happened in 2017. Its debt nearly doubled in 2 years and, by the time it collapsed, it held just £29 million in cash.

As it turns out, quite a lot of people saw this coming, or at least had enough of an inkling that something was wrong to start betting against the company. In April 2017, the FT reported that Carillion had been the most shorted UK stock for 18 months. As Frances says, the rot set in some time ago:

The researchers seem to have gone back through the reports & accounts to about 2009. And they conclude that Carillion was a basket case not just in the last year of its life, but from about 2011 onwards. I’ve now done the same exercise, and I agree with them. Carillion’s cupboards were virtually bare, and the little that was in them stank.

Yet, while all this was going on, Carillion was winning accolades for building public trustethical business practices and corporate governance. Its chairman was advising David Cameron on corporate social responsibility. As the FT’s Kate Burgess said, the Carillion board ticked all the good governance boxes:

On paper, the directors looked well qualified to steer the outsourcer. As chairman, Philip Green was a former chairman of United Utilities, the UK’s largest listed water company. Not only had he run a large contracting company, he was also a fully paid-up member of the great and good as a former adviser to then prime minister David Cameron on corporate responsibility.

The directors did not lack experience, sitting on boards from Royal Dutch Shell to Premier Farnell.

Alison Horner, head of the remuneration committee, was formerly operations director at Tesco and a non-executive director of Tesco Bank. The head of the audit committee was an accountant, as were three other directors.

In 2016, the directors approved a change to the conditions under which executive bonuses could be clawed back. As the Institute of Directors remarked, this is not a good look. The FT’s city editor Jonathan Ford managed to work the term ‘looting’ into his article while stopping short of any accusations that might get the paper sued:

Carillion’s board may not have looted, but it does seem to have practised what one might call “reckless abstraction”. It sucked out cash to placate stock market investors even as executives wrote the mountain of under-priced contracts that ultimately buried the business, triggering a £1.2bn writedown in the second half of last year.

In the five years to 2016, the directors recommended paying £357m of dividends to shareholders, despite generating just £159m of cash from operations. Over the same period, the bonuses for the two top executives climbed from nothing to more than £1m a year in 2016.

Inevitably, people are asking questions about corporate governance. It is 25 years since the Cadbury Review, set up after the collapse of BCCI and Polly Peck, led to the creation of the UK’s corporate governance framework. Since then, there have been numerous reports and the code has been amended every few years. Yet, every so often, someone trousers a large amount of money from a massively indebted company, leaving shareholders, employees, pensioners and creditors to take the hit. After a quarter of a century’s corporate governance reform, the scandalous company failures are still happening. Would the recent proposed reforms to the corporate governance code have saved Carillion? It’s difficult to say, writes corporate lawyer Sophie Brookes:

[W]hether 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.

As ever, the system is only as good as the people operating it.

Perhaps it is unfair to expect the corporate governance framework to prevent the occasional corporate collapse. It could be that it is like the drains; most of the time it works well and we only notice when it fails somewhere and a foul stink erupts. It may be that most non-exec directors and active shareholders are doing a good job holding their executives to account and we would be worse off without them.

Or could it be that there are a lot more firms like Carillion which are only getting away with similar practices because no-one has twigged yet. As Kate Burgess says:

It is worrying to think the construction company’s board was such a model of good governance. If the line up had been different, would another cast of characters have done any better?

And how many other supposedly well-run boards are presiding over impending corporate disasters elsewhere?

Meanwhile, the astonishing revelations about Carillion continue.

There will, no doubt, be more of this to come over the next few weeks and months.

A peculiarly badly managed one-off, sunk by a perfect storm of unfortunate circumstances? Or a symptom of something deeply wrong with the way UK companies are governed?  Whatever happens, Carillion will probably provide the impetus for further corporate governance reform. Whether that will stop something similar happening in future is anyone’s guess.


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23 Responses to Carillion: a one-off or a symptom of a wider malaise?

  1. Jim says:

    Clue: there maybe a link between all the corporate ethics and diversity b*llocks, and not actually doing the job they were supposed to for a profit.

    If you’re relying on some stupid PC paper trail of box ticking to get you contracts, it probably means you’re sh*t at doing the actual job, because if you were any good, you’d be selling yourself that way instead.

    Give me a contractor who is completely up front about wanting to making as much profit as possible, and couldn’t give a stuff about diversity and corporate ethics, because I bet they’d do a better job that the likes of Carillion.

    • Woodsman says:

      No. The facts don’t fit your bigotry. Read the article. The problem with Carillion was lack of reinvestment, dodgy accounting and a failure to acknowledge the straits they were in order to maintain ‘shareholder value’. Same with many large British companies, ethical or not. There are many European and British companies who are both ethical and diverse doing very well.

    • gunnerbear says:

      Want to stop it….tell the CEO he’ll be kneecapped if the company collapses and he’s taken a penny in bonuses…. …tell the Remco members they’ll do 20 years if executive bonuses are paid or exec’ pay goes up and the company fails within 36 months.

      Nothing personal…s’just business….

  2. John says:

    We have seen the same old pattern repeated over and over again.
    Starting with Jim Slater (see in the 1970s, asset-stripping has become the modus operandi of British capitalism.
    The same pattern of under-investment and excessive dividend and bonus payments to directors and shareholders has been repeated again and again and again.
    Maxwell asset-stripped the Mirror Group, leaving thousands of pensioners robbed.
    Philip Green – more recently – presided over a similar operation on BHS.
    Now another Philip Green has done the same with Carillion.
    All of which leaves just one simple question, “Why are these individuals able to get away with it?”
    Another question, “Why – after 40 years – does the law still allow this?”

    • Blissex says:

      «Starting with Jim Slater (see in the 1970s, asset-stripping»

      Let’s call asset stripping “reckless abstraction” as the FT so elegantly does :-).

      « has become the modus operandi of British capitalism.»

      This seems too optimistic to me:

      * That is not just “the modus operandi of British capitalism” in the last 40 years, but in the last century. The decline in british industry was already evident in the 1920s-1930s, and a lot of it was due to the unwillingness of owners and management to scrap and replace plant and processes that were often still those of the 19th and even 18th century. We still have a lot of that stuff around in museum, because it continued to be used for a long time. The owners and management simply did not believe in wasting many on replacing old worn out assets when it could be used to fund generous dividends and management incomes.

      * That is not just “the modus operandi of British capitalism”, but also of public policy, most obviously in the property markets, where government policy is to double south-east house prices every 10-12 years and London ones every 7-8 years, and to help the lucky winners recklessly abstract the book capital gains with re-mortgaging. Consider recent news that property valuations increased by 500 billions in a year and the effect off thatcherism on private debt levels:

      What are the incentives for the executives and owners who control private industry or the politicians and vested interests who drive public policy to give up “reckless abstraction” given that it has delivered to them much better living standards?

  3. The “great and the good” are obviously seriously overstretched. Either non-Execs need to be doing the job, or making room for those of the rest of us who might have had slightly less stellar careers, but can read accounts, question project reports and have the time/integrity to do both diligently.

  4. Dipper says:

    Pensions are a massive problem not entirely of the owners’ making. The government’s policy of QE has crushed returns sending private sector pension funds into many billions of debt. To make business owners pay for the consequences of government policy is a massive tax and creates an incentive to ditch businesses. Furthermore, would all those calling for business owners to fund pension fund shortfalls be happy for business owners to pocket any surpluses that should arise if governments withdraw QE and rates rocket upwards?

    One of the advantages of the private sector for the country is that shortcomings are highly visible and people who have mismanaged or worse can be held to account. This is often not the case in the public sector. Does anyone out there know how much the public sector pension deficit has effectively gone up by since QE started? Very unlikely since the government just pays it out of revenue. so a massive liability that falls on current and future generations is completely hidden from view because it is in the public sector not the private sector.

    • I can’t agree with this. Companies, shareholders and directors did very well out of QE. It pushed up stock and bond markets to dizzy heights, massively reducing the cost of corporate borrowing and enabling companies to buy back shares cheaply, thus vastly increasing returns to shareholders. QE has been the largest handout to business owners in history. Requiring them pay some of that largesse back in the form of higher contributions to pension funds is in no way a “tax”.

      • Dipper says:

        Far be it for a humble troll like me to argue with an esteemed economist such as yourself but surely this is wrong? The benefits you mention are available to all companies so will get competed out across the sector, whereas the deficits incurred by making promises to former workers that are increasingly hard to keep are confined to just that company and not its competitors? Ultimately a single-company pension deficit can only be funded by over-charging customers or under-paying workers, neither of which can be sustained in a competitive environment, and this is why we keep seeing takeovers or bail-outs where the pension fund is removed from the deal.

        And the pension deficit you failed to mention is the government, where the lack of accounting that is endemic to the public sector means this number just balloons without record or comment. Perhaps if the cost of public sector pensions was widely publicised then we might see some of those demanding more funding for the NHS suggesting that public sector pensions take the same kind of haircuts many in the private sector have had to take in order to save the NHS. Not that I , for a minute, would suggest such a thing.

  5. Keith says:

    looting by bosses like allowing slum landlords to return by the sale of council houses is a corrupt exercise in legalised robbery. Racist and cranks like jim and dipper have far too much power in society despite talking out of their bums on every website they visit. it is the fact we have created and empowered people like jim and dipper that is the problem. The extreme nut jobs need to be rooted out and a social democratic regime restored which puts people before profit.

  6. Neil says:

    So the lesson is…….don’t let anyone called Phil Green become a director

  7. GrumpyLecturer says:

    The language that surrounds Capitalist business enterprises, business decisions and employers relationships with employees (workers or otherwise) has changed radically since the mid-1980s so much so that the world of work is perceived in most management literature as a 1960s Haight-Ashbury love-in. Unfortunately, capitalism itself has not changed in fact it can be argued that through the rise of managerialism, aided and abetted by the rise in Human Resource Management as the underpinning legitimatory process, capital has become even more exploitative, greedy and less caring.

  8. Excellent thought-provoking article (a pity that some comments seem more about pre-conceived ideological mindsets rather than about the public good issues to hand). I’ve been prompted to wonder whether the social enterprise and (in Scotland anyway) the housing association fields could offer up better quality and competent, but also public-good-driven, NEDs? In Scotland at least, the Housing Association Registered Social Landlords (RSLs) have a track record second to none on governance and accountability – alongside appropriate adherence to commercial and financial exigencies to ensure financial sustainability. That’s due in no small part to the role of the Scottish Housing regulator – in stark contrast, some might argue, to experiences with the financial services UK regulator and England’s charity sector regulator (see the Scottish Housing Regulator’s website for supportive evidence of those assertions).

  9. Dipper says:

    aren’t you getting this the wrong way round? Just as a householder who always hires the tradesman with the lowest quote is always going to end up with shoddy work, a government who always takes the lowest bidder for its contracts is going to end up with poor contract management. As Capita joins the list surely we can see it is not that companies are charging a fair price and then using dodgy accounting to syphon of the apparently non-existent profits, it is that the government pitches contracts at a rate that can only be afforded in the short term by accounting tricks and in the long term cannot be profitably carried out at all?

  10. Roger Vickers says:

    It seems to me that in its meteoric expansion Carillion became little more than a project management company relying on subcontractors and with few tangible assets, it’s worth being the result of little more than creative financial accounting.
    As for the governance, well what can be expected. There are good people in big business but there are also a huge number who are in it for nothing more than their own enrichment regardless of the impact on others. They appear to become so wrapped up in the group think objective of self service that little issues such as morality ,decency and perhaps even honesty are allowed to get in the way of it. The thought of long term and I mean really long term, generational longevity and sustainability are not even considerations. Feast today and look out for yourself appears to be the mentality.
    In this environment I can imagine that anyone who pipes up at Board level has shorter career prospects and perhaps a lonely existence before moving on out.
    What is going to be even more intriguing is going to be the report of the investigation into the auditors, not widely flagged. Is there a major issue hiding here? Auditors are supposed to call foul on bad practices and there must be some massive reputations on the line. I wonder who will audit the investigators and their investigation to ensure the truth is revealed.

    • John says:

      With regard to auditors – the mega-accountancy global corporations – it should be remembered that the same firms were responsible for credit-rating all the sub-prime mortgage derivative products that caused the worst post-war financial crash in the USA and then the world.
      What price have any of those firms or their senior managers ever paid for doing so?

      • Dipper says:

        I must have missed all those auditors reports on the UK government pension position, the creditworthiness of the NHS.

        Yes by all means have a pop at regulators and auditors, and as someone who worked in banking yes please do raise the issue of the accountants reports on banks prior to the GFC. But please remember that there is considerable legislation and process that allows you to ask those questions of private organisations, and bringing outsourced work into government means you will no longer be able to ask those questions as the information will be completely invisible.

        • gunnerbear says:

          But ministers will be directly accountable if work is brought back in house and we’ll be able to see just how cheap or otherwise the public sector is.

    • Blissex says:

      «Carillion became little more than a project management company relying on subcontractors and with few tangible assets»

      In practice a nominee for the government, to enable the legal spivvery that shifts those debts from the Public Sector Borrowing Requirement to the private sector, if only nominally.

      «the report of the investigation into the auditors, not widely flagged. Is there a major issue hiding here? Auditors are supposed to call foul on bad practices»

      Not quite: they are supposed to call out entirely indefensible *accounting processes*, not to certify that business practices are likely to be sound and profitable. The latter is the job of shareholders, who are always at liberty to hire business analysts to help do that.

  11. BenHR says:

    Difficult to know if it is a one-off or a warning really.

  12. Good article. Saves me the bother of writing the same thing. Also, see their balance sheet, it’s one third intangibles and goodwill i.e. profits they booked early.

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