Parliamentary report on Carillion is powerful – but now investors need to see action because we have been here before

“The report prepared by the Parliamentary Business and Work and Pensions Committees on Carillion offers a clear analysis of what caused the company to collapse and offers a potent-looking list of potential responses, including a break-up of the big auditing firms, an overhaul of the UK’s corporate governance regime and how management teams are paid and reform of key regulators,” says AJ Bell Investment Director Russ Mould.

“The problem is that we have been here before. The debate over how companies are run and for whose benefit still rages on, with investors seemingly no better protected now than in the early 1990s, given that a FTSE 250 firm has just been able to go broke in plain sight.

“The current Corporate Governance code dates back to Sir Adrian Cadbury’s 1992 report Financial Aspects of Corporate Governance, which looked into issues such as the composition of management boards and accounting systems.

“The irony is that Sir Adrian’s work was commissioned by the Financial Reporting Council (FRC) in the wake of the collapse of the Bank of Credit and Commerce International (BCCI), Maxwell Communications and Polly peck to improve governance and try to prevent similar scandals – the same FRC which is now under attack from the Parliamentary Committees for its ‘timid’ and ‘wholly ineffective’ supervision of Carillion and its auditors.

“Since then, numerous reports and reviews have covered many of the topics raised by Rachel Reeve, MP, and her colleagues on the Business and Work and Pensions Committees:

  • Since the Cadbury Report, corporate governance has been addressed by the 1998 Hampel Report, the 2006 Companies Act (which laid down the seven key duties of directors), numerous iterations of the UK Corporate Governance Code (which established down five key principles) and 2010’s Stewardship Code (which outlined a further seven principles for good management and behaviour).
  • The vexed issue of directors’ pay and bonuses has already been addressed by the 1995 Greenbury Report and the 2011 Hutton Report
  • The role of auditors was assessed by the Smith Report of 2003 (while the Enron fiasco in America led to the break-up of what were then the ‘Big Five’ accounting firms, Arthur Andersen in 2002)
  • The role of non-executive directors was directly addressed by 2003’s Higgs Report
  • Short-termism among managers and investors alike was a core topic of the 2012 Kay Review, which was commissioned by David Cameron’s Government and then kicked into the long grass as soon as it was published

See Appendix I below for full history of UK Corporate Governance developments.

“The report on Carillion does point fingers in all of the right areas but MPs, managers, investors and regulators are still trying to find the right route to ensuring corporate behaviour meets the appropriate standards to protect investors, employees, pension holders and suppliers and customers of British firms.

“The key questions in light of the Parliamentary report are now therefore:

1. What actions will be taken in light of the report’s findings? The good news is that the head of the Competition and Markets Authority Andrew Tyrie is already preparing to investigate the auditing oligopoly which exists among the ‘Big Four,’ while Sir John Kingman is to oversee a Government review of the auditors’ regulator, the Financial Reporting Council.

2. If actions are taken, will they make any difference?

“It is to be hoped that the answer is ‘yes’ on both counts.

“After all, Carillion failed when, in theory, the economy was fine, markets were functioning well and credit was cheap. This begs the question of what could happen if the economy turns down, markets take a turn for the worst and interest rates and corporate borrowing costs start to rise? As legendary American investor Warren Buffett once put it: ‘Only when the tide goes out do you discover who’s been swimming naked.’

Appendix I: History of UK Corporate Governance developments

1992

Cadbury Report: Financial Aspects of Corporate Governance

Looks at board composition, accounting systems. Corporate Governance code is issued

1995

Greenbury Report

Looks at director remuneration

1998

Hampel Report

Harmonises Cadbury and Greenbury, concludes no changes needed to the Combined Code

1999

Turnbull Report: Internal Control: Guidance for Directors

Focuses on directors' obligations with regard to risk controls under the Combined Code

2000

Financial Services and Markets Act (FSMA)

 

2001

Myners Report

On the role of institutional investors

2003

Higgs Review: Role and Effectiveness on Non-Executive Directors

Looks at the role of non-executive directors

2003

Smith Report

Looks at the role and performance of auditors

2003

Updated version of the Combined Code on Corporate Governance

 

2006

Companies Act

Lays down seven key directorial duties

2007

Aim Rule Book and Rule 26 from London Stock Exchange

Requires improved disclosure from AIM-quoted firms

2009

Walker Report

Focuses on the role of institutional investors and their response to the financial crisis

2009

UK Corporate Governance Code - by the FRC

Lays down five key principles

2010

Stewardship Code - by the FRC

Lays down seven key principles

2011

Hutton Review

Looks at director remuneration

2011

Vickers Commission

Reports on banking and the ring-fencing of assets

2012

Companies Act

Revised and updated

2012

Kay Review

Study of equity markets calls for a greater focus on the long-term and a greater focus on stewardship from managers and institutional investors alike

2013

An Accident Waiting to Happen

Andrew Tyrie and Parliamentary Commission on Banking publish daming indictment of HBOS

2013

Salz Review

Delivers verdict on business practices at Barclays

2014

FRC Review of Corporate Governance Code

Revised code adds guidance on risk management, internal controls and going concern basis of accounting

2015

FRC consultation on auditing and ethical standards

 

2017

FRC launches review of Corporate Governance Code (due 1 Jan 2019)

 

2018

London Stock Exchange requires AIM firms to apply a recognised code

Comes into force 1 September 2018 - QCA Corporate Governance Code OR UK Corporate Governance Code

2018

Kingman Review - to come

Sir John Kingman to review FRC


Appendix II: Directors’ duties as outlined by the 2006 Companies Act

1

To act within their powers

2

To promote the success of the company

3

To exercise independent judgement

4

To exercise reasonable care, skill and diligence

5

To avoid conflicts of interest

6

To not accept benefits from third parties

7

To declare an interest in a proposed transaction with the company

Source: www.legislation.gov.uk/ukpga/2006/46/contents

Appendix III: Key principles outlined by the UK Corporate Governance Code

A

Leadership

The board should take collective responsibility, feature a strong chairman and have good non-executives

B

Effectiveness

The  board should offer a broad range of skills, receive information in a timely manner and be appointed and re-appointed in a transparent way

C

Accountability

The board should maintain risk management and control systems, have transparent internal reporting and offer a balanced view of the firm's prospects

D

Remuneration

Pay should attract quality board members but not be excessive

E

Relations with shareholders

There should be satisfactory dialogue with shareholders, who should be encouraged to attend the AGM

Source: www.frc.org.uk

Appendix IV: Key principles outlined by the UK Stewardship Code

1

Publicly disclose their policy on how they will discharge the stewardship responsibilities

2

Have a robust policy on the disclosure of conflicts of interest

3

Closely monitor investee companies

4

Establish clear guidelines on when and how they will escalate their stewardship activities

5

Be willing to act collectively with other investors where appropriate

6

Have a clear policy on voting and the disclosure of voting activity

7

Report periodically on their stewardship and voting activities

Source: www.frc.org.uk

These articles are for information purposes only and are not a personal recommendation or advice.