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

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

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

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

Source: www.frc.org.uk

Appendix IV: Key principles outlined by the UK Stewardship Code

Source: www.frc.org.uk

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