Improvements in

Corporate Governance

1. Board Accountability

 The UK CG code needs to be

more rigid & tough, to force
company directors to
demonstrate greater
transparency over how they
are acting in the interests of all stakeholders.

 It is also far too difficult to take action against the minority of board members who
fail in their duties. While the FRC can only strike off accountants, this misses the
vast majority of directors who hail from different backgrounds. Without the real
threat of disqualification, there is little deterrent against irresponsible behavior.

 Stakeholders must also be given better visibility on how a board is functioning.

Today, most FTSE 350 companies undergo a board effectiveness review. But these
evaluations lack consistency and transparency. In fact, a number do not involve
observing boards in action and simply require directors to fill in a questionnaire (a
mere formality). Such an approach often yields a congratulatory conclusion. For
example, in its 2016 annual report, Carillion noted the evaluation had “confirmed
that the board, each of its committees and the directors continue to be highly
effective”.

 The chronic lack of accountability and professionalism now evident in Carillion’s

governance were failures years in the making. The board was either negligently
ignorant of the rotten culture at Carillion or complicit in it

KEY TAKEAWAY for C.G

 Directors owe a fiduciary duty to the company and that directors can be held personally
liable for breach of such duty by failing to act in the interests of the company.
 Good governance requires directors to extend their focus beyond mere profits, since,
after all, the creation of shareholder value hardly arises when a company collapses.
 There should be total transparency and proper accountability of the board, esp when the
company is dealing with public / tax payer’s money. Govt needs to wise up and make
these matters transparent and hold the board and respective govt members (if any)
responsible and punish them seriously.
2. Role of Auditors
Audit function of the Carillion was outsourced in following ways,
 External Auditor was KPMG.
 Internal Audit outsourced to Deloitte LLP.

EXTERNAL AUDIT
No auditor rotation makes the role of DIRECTORS & KPMG a “DUBIOUS” one
In the case of KPMG, continued retention was approved notwithstanding that KPMG had been
Carillion’s outside auditor since the spin-off in 1999, and that there was outstanding guidance
from relevant regulatory authorities suggesting the need for regular re-bidding of the function
and for auditor rotation.
NOW the questions are,
(i) Was the continued retention of KPMG appropriate ?
(ii) How close was KPMG to Carillion ?
(iii) What factors were applied in deciding whether to retain KPMG and not to have a full-
scale bid process or mandatory rotation?

"KPMG audited Carillion for 19 years, pocketing £29 million in the process. Not once during that
time did they qualify their audit opinion on the financial statements, instead signing off the figures
put in front of them by the company’s directors… In failing to exercise—and voice—professional
scepticism towards Carillion’s aggressive accounting judgements, KPMG was complicit in them.
It should take its own share of responsibility for the consequences."

INTERNAL AUDIT

Carillion outsourced its internal audit function to Deloitte in 2009 and has paid £12m in total fees
since then. The audit committee was ‘satisfied’ with internal audit effectiveness in 2016. Did
Carillion receive value for money? This depends on the remit, but it seems unlikely if the internal
auditors were preoccupied with traditional risk and controls testing.

KEY TAKEAWAY for C.G

 Internal audit should include modelling and managing capital and liquidity risk. This
might have been very valuable to Carillion.
3. Executive Compensation / Pay / Remuneration
Carillion’s two executive directors received over £2.5m in remuneration between them in
2016, including bonuses totalling £385,000. These payments are substantial but are in
accordance with the directors’ remuneration policy, agreed by shareholders.

SO WHAT’S FISHY HERE THEN ?

 Well, the change of the malus and clawback conditions, which the Institute of
Directors suggested were ‘relaxed’ in 2016, preventing clawback from taking
place in the event of ‘corporate failure’ – that’s what is fishy and ill-intentional.

KEY TAKEAWAY for C.G = CLAWBACKS are INDISPENSABLE

 In order to align the interests of company executives with those of long-term investors,
long-term incentives should be paid in shares, with a minimum two-year holding period
post-exit and subject to clawback provisions in the event of wrongdoing.
 Companies should specify that awards may be clawed back if the company goes into
compulsory liquidation.
 Foresight is required to establish adequate corporate safeguards in anticipation of a
downturn or collapse. “Pay for performance, rather than pay for failure, should be the
guiding principle”
 Remuneration committees would also do well to consider adopting provisions for the
buyback of shares. Share repurchases, in effect, inflate earnings per share, at least
ostensibly.

4. Board’s failure to deliver

The speed of Carillion’s collapse is notable. The alarming points were,

No Contingency plan which was shocking

 The board was not prepared for its January 2018 debt rescheduling package being
rejected by its bankers. Whether through arrogance (thinking that Carillion was too big to
fail) or over-optimism.
 lack of urgency and follow-through in the board’s decision-making.

 There are tried-and-tested methods for raising cash in an emergency, from a rights issue
or a debt/equity swap to selling assets or recruiting a turnaround specialist.

 The board was working on rescue plans – it paid KPMG £150,000 to prepare for a rights
issue that never happened – but it was unable to transform those plans into actions to save
the company. Ultimately, the Carillion board failed to deliver.
 KEY TAKEAWAY for C.G
 The protection of shareholders’ investments.
 Requisite care necessary should be takeb to discharge its duties to the company’s
employees, pensioners, and suppliers

5. SHORT SELLING INTEREST (High Risk Hedge Fund consideration)

The biggest and most significant consideration here is the fact that some people did spot
that Carillion was mismanaged and that its accounts painted a flattering picture of its
financial health. Years before its collapse, HEDGE FUNDS — and at least one sell-side
analyst — were of the view that Carillion finances were unsustainable.

Late payment is endemic in construction, but Carillion was making its suppliers wait
120 days. Stories in the trade press about the woes of angry subcontractors, which was
enough to give keen-eyed hedge funds reason to think that cash was tight at Carillion.

They then proceeded with one of their favorite finishing moves, “selling short stock” of
Carillion. In total all these high risk investors (hedge funds) earned a £200m by shorting
the stocks of the company. One thing worthy of mention here is that CARILLION was a
popular short-selling target since the end of 2014.
 Black rock earned £80m by shorting &,
 Naya Capital earned £7.6m

So basically these avid investors knew company was in massive trouble way before the
time of real trouble and made effective use of their projection, now question is why
didn’t the directors and the govt know, what sort of slumber were they in ?

KEY TAKEAWAY for C.G

 Well there should be a serious consideration in CG for Short selling interest because as an
INVESTOR, the short selling interest matters.
 These hedge funds employ a high amount of risk to bet on falling share prices, to bet that
the company is in trouble, so the directors should get their cue from them i.e why are they
betting against our company? There must be something wrong and that’s why they are
betting against you.
 These are very sharp investors and they are taking a high amount of risk to bet against
companies. If they can take “risk”, then directors can on the least take “time” to see why r
they taking this risk betting against us.
 CG needs to formulate a method to pay special attention to short selling stocks.
6. Playing recklessly with pensions
One of the most sensitive issues in the Carillion collapse is pensioner rights, with a focus
on how the directors discharged obligations surrounding the company’s 13 final-salary
pension schemes. The 2016 accounts record a net retirement benefit liability of £587m
(£0.6b).

 pension obligations over decades to come was of little interest to a myopic board
who thought of little beyond their next market statement
 Meeting the pension promises they had made to their rank and file staff was far
down their list of priorities.
 This outlook was epitomised by Richard Adam who, as Finance Director,
considered funding the pension schemes a “waste of money”.
All these points to that company’s pension scheme was 'treated with contempt, ridicule
and derision.

KEY TAKEAWAY for C.G

 The case of Carillion emphasized that the answer to the failings of pensions
regulation is not simply new powers, but that in a broader perspective
Government has lacked the decisiveness or bravery to pursue measures that
could make a significant difference, whether to define benefit pension schemes,
shareholder engagement, corporate governance or insolvency law
 The Pensions Regulator, and ultimately pensioners, would benefit from far
harsher sanctions on sponsors who knowingly avoid their pension
responsibilities through corporate transactions.
 REFERENCES

1) https://www.accaglobal.com/in/en/member/member/accounting-
business/2018/04/corporate/carillions-collapse.html

2) https://www.ft.com/content/1958fb80-0fe6-11e8-940e-08320fc2a277

3) https://www.nedonboard.com/carillions-collapse-provides-important-corporate-governance-
lessons/

4) https://www.linkedin.com/pulse/carillion-case-study-corporate-defense-fiasco-sean-lyons

5) https://www.icsa.org.uk/knowledge/governance-and-compliance/analysis/corporate-
governance-carillion-collapse

6) https://sites.duke.edu/thefinregblog/2018/07/18/carillion-plc-a-governance-case-study-from-
the-uk/#_ftn74

7) https://www.theconstructionindex.co.uk/news/view/carillion-report-conclusions-and-
recommendations

8) https://www.simmons-simmons.com/publications/ck0ai7pgy6r3i0b94e8llwhvb/180518-
conduct-risk-and-corporate-governance-lessons-from-carillion

9) https://www.bloomberg.com/opinion/articles/2018-05-16/hedge-funds-are-the-good-guys-in-
carillion-debacle