Companies

How Carillion's Board Missed the Looming Failure

How come no one was prepared for the failure of a company that employs 43,000 people, and builds critical hospitals and roads for Britain?

Destroyed value.

Photographer: PAUL ELLIS/AFP/Getty Images

The postmortem on U.K. construction giant Carillion Plc is now well underway, with a U.K. parliamentary inquiry into the firm's collapse holding hearings on Tuesday. One early conclusion should be clear: Britain's corporate governance code has a fatal flaw, and the way it is applied may help to mask the errors and mismanagement that led to Carillion's collapse.

Carillion was not just a major employer, with 43,000 employees worldwide, almost 20,000 of them in Britain. It was a large government contractor, with responsibility for building hospitals, roads and other critical infrastructure for the taxpayer. So why did the government, a major customer and stakeholder, take so long to plan for Carillion's collapse, especially after three profit warnings in six months last year, which sent the company's stock into a nosedive? Where were the pension fund trustees, auditors and the Pensions Regulator as the company's pension scheme deficit grew and the directors avoided paying in what was owed, while still rewarding shareholders with handsome dividends?

It is generally accepted that when it comes to corporate governance, companies need some flexibility, which is why the principle "comply or explain" lies at the heart of the U.K.'s corporate governance approach. Indeed, the Financial Reporting Council, the U.K. regulator that is currently reviewing the U.K. Corporate Governance Code, is now encouraging boards and shareholders to be more flexible and recognize that the code reflects principles and is not a rulebook. Noncompliance with the code can be a virtue, enabling companies to tailor the code's principles and provisions to their own unique circumstances. It is then for the shareholders to evaluate a board's statement of compliance or its own explanation. That approach should benefit the company, its shareholders and its stakeholders. However, the reality is that when it comes to U.K. listed companies, most choose full compliance rather than making changes to the template that they would then have to justify. Carillion was one example. Explanations for the rare departures from the code tended to show minor diversions of a temporary nature.   

That made little sense. Carillion was a massively complex business. Its website boasts 12 separate businesses, ranging from buildings construction to telecommunications, across 11 sectors, all "making tomorrow a better place." And yet its corporate governance model was centered on a main board that comprised just seven directors -- two executives, a chairman and four independent non-executive directors, who serve on five board governance committees. Four executive committees, all chaired by the former chief executive, are also shown with a reporting line to the board. Hindsight is handy, of course, but it stretches credulity to suggest that a unitary board of such a small size could fulfill its responsibilities effectively given the sheer scale and diversity of Carillion.

While much is made in modern corporate governance about the importance of the business model, that's hardly enough. In Carillion's case, a flawed corporate governance model contributed to its collapse. There are a few things investigators and policy makers can address now to ensure that future Carillions are prevented.

Corporate governance models should be tailored to a company's organizational and business models. In Carillion's case this might, for example, have meant having public interest as well as independent directors on the main board. It might also have included having a separate independent board, accountable to the main board, for each of its individual service lines. A model along those lines could have ensured that the main board was more challenging -- particularly in fulfilling its responsibilities to customers and employees -- was better informed, and received information regarding the financial risks that Carillion was running in a more timely fashion. Carillion's size and responsibility for key infrastructure projects should have meant that the public interest dimension of all the directors' responsibilities, including those to the pension funds, would have played a more central role.

The U.K. Corporate Governance Code requires boards to evaluate their own effectiveness. In practice, such exercises are perfunctory and focus on processes and priorities, which isn't the same as evaluating the effectiveness of the entire corporate governance model. Had the code required the board to evaluate its corporate governance model, Carillion would surely have had to acknowledge that its model poorly equipped the board for oversight of so vast a business empire. It's now up to the Financial Reporting Council to flag the fatal flaw and other governance aspects that allowed Carillion's situation to become so dire, and to bring them within the scope of its current review of the code. Failure to do so would run the risk of future debacles.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Guy Jubb at guy.jubb@btinternet.com

    To contact the editor responsible for this story:
    Therese Raphael at traphael4@bloomberg.net

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