{"id":40256,"date":"2018-01-16T09:05:12","date_gmt":"2018-01-16T09:05:12","guid":{"rendered":"http:\/\/www.taxresearch.org.uk\/Blog\/?p=40256"},"modified":"2018-01-16T09:52:48","modified_gmt":"2018-01-16T09:52:48","slug":"the-systemic-questions-carillion-gives-rise-to","status":"publish","type":"post","link":"https:\/\/www.taxresearch.org.uk\/Blog\/2018\/01\/16\/the-systemic-questions-carillion-gives-rise-to\/","title":{"rendered":"The systemic questions Carillion gives rise to"},"content":{"rendered":"

I have not commented to date on Carillion\u2019s failure<\/a>. Partly that has been because of a lack of time. And partly it\u2019s because I needed to read enough.<\/p>\n

I do not offer specific comment here: there is, very obviously, more to know. But there is now enough known to make some pretty specific observations.<\/p>\n

The first is to suggest that there was misreporting by Carillion. The likelihood that markets were misled as to its profitability and balance sheet worth until about a year ago seems very high. It also now seems that some in the City were aware of this risk from 2013 onwards. In that case the questions are obvious. They are:<\/p>\n

1) If this was known why didn\u2019t the Financial Reporting Council act sooner, quicker, and more directly?<\/p>\n

2) Why was there no whistle blowing? Someone in this company knew how bad things were. Is there appropriate protection in place for them? If not, why not?<\/p>\n

3) How come the auditors managed to satisfy themselves for several years that sensitive issues, such as turnover and the value of goodwill, were fairly stated in this company when it now looks very unlikely that this was true? KPMG are on the line, again<\/a>.<\/p>\n

But let's get more systemic about this and extend the questions:<\/p>\n

4) The losses that will arise as a result of this failure will be to\u00a0 many classes of stakeholder including customers, suppliers, employees, tax authorities, local communities and others.\u00a0 Despite this company law still maintains the pretence that accounts are only prepared on behalf of the shareholders of the company, and that the auditors have no duty to anyone else but those shareholders.\u00a0 Why do we do that when it is so obvious that the consequences of limited liability extend so far beyond\u00a0 the shareholders, who in so many cases (as in this one) represent a tiny proportion of the claims on the company?<\/p>\n

5)\u00a0 \u00a0Why do we remain so relaxed about the concept of limited liability? I do not dispute that it has had its use in mobilising capital for social gain, but it does also give rise to very clear risk of moral hazard. This is particularly true now that the separation of ownership and control is so stark, and when the rewards to control are so often so high, as in the case of Carillion.\u00a0 Management in this case was exceptionally well rewarded,\u00a0 with the chief executive earning more than \u00a31 million a year, and the chairman earning more than \u00a3200,000 for a part-time employment. Non-executives\u00a0 were paid \u00a361,000 the year each, again for a decidedly part-time employment,\u00a0 and the simple fact is that they did not\u00a0 do their jobs appropriately:\u00a0 if they\u00a0 had then this failure would not be so severe.<\/p>\n

So is it time to ask whether\u00a0 limited liability should be denied to the directors of limited companies?\u00a0 Shareholders need it: they are given remarkably little information to decide upon with regards to the affairs of the corporation in which they have invested, and so it is appropriate that their risk is limited.\u00a0 This is, however, not true of the directors:\u00a0 they are meant to know what is going on, and in that situation to limit their liability simply encourages recklessness. And it cannot be argued that\u00a0 it would be unfair that they carry such risk.\u00a0 As evidence look at what is happening in Carillion:\u00a0 most of the directors will walk away without a penny of personal loss.\u00a0 Many of their employees, most of their pensioners, many of their small suppliers, and many of those small suppliers own employees, will walk away with considerable personal loss arising as a consequence of the recklessness of the action of this Board of Directors.<\/p>\n

The directors of Carillion\u00a0 will no doubt think that they did not have liability to these people: caveat emptor\u00a0 when dealing with a limited liability company, they will say. But I do not agree. The\u00a0 primary duty of the directors of a limited liability company is not, whatever most people think, to the shareholders.\u00a0 That primary duty is, instead, to the creditors:\u00a0 it is the duty of the directors to make sure that everyone who deals with the company can be paid. This has failed in the case of Carillion. From the pensioners onwards the\u00a0 creditors of this company have been treated with contempt:\u00a0 in my opinion the directors should be personally responsible for that, to the limit of their own financial assets.<\/p>\n

6) The liability of companies to their pension funds has to be reappraised:\u00a0 the indifference of this company to the deficit that it maintained on its pension fund is indicative of the contempt that they had for their employees, both present and past. If the\u00a0 company was unable to make good this deficit then it, along with all other companies in a similar position, should not have been allowed to do three things. First it should not have been allowed to remunerate its directors at a rate more than ten times median company pay. Second, it should not have been allowed to pay a dividend. Third, it should not have been allowed to continue in business without supervision by a board appointed by the pension trustees, to remain in office until such time until the deficit was cleared. It is no longer\u00a0 acceptable that the ultimate risk in a company should be borne by its pensioners.<\/p>\n

7)\u00a0 The form and content of company accounts has to be brought into question because, quite clearly, the accounts of Carillion\u00a0 failed to draw attention to the risks that were inherent within it.\u00a0 This issue requires further elaboration in due course, but one of the primary problems in current accounting is, I think, the failure to report cash flow adequately. A\u00a0 long time ago company accounts included a cash flow statement: this is long been replaced by statement of funds flow,\u00a0 but these things are not the same\u00a0 and the funds flow statement does not, in my opinion, draw adequate attention to the ability of the company to service its debts as they fall due,\u00a0 which is vital if solvency is to be proved.\u00a0 I am well aware that there is a purpose to a funds flow statement,\u00a0 and that there is an argument that for a heavily solvent company this is a much better and more useful document, but there is an important caveat in that statement,\u00a0 and it is that the company is heavily solvent. In precisely the\u00a0 circumstance when a statement on insolvency is required the funds flow statement\u00a0 fails to deliver,\u00a0 and a cash flow statement is necessary.\u00a0 Precisely because a cash flow statement would focus the minds of the directors on their duty to ensure that creditors can be paid it should be included in all financial statements.<\/p>\n

That are, of course, other additional statements that are required. There was no country-by-country reporting in these accounts, and that means another important aspect of risk could not be appraised.<\/p>\n

But then there is perhaps the most important questions of all:<\/p>\n

8) Why is it that the Financial\u00a0 Reporting Council's\u00a0 membership is still dominated by\u00a0 those associated with the Big Four firms of accountants?\u00a0 Shouldn't this be brought to an end?<\/p>\n

9) Why is it that the UK does not have a company law regulator who ensures that the requirements of the Companies Acts are enforced, because that is not the job of Companies House?\u00a0 Hasn't Parliament been negligent in ignoring this issue?<\/p>\n

10)\u00a0 Why is it that financial ethics training does not highlight these issues, and ask these questions. Indeed, why does it seemingly fall to just Atul Shah to do so in academia?<\/p>\n

11) When will the\u00a0 audit market be reformed so that we have genuine separation of auditors from other aspects of financial services, not least\u00a0 so that the Big Four\u00a0 merry-go-round does not profit whatever happens in these situations, as PWC\u00a0 are now doing here?<\/p>\n

And, perhaps, most important of all:<\/p>\n

12) When will\u00a0 government realise that dumping its obligations into limited companies, who have no capacity to fulfil them, at long-term costs to the employees who provide public services, is no way to run a state?<\/p>\n

Until such questions are answered Carillion will leave a very big stain on our economy, and the ethics of finance and\u00a0 accountancy.<\/p>\n

I am not hopeful.<\/p>\n","protected":false},"excerpt":{"rendered":"

I have not commented to date on Carillion\u2019s failure. Partly that has been because of a lack of time. And partly it\u2019s because I needed
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