Where now for Corporate Accountability – Self Regulation or Political Interference?

At our latest Chair and NED lunch, having agreed to spare our guests any talk of Brexit, we posed the question “Where now for Corporate Accountability”?

This was a media headline following the collapse of Carillion in January 2018.

The recent collapse of Thomas Cook, involving the largest peacetime repatriation effort in British history, begs the same question. Probably even more so, as many are questioning if there was any real change in Corporate Accountability post Carillion at all. Questions are also being raised on whether anyone was held to account for Carillion and indeed, will anyone be for Thomas Cook?

So we asked; “should Corporate Accountability change and if so, how? What should boards do to prevent these collapses and how accountable should individual board members be when this happens?”

“Businesses fail but they can fail better in a lot of cases”.

Richard Pennycook, Chair of Howdens, On The Beach, Fenwick’s & The British Retail Consortium, was unable to attend so contributed in absentia; “An irony of Carillion is that the taxpayer got great value for about ten years by putting big infrastructure risk onto private companies who did not price any contingency into assumed perfect execution. So in Capitalism, the system has to allow companies to fail ‘Darwinian’ style. He also felt that boards habitually act too late when early intervention could save a lot of shareholder value. Any company with complex capital structures or high debt should have a turnaround/restructuring specialist on the board”.

Richard also said: “There are questions to answer about the de-stabilising effects of Hedge Funds in big rescue situations particularly because of their concert-party behaviours and use of CFDs (a popular form of derivative trading). Both Carillion and Thomas Cook should have been able to execute an orderly run off rather than going into liquidation.”

“Boards need to be able to ensure that NEDs have the requisite amount of time available to conduct the role”.

Stephen Billingham, Chair of Anglian Water Services, was quite clear; “Boards are wholly responsible for the failure of the organisation otherwise – what are boards for“? He went further and suggested that directors on boards of companies that have failed, should not be on boards again. “They have failed to do their duty to the shareholders and employees. Directors of companies that are failing, have a duty to look for the best exit for all concerned.”

Our Chair asked, “So how is Corporate Accounting going to change to make directors more responsible?”

Robin Sheppard, Chair of Bespoke Hotels, believes the senior debt providers, be it bank or mezzanine finance providers, should have a director as a representative on the board. “Invariably businesses fail because they become over-burdened with debt and the board ends up playing cat and mouse with the debt provider; they don’t want to tell them the truth, so the provider is kept in the dark. Therefore the bank should, as a condition of the loan, sit on the board and share the same fiduciary duties as the rest of the shareholders; but I doubt that’ll ever happen!”

Ian Edward, NED, The Seafood Pub Company, said in his view, the credibility of corporate accounting and associated reporting has been lost. If you look at public companies now, again and again, the adjusted profit numbers they want you to believe are massively different to the statutory ones. There are no requirements for ‘proper’ explanations for adjusted numbers in the accounts. Thomas Cook is a classic example. If you look at Thomas Cook’s annual profit for the last five years, about 80% were exceptional items. Proper disclosure and more disclosure is required. He then directed his criticism at the major audit firms with their oligopoly of 4 and said, it appears there is no-one with the nous to change the system.

“The Brydon review is the most important of the three reviews on the accounting profession”.

Beautifully choreographed, David Sayer, Vice-chair of KPMG UK, intervened saying he was the only top 4 representative fool enough to attend the lunch! He made the point that auditors are not responsible for corporate failures but they are responsible for producing a true and fair view on the accounts. For this they should be, and are, held accountable by the regulator which is being beefed up.  Where there is a corporate failure, the auditors are investigated along with the directors. However our free economic system is responsible for corporate failure and this is a very good thing in a dynamic economy. It is accelerating because of the digitisation which is producing huge benefits and challenges. Consumers are choosing to buy in a different way and a lot of retailers are in trouble. Is the corporate failure of the retailers the responsibility of the directors or consumers? Our economy produces corporate failures but it does need to be managed; the accounts need to be true and fair which is rather different from being accurate because an awful lot of opinions are included in the valuation of assets in accounts. If you look at banks for example, the bulk of their assets are the net present value of future earnings from money lent, which is dependent on the future which actually nobody knows. In terms of there being only four major audit firms, this is a rather unwelcome situation created by the sudden demise of Anderson.

“Our free economic system is responsible for corporate failure and this is a very good thing in a dynamic economy”.

Ian added “For investors regarding the accounts – what is really going on particularly where we have allowed adjustments to operating profit or EBITDA to appear? “

David replied “Which is why the Brydon review, in my opinion, is the most important of the three reviews on the accounting profession and it is pity we did not have that first, then the review on regulation and lastly, a review by the CMA on what you do about the narrowness of competition in the audit market. I look forward to seeing the report into the sector by Sir Donald Brydon, due to be published later this year”.

Angela Knight CBE, Non-executive Director, Taylor Wimpey plc, responded to some of the previous comments and whilst agreeing that Boards held responsibility, warned against the notion of all Directors on boards of companies that failed, not being able to sit on future boards. She was brought in as one of a new board to turn round a company that had got into serious difficulties. If this meant should she and the rest of the Board fail in the turnaround, they would then be in danger of being excluded from future work -she and the others brought in wouldn’t have gone anywhere near it.

Regarding the comments on disclosure in annual accounts, she was recently a panel judge for PWC‘s “building public trust” awards. As part of this exercise she had to read many annual reports and became disillusioned by the amount of pages she had to get through before she got to any of the numbers. In her view, annual reports should be shorter with only meaningful detail included. “It isn’t just disclosure, in fact disclosure can go mad, it is about getting something that is meaningful in terms of the detail included in the report”.

Angela added that with one of the boards she is on, they have just awarded the audit to a non-big 4 and so she will be able to assess first-hand the difference in the quality of delivery.

Her final point was that in a healthy economy and echoing what Richard Pennycook had said, not everyone will survive. Decisions have to be made. Failures will happen, “What is wrong however, is when a company goes straight into liquidation, as opposed to administration, then there is nothing left for the employees or pensioners“.

Stephen Billingham, spoke once more in support of the big 4 accountancy firms and said they are the best at what they do and they have the brightest people. “The standards they provide are first class. There is no benefit in attempting to dilute the big 4. Where I think it has gone wrong, is the accounting profession as a whole thinks that the extent and volume of disclosures is a way of telling the story. The accounts tell you a story about what is going on in the business and if they don’t, then they are not doing their job. The duty falls upon the directors to ensure the accounts and reporting fairly reflect what is going on in the business and makes sense to investors”.

Tony Cocker, Chairman of Infinis, also fully endorses the notion that failure is inevitable. This is capitalism after all. However, if the company fails but has the right level of mitigation in place to protect employees and pensioners, then it is unlikely that the same level of outcry over the failure would be heard. “Would people be so worried about these failures if for example, there had already been a plan in place to repatriate holiday makers in the event of the collapse of Thomas Cook or other collapses where the pension schemes had been fully funded”?

Richard Farr, MD Pensions for Lincoln Pensions and a former NED at Booker plc,  suggested in response to Tony’s final point, that a range of “what if scenarios” should always be put in place and reported. If then, some hugely unexpected figure emerges and was covered in the what-if scenario process, it is more likely that the right level of mitigation would be in place.

Ian Bull, NED at St Modwen Properties, Dunelm plc, and Domino’s Pizza, agreed that some changes in reporting standards have not helped the clarity of what is really happening to the fundamentals of a business. For example, the year-end reporting windows which are always under pressure, suffer from increasing demands for content, all well intended but none-the-less mostly additive each time. It is important to step back and decide what is actually required to put in the annual report and accounts in as concise a way as possible. A further concern is the amount of time NEDs have available in order to go into the finer detail of companies and their operations. Boards need to be able to ensure that NEDs have the requisite amount of time available to conduct the role and therefore, rather than legislating for the number of posts any individual can hold, it becomes self-regulating.

“It isn’t just disclosure, in fact disclosure can go mad, it is about getting something that is meaningful in terms of the detail included in the report”.

Martin Stewart, Chair Risk Committee, Coventry Building Society and a former Director of the Bank of England, agrees that self-regulation is far better than the danger presented by politicians starting to interfere. In Banking, the Senior Managers Regime is a regulation which has been put in place that the regulator didn’t even ask for. Political reaction to complex issues does not always make for constructive regulation for UK plc.

Neil Holden, NED, Calmindon Ltd, believes recovery plans should be in place and if an organisation is going to fail, then fail gracefully. For larger companies, there should be plans in place for failure, what this might mean for their customers for example, and how it would be dealt with.

Bill Priestley, Chief Investment Partner, Epiris, representing the private equity world. Before PE makes an investment, which can take six months to make a decision, a lot of financial reporting detail is required. Thereafter we tend to trust the people we select for our boards. I accept that we are likely to put more debt into a business so there is a higher degree of risk, but I struggle to see how you would sit on any board without a high level of detail and information.

I don’t have a lot of sympathy for those NEDs with five or six roles and only speak to the Chairman once a month.

Mike Tynan, Chair, Training 2000 Ltd, Chair Brevia Nuclear, agreed wholeheartedly with the point about frequency of communication, asking how often the Chair challenges the executive directors regarding financial information and are they really under the skin of the business. Is it not better to be provided with management information, which may not be perfect but is current, and enables intervention to happen in a timely fashion rather than analysis of past events?

Roger Stephenson, Deputy Chair, Lock & Co. Hatters – a 343 year old family business, was quite clear that in his view it is the duty of the board not to be remote and to understand what is going on in the company. Proper management reporting and commercial level information so you understand what makes the business tick, enables the board to be closer to the business and mitigate the risk of failure.

Simon Linares, Group HR Director, Direct Line Insurance Group, about to start his first NED role, sees the efficacy of NEDs from an executive director’s position and in his opinion the most effective, particularly when a company is struggling, are those that are challengers rather than friends of the executive and protect shareholders and employees.

“Directors of companies that are failing, have a duty to look for the best exit for all concerned.

In Summary:

Some clear themes emerged. Businesses fail but they can fail better in a lot of cases. Good practice on boards will lead to more self-regulation with companies seeking to ensure that any NEDs they appoint have the time deemed necessary to be close to the detail of a company’s operations and accounts. This may mean that we see, more routinely, companies recruiting only those who have for example, no more than two other NED roles which are current. Good advice for any NED is to ensure, when taking on a new role, that they clearly understand the mechanisms and practices around how this business will enable them to get ‘under the skin’ in order to be effective.