Carillion collapse & taming corporations
The collapse of Carillion isn’t an isolated event. The British high street is now full of collapses and closures resulting in loss of jobs, pensions, supply chains and destruction of local economies. Big names such as Maplin, BHS and Toys R Us have disappeared. Carpetright, Poundland and House of Fraser are teetering. Inevitably parliamentary committees and media ponder over ‘what’s to be done?’. Within the contradictions of capitalism, the usual response to unexpected scandals and collapses is to tweak accounting, auditing, corporate governance and pensions reforms. This is welcome but simultaneously misses the bigger picture. The real problem is the power of corporations and how wealthy elites are able to treat corporations as their private fiefdoms. All this is permitted by law.
The laws and policies are introduced by political parties funded by big business and wealthy elites. They control the media and provide jobs to former and potential ministers to advance their interests. In return, laws and institutional structures are devised to appease corporate interests.
Consider the case of Carillion, whose final balance boasted assets of £2.2m. Some £1.6m of this related to what accountants call ‘goodwill’ which is the difference between the price paid for the tangible assets of acquired companies and the value of their tangible assets. In economic terms, it could be rationalised that Carillion had bought businesses with some economic advantages which it hoped would enable it to earn superior returns and £1.6m represented a kind of present value of those future returns. But Carillion did not have superior returns. Its cash margins on contracts were between 2% and 5% of sales i.e. there was no sign of any superior performance and returns. Therefore, goodwill should not have been shown as an asset in its balance sheet. The entire asset should have been written-down. Instead, the dubious asset of ‘goodwill’ continued to appear in balance sheet in full right to the end. Accounting rules permitted it.
The accounting rules for treatment of ‘goodwill’ are not the outcome of any parliamentary debates. Rather the rules were formed by the Financial Reporting Council (FRC), a body colonised by big business and accountancy firms. Inevitably, it delivered the results desired by the elites.
The FRC claims that it consults corporations, investors and elites in order to develop and they all approve its accounting rules. Imagine if in 18th century America someone developed social policies by consulting slave owners and then said that there is widespread support for slavery. If they spoke to slaves, they would have soon learnt that there is no support for slavery. Similarly, the selective consultations of accounting rule makers privilege the worldviews of corporate elites and shareholders. No consideration is given to the consequences of the rules for employees and other stakeholders.
The failure to write off goodwill in Carillion’s income statement meant that the company reported artificially high profits which masked its deteriorating financial position. Higher profits justified the payment of higher dividends to appease capital markets and shareholders. Higher profits enabled directors to claim performance related bonuses and shareholders happily approved them. The dividends personally benefitted directors because they held shares and share options in the company. Directors failed to address the deficit of over £800m on the company’s pension schemes. No law or accounting rule required company directors to eliminate the deficit. The Pension Regulator does not have powers to demand that companies with pension scheme deficits should not be able to pay dividends without a plan to eliminate the deficits. Britain actually does not have a central enforcer of company law to oversee companies.
The liquidation of Carillion has inflicted losses on employees, supply chain creditors and left the HMRC in the lurch. Some institutional shareholders huffed and puffed about the loss of their investment, but at least their liability is limited. The same cannot be said about society at large which faces unlimited liability. In common with other insolvent businesses, Carillion’s secured creditors, mainly banks, will be at the head of the queue and are likely to recover a substantial part of the £1.5bn owed to them. Carillion owed around £2bn to its 30,000 suppliers, which includes plumbers, electricians, truck drivers, self-employed construction workers, other contractors and HMRC and they will be lucky to recover anything. In British insolvency law, pension schemes rank as unsecured creditors too, but may be bailed out by the Pension Protection Fund (PPF). The bailout for some members will be up to a maximum of 90% of the deficit. This would lead to reductions in pensions for retirees who may have to be supported by the taxpayer funded welfare system.
This state of affairs exists because of the privileging of the interests of corporations and economic elites. From a risk management perspective, in the event of bankruptcy, pension scheme liabilities should be prioritised i.e. paid before any other creditor. With the passing of time, employees simply can’t rebuild their pension pots. Pensions are probably the major source of income for most retirees and they cannot afford to forego any part of it. In contrast, banks and financial institutions hold diversified portfolios and are in a position to absorb some of the losses from corporate bankruptcies. But such social logic does not inform laws. The same malaise is present in accounting rule making. The rules advance the interests of shareholders and markets, but are not road-tested to ascertain negative impacts on others. The Carillion collapse should encourage reflections on the fundamental causes of bad policies and reinvigorate calls for reforms which prioritise societal concerns over appeasement of corporations and economic elites.
Prem Sikka is Professor of Accounting and Finance at the University of Sheffield and Emeritus Professor of Accounting at the University of Essex.