The collapse of Carillion: lessons for NEDs

In the wake of another large-scale corporate governance disaster, non-executives must present greater challenge in the boardroom to protect their companies and stakeholders

The collapse of construction giant Carillion has reignited debate about the duties – and effectiveness – of non-executive directors after MPs branded the company’s former board members “delusional”.

Carillion went into liquidation on 15 January after buckling under the weight of a £1.5bn debt pile. It was the UK’s second-largest construction company, and was heavily involved in several key building and infrastructure projects, including the forthcoming HS2 high speed railway line, and the Royal Liverpool and Midland Metropolitan Hospitals (both now delayed and unfinished).

Carillion employed 43,000 staff globally, and in 2016 had sales of £5.2bn. However, the company took on too many risky contracts with low margins that proved unprofitable. Payment delays in the Middle East also hit its accounts. Last year it issued three profit warnings in five months and wrote down more than £1bn from the value of contracts. Investors dumped shares in droves, and at the time of its collapse, the plummeting share price left it worth just £61m, with a £900m debt pile and a £600m pension deficit.

NED fallout

Experts believe that the debacle will have ramifications for non-executives generally to “up their game”, especially as the UK’s corporate governance regulator, the Financial Reporting Council (FRC), is conducting a review into the effectiveness of the Corporate Governance Code.

Nauzer Signaporia, technical partner at accountancy firm H W Fisher, says that Carillion’s collapse will mean that non-executives will need to be more keenly aware of external market forces and what their impact could be on the company.

“When you have a situation where fund managers seem to know more about the financial state of the company than the board does and are actively trying to short it, then non-executives are in trouble. How they did not pick up on this – and try to do something about it – is shocking.”

Stakeholder focus

Signaporia also believes that, while the UK’s Corporate Governance Code says that boards must consider the impact of its strategy on stakeholders (and not just shareholders), such as employees, customers and suppliers, these issues will become more prominent and a greater focus of regulatory scrutiny – especially since the company continued to pay out dividends and executive bonuses when it was becoming increasingly indebted.

“The company’s pension deficit has ballooned in recent years and the board did nothing to address the problem. Instead, it was too focused on revenue recognition and goodwill impairment as major risks. Given the number of employees and sub-contractors that have been affected by this, I suspect that the government and the FRC will ensure that the interests of employees and wider stakeholders – such as suppliers and customers – are better protected in future.”

Need for independence

One non-executive director, who declined to be named, says that it will become increasingly important that non-executives ensure that assurance functions like risk management and internal audit can provide sufficient independent challenge to management thinking.

“Companies need more critical feedback and independent advice to make sure that they are aware of significant risks to the business, as well as their likelihood and potential impact,” he says. “As such, they will need to ensure that their internal audit and risk management functions are appropriately resourced and given the necessary scope to do their jobs well,” he says.

Boards will also need to re-examine whether the business’ risk appetite is appropriate and sustainable, as well as look at actual cashflow and cash holdings as opposed to revenue forecasts, says Mufid Sukkar, group chief strategy officer at financial services company Nest Investments and a non-executive director.

“Revenue recognition in some industry sectors has become increasingly aggressive – so much so that in some cases it no longer reflects reality,” he says. “The best way to assess a company’s underlying financials is to see how much cash it actually holds. Non-executives will have to go back to the core basics and check bank balances if they want to get a true sense of how the company is being governed and if the strategy is paying off.”