Research news

Dr Bruce Hearn

The shock liquidation of one of the UK’s largest employers, Wolverhampton-based Carillion, can be traced back to unchecked risk-taking in volatile countries by its CEO, writes Dr Bruce Hearn. 

The firm’s aggressive expansion in the Middle East, where CEO Richard Howson made his name, would surely have set alarm bells ringing for a hands-on board, but a structural failure of corporate governance in Carillion’s case meant that this chasing of prestige projects went largely unimpeded.

Carillion’s failings were a perfect storm of three inter-related issues: ineffective monitoring of its leadership, disempowerment of shareholders caused by its conglomerate structure, and critical mismanagement of cash flow, or ‘working capital’. 

The CEO 

Carillion’s leadership was long dominated by CEO Richard Howson, whose impeccable track record was honed through having worked his way up internally within the company. While most of us who work for large organizations will recognize this traditional route in achieving recognition and success, there is a downside to this. As with Enron, before it went bust in 2001, this extended social network of internal contacts can act to enhance a “power base” and exacerbate influence throughout the firm.  Furthermore, and dependent on the specific route of the career trajectory taken, this can be linked directly towards a personal bias towards parts of the company in terms of prestige projects undertaken. 

Richard Howson notably built his career in the Middle East and North Africa arm of Carillion, rising rapidly from Managing Director to board-level Executive Director before progressing into the role of Chief Operating Officer in the central group board of Carillion plc. Consequently, this personal background is likely to form the basis for the company’s leadership decision to expand its interests in Middle Eastern regional construction projects. The inability of these to pay on time precipitated in part the revenues crisis that triggered the firm to fail. 

Too busy to monitor 

Given corporate governance scandals of the past, some quarters of the media are quick to link failings to excessive remuneration packages and notions of “fat cats”. However, in Carillion’s case, director remuneration is in line with other comparably sized listed firms. Nevertheless, the fundamental effectiveness of monitoring should not be overlooked.  While the Chair of Carillion’s board, Phillip Green CBE, had sufficient social stature and experience to be more than a match in challenging the CEO, in 2016 he held a further five chairmanship or senior advisory roles concurrently to his role at Carillion. This contrasted to all other nonexecutives having one or, at most, two consecutive nonexecutive roles, and is indicative of the potential to be too “busy” to monitor effectively. 

Powerless shareholders 

The corporate model at the heart of the UK’s market-based governance regime is that of dispersed ownership.  This rests on the assumption that ownership of a given corporation is widely dispersed amongst many minority shareholders. Their interests are then served by their managerial agents, namely corporate insiders such as the CEO, executives and senior management teams. However, the corporate structure of Carillion is completely at odds with this notion of a singular firm.  Instead, it is structured as a conglomerate based on a central holding company and satellite subordinate firms that are active in many, at best, partially related industries ranging from construction, facilities management, support services and public private partnership projects.  

This structure yields two potentially serious governance problems.  

Firstly, investors as well as their representative nonexecutive directors lack the expertise and knowledge to fully understand the dynamics of group-wide operations – this is an important vulnerability given that all group constituent firms are bound to any given failing entity.  

Secondly, such a diversified group conglomerate structure exacerbates the relative powerlessness of outside shareholders to the whims of insiders, such as the CEO. Such conglomerates are ubiquitous in many countries around the world, such as Keiretsu in Japan or Grupo Económico in Spain.  A common theme is their association with a dominant family or controlling entity, whose powerful social affiliation acts to minimize potential flaws associated with insider CEO and executive behaviours.  However, when such a structure is associated with a dominant controlling entity, such as a family, it is at pains to maintain external credibility and reputational capital. This is at odds in Carillion’s case where a grouping of dominant insiders around the CEO relied on the dispersed ownership model, knowing they had a base of otherwise disenfranchised shareholders and creditors who were powerless to monitor effectively. 

Cash flow crisis 

As with all crises, the governance failing itself is not attributable to any one single underlying failure but to a number of preceding problems that occurred together. Carillion’s woes can be directly attributable to a crisis in working capital management, where the group had a strategic orientation towards expansion in risky construction projects in equally volatile regions of the world. Payments associated with these projects were slow to crystallize causing a shortfall in available operating or “working” capital with which to service interest payments on loans and thereby maintain the company’s overall position in credit ratings. Bank foreclosure was thus only a matter of time.  

However, the real culprit to this failure must lie with the board of directors, the nature of its leadership and the ineffectiveness of its monitoring in the light of the “busyness” of nonexecutive directors and, importantly, the extended diversified group corporate structure. 

Interestingly, a natural remedy for such failings may take the form of governance reform shaped on the stakeholder model, prevalent in continental Europe. Here, workers, creditors, customers and suppliers all have mandated roles on the board or have the capacity to vote on board-related matters. In Carillion, these stakeholders would have had both the motivation to monitor and the ability to take appropriate action thereby avoiding the catastrophe that is currently unfolding in Wolverhampton. 

Dr Bruce Hearn is an expert in corporate governance at the University of Sussex.

Sources: Carillion annual reports from 2012 – 2017 inclusive. Obtained from investor relations portal of Carillion’s corporate website

Back to news list