RI Comment: Carillion collapse is a failure of investor stewardship

Existence of Stewardship Code did not prevent corporate implosion

The collapse of UK construction company Carillion asks fundamental questions about the effectiveness, or otherwise, of investor stewardship.

The guidance to Principle 1 of the UK’s Stewardship Code is clear: “Stewardship activities include monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure, and corporate governance, including culture and remuneration.”

It is not clear to us that shareholders in Carillion fulfilled this criterion and could potentially be in breach of the voluntary code, although there are no real sanctions for this.

The company imploded this week in what is the largest corporate governance failure since in the UK since the financial crisis.

The Stewardship Code, which dates from 2010, was designed to avoid the sort of blow-up characterized by the financial crisis.

Although some within the governance sector are cautious about the idea that any corporate failure is necessarily a failure of investor stewardship, let’s look firstly at how large institutions voted at Carillion’s most recent AGM.

Norges Bank Investment Management (with a disclosed stake of around c.2.1%) supported all 17 resolutions at the last AGM, in May. It did vote against CEO Richard Howson in 2014, but supported him subsequently.

But another leading investor, the California State Teachers Retirement System (CalSTRS), voted against the entire management roster last time, though its state sibling CalPERS backed all resolutions. The most recent disclosures from the BT Pension Scheme (for 2016) show it voted for all resolutions at the company.

The top three holders of the stock, according to the 2016 report and accounts, were BlackRock (8.8%), Deutsche Bank (5.82%) and UBS (5.08%). BlackRock, according to its voting records, voted for all proposals at the May 2017 AGM. As passive investors, they have to be in the stock, but they aren’t obliged to support management.

The UK has had a Corporate Governance code since 1992 and is regularly held up as a global leader; Carillion, of course, was in full compliance with the Code.

The Financial Reporting Council is the UK watchdog that is in many ways at the heart of this crisis as it oversees corporate governance, the accounting profession and investor stewardship.

Catherine Howarth, CEO of campaign group ShareAction, told RI: “In the year that both the UK’s Corporate Governance Code and the UK’s Stewardship Code undergo formal review by the Financial Reporting Council, Carillion is a stark reminder of why a box-ticking mentality can be a very big problem.

“Pension savers across the UK should be asking questions about what their fiduciaries were doing to maintain a watchful eye on this company once the first profit warnings were delivered.”

Ros Altmann, the former Pensions Minister, said the crisis “poses questions about how investors approach their responsibilities when companies issue profit warnings, despite consistently increasing dividends and boosting top executives’ pay”.Carillion itself set great store by sustainability. Its most recent sustainability report is mapped against the Sustainable Development Goals (SDGs). It was well ranked by the CDP, a constituent of FTSE4Good and compiled the report using Global Reporting Initiative standards.

The company, which was deleted from FTSE4Good as of today, was also a signatory to the UN Global Compact, so it ticked a lot of sustainability boxes. As it said of itself: “Sustainability is a core strategic business model capability, making Carillion a better company to work for, to do business with and to invest in.” Indeed, Chairman Philip Green, a former corporate responsibility advisor to the UK government, trumpeted how the firm had won the Queen’s Award for Sustainable Development.

The company also made a point of its openness to “regular and active” dialogue with shareholders. The board went through a board evaluation process, had good gender diversity and looked well qualified.

The Carillion collapse has highlighted the issue of short-selling by institutional investors, as we noted back in July last year. This is a topic we plan to explore in greater detail in future.

Schroders is one fund manager who flagged up issues with Carillion last November.

Governance head Jessica Ground told BBC Radio this week: “As active fund managers we had been exiting the position.” She referred to the concerns it had raised late last year. She continued: “A lot of things we had been raising with the company, and we had been signaling, but it can be hard to make the changes.”

But business group the Institute of Directors had broader questions about the role of the board and investors. Its Head of Corporate Governance Roger Barker said: “The question that arises is where were the board of directors in all this, where were the shareholders, where were the auditors and where were the government?

“There should have been checks and balances around the management to ask tough questions.” He said a change to Carillion’s bonus clawback policy had been “waved through” by shareholders in 2016.

This went “unnoticed by shareholders”, he said. “This points to the limits that shareholders face in really being on top of the detail at all these companies that they are invested in.” In other words, a failure of stewardship.

Prem Sikka, the forthright accounting professor says: “The big mistake in corporate governance is the assumption that shareholders will somehow invigilate companies and take care of the interests of other stakeholders. That fiction needs to be laid to rest and a fundamental reform of corporate governance is long overdue.”

The upcoming revision to the Stewardship Code needs to absorb the failures at Carillion or risk becoming an irrelevance.

With reporting by Carlos Tornero.