Critically appraise the corporate governance, risk management and internal control weaknesses, which contributed to the failing of British Home Stores in 2016.
The need for corporate governance began with the first limited company in 1856, which spilt the roles of ownership and control. A risk of financial irregularities arose from the separation of ownership and control because of threats introduced by dishonest or incompetent managers. (Stimpson and Taylor, 2013, p. 104) Because of this, there was a demand for a system which organisations could be directed and controlled on behalf of the stakeholders and shareholders. (Cadbury, 1992) Cadbury first defined corporate governance in the UK to create an emphasis on the relationship between managers and shareholders and create a system, which would manage an organisation in the best interests of shareholders in order for the organisation to reach its objectives. (Stimpson and Taylor, 2013, p. 104) The governance of an organisation is the responsibility of the board of directors who are appointed by shareholders. (Stimpson and Taylor, 2013, p.105)
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Sir Philip Green bought British Home Stores (BHS), a company established since 1928, in 2000 for £200m. (Sky News, 2016) This aim of this essay is to assess the corporate governance issues and internal control weaknesses of BHS, whilst owned by Sir Phillip Green until March 2015 when he sold it to Dominic Chappell, a thrice bankruptee, for £1. (Rayner, 2016) By April 2016, just 13 months after the questionable sale to Dominic Chappell (Retail Acquisitions), BHS had collapsed in administration which left 11,000 employees facing redundancy. (Armstrong, 2016) At the time of the collapse, BHS had a £571 black hole in two of its pension schemes leaving 20,000 of its pensioners facing lower benefits. (Sky News, 2016) Poor corporate governance and internal control weaknesses were at the heart of the demise of BHS which will be discussed throughout this essay.
- To critically analyse and explain the internal control and risk failings that led to the collapse of BHS.
- To critically appraise the corporate Governance Issues that led to the collapse of BHS and their future implications.
- To critically analyse the social and ethical issues that led to the collapse of BHS and their corporate social responsibility and its future implications
- To briefly discuss forensic accounting opportunities which could have been performed at the time of the collapse of BHS.
Corporate Governance issues and Future Implications
Stimpson and Taylor (2013, p.105) state that good governance of company ‘must act in the best interests of its stakeholders.’ However, throughout Sir Phillip Green’s reign of the company from 2000 to 2015, this was not the case. When Green bought the company in 2000 it had a £5m surplus in their pension fund, however by the time the company was sold in 2015 to Dominic Chappell this had dramatically changed to a £571 deficit. (Sky News, 2016) Pension regulators had repeatedly requested for the contribution to the pension scheme to be increased, however Arcadia’s (Parent company of BHS) Chief Operating Officer refused to increase contribution beyond £6.5m. (Armstrong, 2016) Other proposals were discussed with Green by Pension Regulators to rescue the pension fund black hole, for example in 2014, Project Thor, which was a £110m rescue scheme considered to help with the pension deficit, was suspended after Green decided the scheme was too expensive. Project Thor was created to ensure that BHS’s 20,000 pensioners would have had a better outcome in terms of pension benefits. (Armstrong, 2016) According to the UK Corporate Governance Code (2018), in order for a company to be successful, sustainable and survive long term there must be a relationship between stakeholders and directors, which is based on respect, trust and mutual benefit. However, Green did not act in the best interests of 20,000 of stakeholders when Project Thor discussions was suspended.
Furthermore, Sir Adrian Cadbury (1992) identified the underpinned reasons for why several organisations have collapsed (Stimpson and Taylor, 2013), including the collapse of Carillion, in 2018. (Thomas, 2018) In the case of Carillion, which was a construction company employing 43,000 people globally, collapsed with a ‘£1.5 billion debt pile’. (Thomas, 2016) The collapse of Carillion was blamed on recklessness and greed, as they took on too many risky contracts, which turned out to be unprofitable. (Thomas, 2016) As well as this, Carillion were accounting for revenues early and accounting for costs late, which provided an unclear picture of their financial position. (Burgess, 2018) Stimpson and Taylor (2013) identified ‘unreliable financial reporting’ as one of the reasons which underpinned the collapse of organisations. In addition to, companies being run in the interests of executive directors, and not shareholders, as well as awarding themselves high remuneration packages. According to an article by Financial Times (2016), Carillion were signing off on ‘hefty pay packages and bonuses’ even though they had not met key performance targets. Referring to the collapse of BHS, Green declared £423 million in dividends between 2002 and 2004 most of which were given to Green and BHS parent company, Arcadia, which is owned by Greens family. (Martin, 2016) It is against the UK corporate code of governance (2018) for any director to be in a position where they are involved in deciding their own remuneration package. (Stimpson and Taylor, 2013)
Moreover, Cadbury’s corporate governance report (1992) explains a code of ‘best practice’ for companies using four key principles of transparency, accountability, probity and equity (T.A.P.E), these key principles combined have become a ‘benchmark for good corporate governance’. (Stimpson and Taylor, 2013, p.109)
Source: (Stimpson and Taylor, 2013, p.109)
In the running months up to the sale to Dominic Chappell, head of BHS pension trustees, Chris Martin, was persistently requesting Sir Philip Green to fill out a ‘moral hazard’ form to explain the circumstances for which assets had been taken out of the business under Greens stewardship, to which Green continuously refused. (Armstrong, 2016) The ‘moral hazard’ form requested details of dividends paid out by BHS, management charges paid to Arcadia (Greens parent company), property transactions and rental payments. (Armstrong, 2016) However, just one month before the sale Financial Director of Arcadia, Neville Khan, told Martin that Green would not fill out the ‘moral hazard’ form unless he was forced into it. (Armstrong, 2016) Referring to Cadbury’s ‘code of best practice’, Green had not displayed any of these qualities, which questions the strength of corporate governance in BHS. When BHS was sold for £1 in 2015 it was in a far weaker than when it was acquired by Green in 2000 with a £5m surplus in its pension fund. Furthermore, a consistently high level of dividend payments and trading losses reaching £19.4 million and £21 million in 2013 and 2014, respectively, contributed to the collapse of the company in 2016. (Bulter, 2014) According to UK government legislation (2018), companies cannot pay dividends unless the company has made a profit, and the pay out cannot be more than its available profits from current and previous financial years. This is to ensure the success and sustainability of the company which the responsibility of board, according to the UK corporate governance code. (Frc.org.uk, 2018)
Another essential key principle of the UK corporate governance code is to ensure that non-executive directors are able to challenge proposals on strategy. (Frc.org.uk, 2018) Non- executive directors are board members whose duty is to scrutinize the decisions and performance of managers and directors. (Velkova, 2015) The key concept of non- executive directors is to be independent; this is to ensure that they are able to be objective and challenge directors when they making decisions against agreed performance objectives. The UK Corporate Governance Code has created strict criteria, which ensures the independence of non-executive directors. (Frc.org.uk, 2018) However, in this case of BHS, non-executive directors were close friends and relatives of Green, who were extremely unlikely to challenge him in the face of any wrongdoing. (Withersworldwide.com, 2018) Some would argue that the sale to Dominic Chappell (Retail Acquisitions), ‘a man with no previous retail experience and no financial credibility’, is the most crucial part, which led to BHS falling into administration in April 2016. (Armstrong, 2016) Although, KPMG, who were the advisers to BHS’s pension trustees, stated that if they sale to Retail Acquisitions had been blocked BHS would have fallen into administration earlier, even though they had concerns about Retail Acquisitions. (Armstrong, 2016) The non-executive directors should have recognised and challenged Green over the £1 sale to Dominic Chappell but because of poor corporate governance in BHS, this did not happen.
Concerning future implications of corporate governance, Forbes and Hodgkinson (2014) state that areas for reform should be on the board of directors, both executive and non-executive, shareholder rights and participation as well as ‘comply or explain’ approach to governance. One key factor for consideration is that shareholders are typically thinking short-term, focusing on the dividends, which they will receive, and instead ignoring the stability and sustainability of the company. A strong board must be in place with independent non-executive directors who are able to challenge, debate in order to ensure organisations are acting in the best interests of shareholders and in line with their strategy. (Ey.com, 2017)
Corporate Governance needs to keep up with the rapid speed of change in the business environment and needs to evolve so that it can respond to threats and opportunities. By creating, a diverse board of members with high level of expertise is necessary so that the right skills are available across the board to identify these threats and opportunities. In addition, the board should have regular meeting to ensure that their strategy is keeping up with the new trends of the business environment and responding accordingly. (Ey.com, 2017) In addition, the board of directors must ensure they are considering wider stakeholders and consistently acting in their best interest, not their own.
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Finally, encouraging ‘whistle-blowing’ in an organisation will create an organisation with a transparent work culture, which in turn will act as a fraud and risk deterrent. Putting laws in place to protect these individuals and to ensure that they feel as though they are able to come forward without any repercussions is also essential in order to encourage a transparent work culture and ‘whistle-blowing’. (Forbes and Hodgkinson, 2014)
Internal Control and Risk Failings (300)
A strong internal audit function is a key aspect in achieving good corporate governance. Internal audit plays an important role in providing assuring and evaluating the organisation governance processes. (Stimpson and Taylor, 2013) According the Institute of Internal Auditors (2016), the internal audit function should recognise the weaknesses; make recommendations on the company’s ethics and values, performance management and accountability of management and risk, and control information. Good corporate governance with be demonstrated through appropriate procedures in place which control good practice in activities. (Stimpson and Taylor, 2013) In Sept 2004, the Committee of Sponsoring Organisations (COSO) introduced a framework, which would provide a benchmark for organisations to improve their risk management processes. Developed from existing COSO internal control framework, it demonstrates how internal control is an integral part of risk management. (Pang and Shi, 2009)
Moreover, BHS had poor risk management and internal controls, which led to the collapse in 2016. In the 13 months in which Dominic Chappell owned BHS he ‘no distinction between his own money and BHS’s money’ (Williams, 2016, p.xx), after he consistently attempted to withdraw from the company’s funds. In the final days before BHS collapsed into administration, he tried to extract £1.5 million as well as asking the accounts department for £90,000 to pay his own personal tax bill. He even attempted to pay for his family holiday flights to the Bahamas using BHS’s travel budget however, Darren Topp, Chief Executive, blocked this when he spotted the payment. (Williams, 2016)
In addition to these poor internal controls, BHS failed to keep up the changing market and did not have any online presence in its dying days. Since BHS was established in 1928, the shopping market and consumer needs have changed drastically, with the majority of shoppers purchasing goods online. Furthermore, 51% of UK consumers prefer to shop online (Ecommerce News, 2018) and since BHS had no online presence, they restricted themselves to consumer who want to shop in-store. Most UK shops have responded to this shift in consumer needs, which meant that BHS could not compete with their competitors, like huge high street brand, Primark. BHS directors should have recognised this drastic shift in consumer needs and responded their business plan accordingly; this is a significant factor, which led to their continued fall of profits, which ultimately led to the collapse in 2016.
Corporate Social Responsibility
Corporate Social Responsibility (CSR) is the responsibility a business has to align their values and behaviours with the needs and expectations of the stakeholders. (Beal, 2014) Business’ have a responsibility to their stakeholders, which includes customers, employees, suppliers, investors, communities, regulator and society a whole. (Stimpson and Taylor, 2013) A business must ensure that they are considering the effects of their decisions and actions on the surrounding social system. (Davis and Blomstrom, 1966) CSR is an obligation that organisation have to consider the economic, ethical and legal expectations society has on them, it outlines how companies manage their business processes and decisions to create a positive impact on society. (Baker, 2003; Stimpson and Taylor, 2013)
The stakeholder theory of CSR highlights the many stakeholders of an organisation and separates them into two categories: primary stakeholders (employees, customers, suppliers, competitors and creditors), and secondary stakeholders (local communities and public). Stimpson and Taylor (2013) argue that the financial performance of a business relies on good stakeholder management, and not just focusing on the shareholders. By identifying stakeholder who are most important to the success of the business, the stakeholder theory states that more effect should be concentrated on managing the businesses relationship with them. (Stimpson and Taylor, 2013)
In the case of BHS, the effects on their collapse rippled through society and the impacts on society were damaging. When BHS collapsed 11,000 employees lost their jobs along with further jobs lost among their suppliers who relied on BHS for income, unpaid creditors only received 3p to the £1. (Armstrong, 2016) As well as this, the £571 million black hole in the pension fund left 20,000 pensioners facing lower benefits, which would be paid out by the government. (Sky News, 2016) In addition, the government have to pay benefits to 11,000 unemployed members of the public and 20,000 pensioners who will not be paying tax back into the country, which ultimately affects money spent on the NHS, schools and education as well as personal social services and social protection.
It is incredibly important that organisations recognise the impact, which they have on their stakeholders. Carillion, which collapsed in 2018, had a damaging effect globally leaving 43,000 employees unemployed, and school construction sites they had started unfinished. (Thomas, 2018) The most damaging and almost irreversible effect is on the public who lose trust in large companies, like BHS and Carillion; the public are not going to invest their money if they do not trust corporate governance of companies, as they may assume organisations are run in the best interests of stakeholders. Because of this, stronger legislation needs to be implemented across organisations to create stronger corporate governance and ensure that organisations are acting fairly and demonstrating social responsibility to its stakeholders.
The ethical behaviour of an organisation interlinks with corporate governance and corporate social responsibility. If an organisation is not socially responsible, they will be not be acting in an ethical manor. (Hartman et al., 2018) Three theories of ethical behaviour have been identified by Stimpson and Taylor (2013); consequentialism, deontology and contractualism. Consequentialism states that if the outcome of actions is ethical then the steps, which were took to achieve it, are in turn ethical, whatever they may be. (Stimpson and Taylor, 2013, p.66) Deontology identifies that if the outcome of actions is to be ethical, then all the steps, which were, took to achieve must be ethical too, otherwise the outcome would become unethical. (Stimpson and Taylor, 2013, p.66) Contractualism states that each individual has a different notion of what action is ethical or unethical. For example, an individual may think an action is ethical whereas another individual may disagree and think it was unethical. It states that there are ‘no moral absolutes’. (Stimpson and Taylor, 2013, p.66)
Hartman et al. (2013) identifies that the right organisational structure and culture in an organisation will make it harder for someone to behave unethically. Sir Philip Green behaved unethically on several counts throughout his reign at BHS, along with Dominic Chappell. Both of these individuals unethically withdrew money from BHS. Sir Philip Green paid out £423 million in dividends most of which went to him and his family (Armstrong, 2016) and Dominic Chappell withdrew £1.5 million from company funds in BHS’s dying days. Unfortunately, if no legislation is in place or no laws have been broken there is no punishment for directors acting unethically. Unethical leadership leads to a poor corporate culture, which affects their corporate social responsibility, directors who act unethically, are most typically acting in the best interest of themselves, most likely for personal monetary gain, which has negative impacts on their stakeholders. In the case of BHS, a lack of internal controls and poor corporate governance allowed Sir Philip Green and Dominic Chappell to behave unethically and consistently make unethical decisions, which contributed significantly to the collapse in 2015.
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