The Horsemen of Corporate CollapseDate Released: Sat, 1 June 2019 15:33 +0200
With all the revelations emanating from South Africa’s many commissions of inquiry we might start thinking this is the only place in the world with misdoings of the magnitude of Steinhoff, Bosasa, Eskom and the many-headed State Capture companies. It’s not, it’s a global issue.
I certainly don’t draw comfort from the fact that we are not alone. The extent of poor governance, corporate misdemeanours and unethical business practices the world over points to an alarming trend of companies proclaiming good governance, accountability, transparency, probity and a focus on the sustainable success, but doing the opposite.
A recent, spectacular example of corporate failure, this time in the UK, was the public listed company Carillion. On Jul 9, 2018 the international news agency Reuters announced: Carillion, which employed 43 000 people to provide services in defence, education, health and transport, collapsed in January, becoming the largest construction bankruptcy in British history. It left creditors and the firm's pensioners facing steep losses and put thousands of jobs at risk’.
The collapse was put down to ‘recklessness, hubris, and greed’, according to the inquiry into and report on Carillion by the UK’s House of Commons Business, Energy and Industrial Strategy and Work and Pensions Committees. As we await the report on Steinhoff, what is interesting to note is that the pattern of ethical and moral abdication worldwide is often the same.
It is also consistent with the considerable body of theory and empirical research on how corporate misdemeanours follow a routine pattern of moral disengagement, moral justification and displacement of responsibility which leads to unethical behaviour, lack of accountability, recklessness, hubris and greed.
Too often, hubristic corporate leaders transform into self-pitying victims when their company collapses and instead of taking responsibility they blame market forces turned against them or unscrupulous competitors, or people hiding misdoings from them.
Business ethics researcher Professor Adam Barsky from the University of Melbourne has extensively researched moral disengagement and unethical behaviour, and his work from 2011 is as valid today, with the passing years having offered an exponential increase of examples. He logically sets out the predictable pattern of organisational corruption, with obvious red flags and neon signs along the way.
In the Journal of Business Ethics, Vol. 104, No. 1 (November 2011) in an article titled Investigating the Effects of Moral Disengagement and Participation on Unethical Work Behaviour, Barsky offers the following ‘Unethical Deception Scale’ checklist. All companies need to answer how many of the 12 points get a ‘Yes’.
Unethical Deception Scale
1. Conceal information from the public that could be damaging to your performance. 2. Report financial data inappropriately to make it seem you are performing your job better than you are.
3. Conceal information from your supervisor that might be detrimental to your performance.
4. Withhold negative information about your products or services from customers and clients.
5. Exaggerate the truth about financial information (e.g. revenue, losses, budget etc.) to make your performance look good.
6. Exaggerate the truth about your company’s products or services to customers and clients.
7. Misrepresent the truth to the internal auditor to help make your finances (e.g. revenue, losses, budget etc.) look good.
8. Fail to inform customers or clients of important changes to your products or services.
9. Misrepresent financial data to your customers, clients, or shareholders.
10. Understate losses or expenditures to make your department's financial situation look better.
11. Misrepresent the truth to your supervisor to help make your finances (e.g., revenue, losses, budget, etc.) look good.
12. Withhold negative information from a potential client or customer about your services or products.
Too many ‘Yes’ answers strongly indicate moral disengagement in the company, which paves the way for recklessness, hubris and greed, and the risk of corporate collapse. So what are some of the red flags for this?
In an opinion piece in the New York Times by James Comey former F.B.I. director,
titled How Trump Co-opts Leaders Like Bill Barr, he describes how moral disengagement is never the work of one person.
People have been asking me hard questions. What happened to the leaders in the Trump administration, especially the attorney general, Bill Barr, who I have said was due the benefit of the doubt?
How could Mr. Barr, a bright and accomplished lawyer, start channeling the president in using words like “no collusion” and F.B.I. “spying”? And downplaying acts of obstruction of justice as products of the president’s being “frustrated and angry,” something he would never say to justify the thousands of crimes prosecuted every day that are the product of frustration and anger?
Comey points out how many accomplished people lacked the inner strength to resist the compromises required to remain on Trump’s team and comply with ‘management orders’. He says the only person who has emerged with honour from the Trump administration is James Mattis. His moral fibre is such that he walked away.
It takes character like Mr. Mattis’s to avoid the damage, because Mr. Trump eats your soul in small bites.
It starts with your sitting silent while he lies, both in public and private, making you complicit by your silence. In meetings with him, his assertions about what “everyone thinks” and what is “obviously true” wash over you, unchallenged …
Speaking rapid-fire with no spot for others to jump into the conversation, Mr. Trump makes everyone a co-conspirator to his preferred set of facts, or delusions. I have felt it — this president building with his words a web of alternative reality and busily wrapping it around all of us in the room.
… Of course, to stay, you must be seen as on his team, so you make further compromises. You use his language, praise his leadership, tout his commitment to values.
And then you are lost. He has eaten your soul.
It’s no different in the Carillion and Steinhoff-type corporate environments.
In the Carillion case, the report by the House of Commons Business, Energy and Industrial Strategy and Work and Pensions Committees references a wide range of research including Sridhar Ramamoorti, David Morrison, Joseph Koletar and Kelly Pope’s ABCs of Fraud which elaborates on the antecedent conditions of fraud, and distinguishes between the bad apple, bad bushel and bad crop.
Perpetrator/s are categorised as apple (individual fraudster), bushel (collusive fraud) or crop (collusive fraud with an ethically bereft tone-at-the-top).
In the Carillion case the parliamentary committee is very clear that there was a rotten corporate culture (equating to a bad crop) with the associated undesirable behaviour, of executive leadership pushing the blame onto someone else and morally justifying what they did.
The Barksy article elaborates on moral justification. It says the first rationalisation of moral justification involves “cognitive reconstruction of the behaviour itself” where the person justifies to themselves the morality of their actions by attributing them to being in the service of higher loyalties or important causes. One example is the decision-makers at Enron who were quoted as ‘morally justifying’ their fraudulent behavior by attributing it to the important cause of ‘creating a deregulated and ultimately better energy market’.
Barsky goes on to offer several hypotheses for moral justification, moral disengagement, deceptive behaviour and displacement of responsibility.
In Barsky’s Hypothesis 1, for example, he says ‘moral justification is positively related to engagement in deceptive behaviour’. Linked in to this is ‘displacement of responsibility’. Barsky explains that this form of self-deception removes the ethical decision from the leadership’s backyard due to ‘circumstances beyond their control’, thus watering down the ethical demands of the situation.
Barsky says the circumstances may include management orders, peer pressure, dire financial straits or existing precedents. And when leaders don’t behave as they should, it sets the wrong tone as employees look to the leaders for standards of conduct. They are more likely to report problems or misconduct in an atmosphere of good leadership but when you don’t lead by example how can you expect the people working for you to do so?
Research further shows that staff compliance with unethical leadership tends to be far higher in an autocratically run organisation. Barsky says if you give people the opportunity to engage in the decision-making in a participatory process, it is less likely that deception will occur as people at all levels tend to feel more accountable for their actions.
In the Carillion report the committee members speak about Carillion’s rotten corporate culture where individuals at the top wielded enormous power but still tried to morally justify why things went wrong. By extrapolation, Carillion’s collapse followed the predictable pattern of: 1. Moral justification 2. Displaced responsibility and refusal to take responsibility for the collapse 3. No participation in the way the company goals were set 4. Not setting the right example from the top of how things should be done and therefore giving people below the ‘licence’ to not do the right thing either.
Things can go wrong in business and companies do get into trouble, and this can be due to factors beyond the control of the decision makers. There is much to be learnt for example about the way in which Brand Pretorius dealt with the turnaround of McCarthy Retail Limited.
But what is particularly galling is top executives who are paid a huge amount of money to run things properly, and then don’t take responsibility. Frankly, too many don’t. In the Carillion case a number of questions were asked about this, such as why non-executive directors too often failed to scrutinise the executive directors, why internal controls were not maintained, why suppliers were treated with contempt - Carillion’s suppliers were paid 120 days after delivery except if they paid a fee for earlier payment, and why their aggressive accounting went unchecked. In repeated examples their aggressive accounting was nothing more than diddling the numbers.
The report questioned what ‘aggressive accounting’ for a company like Carillion would look like. It explained as follows: Much of Carillion’s revenue came from construction contracts that are inherently difficult to account for. Accruals accounting dictates revenue should be recognised when it is earned, not when it is received. For construction projects spanning several years, this means companies must assess how far to completion their projects are. This is usually done by reference to the costs incurred to date as a percentage of the total forecast costs of the project … This puts a great emphasis on total estimated costs of a project. As KPMG’s audit report on Carillion’s 2016 annual report notes, “changes to these estimates could give rise to material variances in the amount of revenue and margin recognised”. A company wanting to indulge in aggressive accounting would make every effort to minimise the estimates of total final costs to ensure that margins on contracts are maintained and greater amounts of revenue are recognised up front.
Deloitte, Carillion’s internal auditors, explained that the company had two processes to review margins reported by site teams: monthly Project Review Meetings (PRMs) at which a management contract appraisal could adjust the site team’s position; and peer reviews to “provide challenge to the financial, operational and commercial performance of contracts”.
In July and August 2017, Deloitte examined peer reviews conducted between January 2015 and July 2017 of the contracts which made up the £845 million provision. They found that management contract appraisals tended to report higher profit margins than peer reviews. In 42% of cases, three times as many, management used higher margins than recommended by the peer reviews.
Deloitte noted that the differences between the two assessments were far from trivial: in more than half the cases where the peer review recommended a lower margin, the difference exceeded £5 million. A November 2016 peer review of the Royal Liverpool University Hospital contract suggested a loss of 12.7%, compared with the contract appraisal margin of 4.9% profit. The result was that the annual accounts published in March 2017 recognised approximately £53 million in revenue in excess of what would have appeared had the peer review estimate been used.
This was the Carillion way, and in the Carillion report, the committee was particularly critical of three key Carillion figures: Richard Adam, Richard Howson and Philip Green.
Richard Adam was Carillion’s Finance Director for 10 years. He was the architect of Carillion’s aggressive accounting policies … His voluntary departure at the end of 2016 and subsequent sale of all his shares were the actions of a man who knew where the company was heading.
Richard Howson, Chief Executive from 1 January 2012 until his sacking when the company issued its profit warning on 10 July 2017, was the figurehead for a business that careered progressively out of control under his misguidedly self-assured leadership … Mr Howson demonstrated little grasp of the unsustainability of Carillion’s business model or the basic failings of governance that lay at the root of its problems.
- Philip Green joined the board in 2011 and became Chairman in 2014. Philip Green was Carillion’s Chairman from 2014 until its liquidation. He interpreted his role as to be an unquestioning optimist, an outlook he maintained in a delusional, upbeat assessment of the company’s prospects only days before it began its public decline. While the company’s senior executives were fired, Mr Green continued to insist that he was the man to lead a turnaround of the company as head of a “new leadership team”. Mr Green told us he accepted responsibility for the consequences of Carillion’s collapse, but that it was not for him to assign culpability. As leader of the board he was both responsible and culpable.
- The UK Corporate Governance Code says that a company’s Chairman is “responsible for leadership of the board and ensuring its effectiveness on all aspects of its role”. In this position, Philip Green oversaw low levels of investment, declining cash flow, rising debt and a growing pension deficit. Yet his board agreed year-on-year dividend increases and a rise in remuneration for his executive board colleagues from £1.8 million to £3.0 million. Mr Green was still at the helm when the company crashed in January 2018.
The committee felt compelled to spell out the definition of corporate governance:
Corporate governance is the process by which a company is directed and controlled. Its purpose is “to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company”. The UK Corporate Governance Code, held by the Financial Reporting Council (FRC), states that the “underlying principles of good governance [are] accountability, transparency, probity and a focus on the sustainable success of an entity over the longer term”. Philip Green told us that Carillion’s board upheld these standards, describing a culture of “honesty, openness, transparency and challenging management robustly, but in a supportive way”.
The documents we saw, however, showed a very different picture.
Remarkably, at the time of the 10 July 2017 profit warning, Carillion’s board was “thinking again how to remunerate executives rather than what was going on with the business”. The report explains that in the year’s leading up to the company’s collapse, Carillion’s remuneration committee paid substantially higher salaries and bonuses to senior staff while financial performance declined. It was the opposite of payment by results.
This is a familiar trend that we see in South Africa. What we also see is executive and non-executive directors who have behaved unethically, still maintaining top positions.
Alison Horner was a non-executive director and Chair of Carillion’s Remuneration Committee for four years. The report reads: Alison Horner presided over growing salaries and bonuses at the top of the company as its performance faltered. In her evidence to us, she sought to justify her approach by pointing to industry standards, the guidance of advisors, and conversations with shareholders. She failed to demonstrate to us any sense of challenge to the advice she was given, any concern about the views of stakeholders, or any regret at the largesse at the top of Carillion. Ms Horner continues to hold the role of Chief People Officer of Tesco, where she has responsibilities to more than half a million employees. We hope that, in that post, she will reflect.
The committee recommended that the Insolvency Service, in its investigation into the conduct of former directors of Carillion, includes careful consideration of potential breaches of duties under the Companies Act, as part of their assessment of whether to take action for those breaches or to recommend to the Secretary of State action for disqualification as a director.
The report states that the only Carillion director to emerge from the collapse with any credit was Emma Mercer. She demonstrated a willingness to speak the truth and challenge the status quo, fundamental qualities in a director that were not evident in any of the other directors who sought to blame everyone but themselves for the destruction they caused. A huge number of employees, suppliers and clients suffered because of their failure of leadership.
In South Africa, we await the outcome of the Steinhoff debacle with huge anticipation, as it is absolutely essential that our regulators, parliament and everyone involved starts getting far harder on executives and board members who take no responsibility for what happens. Where jail time is the sanction, then it must be enforced. Disgraced directors should be barred from sitting on boards. Of course the rule of law must prevail. But if the law must do its work, quick justice is essential otherwise the legal processes themselves become complicit in not rooting out these rotten practices. Then society loses out and these corporate misdemeanours fade from our consciousness.
Strong anti-fraud and anti-corruption behaviour needs to be front of mind for all members of governing bodies, explicitly considering prevention, deterrence and detection.
Prevention entails routinely encouraging ethical thinking in the organisation, emphasising its importance to the company as much as any other imperative such as productivity, and to deal decisively, without fear or favour, with violations of ethics, trust and responsibility, with a strong tone set from the top.
Deterrence requires that proper controls are in place, whistle-blower hotlines, activity monitoring at all levels, open communications with employees, vendors, suppliers and customers and perpetrator punishment protocols.
Lastly, detection would be proactive fraudulent identifying processes, with a strong understanding of potential fraud paths, and a proper understanding of the business model and what risks it faces by possible fraudulent activities at all levels.
All this emphasises the critical role of managerial values and behaviour in limiting the mechanism for moral disengagement and corruption. In reading this you might be left with more questions than answers but hopefully it can contribute to a step in the right direction and we can collectively start stemming the tide of the widespread corporate and political corruption with which we have become far too familiar in our own country and worldwide.
Source:Leadership Magazine http://mags.capemedia.co.za/leadership/404/