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By Professor Mak Yuen Teen

The fall of a giant

Before its collapse, Carillion was the second largest construction company in the United Kingdom (U.K.). The firm boasted approximately 43,000 employees, generated revenues of between £3 billion to £4 billion, and had a market capitalisation of around £2 billion.

In early January 2018, Carillion ran into major difficulties and collapsed. In addition to destroying shareholder value, the company’s demise left unfunded pension liabilities of approximately £2.6 billion with respect to 27,000 employees. Thirty thousand unpaid suppliers were collectively owed £2 billion, and there was uncertainty regarding hundreds of service contracts with an estimated cost of around £150 million to ensure continuity of services.

Birth of Carillion

Carillion demerged from Tarmac Group in 1999. Thereafter, Carillion grew rapidly and expanded beyond the construction sector into facilities management. Most of its growth was attributed to acquisitions aimed at removing competition. Mowlem – one of the U.K.’s largest construction and civil engineering firms – and Alfred McAlpine – a sizeable construction firm – were acquired by Carillion in 2006 and 2008 respectively. In 2014, Carillion tried unsuccessfully to merge with one of the largest players in the market, Balfour Beatty. Balfour Beatty was skeptical about the potential benefits from cost savings. In 2011, Carillion purchased Eaga plc (Eaga), a supplier of heating and renewable energy services. Before the acquisition, Eaga had accumulated profits of £31 million. However, five years after the merger, its losses totaled £260 million. At the same time, Carillion failed to fund its pension deficit of £605 million.

Carillion did not appear have a clear strategy for its acquisitions and consistently paid more than the target’s net identifiable assets. As a result, large amounts of goodwill were accumulated. Failing to generate synergies from its acquisitions, Richard Howson, the former Chief Executive Officer (CEO) of Carillion, stated that the company would shift its strategy to bid aggressively for contracts to generate cash, leading Carillion into an international expansion to gain exposure to new markets.

Spread your wings and learn how to fly

In 2011, Carillion had a contract with Msheireb Properties, a construction company based in Qatar, to build residential and commercial buildings in Doha.10 However, in 2018, there was a major dispute between Carillion and Msheireb Properties regarding a £200 million payment from the Qatari company to Carillion,11 and this was identified as the cause of the liquidation of Carillion’s Qatari arm in the same year.

It was later discovered that even though a 2009 board strategy paper gave a poor outlook on the Middle East market, Carillion still pursued several construction partnerships in the region, including 13 construction contracts in Qatar between 2010 and 2014.

The people behind the scene

According to the Corporate Governance section of Carillion’s annual report, the majority of the board members were independent directors. Some of the directors, including the Chairman, had numerous external roles as well. Carillion’s board consisted of seven members as of 2016, comprising an independent Chairman, two executive directors who were the CEO and Chief Financial Officer (CFO), and four independent non-executive directors. In line with the U.K. Corporate Governance Code, all directors of Carillion offered themselves for annual re-election at each Annual General Meeting.

Board committees

The Audit Committee (AC), led by Andrew Dougal, reviewed and reported to the board on the Group’s financial reporting, made recommendations on the appointment of external auditors, and reviewed the external and internal audit functions. Risk management functions came under the purview of the AC as well. Carillion’s internal audit was outsourced to Deloitte.

The Remuneration Committee (RC) reviewed and advised the board on remuneration arrangements for the Chairman, executive directors and their direct reports. This committee, chaired by Alison Horner, increased the remuneration of numerous senior staff in 2016 despite the company’s declining share price. Howson, the CEO of Carillion at that time, also received bonuses of more than 30% of his salary even though he did not meet any of his financial performance targets. Additionally, Carillion changed its pay policy in 2016, which made it more difficult for the company to recover or claw back executive bonuses.

The Financial Reporting Council (FRC) Stewardship Code maintains that “investors monitor the performance of companies in which they invest, including by checking on the effectiveness of leadership and the quality of reporting”. BlackRock was one of the major shareholders in Carillion. In 2016 and 2017, BlackRock rejected a request from Carillion’s RC to support the increase in remuneration and bonuses for the executives of Carillion. Amra Balic, managing director of BlackRock, said that focus of Carillion’s board was on the executives’ remuneration and not on what was happening to the company.

Executive directors

Carillion had two senior executives on the board of directors. They were the CEO and CFO of the company.

Chief Executive Officer
Howson was the CEO of Carillion from January 2012 and resigned in July 2017 following the company’s profit warning. He had joined the board in 2009 and was its longest-serving member. He was the Chief Operating Officer (COO) of the company prior to his appointment as CEO. The company’s 2016 annual report said that Howson possessed “detailed knowledge of key business units” and operational leadership experience.

After Howson resigned in July 2017, he was replaced by Keith Cochrane as interim CEO. Cochrane was an independent non-executive director. He is a chartered accountant who had worked at Arthur Andersen.

Chief Financial Officer
From 2007 to 2017, Carillion had three CFOs. Richard Adam held the role from 2007 to 2016. His successor, Zafar Khan, was Carillion’s CFO for a mere nine months, from 1 January 2017 to 11 September 2017, before passing the baton to Emma Mercer.

Adam started his career as an audit manager with KPMG. During the U.K. inquiry into Carillion’s collapse, he was severely criticised and named as the “architect of Carillion’s aggressive accounting policies who resolutely refused to make adequate contributions to the company’s pension schemes”. Adam also proceeded to sell £776,000 worth of his Carillion shares in March and May 2017.

Khan was previously the CFO of Associated British Ports Holdings before joining Carillion in 2011. In 2016, Khan was promoted to CFO from his prior position as the Group Financial Controller. He was fired by Carillion’s board in September 2017, having “spooked” the board with a financial update that showed the company’s poor situation. During the inquiry, many directors tried to put the blame on him for the company’s collapse.

Mercer was often referred to in the press as a “whistleblower”. During the inquiry, she was described as “the only Carillion director to emerge from the collapse with any credit”. When she was in charge of finances of the Group’s construction department immediately prior to becoming CFO, she raised concerns about Carillion’s accounting practices to the Group’s human resources department – going through internal whistleblowing processes, and eventually bringing it up to the board in May 2017. It took Mercer just six weeks after taking over as CFO to “spot and pull the thread that unraveled the company”.

Corporate culture

The U.K. Corporate Governance Code states that the underlying principles of good governance are accountability, transparency and a focus on the long-term success of an entity. After the collapse of Carillion, Phillip Green, who was the Chairman of Carillion since May 2014, insisted that Carillion’s board upheld those standards, describing a culture of “honesty, openness, and transparency”.

However, after the liquidation of the company, minutes from a board meeting in August 2017 showed that there was a culture of manipulation of numbers and “wilful blindness” among long-serving staff with regard to what was happening in the company. In view of this, the board emphasised that the culture of the organisation required urgent changes.

When Carillion collapsed in January 2018, the Group’s structure consisted of 326 companies across many geographical locations. A representative of The Insolvency Service in the U.K. stated that it was difficult to ascertain basic information, such as director listings, from these companies.

Carillion also had a rather dispersed shareholding structure, with major shareholders each holding around 10% or less.

Lack of shareholder engagement

In Carillion’s 2016 annual report, the firm stated that it strove to engage in “regular dialogue with shareholders to discuss and take feedback on its remuneration policy and governance matters”.

However, institutional investors became frustrated by the behaviour of Carillion’s board as the responses given by them were incomplete and vague. As a result, some investors such as Standard Life and Kiltearn Partners started to divest their investments in the company. They were “left with little option other than to divest” due to the company’s failure to provide trustworthy information and respond accordingly to investors’ enquiries and discussions.

How to earn money – the Carillion way

Carillion operated three primary businesses:

  • Support services, which the company described as the provision of maintenance, facilities management and energy services for major property and infrastructure.
  • Project finance, which included arranging the funding for Public-Private Partnership projects and delivering public sector properties and infrastructure.
  • Construction services, which included the delivery of properties and infrastructure.

To drive revenue growth, then-CEO Howson believed that Carllion had to bid aggressively to secure contracts and make money, which exerted a strain on margins.

Carillion disclosed its 2016 financial performance partly through the use of Alternative Performance Metrics (APMs) “to present additional information that reflects how the directors measure the progress of the Group”. The APMs were determined by adding back traditional accounting items such as (i) non-recurring charges, (ii) change in fair value of financial instruments and currency instruments, and (iii) amortisation of intangibles.

In Carillion’s financial reports, revenue was recorded based on recognition of revenues and margins from the company’s portfolio of construction contracts. Its revenue recognition policy was based on management’s estimates that were reviewed by the AC. The AC had determined that management’s estimates were reasonable.

In July and August 2017, Deloitte examined peer reviews conducted between January 2015 and July 2017 related to the construction contracts. It found that Carillion’s management contract appraisals tended to report higher profit margins than its peers. Differences between the two assessments were substantial: in more than 50% of the cases where the peer review pointed to a lower margin, the differences exceeded £5 million.

Further, board minutes revealed that the board was aware of the concerns related to the aggressive accounting methods. Board meeting minutes from June 2017 stated that “management need to be aware that high-level instructions such as that to ‘hold the position’ (i.e. maintain the traded margin) may, if crudely implemented, have unintended consequences”.

Additionally, the board members had personal incentives to present a rosy picture of the company. Board minutes from March 2015 showed that the Carillion board raised concerns about potential claw-backs of director bonuses, saying that the bonuses should not include “retrospective judgements on views taken on contracts in good faith”.

While the growth in its revenues was substantial at around 10%, the company continued to experience chronically weak margins. Gross margins were in single digits from 2009 to 2016.

Despite the weak margins, Carillion’s board had been increasing the dividend payouts yearly since the company’s inception in 1999. This was despite its stated policy of only distributing dividends when the net profit was strong and sustainable.

Although net profit decreased in 2012 and 2013, the company still increased its dividend payments. A dividend distribution of £55 million was made just one month prior to its profit warning on 10 July 2017. Despite proposals from then-CFO Khan to withhold dividends and pay off debt, Dougal, the AC Chairman, and Keith Cochrane, a senior independent non-executive director, supported the dividend distribution for fear of market ramifications.

Pension schemes

The most significant pension schemes arose from the acquisition of Mowlem and Alfred McAlpine. By the end of 2011, the pension deficit arising from these companies amounted to £424 million. In the U.K., it is mandatory for pension schemes to be valued at least once every three years to assess if the statutory funding objective is met. Carillion had deficits of £327 million in 2008, £617 million in 2011, and £439 million in 2013.

After the profit warning in July 2017, Carillion stated that it would cut costs. The pension scheme payments were one of the ways for the company to do so.61 It was later discovered that Carillion’s directors were not part of the pension scheme. Managing risk of pension deficit was excluded from the directors’ performance indicators.

Debt and other liabilities

Carillion had also been taking more debt to fund its operations. The build-up of liabilities and the company’s inability to service its debt sparked concerns among Carillion’s shareholders.

However, Carillion’s growing debt did not seem to be a major concern to the board. Keith Cochrane, a non-executive director in Carillion, described the debt and pension deficit as a lesser concern in 2015. On hindsight, many of the directors agreed that the debt level was unsustainable.

Additionally, Carillion relied on an extensive network of suppliers. At the point of the company’s collapse, the trade association of construction in the U.K. estimated that Carillion’s supply chain included almost 30,000 companies which were owed money by Carillion.

Carillion signed the U.K. government’s Prompt Payment Code in 2013, under which the company pledged that it would pay suppliers on time. However, Carillion paid its suppliers late. Early payment schemes, in which the contractors could get additional discounts by paying the suppliers at an earlier time, were made available in the U.K. in 2012 and Carillion was one of the first participants. However, after signing this scheme, Carillion changed its payment terms to 120 days. CFO Mercer claimed that this was a deliberate strategy employed by Carillion to improve its working capital.

Accounting practices

Many institutional investors questioned the timing of the £845 million provision made in July 2017. They were uncertain if the management knew or ought to have known earlier about the £845 million impairment. Of the £845 million, £729 million were from revenues that should not have been recognised in the first place.

Moody’s, one of the world’s leading credit agencies, claimed that Carillion had concealed its true level of borrowing from financial creditors. Carillion presented bank borrowings as liabilities to other creditors, instead of recording them as bank borrowings. As a result, as much as £498 million was claimed to have been misclassified.

Mercer spotted an unusual way in which the company was classifying receivable balances for construction contracts. Subsequently, she flagged out the company’s aggressive accounting policies. The board of Carillion then engaged KPMG to review work that it had previously audited and approved. KPMG agreed that Carillion had misclassified its assets, but it stressed that the company had not misstated its revenue.

Khan, who signed off the 2016 annual report, said that he did not adopt aggressive accounting. When KPMG sought clarification with management as to whether the company’s financial statements were misstated due to fraud or error, the board answered that provisions were made due to a deterioration of construction contracts between March and June 2017.

The review done by KPMG eventually led to the £845 million in impairment made in July 2017.

The world finds out

A profit warning was issued on 10 July 2017 after the £845 million in impairment was made. This impairment erased seven years of Carillion’s profits. The financial health of the company was then called into question, as net liabilities now amounted to £405 million and borrowings also increased to £961 million. Goodwill recognised on the balance sheet was reduced by £134 million and the working capital ratio fell to 0.74.

Even before the disclosure was made, there was a sell-off of Carillion stock. Carillion’s share price fell by approximately 70% over a short span of five days from 7 July 2017 to 12 July 2017, and it did not recover prior to the eventual liquidation of the company on 15 January 2018. Most institutional investors had sold their shares after the July 2017 profit warnings.

Was the external auditor at fault?

KPMG had been Carillion’s auditor since 1999.78 In March 2017, KPMG signed off the company’s 2016 annual report, stating that it gave a “true and fair view of the financial statements provided by the company”.

However, on 10 July 2017, four months after the 2016 annual report was published, Carillion issued a profit warning, reporting impairment charges amounting to £845 million. A second profit warning was issued in September 2017, with an increase the amount of impairment to £1.045 billion.

In mid-January 2018, Carillion officially became insolvent. With only £29 million in cash, the company was unable to repay debt exceeding £1 billion to banks, £2 billion to suppliers and £2.3 billion to pension holders.

On 29 January 2018, the FRC started an inquiry into the 2014, 2015 and 2016 audits of Carillion, focusing on accounting estimates and recognition of revenue for significant contracts, and accounting treatment for pensions. In early 2019, FRC announced a second investigation regarding KPMG’s audit of Carillion’s accounts.

KPMG was questioned by the FRC about its competence in performing adequate testing of revenue for certain audits and about its testing for impairment of goodwill. In particular, FRC questioned whether KPMG had sufficiently challenged management’s assumptions on goodwill impairment.

What about the internal auditor?

Deloitte had been Carillion’s internal auditor since 2010. Annual fees of about £775,000 were charged.

Throughout Deloitte’s appointment as internal auditor, a number of recommendations were made. However, issues raised were normally not deemed to be of high priority by Deloitte. Out of 309 recommendations between 2012 and 2016, only 15 were deemed to be such. Moreover, out of 61 internal audit reports made in 2015 and 2016, only one cited a lack of internal controls. The FRC’s enquiry found that Deloitte did not know about the ongoing dispute with Msheireb Properties with regards to the £200 million of debt owed. The FRC’s view was that Deloitte had failed in performing its professional duty to identify insufficient risk management and financial controls.

Apart from being Carillion’s internal auditor, Deloitte also acted as advisors to the RC, providing advice on the company’s pension scheme and undertaking due diligence for the acquisition of Eaga in 2011. After the acquisition, Deloitte received £730,000 in fees for attempting to restructure Eaga to improve profitability.

Involvement of other Big Four accounting firms

Ernst & Young (EY) was another big four accounting firm engaged by Carillion to try to turn it around. After the profit warnings in July 2017, it was tasked with a cost reduction project to cut £123 million in expenses.

PwC was later engaged to be the special manager in the liquidation of Carillion by the government. At the same time, PwC was engaged by the pension trustees of Carillion to advise on how to protect the members of the pension schemes while Carillion was facing worsening financial difficulties. It also advised the government, a major Carillion shareholder, on contingency plans in the event of the collapse of Carillion.

FRC’s handling of Carillion

The FRC is the regulator of accountants, auditors and actuaries in the U.K. and its primary responsibilities includes maintaining high standards of financial reporting and auditing and pursuing sanctions against those who fall below established professional standards.

Generally, the FRC can take legal action with respect of misconduct and breaches of professional standards. However, the U.K. Corporate Governance Code operates on a “comply or explain” basis. Directors of companies are not subjected to legal action for non-compliance with the Code. It is principally a matter for shareholders to ensure that the board complies with the Code and that the company is managed effectively.

As early as 2015, FRC identified some concerns relating to Carillion’s poor disclosure of information. It reviewed the company’s accounts and found that there were inadequate disclosures by the company. After Carillion made the necessary disclosures, FRC did not follow up the following year. In addition, FRC had not evaluated the audit of Carillion accounts by KPMG since 2013 despite reports of aggressive accounting practices. FRC only took action after the first profit warning in July 2017.

After the collapse of Carillion, FRC conducted a thorough audit review for Carillion, starting from the financial year 2014. On 19 March 2018, it started an investigation into the conduct of Adam and Khan with regards to their respective approvals of Carillion’s financial statements.

However, under its powers at that time, the FRC could only act against those with accounting qualifications. Thus, it could not launch an investigation into all the directors who had certain powers over the financial statements. Additionally, the CEO of FRC shared that the FRC’s enforcement team had only been increased from 20 to 29 since January 2016, although it had forward plans for increasing manpower.

Government’s role

In 2011, the U.K. Cabinet Office introduced a new approach – the ‘Crown Representative’ network – for how the government engages with its key strategic suppliers. Its role was to “act as a focal point for particular groups of providers looking to supply to the public sector”.

The U.K. Cabinet Office has the responsibility to monitor financial information, especially regarding “trigger events”, referring to information that “could potentially lead to the invocation of financial distress measures in government contracts”. An example of a trigger event was the profit warning issued by Carillion. From July to November 2017, Carillion issued a total of three profit warnings.

However, from August to November 2017, no Crown Representative was appointed to Carillion. The government said that this temporary vacancy did not affect its ability to identify Carillion’s problems.

Pension trustees and pension regulators

Trustees invest the assets of a pension scheme and are responsible for ensuring members’ benefits are secured and that it is run smoothly. However, Carillion exercised budgetary control over the trustees. As a result, the pension trustees had very limited power. Thus, to recover pension payments, they had to write to the pension regulators to intervene.

Unlike the trustees, pension regulators have powers under Section 231 of the U.K. Pensions Act 2004 to impose a schedule of pension contributions. However, the regulators did not enforce this on Carillion. Furthermore, the pension regulators failed to challenge Carillion about its dividend policy, instead merely acknowledging that the company dividend payment to pension contribution was better than other listed companies. It also stated that it would not prevent the company from paying out a dividend if it the company believed it was the right thing to do.

Plea for government support

Carillion eventually sought financial aid from the government on 31 December 2017. Although the government and Carillion were in discussions at the time, the only aid that the government had given to Carillion was a deferral of tax liabilities under a HM Revenue and Customs “Time To Pay” arrangement valued at £22 million in October 2017.

Subsequently, Carillion made another request to the government to defer tax liabilities totaling £91 million from January to April 2018. However, it did not succeed in its request. The government ignored further requests for guarantees or administration, aimed at propping up a failing business. Carillion’s fate was thus sealed.

The end

Carillion’s 2016 annual report stated the company as “one of the U.K.’s leading integrated support services companies, with a substantial portfolio of Public Private Partnership projects, extensive construction capabilities and a sector-leading ability to deliver sustainable solutions”. However, Carillion and its five subsidiaries were wound up by the U.K. High Court on 15 January 2018. The court appointed David Chapman, the Official Receiver, as liquidator.

The collapse of Carillion had great repercussions that affected many stakeholders. By April 2018, there were more than 1,800 redundancies.108 The Official Receiver estimated that total liabilities could be as high as nearly £7 billion. Taxpayers also borne the brunt of the collapse as the Redundancy Payment Office made around £50 million in redundancy payments to workers, with the final bill likely to be around £65 million.

In February 2019, it was announced that £413 million had been recovered from Carillion with more recoveries to come. However, it was “far too little and too late” for those badly affected by the collapse of Carillion, including its employees, suppliers and customers.


Discussion questions

  1. Directors are supposed to act in the interests of the company. To what extent are they required to take into account the interests of stakeholders, other than shareholders? What steps should directors take in ensuring that interests of different stakeholders are taken into account? In Carillion’s case, do you think the directors have adequately discharged their duties?
  2. In your view, who was most responsible for Carillion’s collapse? Analyse the role of different players who contributed to the company’s eventual downfall.
  3. Examine Carillion’s financial performance and position prior to the collapse. What were some of the primary issues with Carillion’s financial position? Assess how the company dealt with its financial issues.
  4. Critically evaluate the remuneration policies for directors and senior management of Carillion before its collapse and compare them with the financial performance of the company. To what extent did the remuneration policies contribute to its collapse?
  5. Assess the handling of the Carillion scandal by the regulatory bodies in the U.K. What should the government and regulators have done to protect various stakeholders?
  6. The external and internal auditors form the third line of defence for internal control and risk management of a company. Assess the effectiveness of the external and internal auditors in performing their roles. What factors may have impeded their effectiveness? Explain.
  7. The Carillion collapse has led to intense scrutiny of the accounting industry, in particular, the dominance of the Big 4 firms and contributed to a breakdown in trust of the value of the external audit. What changes, if any, do you think are necessary to improve trust in the external audit?


The content was first published on CPA Australia.

Photo by Dayne Topkin on Unsplash.