Carillion Contents


Government responsibilities

168.It will always be the case that even well-run companies will sometimes take poor decisions and be the authors of their own demise; no Government can prevent business failures. However, there are a number of lessons arising from the collapse of Carillion which may help to reduce the risks and impact of any future failures. These can be split into two categories. First, there are lessons for the Government on the way in which they manage the relationship with a company of such strategic importance. These are primarily matters for the Public Administration and Constitutional Affairs Committee. Second, the collapse of Carillion raises a series of questions about the wider business and pensions environment, for which the Government has ultimate responsibility, albeit much of it delegated to various regulators. The Government is responsible for ensuring that our current structure of stakeholder interests and incentives are balanced to best serve the public interest, and for ensuring that there is effective enforcement when things go wrong. Some of these issues are outlined below.

Government relationships with strategic suppliers

169.The wider implications of the collapse of Carillion for the way in which the Government outsources public services are currently the subject of an inquiry by the Public Administration and Constitutional Affairs Select Committee.481 We therefore do not explore this whole business model here and look forward to their report. But it is clear that the role of the Crown Representative is particularly in need of review. We noted in Chapter 2 the unfortunate absence of a Crown Representative in Carillion at a critical period, but we question whether the role as it stands is suited to the task of ensuring that the Government’s and the taxpayers’ interests are being properly served. Where a company is providing so many key services for Government, it is essential that the Government can maintain confidence in that company’s ability to deliver for the period it is contracted to do so. Carillion was a hugely complex company, it operated in the highly volatile construction and outsourcing services markets, and it entered into long contracts with uncertain returns. It seems inconceivable that a credible oversight function could be performed properly by an examination of published accounts and quarterly meetings with the board. Some individual Crown Representatives are responsible for three separate strategic suppliers: for example, the Crown Representative for Capita also covers Fujitsu and Motorola.482 A deeper engagement with the business at all levels is required, to gain an understanding of the company’s culture (for example, with regard to the timeliness of payments) and to enable any concerns affecting Government contracts to be detected and escalated early. While this may be a costlier system, that expenditure should be set against the actual costs now being incurred by the Government intervention to keep public services running following Carillion’s collapse. We recommend that the Government immediately reviews the role and responsibilities of its Crown Representatives in the light of the Carillion case. This review should consider whether devoting more resources to liaison with strategic suppliers would offer better value for the taxpayer.

Prompt Payment Code

170.The issue of late payments is not limited to Carillion. Ahead of the 2018 Spring Statement, the FSB published research showing 84% of small firms report being paid late, with 37% finding that agreed payment terms have lengthened in the past two years, hampering cash flow. Only 4% see payment terms improving.483 We welcome the Chancellor’s subsequent call for evidence on late payments in his statement;484 however, this is little comfort for Carillion’s suppliers and for others whose businesses are put at risk by late payers. The BEIS Committee will be considering the effectiveness of the Prompt Payment Code and its enforcement as part of its ongoing inquiry into small businesses and productivity.485

Corporate Culture

171.Responsibility for the wider business environment and culture is shared among Government, regulators and, of course, business itself. Business culture is set primarily by board members, who must act in accordance with duties set out in section 172 of the Companies Act 2006. Whether or not this law turns out to have been breached by Carillion’s directors, this case indicates that it is an inadequate influence on corporate behaviour. There is no realistic chance of shareholders bringing actions against board members for breach of their duties, given the impact such action would have on the share price.486 In its report on Corporate Governance, the former BEIS Committee flagged up the ineffectiveness of section 172, but also recognised the difficulties of achieving sufficient legal clarity to influence decision making in the boardroom without presenting an unreasonable degree of legal exposure.487 It advocated more specific and accurate reporting on the fulfilment of section 172 duties, combined with robust enforcement. The Government has accepted this recommendation but the necessary regulations required to implement the changes have still not been laid before Parliament.

172.Whilst the UK has in many respects an enviable system of corporate governance that helps to attract investment from around the world, too often the high-profile company failings exposed recently have arisen from rotten corporate cultures. We came across the systematic exploitation of workers, and inadequate rights that are meant to protect them, by some companies in our joint work on the Taylor Review of modern working practices.488 Examples of unjustified executive pay are by no means confined to Carillion, nor is the poor treatment of suppliers. Effective corporate governance is required to ensure responsible business ownership and to protect workers: it should not be left to the courts to clear up the corporate mess.

173.The Government has already begun to respond to some of these lessons, through the amendments to directors’ duties we have described, and to insolvency law. The White Paper on Insolvency and Corporate Governance published in March 2018 directly addresses some of the issues that our predecessor Committees raised in relation to BHS, and some relevant to the collapse of Carillion. These include proposals to:

a)Strengthen governance, accountability and internal controls within complex company structures;

b)Improve transparency around the payment of dividends and the circumstances in which they can be paid;

c)Improve the awareness of directors about the use of professional independent advisors;

d)Better protect supply chains and other creditors whilst preserving the primacy of the interests of shareholders.489

We welcome the Government’s consultation on implementing some technical reforms arising from recent company collapses. However, we do not believe that these changes, even if successfully enacted, would have prevented the corporate failures we have seen, nor tackle some of the systemic weaknesses in our corporate frameworks that enable these periodic disasters to occur.

174.The BEIS Committee is currently looking at different aspects of corporate governance, starting with action to improve the gender pay gap and to curb unjustifiably high executive pay. It plans to revisit the implementation by Government and regulators of some of the major lessons arising from the demise of BHS, Carillion and other corporate failures and to look at the extent to which corporate law supports the Government’s industrial strategy, not least in respect of takeovers.

Investors and stewardship

175.We set out in Chapter 2 the different approaches adopted by major shareholders and the collective failure of their combined stewardship responsibilities. Under the rules governing engagement, conversations between investor and company generally occur on a bilateral basis, other than in situations of corporate or economic stress.490 There are also requirements preventing the release of information that is not available to other investors and constraints on acting in concert in the Takeover Code. The BEIS Committee explored in its report on corporate governance the potential for the UK Investor Forum to provide a basis for concerted action in limited cases, but noted also the challenges presented by the trends towards highly dispersed share ownership and passive rather than managed funds.491 Proper engagement can be resource-intensive and—if the board is unreceptive—ineffectual, as with Carillion. In this scenario, it can make sense just to divest, or to stay in but rely on other institutional investors to engage effectively. There is also a strong financial interest for shareholders not to say anything in public which may have an adverse impact on the share price. This might help to explain why the press and Parliament sometimes appear to do a better job of holding company boards to account than shareholders.

176.The potential consequences of what some have characterised “ownerless companies”, subject to the whims of increasingly short-termist investors, have been subject to much debate and deserve consideration in the context of the Government’s industrial strategy. Some of the issues were highlighted in the recent hostile takeover of the supplier GKN by the turnaround specialist, Melrose. They won the battle for ownership of the company with promises of higher returns to shareholders, with a business model that envisages relatively short-term ownership. They were up against a company with a long history of supplying parts to the automotive and aerospace sectors, including defence-related components, in the UK and US. Whatever the objectives of the Government’s industrial strategy to support the development of productive sectors and supply chains in the UK, there is nothing in law or governance codes that requires investors to do anything other than look after their own interests. These may or may not align with those of the board, employees, or the long-term aspirations of the sector and government.

177.The Government has recognised that there is a problem. In its consultation on Insolvency and Corporate Governance, it includes a section on shareholder responsibilities in which it argues that “recent corporate failures make it right to ask whether a larger proportion of institutional investors could be more active and engaged stewards and whether more could be done to ensure that company directors and their investors engage constructively.”492 It asks for submissions on what changes could be made to the Stewardship Code to promote engaged stewardship, including the active monitoring of risk. It includes as possible options for reform:

This last option is reactive and of questionable impact, although fully in line with the tone of regulatory intervention in the corporate realm. It is odd that the Government itself is inviting submissions on reforms to the Stewardship Code when the FRC is already committed to an overhaul of that Code later this year and the Government has previously referred recommendations relating to the Stewardship Code to the FRC review.494

178.In its report on Corporate Governance, the previous BEIS Committee called for the revised Stewardship Code to provide more explicit guidelines on high quality engagement, requirements for greater transparency in the voting records of asset managers and an undertaking to call out poor performance on an annual basis.495 Following the Committee’s report the Government asked the Investment Association to establish a public register of those companies experiencing a dissenting vote of more than 20% in any reporting year. This is now established and should help provide greater transparency on the effectiveness of company engagement with investors. The implementation of the EU Shareholder Rights Directive should also help to address short-termism and insufficient oversight of remuneration and related party transactions.496

179.The effective governance of companies and faith in our business culture relies upon the effective stewardship of major investors. They in turn rely upon accurate financial reporting and honest, constructive engagement with company boards. The current Stewardship Code is insufficiently detailed to be effective and, as it exists on a comply or explain basis, completely unenforceable. It needs some teeth. Proposals for greater reporting and transparency in terms of investor engagement and voting records are very welcome and should be taken forward speedily. However, given the incentives governing shareholder behaviour, and the questionable quality of the financial information available to them, we are not convinced that these measures in themselves will be effective in improving engagement, still less in shifting incentives towards long-term investment and away from the focus on dividend delivery. A more active and interventionist approach is needed in the forthcoming revision of the Stewardship Code, including a more visible role for the regulators, principally the Financial Reporting Council.

The Pensions Regulator

180.Carillion consistently refused to make adequate contributions to its pension schemes, favouring dividend payments and cash-chasing growth. It was a classic case for The Pension Regulator to use its powers proactively, under section 231 of the Pensions Act 2004, to enforce an adequate schedule of contributions. Rt Hon Esther McVey MP, the Secretary of State for Work and Pensions, concurred with this assessment, telling us that TPR should have used that power.497 The other major corporate collapse the two Committees considered together, BHS, was also characterised by long-term underfunding of pension schemes. But the BHS case was different—the foremost concern in that case was the dumping of pensions liabilities through the sale of the company. The cases were, though, united by two key factors. First, a casual corporate disregard for pension obligations. And second, a pensions regulator unable and unwilling to take adequate steps to ensure that pensions promises made to staff were met.

181.The Work and Pensions Committee published a report on defined benefit (DB) pension schemes in December 2016.498 This drew on the joint inquiry into BHS and subsequent work on the wider sector. The Committee recommended that TPR should regard deficit recovery plans of over ten years exceptional and that trustees should be given powers to demand timely information from sponsors. It also recommended stronger powers for TPR in areas such as levying punitive fines to deter avoidance, intervening in major corporate transactions to ensure pensions are protected, and approving the consolidation and restructuring of schemes.499 Many of the recommendations of that report were adopted by the Government in its March 2018 White Paper, Protecting Defined Benefit Pension Schemes. The Government now intends to consult on the details of the proposed additional TPR powers.

182.The Work and Pensions Committee has commenced an inquiry into the implementation of that White Paper.500 The inquiry will be informed by the Committee’s work on problematic major schemes, which has been primarily conducted through detailed correspondence and has considered:

In the course of that work, it has become ever more apparent that, while some new powers are required, the problems in DB pensions regulation are primarily about the regulatory approach.

183.The Government and TPR recognise this concern and have pledged to act. The Secretary of State for Work and Pensions stressed that being “ tougher, clearer, quicker” should be the “key focus” for a Pensions Regulator which would be “on the front foot”.502 TPR told us that, while it accepted that “over the last decade there have been times when the balance between employer and scheme may not always have been right”, it was “a very different organisation from five years ago”.503 It is true that TPR has made changes:

184.These are positive developments, but what has this meant in practice? We were deeply concerned by the evidence we received from TPR, which sought to defend the passive approach they and their predecessors had taken to the Carillion pension schemes. Lesley Titcomb told us that TPR had secured an improved recovery plan for the schemes having threatened the use of section 231 powers.508 As we established in Chapter 2, the impact on the contributions received by the schemes was, at best, minimal. Mike Birch, said, with regard to section 231, “we do not threaten it when we do not think we would use it, so we were concerned”.509 However, in 13 years of DB scheme regulation, TPR has issued just three Warning Notices relating to its section 231 powers, and has not seen a single case through to imposing a schedule of contributions. In these circumstances, it is difficult to perceive a threat from TPR of using its section 231 powers as a credible deterrent. We have little doubt that the likes of Richard Adam took TPR’s posturing with a pinch of salt; other finance directors with his dismissive approach to pensions obligations would do likewise.

185.The hollowness of TPR threats is not restricted to its powers to impose contributions. The Pensions Act 2004 established a process of voluntary clearance for corporate transactions such as sales or mergers. Under this process, TPR can confirm that it does not regard the transaction to be materially detrimental to the pension scheme.510 It can therefore provide assurance that it will not subsequently use its powers to combat the avoidance of pension responsibilities, which could involve legal action and a requirement to contribute funds, in relation to the transaction.511 Though clearance applications were common in the early years of TPR’s existence, however, they soon fell rapidly into disuse:

Figure 8: Number of clearance cases handled by The Pensions Regulator

Sources: TPR freedom of information release 2016-02-10: “Numbers of cases of clearance relating to corporate transactions”; TPR Compliance and enforcement quarterly bulletins from April 2017 onwards; *Committee calculation based on the above.

TPR handled 263 clearance cases in 2005–06, but just 10 in 2016–17. This does not reflect a marked decline in corporate activity, but a realisation on the part of companies and their lawyers that threats from TPR are hollow: it is a paper tiger. There is little incentive to seek clearance to avoid being subject to powers that TPR has very rarely deployed with success.

186.The Government cited Sir Philip Green’s settlement with the BHS pension schemes as evidence that TPR’s anti-avoidance powers can be effective.512 But that settlement was driven primarily by considerable public, press and parliamentary pressure. To stand independently in protection of pension promises, TPR needs to reset its reputation and demonstrate a marked break with hesitancy. Yet in evidence to us, TPR’s current leadership defended its empty threats on Carillion, and displayed very little grasp of either which schemes were likely upcoming problem cases, or what TPR would do to protect the interests of members of those schemes.513 It is difficult to imagine that any reluctant scheme sponsor watching would have been cowed by TPR’s alleged new approach.

187.The case of Carillion emphasised that the answer to the failings of pensions regulation is not simply new powers. The Pensions Regulator, and ultimately pensioners, would benefit from far harsher sanctions on sponsors who knowingly avoid their pension responsibilities through corporate transactions. But Carillion’s pension schemes were not dumped as part of a sudden company sale; they were underfunded over an extended period in full view of TPR. TPR saw the wholly inadequate recovery plans and had the opportunity to impose a more appropriate schedule of contributions while the company was still solvent. Though it warned Carillion that it was prepared to do, it did not follow through with this ultimately hollow threat. TPR’s bluff has been called too many times. It has said it will be quicker, bolder and more proactive. It certainly needs to be. But this will require substantial cultural change in an organisation where a tentative and apologetic approach is ingrained. We are far from convinced that TPR’s current leadership is equipped to effect that change. The Work and Pensions Committee will further consider TPR in its ongoing inquiry into the Defined Benefit Pensions White Paper.

Financial Reporting Council

188.The timid and reactive engagement by the Financial Reporting Council with Carillion underlines the conclusion of the previous BEIS Committee that enforcement of corporate governance responsibilities is not strong enough. The Committee’s report recommended a more interventionist approach from an expanded and better-resourced FRC, including spot checks on companies to act as a deterrent against poor practice, and increased powers to allow it to initiate legal action against any director. The Government did not accept these ambitious recommendations. The Secretary of State for Business, Energy and Industrial Strategy, the Rt Hon Greg Clark MP, has consistently argued that the increased powers sought by the FRC are unnecessary. He told us that the powers that they need are there if they act jointly with the Insolvency Service and the Financial Conduct Authority.514 To this end, these regulators have now signed a Memorandum of Understanding (MoU) to facilitate better use of their different powers when investigating the same company. Stephen Haddrill was not convinced that this was sufficient, telling us “as we saw before the financial crisis, regulators can collaborate and then they stop collaborating. I would like to see some structure around that”.515

189.The present regulatory set up is convoluted and inconsistent. The FRC can pursue some directors, not others; monitor some reports but not others. There are too many regulators in the corporate kitchen, each with overlapping responsibilities but slightly different aims and agendas. Any government will know that it is hard enough to secure internal agreement, so to expect three or four regulators to cooperate seamlessly and harmoniously in pursuit of a common goal seems unrealistic and likely to slow down further already sluggish progress on investigations. Similar problems have been evident in pensions regulation. In its investigation into the British Steel Pension scheme, the Work and Pensions Committee found that steelworkers were gravely let down by two slow-moving and timid regulators—TPR and the FCA—who failed to co-ordinate to protect their pensions.516

190.The Government announced a review of the FRC on 17 March 2018, to be led by Sir John Kingman. The Government’s stated objective of the review is to ensure that the FRC will remain “best in class” and the scope is wide: it aims to “ensure that its structures, culture and processes; oversight, accountability, and powers; and its impact, resources, and capacity are fit for the future.”517 It is not clear from the terms of reference or the evidence from the Secretary of State whether this review is an effort to revamp a body judged reluctant to throw its weight around, or a vehicle to re-examine the case for tougher regulation of company directors and further powers for the regulators.518

191.At present, the role of the FRC is confused. It is the professional regulator for accountants but also responsible for the voluntary codes that guide the behaviour of directors and investors. It has an apparently little-known role in investigating complaints raised relating to its remit by whistle-blowers.519 The quality of audits, as we have seen, is not of a consistently high standard. The FRC reports that 81% of FTSE 350 audits in 2016 required only limited improvement, meaning that 19% were significantly below standard: not a ringing endorsement of a high quality and competitive audit market.520 Where standards fall below what is expected, the FRC is far too passive in demanding improvements and monitoring subsequent performance. It therefore offers no effective deterrent to sloppy auditing and accounting, and does nothing to dispel views that it is too sympathetic or close to the accountants and auditors it regulates.

192.The FRC does not appear to acknowledge a link, in terms of its responsibility, between adequate financial reporting, good corporate behaviour and the survival of companies. Stephen Haddrill told us that the FRC cannot see inside a company and does not oversee a system designed to stop companies collapsing. He argued against having powers to intervene in every company—there was a need for enterprise and must be room for failure—but advocated stronger powers to “be more transparent about the sorts of things we are finding.”521 This lack of transparency contributes to its inability to act as a credible threat to poor reporting practices. Companies can expect nothing more than a quiet word and encouragement to do better next time. There are signs that the FRC is beginning to adopt a more proactive approach.522 In April 2018 it invited representatives from the investment community to form an Investors Advisory Group, to improve engagement between the FRC and the broad investor community. That month it also announced plans to enhance the monitoring of the six largest audit firms to, amongst other matters, “avoid systemic deficiencies within firms’ networks”.523

193.This case is a test of the regulatory system. The Carillion collapse has exposed the toothlessness of the Financial Reporting Council and its reluctance to use aggressively the powers that it does have. There are four different regulators engaged, potentially pursuing action against different directors for related failings in discharging their duties. We have no confidence in the ability of these regulators, even with a new Memorandum of Understanding, to work together in a joined-up, rapid and coherent manner, to apportion blame and impose sanctions in high profile cases.

194.At present, the mindset of the FRC is to be content with apportioning blame once disaster has struck rather than to proactively challenge companies and flag issues of concern to avert avoidable business failures in the first place. We welcome the Government’s review of the FRC’s powers and effectiveness. We believe that the Government should provide the FRC with the necessary powers to be a much more aggressive and proactive regulator: one that can publicly question companies about dubious reporting, investigate allegations of poor practice from whistle-blowers and others, and can, through the judicious exercise of new powers, provide a sufficient deterrent against poor boardroom behaviour to drive up confidence in UK business standards over the long term. Such an approach will require a significant shift in culture at the FRC itself.

The Big Four

195.Regulation should not be the sole driver of audit standards. As with other markets, competition between providers should place upwards pressure on the quality of services and downwards pressure on the price. KPMG’s cursory approval of Carillion’s annual accounts as external auditor for all 19 years of the company’s existence bore none of the hallmarks of competition. This is far from an isolated problem: KPMG approved upbeat assessments of the state of HBOS months before the bank’s spectacular 2008 collapse.

196.KPMG’s close relationship with Carillion was not limited to its long tenure. Richard Adam, the longstanding Finance Director, and Emma Mercer, who took over that role, qualified as accountants at the firm.524 This is far from unusual: the Competition Commission found that two-thirds of chief financial officers of large listed and private companies were Big Four alumni. Alongside regular audit fees, which averaged £1.5 million per year between 2008 and 2016, KPMG was paid £400,000 per year on average for additional taxation and assurance services.525

197.Unlike in other markets, incentives to enforce the quality of audit services are skewed. The primary users of the audited accounts are shareholders and potential shareholders, who rely on trusted information about public companies.526 The audit is, however, paid for by the company, and directors can benefit from an auditor who is willing to turn a blind eye to sharp practice. This is particularly true when an established big-name brand brings credibility to financial statements. The auditor can expect a steady income for up to 20 consecutive years of audits. For example, in its report on KPMG audits of Pendragon, a motor retail group, the FRC found that the auditor operated with insufficient independence from the company.527 The FRC is currently investigating KPMG’s audits of the accounts of Rolls-Royce Group over a period when the engineering company admits it committed a series of bribery and corruption offences.528 Murdo Murchison said he would write to the audit committee chairs of the two other UK listed companies Kiltearn Partners invests in audited by KPMG, seeking assurances about the quality of that work.529 Euan Sterling, of Aberdeen Standard Investments, another company that invested in Carillion, said “reading a set of accounts is like reading a mystery novel”.530

Reviews of competition in the audit market

198.Concerns about independence and audit quality are not restricted to KPMG. Together, the Big Four global accountancy firms, PwC, KPMG, Deloitte and EY, have dominated the audits of major UK companies since the implosion in 2002 of Arthur Andersen, the fifth member of what was then a Big Five. The Big Four oligopoly has been subject to two official UK competition inquiries:

199.Both studies found substantial barriers to effective competition. For example, the prospect of a new firm entering the market should loom as a healthy threat to incumbent firms. Oxera’s report found that a rival to the Big Four was unlikely to emerge:

Substantial entry is unlikely to be attractive, due to significant barriers, including the perception bias against mid-tier firms, high costs of entry, a long payback period for any potential investment, and significant business risks when competing against the incumbents in the market.533

It concluded that market entry by mid-market firms was only feasible if reputational bias against smaller firms was reduced and low rates of switching between auditors were increased.534

200.The Competition Commission found that systemic factors acted against switching. Tendering for audit was expensive and had uncertain benefits. The incumbent firm had the opportunity to respond to any dissatisfaction from the audited company. Furthermore, the incumbent auditors and the audited benefit from mutual understanding and continuity. The CC concluded that “companies are offered higher prices, lower quality (including less sceptical audits) and less innovation and differentiation of offering than would be the case in a well-functioning market”.535

The audit market in 2018

201.The Competition Commission recommended remedial measures to improve competition in the audit market. These were enacted by a 2014 Order by the Competition and Markets Authority (CMA), which replaced the Commission.536 FTSE 350 companies must put their statutory audit out to tender at least every 10 years, and the maximum tenure is 20 years.537 Measures were also taken to strengthen the accountability of the external auditor to a company’s audit committee and reduce the influence of management.538

202.There is little sign, however, that those changes have had any substantial impact on the audit market. In 2016, the Big Four audited 99% of the FTSE 100 and 97% of the FTSE 250.539 This dominance has been almost constant since the demise of Arthur Andersen. If anything, the Big Four has further strengthened its grip. In 2016, it audited 75% of listed firms outside the FTSE 250 for the first time since 2006. The Secretary of State for Business, Energy and Industrial Strategy has argued that “increasing capacity in the FTSE 350 audit market would clearly be beneficial”.540

Figure 9: Sustained market domination by the Big Four

In March 2018, Grant Thornton, the sixth biggest UK firm in terms of audit fee income,541 announced that it would no longer compete for FTSE 350 audit contracts.542 Grant Thornton explained that “structures in the market” made it “impossible” for the company to succeed.543

Non-audit services

203.The Big Four offer a wide range of professional services in addition to audit. In 2016, combined Big Four income from audit services was £2 billion. Their income from non-audit services was £7.9 billion, four times as much. This included £1.1 billion of fees for non-audit services for audit clients.544 When non-audit fee income is included, the difference between the Big Four and potential rivals is even more stark.

Figure 10: The Big Four and the next four - 2016 fee income

204.It is often reported that audit services are used as a “loss-leader” by accountancy firms.545 By bidding for audit work at relatively low rates, firms can establish contacts and reputation in a company or industry and increase their chances of winning lucrative non-audit consultancy work. This would act as a barrier to smaller and more audit-focused firms competing on audit pricing. Oxera found the ability to offer additional services on top of the audit gave the Big Four further advantages over smaller firms.546 The Competition Commission considered the “bundling” of audit and non-audit services in its inquiry. It found it could not separately identify profit made from different services, partly because of the difficulty of attributing costs within broad corporate structures.547 It did not find sufficient evidence to conclude that bundling harmed competition.548

205.There is, however, a simpler explanation of how the dominance of a few giant audit and professional services firms can inhibit competition. A company may be unable or unwilling to appoint one or more members of the Big Four as auditor for a variety of reasons. For example, a firm may:

When there are only four options, the removal of one, two or even three firms from the equation leaves very few options left. In both the Oxera and Competition Commission reviews, financial services industry bodies reported that companies could have no effective choice of alternative auditor.549

206.This concern was very evident in Carillion. While KPMG provided external audit services, the company was similarly lucrative for the other Big Four firms. Deloitte provided internal audit services. EY was drafted in to try to restructure the company, and one of its partners was seconded onto the Carillion board. In other struggling companies, the names of the same giant companies appear, albeit often in different roles. As we set out in Chapter 2, when the Official Receiver needed a large firm to act as Special Manager to the liquidation of Carillion at short notice in January 2018, it sought a firm that was “not conflicted”.550 Despite having carried out more than £17 million of work on Carillion between 2008 and 2018, for the company, its pension schemes, and for government, PwC was the least conflicted Big Four firm.551 It was appointed Special Manager as a monopoly supplier, underwritten by the taxpayer. Given that privileged position, it was perhaps unsurprising that PwC was unable or unwilling to provide an estimate of how long its work would take, or what the eventual bill would be.552

Time for action

207.Murdo Murchison of Kiltearn Partners said that “there appears to be a lack of competition in a key part of the financial system, which periodically causes a lot of other participants in that system a lot of trouble”.553 Stephen Haddrill, Chief Executive of the FRC, told us that the CMA would “need to review the effectiveness of what they recommended” regarding competition in the audit market, “and look at it again”.554 The Secretary of State for Business, Energy and Industrial Strategy, the Rt Hon Greg Clark MP, said he was “not averse” to reconsidering competition in audit market, as concentrated markets tended to act against the interests of consumers.555 Similarly, Rt Hon Andrew Tyrie, incoming Chair of the CMA, said that “something needs to be done” about the audit market.556

208.A range of potential policy options could generate more competition in audit. These include:

209.The 2013 Competition Commission report considered how the interests of management and auditors could converge on matters of judgement, against the interests of shareholders. At times, management had “strong incentives to manage reported financial performance to accord with expectations and to portray performance in an unduly favourable light”.557 To maintain lucrative working relationships, auditors had incentives to “accommodate executive management” in this unwarranted optimism.558 This is the story of Carillion’s audits. But the weaknesses in regulation and competitive pressure which not only permitted those failures, but incentivised them to occur, are not restricted to one company. They are systemic in a market that has been stubbornly resistant to healthy competition, to the detriment of shareholders and the economy as a whole. That market is overdue shock treatment.

210.The market for auditing major companies is neatly divvied up among the Big Four firms. It has long been thus and the prospect of an entrant firm or other competition shaking up that established order is becoming ever more distant. KPMG’s long and complacent tenure auditing Carillion was not an isolated failure. It was symptomatic of a market which works for the members of the oligopoly but fails the wider economy. Waiting for a more competitive market that promotes quality and trust in audits has failed. It is time for a radically different approach.

211.The dominant role of the Big Four stretches well beyond statutory audits. They have been prominent advisors to Governments of all colours and boast an extensive alumni network which dominates the ranks of regulators and finance directors. They provide a huge range of professional services to major companies, advising on internal audit, tax planning, risk, remuneration, corporate governance, controls, regulatory compliance, mergers and acquisitions, pensions restructuring, business turnaround and insolvency services. If one member of the oligopoly is a company’s external auditor, the others can rely on providing other services, at all stages in a company’s life cycle, and rack up substantial fees whatever the result. The Big Four collectively even benefit from mutual failure, as one of them will be invariably called in to advise on clearing up the mess left by the implementation of the previous advisors’ proposed remedy.

212.The lack of meaningful competition creates conflicts of interest at every turn. In the case of Carillion, KPMG were external auditors, Deloitte were internal auditors and EY were tasked with turning the company around. Though PwC had variously advised the company, its pension schemes and the Government on Carillion contracts, it was the least conflicted of the Four. As the Official Receiver searched for a company to take on the job of Special Manager in the insolvency, the oligopoly had become a monopoly and PwC could name its price. The economy needs a competitive market for audit and professional services which engenders trust. Carillion betrayed the market’s current state as a cosy club incapable of providing the degree of independent challenge needed.

213.We recommend that the Government refers the statutory audit market to the Competition and Markets Authority. The terms of reference of that review should explicitly include consideration of both breaking up the Big Four into more audit firms, and detaching audit arms from those providing other professional services.


214.The collapse of Carillion has tested the adequacy of the system of checks and balances on corporate conduct. It has clearly exposed serious flaws, some well-known, some new. In tracing these, key themes emerge. We have no confidence in our regulators. FRC and TPR share a passive, reactive mindset and are too timid to make effective use of the powers they have. They do not seek to influence corporate decision-making with the realistic threat of intervention. The steps they are beginning to take now, and extra powers they may receive, will have little impact unless they are accompanied by a change of culture and outlook. That is what the Government should seek to achieve.

215.The Government has recognised the weaknesses in the regulatory regimes exposed by Carillion and other corporate failures, but its responses have been cautious, largely technical, and characterised by seemingly endless consultation. Our select committees have offered firm and bold recommendations based on exhaustive and compelling evidence but the Government has lacked the decisiveness or bravery to pursue measures that could make a significant difference, whether to defined benefit pension schemes, shareholder engagement, corporate governance or insolvency law. That must change. Other measures that the Government has taken to improve the business environment, such as the Prompt Payment Code, have proved wholly ineffective in protecting small suppliers from an aggressive company and need revisiting.

216.The directors of Carillion, not the Government, are responsible for the collapse of the company and its consequences. The Government has done a competent job in clearing up the mess. But successive Governments have nurtured a business environment and pursued a model of service delivery which made such a collapse, if not inevitable, then at least a distinct possibility. The Government’s drive for cost savings can itself come at a price: the cheapest bid is not always the best. Yet companies have danced to the Government’s tune, focussing on delivering on price, not service; volume not value. In these circumstances, when swathes of public services are affected, close monitoring of exposure to risks would seem essential. Yet we have a semi-professional part-time system that does not provide the necessary degree of insight for Government to manage risks around service provision and company behaviour. The consequences of this are clear in the taxpayer being left to foot so much of the bill for the Carillion clean-up operation.

217.Other issues raised are deep-seated and need much more work. The right alignment of incentives in the investment chain is a fiendishly difficult balance to strike. The economic system is predicated on strong investor engagement, yet the mechanisms and incentives to support engagement are weak and possibly weakening. The audit profession is in danger of suffering a crisis in confidence. The FRC and others have their work cut out to restore trust in the value, purpose and conduct of audits. Competition has the potential to drive improvements in quality and accountability, but it is currently severely lacking in a market carved up by four entrenched professional services giants. There are no easy solutions, but there are some bold ones.

218.Carillion was the most spectacular corporate collapse for some time. The price will be high, in jobs, businesses, trust and reputation. Most companies are not run with Carillion’s reckless short-termism, and most company directors are far more concerned by the wider consequences of their actions than the Carillion board. But that should not obscure the fact that Carillion became a giant and unsustainable corporate time bomb in a regulatory and legal environment still in existence today. The individuals who failed in their responsibilities, in running Carillion and in challenging, advising or regulating it, were often acting entirely in line with their personal incentives. Carillion could happen again, and soon. Rather than a source of despair, that can be an opportunity. The Government can grasp the initiative with an ambitious and wide-ranging set of reforms that reset our systems of corporate accountability in the long-term public interest. It would have our support in doing so.

481 Public Administration and Constitutional Affairs Select Committee, Sourcing public services: lessons learned from the collapse of Carillion inquiry

482 Cabinet Office and Crown Commercial Service, Transparency Data: Crown Representatives and Strategic Suppliers, accessed 1 May 2018

484 HC Deb, 13 March 2018, col 720

485 Business, Energy and Industrial Strategy Committee, Small businesses and productivity inquiry, accessed 25 April 2018

486 Kiltearn Partners report that they were interested in pursuing legal action against board members in respect of the liability of issuers in connection with published information, under section 90A and Schedule 10A, Part 2 of the Financial Services and Markets Act 2000.

487 Business, Energy and Industrial Strategy Committee, Third Report of Session 2016–17, Corporate Governance, HC 702, April 2017, para 25–31

488 Work and Pensions and Business, Energy and Industrial Strategy select committees, A framework for modern employment, HC 352, November 2017

489 Department for Business, Energy and Industrial Strategy, Insolvency and Corporate Governance, March 2018, p 6

490 Financial Reporting Council, Stewardship Code, Principle 5

491 Business, Energy and Industrial Strategy Committee, Third Report of Session 2016–17, Corporate Governance, HC 702, April 2017, para 44 - 52

492 Department for Business, Energy and Industrial Strategy, Insolvency and Corporate Governance, March 2018, p 26

493 As above, p 27

494 Business, Energy and Industrial Strategy Committee, Second Special Report of Session 2017–19, Government Response to Third Report on Corporate Governance, HC 338, September 2017

495 Business, Energy and Industrial Strategy Committee, Third Report of Session 2016–17, Corporate Governance, HC 702, April 2017, para 55 and 60.

496 The Shareholder Rights Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 came into force on 10 June 2017 and is due to be transposed into UK law by 10 June 2019.

497 Q1285 [Esther McVey]

498 Work and Pensions Committee, Sixth report of session 2016–17, Defined benefit pension schemes, HC 55, December 2016

499 As above.

500 Work and Pensions Committee, Defined benefits white paper inquiry

501 Work and Pensions Committee, Defined Benefit Pensions

502 Q1285 and Q1304 [Esther McVey]

504 As above.

505 The Pensions Regulator, Corporate Plan 2017–2020, April 2017

506 The Pensions Regulator, Protecting Workplace Pensions, accessed 1 May 2018

508 Q731 [Lesley Titcomb]

509 Q671 [Mike Birch]

510 This calculation would incorporate any mitigatory measures such as the transfer of assets. It also takes into account the relative strength of the sponsor covenants before and after the transaction.

511 These are known as “anti-avoidance” or “moral hazard” powers.

512 Q1293 [Esther McVey]

513 Q707, Q712, Q718 [Lesley Titcomb]

514 Q1251 [Greg Clark]

515 Q21 [Stephen Haddrill]

516 Work and Pensions Committee, British Steel Pension Scheme, Sixth Report of Session 2017–19, HC 828, February 2018

517 ‘Government launches review of audit regulator’ Department for Business, Energy and Industrial Strategy Press Notice, 17 April 2018

518 Oral evidence taken before the Liaison Committee on 7 February 2018, HC 770 (2017–19), Q70 [David Lidington]

519 According to the FRC’s Annual Report for 2016–17, it received 12 such complaints that year and investigated further only two.

520 Financial Reporting Council, Developments in audit 2016–17, July 2017, p 5

521 Q78 [Stephen Haddrill]

522 Also, an independent review of the FRC’s enforcement procedures sanctions in October 2017 made some technical recommendations but made no case for major change.

523 Financial Reporting Council, FRC to enhance monitoring of audit firms, 10 April 2018

529 Q1128 [Euan Stirling]

530 Q1129 [Euan Stirling]

533 Oxera, Competition and choice in the UK audit market, April 2006, executive summary page p i

534 As above.

535 Competition Commission, Statutory audit services for large companies market investigation, October 2013, para 34

536 Competition and Markets Authority, CMA finalises audit changes, 26 September 2014

537 Subject to transitional measures

538 Competition and Markets Authority, CMA finalises audit changes, 26 September 2014

539 Financial Reporting Council, Key Facts and Trends in the Accountancy Profession 2017, July 2017, p 45

541 Behind the Big Four and BDO in 2016. Grant Thornton was the fifth biggest firm in terms of total fee income, incorporating non-audit services.

542Grant Thornton exits audit market for big UK companies.‘Financial Times, March 29 2018

543 As above.

544 Financial Reporting Council RC, Key Facts and Trends in the Accountancy Profession, July 2017, p 37

545 See, for example: “Does the big four alumni stifle competition?”, ICAEW Economia, 11 October 2012; “Carillion’s demise shines a light on an auditor expectation gulf”, City A.M., 31 January 2018; “Audit Reform: The Conflict Minefield” AccountancyAge, 7 July 2016.

547 Competition Commission, Statutory audit services for large companies market investigation, October 2013, para 10

548 Competition Commission, Statutory audit services for large companies market investigation, October 2013, para 29

549 Oxera, Competition and choice in the UK audit market, April 2006, p i; Competition Commission, Statutory audit services for large companies market investigation, October 2013, para 9.33–9.34

551 Work and Pensions Committee, Committees publish responses from Big Four on Carillion, 13 February 2018. Note that the original total quoted here for PwC work was £21.1 million. PwC subsequently informed us that out of a total of £4.6 million that they gave us for work done on the Electric Supply Pension Scheme, only £200,000 related to Carillion. Letter from PwC to the Chairs, 23 February 2018

552 Q1333 and Q1367 [David Kelly]

553 Q1046 [Murdo Murchison]

554 Q70 [Stephen Haddrill]

555 Qq 1258–9 [Greg Clark]

556 Oral evidence taken before the Business, Energy and Industrial Strategy Committee on 24 April 2018 HC 985 (2017–19), Q31 [Andrew Tyrie]

557 Competition Commission, Statutory audit services for large companies market investigation, October 2013, para 11.23

558 Competition Commission Statutory audit services for large companies market investigation, October 2013, para 26

Published: 16 May 2018