When corporate governance falls apart: Four examples of what NOT to do
In this article from corporate governance expert Nigel Kendall, we explore examples of where good governance practice was inadequately heeded – or wilfully ignored.
By AnsaradaThu Mar 23 2023CEO-CFO, Security and risk management, Governance Risk and Compliance, Environmental Social and Governance, Board
Good corporate governance ensures that a company operates in a responsible, ethical, and sustainable manner, with transparency and accountability to its stakeholders. Proper governance is a crucial element of promoting trust and confidence in a company and ensuring that it is acting in the best interests of all its stakeholders, while creating value and fulfilling its mission and purpose.
However, when governance goes wrong, the risks of fraud, corruption and other forms of misconduct can lead to catastrophe. To help illustrate what NOT to do, corporate governance expert Nigel Kendall, Applied Corporate Governance, has sourced four real-world examples, aligned with failings in:
- Statutory awareness
- Regulatory awareness
- Business fundamentals
- Ethical culture
1. Knowingly breaking the law
Lack of knowledge of the law is unlikely at the boardrooms of most larger companies, but failure to spot law-breaking practices is less uncommon. When it occurs with a major impact, the directors are at risk, and culpable for permitting it to happen on their watch. HBOS allowed criminal activity to be conducted right under its nose.
HBOSOnce upon a time, in a not-too-distant era, Halifax Building Society was the biggest and most robust savings and mortgages mutual in the UK, the role model for the rest of the building society movement. Even earlier, the Bank of Scotland was the oldest bank in Scotland, dating back to the 17th century, and a pillar of the Scottish financial establishment. Then came the deregulation of the building societies, and Bank of Scotland merged with Halifax, its mutual competitor in housing finance, calling the new bank HBOS.
Briefly, the culture of the resulting institution changed from traditional caution to aggressive greed and things quite rapidly went wrong. Lending became rash and some very bad practices went on in hidden corners of the bank. The crash of 2008 brought the bank to the point of crisis and the UK government intervened to prevent what it perceived as a looming systemic crisis. The Prime Minister persuaded the chairman of Lloyds TSB, a well-run, traditional and profitable institution, that his bank had to take over HBOS to stave off a disastrous crash and in return would be allowed exemption from any relevant competition restrictions. The deal was done with almost no due diligence and the mess that Lloyds acquired brought Lloyds itself to its knees and a government bail-out. In early 2009, with the housing market weakening, HBOS revealed losses of £10 billion, crippling for Lloyds.
From then on, everything went wrong for Lloyds and amidst fines and lawsuits, the chairman and CEO lost their jobs and, years later, were being pursued in court by an action group which alleged that Lloyds misled investors during the deal process, concealing the true state of HBOS. In September 2012, Peter Cummings, the head of HBOS corporate banking from 2006 to 2008, was fined £500,000 by the UK financial regulator and also banned from working in the banking industry over his role in the bank's collapse.
The arrival of subsequent CEO, Antonio Horta-Osorio, put things on a path to recovery, but he struggled to leave the inherited problems behind. One of the unpleasant legacies which came into the public eye in subsequent years was what was described in the newspapers as the loan scam. In brief, the manager of one of the HBOS branches gave loans to small businesses with the proviso that they use an outside firm of consultants to help their business. Unbeknown to the borrowers, the HBOS manager had a deal going with the firm concerned which generated considerable fees for the consultants and resulted in the loans growing to the point where the firms collapsed and often fell into the clutches of the consultants.
It took many years for justice to start to be done and a number of those involved received jail sentences. However, this legacy issue generated very bad publicity for Lloyds, which was accused of avoiding its responsibility to the people whose lives had been ruined. It eventually reached the point of considering reviews of claims for compensation potentially amounting to £100m following this £245m scandal. But time had passed and the victims had been treated very harshly by the system. It commenced before Lloyds acquired HBOS, but Lloyds was criticized for behaving brutally towards the victims when the nature of the fraud had become clear to all those involved, though not yet proven in the courts.
2. Deliberately ignoring regulation
Most established industries operate under regulatory supervision - rules drawn up for the protection of the public. Companies therefore must comply with these regulations and boards are responsible for ensuring that the executive does actually comply. Uber, however, thought it could avoid regulators by defining itself differently. What did the board do in this situation?
UberUber has been in the headlines for most of its existence. The hard-driving style of its founder led it into clashes with regulatory authorities in most of the regions in which it operates, most of which are still unresolved. On top of that, it had at one stage used a software device to avoid scrutiny by regulators and mislead them.
Uber’s business model from its early days relied on the claim that it is simply an app which puts drivers and passengers in touch. As such it has avoided, or evaded, the regulations which have long governed taxi drivers in the developed countries of the world. This position has been challenged around the world, but Uber, under its founder, Travis Kalanick, proceeded as if he was not governed by the regulations, appealing judgements or ignoring them.
Thus, in 2014, the German regional court in Frankfurt banned his UberPop service, and again banned it the next year after the earlier ruling was reversed. In 2015, the French Constitutional court banned Uber from using non-professional drivers using their own cars, and the following year Uber executives were found guilty of running an illegal car hiring service. Spain also banned Uber at one stage, and in Italy a court banned Uber’s apps, though this was later reversed.
In 2017, Denmark changed its regulations, requiring cabs to be fitted with certain recording sensors, which meant that Uber’s business model no longer worked and it had to withdraw from the country. And in London, one of the largest markets for Uber, the regulator, Transport for London, ruled that Uber was not a “fit and proper” operator and said its license would not be renewed. Needless to say, Uber appealed and continued operating until its license was later restored, albeit with conditions. It later failed these conditions and after a ruling in 2021 requiring it to treat all drivers as if they were employees, is currently operating under a time-limited license.
However, in June 2017, the tensions Travis Kalanick seems to have thrived on finally tore the company apart at the top. Moreover, revelations about its culture included allegations of endemic sexual harassment and the admission that the medical records of the rape victim of one of its Indian drivers were accessed by a senior executive. Additionally, it was accused of stealing intellectual property relating to self-driving cars from an affiliate of Google. The end result was the departure of Mr Kalanick, and his successor has spent a great deal of his time trying to mend fences with regulators around the world.
But the board allowed the CEO to ignore the regulatory dimension for years, on the basis that he was building a huge business in an astonishingly short time and should be allowed to continue. And the business was by its nature, disruptive.
However, the view that Uber faces regulatory and legal problems around the world will hang over the company until this approach, and these issues, are resolved, and almost certainly affected its disastrous share performance post IPO in May 2019. Its opening price was $45, valuing it at around $82 billion, but when the six-month lock-up period ended in November of that year, investors rushed to cash out and its shares traded at over 40% lower, and in early 2020, touched $21. In early 2021 they peaked at $61, but by mid-2022 were back down at $21. They have subsequently crept back up to $34 by mid-February 2023, but are still well below the offer price, registering a loss in value of some $20 billion. In the months after listing, they were criticized for being brought to the market at too rich a valuation, and, despite the best efforts of Dara Khosrowshahi, their subsequent, erratic performance reflects the fundamental poor view of Uber’s governance and hence its prospects.
3. Blind to reality
The CEO and the executive team are responsible for running the company to achieve its goals. The board is responsible for ensuring that the executives deliver. To do this, they must have a sufficient understanding of the market in which the company is operating to be able to judge its performance. And they must be aware of how their company is viewed by its peers and other investors. This is what “due skill and care” imply. How could Carillion’s directors not be aware of its progressively growing insolvency?
CarillionIn January 2018, one of the UK’s largest construction companies went into liquidation. After parting with its CEO of five years, Richard Howson, as well as two finance directors in quick succession, Carillion and its interim CEO, Keith Cochrane, ran out of funding. A company which employed 45,000 staff worldwide, and less than two years earlier had been valued at more than £2bn, was gone.
Carillion’s demise was a shock, but only to those who hadn’t been watching closely over the previous years. For some time, the company had been one of the most “shorted” stocks on the FTSE 350, as investors looked past its posted trading figures at the growing debt. They saw a company which seemed to be masking its poor profitability with a series of acquisitions, and managing its shortage of cash to pay suppliers by special funding arrangements with banks. Moreover, the growing asset on its balance sheet which represented work in progress on uncompleted contracts could be seen as potentially un-invoiceable. Overall, Carillion, which was an amalgam of a number of respected, traditional construction companies, had apparently got itself into a mess by under-pricing its bidding for a number of large government out-sourced contracts, and was paying the price.
Eventually, the positive public presentation could no longer hide the cash shortage, lenders decided it was a lost cause, the government declined to bail it out, and like all businesses when they run out of money, it went bust.
So far, so obvious, but where was the board all this time? If investors had been short selling the shares for years, that must surely have been on the agenda of board meetings for most of that time, particularly since controversial amendments were made to the top executives’ bonus plans during that time. Moreover, in May 2017, the Finance Director made her concerns clear to the board nearly three months before the public announcement of the problems, which led to the departure of the CEO. What did the board do? It asked KPMG, the company’s auditors, who had signed off the previous year’s accounts, to look again as to whether they needed to be restated. This author once interviewed Keith Cochrane in researching for a book he was writing on Corporate Governance and found a very practical, down-to-earth senior executive. How could a person like this attend board meetings of Carillion as a non-executive director and not sense the vulnerabilities?
Surely this board did not exercise the duties of skill and care which the Companies Act demanded of them.
4. Cultural pressures leading to ethical failure
It is generally accepted that an ethical culture is fundamental to the long-term success of any business, and indeed for the health of whole societies. This is recognized in the public face presented by most well-established companies, which are proud of their traditions. However, complacency at board level, or even turning a blind eye to what may be seen as minor infractions at the time, can overnight lose the trust of customers which has taken years to build up. The proud culture at Kobe masked fear of missing expectations at an operational level, which eventually produced disaster.
Kobe Steel is an iconic Japanese company with a history going back to its foundation in 1905. In 1995, its head office was destroyed and other facilities disrupted by the Kobe earthquake, but it recovered and continued to grow. So how did this company, one of the top 10 steel producers in the world, suddenly hit the news with such an impact that for weeks on end, its global website simply featured a succession of apologies for its ‘Improper Conduct’?
In October 2017, it was obliged to issue a series of apologies to its customers, primarily, for the recently published fact that for many years it had falsified its quality control certificates. These events, which resulted in an almost daily series of apologies, were reported to have arisen from new quality processes that were put in place earlier and had resulted in the exposure of a widespread breakdown in quality assurance.
The details have been widely published but, in summary, hundreds of customers were affected, ranging from aircraft and automobile makers to high-speed train manufacturers, and tens of thousands of tons of steel and other products had been incorrectly certified. The US authorities commenced an investigation, as did the Japan Quality Assurance Organization, and it was reported on 26 October 2017 that Kobe Steel was losing Japan's quality seal for copper products.
Kobe’s announcements made it clear that they had no idea how big the adverse impact on the company would be. As a result, shareholders saw the value of their investment in Kobe collapse by up to 40%. In a few short weeks, Kobe’s market value fell by £3 billion.
General Principle 2 of the Japanese Corporate Governance Code states that:
“The Board and management should exercise their leadership in establishing a corporate culture where the rights and positions of stakeholders are respected and sound business ethics are ensured”.
The sub-principles, which focus the directors’ attention on the interests of stakeholders generally, cover the following areas:
- Principle 2.1 Business Principles as the Foundation of Corporate Value Creation Over the Mid- to Long-Term
- Principle 2.2 Code of Conduct
- Principle 2.3 Sustainability Issues, Including Social and Environmental Matters
- Principle 2.4 Ensuring Diversity, Including Active Participation of Women
- Principle 2.5 Whistleblowing
So, the Board is expected to give due regard to the interests of the wider group of stakeholders in the long-term interests of the business. This is clearly relevant to the loss of reputation, and customers, resulting from the dishonest product certifications.
And it is also worth noting the Supplementary Principle to Principle 2.2, regarding Conduct, which gives additional guidance:
The board should review regularly (or where appropriate) whether or not the code of conduct is being widely implemented. The review should focus on the substantive assessment of whether the company’s corporate culture truly embraces the intent and spirit of the code of conduct, and not solely on the form of implementation and compliance
The Board seems to have been tardy, to say the least, in its review process.
Avoid corporate governance fails
To avoid the risk of corporate governance failures, companies and their Boards need to be across statutory and regulatory requirements, and act ethically and in accordance with corporate governance fundamentals. To stay ahead of regulatory change and governance risks, you need a centralized system in place to manage and monitor all these risks simultaneously, one that allows the rest of the business to engage with it.
Ansarada TriLine GRC is an integrated GRC system that allows you to centralize and manage all your risks, controls, events, metrics, contracts and more in a single place. It allows you to reduce the complexity and workload associated with best-practice corporate governance, and ensure a simplified and standardized approach to meeting all your governance, risk and compliance management requirements.
Good governance starts here
The author, Nigel Kendall is a Chartered Accountant, Corporate Governance Consultant, and the author of several books on financial management and corporate governance. His first book gained him the endorsement of Sir Adrian Cadbury, the father of modern corporate governance. With a wide-ranging career history and over 20 years’ experience as an independent consultant, Nigel works regularly with boards of all-sizes of organisations on corporate governance, best boardroom practice and strategy.Nigel Kendall, Corporate Governance Consultant, Applied Corporate Governance