Government proposes major corporate governance reforms to prevent the next Carillion or BHS scandal

 By Gareth Jones

The government has today published proposed reforms to the UK’s corporate governance regime and new rules on how firms are audited, as part of an initiative to restore trust in businesses after recent corporate failures.

In unveiling these policy changes, Business Secretary Kwasi Kwarteng said that “Restoring business confidence, but also people’s confidence in business, is crucial to repairing our economy.”

These reforms include restrictions on shareholder dividends and executive bonuses for companies with insufficient cash reserves. The government also want company directors to take much greater responsibility for their company accounts and reports. Under these proposals, directors will face fines, suspensions and the claw back of bonuses if their duties are seen to be breached.

These reforms have arguably been a long time coming. The major corporate scandals in the past five years, including Carillion, BHS, Thomas Cook and Patisserie Valerie are examples of companies going insolvent due, in part, to the greed and recklessness of bosses – which have resulted in job losses, knock on effects for customers and suppliers and the UK taxpayer picking up the tab. In the case of BHS, for example, Philip Green and his family extracted an estimated £586 million out of the company in dividends and rental payments under his ownership between 2000 and 2015, before selling the company (with its debts and liabilities) to a little-known businessman where it subsequently entered administration and was wound down. In the case of Carillion, their company directors sanctioned a record pay out in dividends and bonuses in 2018, shortly before the company a profit warning that preceded its collapse.

These scandals provoked considerable anger at the time and led to the Conservative Party pledging to strengthening the UK’s corporate governance regime in its 2019 election manifesto. At the heart of these reforms is changes to the audit regime. Many observers (including MPs who sit on select committees) have concluded that recent corporate scandals (such as those mentioned above) were enabled by auditors not providing sufficiently robust or rigorous scrutiny of company accounts – and this lack of sufficient scrutiny has been a result of the overly dominant role that the ‘Big 4’ auditing firms (Deloitte, PwC, E&Y and KPMG) have on the market and the potential for conflicts of interest among these firms, who also offer advisory services to the same companies.

The government proposals aim to end the Big Four firms’ dominance of auditing. Large companies would be required to use a smaller “challenger” firm to conduct a meaningful portion of their annual audit, while the government is also considering placing a cap on Big Four’s market share of FTSE 350 audits if competition in the sector does not improve.

The government’s reforms also seek to implement the recommendations from an independent review conducted by Sir John Kingman, most notably replacing the existing regulator – the Financial Reporting Council (FRC) with a new regulator - the Audit, Reporting and Governance Authority (ARGA). This new regulator would oversee unlisted companies as well as those on the stock market and will have the power to tackle conflicts of interest among the Big Four auditors by imposing an operational split between their audit and non-audit functions.

The proposals have broad cross-party support, with Labour welcoming the tougher rules for directors. Business groups expressed some concern about the audit proposals, with the CBI noting that requiring companies to share audits will add unnecessary complexity.