Corporate Governance and the Collapse of British Home Stores (BHS) Ltd.

Corporate Governance
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Corporate Governance
Corporate governance is a vital prospect in contemporary businesses considering the role it plays in every decision that stakeholders make. Within the confines of corporate governance, each stakeholder, including the board of directors, the chief executive officer, employees, and shareholders, have specific roles and responsibilities that must be accommodated in the decision making process. Corporate governance, hence, is the platform of decision sanity in contemporary businesses. In the UK, corporate governance is enshrined in the Corporate Governance Code, the Companies Acts (s.263 CA 1985 initially, now s.830 CA 2006), Pensions Act 2004, and the common law capital maintenance rule. As such, organisations that violate elements of corporate governance engage in illegal and unethical operations. That was the case with British Home Stores (BHS), a retail outlet whose ignorance to the basic principles of corporate governance, moral responsibilities, and the law rendered it into administration and eventual closure in 2016. BHS had a long history of retail in entertainment and beauty products, electronics, and home furnishings right from 1928. In 200, Sir Philip Green bought the struggling outlet and ran it through a range of corporate governance irregularities. In 2015, Green sold BHS to the serially bankrupt Dominic Chappell for £1. The outlet would tumble into administration barely 12 months after Chappell’s acquisition. The BHS case bears a range of corporate governance, theory, law, and ethical concerns that this paper will analyse.[Foreman-Peck, James and Leslie Hannah. UK Corporate Law and Corporate Governance before 1914: A Re-Interpretation. St. Louis: Federal Reserve Bank of St Louis, 2015.]
Corporate Governance Issues
The agency theory can be employed for a detailed understanding of corporate governance thereby leading to an efficient analysis of corporate governance issues at BHS. The agency theory defines stakeholder relationships in companies and the value of such relationships to the governance of the organizations. The theory posits that business organizations consist of principals who are the shareholders and agents such as the directors of the company. The agents run the businesses as delegated by the principals. The principals expect their agents to make decisions that befit their interests and those of the agents. That marks the basis of corporate governance. However, as will be demonstrated in the case of BHS, it is not all the time that agents make decisions in the interest of all the stakeholders. Occasionally, agents can showcase self-interest and opportunistic behaviours that fall short of the agency theory and corporate governance, by extension, expectations.[Dinh Tran, Ngoc Huy and Ngoc Hien Dinh Tran.(2011), 47] [Essawi, Mohammed Subhi Al and Petre Brezeanu. "The Diversity of Corporate Governance Models. Overview at the Country Level." Annals of the University of Petroşani.Economics 11, (2011): 13.] [Seidl, David, Paul Sanderson, and John Roberts, 2009(61)]
There are a range of corporate governance issues that emanate from the BHS case. Primarily, corporate governance emphasizes board leadership and company purpose. The Corporate Governance Code indicates that a successful company must be led by an entrepreneurial and effective board. The board has the role bears the responsibility of promoting the long-term success of the organization. That happens through insightful and critical decision making in every aspect of the organization. At BHS, the board membership was not as diverse as provided in the law. BHS was acquired by the Arcadia Group Ltd, an investment company under the ownership of Green. As at the turn of 2000, the Arcadia Group was the leading shareholder in BHS with Green’s wife, Lady Tina Green, as the chairperson in the board of directors. The constitution of the board implied that the decisions made by the organization largely favoured the demands of the majority shareholder group with an influential representation at the board. The composition of the board was a factor of debates in 2015 when Green sold the company to Chappelle. As a governance insight issue, the company should always be positioned to make sane decisions that are likely to secure its future. Chappelle was poised to be the leader of the board with personal characteristics that did not befit the position. Primarily, Chappelle had been declared bankrupt on 3 occasions before he engaged in BHS. Additionally, Chappelle did not have any experience in managing an outlet such as BHS. Having a member of the board who was not fit to fill the office rendered BHS’s board ineffective leading to the collapse of the organization soon after the takeover.[Financial Reporting Council (2018).] [Financial Reporting Council (2018).] [All Answers ltd, 'Quality of Corporate Governance in BHS and its Impact on Key Stakeholders' (ukdiss.com, March 2022)] [International Corporate Governance and Law Forum, J. J. Du Plessis, and Chee Keong Low. 2017(43)] [Pardis, Seyed Taghi, Saudah Sofian, and Dewi Fariha Abdullah 2016 (109).] [Murphy, Richard. 2017 (109)] [Neshat Safari and Martin Gelter, British Home Stores Collapse: The Case for an Employee Derivative Claim, 19 J. Corp. L. Stud. 43 (2019)]
The board, as an agent is mandated to assess and monitor culture. That is, the board should suggest corrections in cases where there are policies, behaviour, or practices that are not satisfactory to the values, strategy, and purpose of the company. One of the aspects of corrections should be on the composition of the board. The CEO, as a member of the board, should always act in the interest of shareholders as per the shareholder primacy provisions. In 2002-2004, the CEO sanctioned expenditures beyond the shareholder primacy provisions, which was a violation of corporate governance code’s provisions on responsibilities of the CEO. Further in the case of BHS, the board failed to monitor culture leading to notable losses to the organisation. Take for instance the period between 2000 and 2004. The parliamentary committee report on BHS indicated that the entire dividends paid by BHS Ltd in the 2002–04 period were £414 million, over double the company's after-tax profits of £208 million. The parent company, BHS Group, paid £423 million in dividends during the same time period. It means that BHS paid dividends to its shareholders at a rate that steered the organization into losses. The payments occurred for a series of 4 years without the board questioning the behaviour. To the extent of their ignorance to dividend swindling in which BHS was trapped, the board did not execute its role as mandated in the corporate governance code.[Emenalo, Chukwunonye, (01, 2012): 42.] [Financial Reporting Council. Stephen John Denison vs BHS. Particulars of Fact and Acts of Misconduct 10.08.18] [Calder, Alan. Corporate governance: a practical guide to the legal frameworks and international codes of practice. (2008) 16.] [Costa, King and Thelela Ngcetane-Vika. A Comparative Analysis of Strengths and Weaknesses of Corporate Governance Practices between Two Jurisdictions; UK and South Africa. St. Louis: Federal Reserve Bank of St Louis, 2021.]
The corporate governance code further emphasizes the board’s role in audit, risk, and internal control of the organization that were violated at BHS. Within the confines of stewardship theory, all stakeholders of a business should execute their responsibility with the motivation to protect the interest of others. The implication of stewardship is engraved in the code of governance in which the provision states that the board must adopt fair and transparent rules and procedures to assure the effectiveness and independence of internal and external audit activities, as well as to satisfy itself that financial and narrative statements are accurate. With such a mandate, the board should showcase a fair, understandable, and balanced assessment of the company’s prospects and position. Should there be any risks identifiable during the audit, the board should establish the risk management mechanisms to address the issues. In the parliamentary committee report, BHS did not submit any audit report that outlined its potential risks and the risk management mechanisms. That explains the inability of the organization to address the losses after 2004.[Financial Reporting Council. Stephen John Denison vs BHS. Particulars of Fact and Acts of Misconduct 10.08.18] [Financial Reporting Council (2018).] [Jovanovic, Jelena and Biljana Grujic. "Historical Development of Corporate Governance as The Basis For Current Corporate Trends 3." Ekonomika 62, no. 1 (Jan, 2016): 189.]
Legal Context Analysis
There are a range of legal provisions that can be vital in analysing the BHS case. The first aspect of legalities would encompass the dividends and deficit. As noted, BHS paid dividends, between 2000 and 2004 to the tunes that exceeded its after tax profits. It is highly questionable who BHS managed to pay all the above dividends when the common law capital maintenance rule and the Companies Act (s.263 CA 1985 at the time, now s.830 CA 2006) collectively prohibit business organizations within the UK from making distributions beyond the limits of their after tax profits. The answer appears to be hidden in the fine print of a company's earnings eligible for payout concept and relevant accounting rules. The earnings available for distribution by a private corporation are calculated as follows: cumulative, realized profits (not previously dispersed or capitalised) minus cumulative, realized losses (not previously written off in a reduction or reorganization of its share capital) (section 830(2)). To that effect, negative goodwill, which is the value originating from a company's acquisition of another firm for a price less than the worth of that organization's net assets, when recognized in the purchaser's profit and loss account represents a realised profit under relevant accounting standards.[Moore, Marc and Martin Petrin. 2017(86).] [Roach, Lee. 2022 (76)] [Pacala, Anca. "Corporate Governance: Principles and Regulations." Journal of Electrical and Electronics Engineering 5, no. 1 (2012): 155.]
The Company’s Act 2006 further opened loopholes that BHS purchasers used to pay more dividends than necessary. The value of amortised negative goodwill, which is the difference between the value of the net assets purchased when BHS was acquired and the purchase price paid for it, was accommodated in the dividends paid by BHS. The profits available for payment of dividend were effectively increased by almost £100 million as a result of this. The value from the sale of a handful of BHS stores in 2001 was also included in the distributions within the duration. These were sold to a Jersey firm that was afterwards purchased by Lady Green and leased back to BHS. The rental most likely covered the Jersey firm's borrowing charges. This transaction boosted BHS's profit and loss account by £100 million, allowing shareholders to extract another £100 million in dividends. The short-term profits collected by shareholders effectively destroyed value from the BHS companies in the long run, preventing them from using it for objectives like investment or pension contributions. Financial engineering of this nature was legal and commonplace. The law's idea of capital maintenance was not popular, and its limits were viewed as dividend traps, limiting owners' ability to realize value in the short term. Leading accounting firms were quick to offer guidance on reorganization options that could be utilized to unlock a company's value for its shareholders on a timely basis. Sir Philip himself employed such a reorganization to make the Arcadia dividend possible. It remained a matter of legal debates to determine whether the harm to employees, retirees, and the community was ultimately caused by this culture or by flaws in the law.[Dobroteanu, Laurentiu, Camelia Liliana Dobroteanu, and Adriana Sofia Raileanu. "Independenta Auditorilor În Contextul Guvernantei Corporative: Auditors' Independence in the Context of Corporate Governance." Audit Financiar 8, no. 3 (2010): 18-22.] [Mallin, Christine. 2018 (23)] [Forbes, William, and Lynn Hodgkinson. 2014, 67.] [Sjåfjell, Beate. "Sustainable Value Creation within Planetary Boundaries—Reforming Corporate Purpose and Duties of the Corporate Board." Sustainability 12, no. 15 (2020): 6245] [Huy, Dinh Tran Ngoc and Dinh Tran Ngoc Hien. "The Backbone of European Corporate Governance Standards after Financial Crisis, Corporate Scandals and Manipulation." Economic and Business Review for Central and South - Eastern Europe 12, no. 4 (2010): 236.]
Section 172 of the Companies Act 2006 has been a factor of debate considering its weaknesses in aiding corporate governance issues at BHS. Within the confines of s. 172, it remained unclear whether the duty to promote the long-term success of a business entity is enforceable or the mechanisms to balance the shareholder interests of a company. The section states that a director of an entity should behave in a manner he/she believes, in good faith, will most likely enhance the achievement for the benefit of its members as a whole. The director can do so while taking into account the following enlightened shareholder value interests: the impacts of the company's operations to the environment and the community, the interests of the employees on the decisions made, and the likely long-term consequences of any decision. Put simply, the implementation of section 172 of the Companies Act relied primarily on the discretion of the director over what he/she considered enforceable at the time. With such a legal loophole, it was possible for any director to act in favour of personal interests.[Cosh, Andy, Paul Guest, and Alan Hughes. UK Corporate Governance and Takeover Performance. St. Louis: Federal Reserve Bank of St Louis, (2007), 53.] [Hegazy, Mohamed and Karim Hegazy. "Corporate Governance in the U.K: Audit Committees and Disclosure Arrangements - A Web-Based Analysis." Journal of Business Studies Quarterly 1, no. 2 (03, 2010): 45.] [Sanderson, Seidl, Roberts, and Krieger (2010) 119]
Offering protection to the interests of employees is another prospect that section 172 seems to ignore in its inputs. There are multiple incidences in which the section excludes the interests of the employees. It prioritizes shareholder interests primarily, as arguably the characteristics of a company as an entity established philosophically or purposes of creating profits to those shareholders. Secondly, section 172 abandons the degree of enlightened care for the community and employees up to the discretion of each individual director. Furthermore, since the r...