14 January 2019

By Professor David Whyte and Ben Crawford, University of Liverpool

In the first report from a collaborative project between the Institute of Employment Rights and the University of Liverpool - Employment Rights and the Shareholder: Workers Rights vs Owners Rights - Professor David Whyte and PhD student Ben Crawford explain how and why the UK's privatisation model is falling apart.

We are often told that privatisation and outsourcing makes the provision of basic services and amenities more efficient.

Yet the British government’s outsourcing model is now being exposed as a financial and social catastrophe.

There can be no clearer example of the failure of the British government’s outsourcing fiasco than the Carillion-built Royal Liverpool Hospital.

Not only did the Carillion collapse put the entire project in jeopardy, this vitally important part of the NHS infrastructure is still under threat.

Last October it was announced that the contractor Laing O’Rourke was taking over the job.

Within three weeks, the financial press were reporting urgent warnings about Laing O’Rourke because it had delayed filing its accounts by two months and consequently its bankers were holding off on a crucial refinancing.

This kind of perpetual instability is now the norm in the sector.

Industry reports are indicating that the likes of Serco, Capita and Mitie are not far from the point of collapse. Interserve, which employs a total of 75,000 worldwide and 45,000 in the UK (Carillion had 45,000 and 20,000 respectively) is currently in rescue talks that will put it under creditor control.

As analysts Company Watch recently pointed out, all of those firms have the same “bankrupt” business model as Carillion.

It is therefore time to ask if Carillion is the “Northern Rock” of the outsourcing sector; is it simply the first in a long line of corporate collapses that will decimate the outsourcing sector and lead to a new round of government “bail-outs”?

The business model that firms like Carillion, Serco, Capita and Mitie apply is an unashamedly parasitical one which feeds directly on workers’ rights to fuel ever-rising boardroom bonuses and to fork out shareholders’ dividends based on false promises.

Carillion and Laing O’Rourke were two of the worst construction firms exposed for blacklisting.

But the violation of workers’ rights for profit in this industry is by no means confined to illegal employment practices. Take the story of the £2.6 billion hole in Carillion’s pension liabilities.

The pensions added up to around a third of the £7bn in liabilities left when the firm collapsed. It only held £61 million in cash. Debt had increased significantly between 2006 and 2008 as Carillion purchased construction rivals Mowlem and McAlpine, and spiked by nearly £500m between 2010 and 2012 to fund the purchase of renewable energy firm Eaga.

Each acquisition came with an increase in Carillion’s pension liability. Yet Carillion’s finance director reportedly viewed funding pension schemes as “a waste of money.”

Shareholders’ dividends were apparently not a “waste of money.” Dividends were increased every year from 2012 to 2016, paying out £376m over this period despite generating only £159m in cash.

Indeed, Carillion handed out a total of £775.8m to shareholders over its lifetime. In 2016, Carillion paid out £78.9m in dividends, despite an operating loss of £38m.

Those high-dividend payments were in turn used as an indication of the “success” of the firm and thus justified the huge executive salaries and bonuses enjoyed by the members of Carillion’s board.

This bankrupt business model was largely based around “goodwill” or intangible assets that accrued to the company when they acquire other businesses through mergers and takeovers.

Also known as “fair value accounting” (FVA), the key risk of goodwill valuation is that it compresses expected future revenues into present values, enabling what are essentially gambles on future revenue to be presented as economic certainties.

Despite distinct similarities with practices which played a key role in the downfall of Enron, FVA accountancy was adopted EU-wide in 2005 through the International Accounting Standards Board (IASB) International Financial Reporting Standards.

In the case of Carillion, goodwill asset values enabled the firm to borrow more to fund bonuses and dividends, which in turn required new contract acquisitions for ready cash to pay down lenders due to the lack of revenue from the underlying assets.

In this model the solution to underperforming contracts is to bid for more, with a result of ever-lower margins as competitive pressures and a “win at all costs” mentality drive tenders down.

The government has been a willing partner in this, outsourcing risk as the price for cheaper service provision, paid for at the expense of workers and service users across huge swathes of the public sector as the major providers seek to both carve out profit and deliver cost savings.

The elephant in the room for the government is that this “on the never-never” model of business is aggressively encouraged and ultimately created by government policy.

The companies that apply this model do so largely because they are pretty much guaranteed a succession of PFI and similar public-private model contracts.

This model accumulates contracts on the assumption that the company can find the means to deliver them in the future.

The British government continued to award contracts to Carillion when it was clearly in dire financial straits and it is anticipated that new public service contracts for Interserve are shortly to be announced.

In short, the model is parasitical: it is drip-fed by an endless succession of public sector-created markets that puts workers’ futures, as well as future earnings “on the never-never.”

The risks of the “never-never” model are not completely invisible to investors. Key institutional players started divesting from Carillion in 2015, and major hedge funds won big by short-selling Carillion, with some taking short positions form as early as 2012.

This is exactly what is going on right now with the other “never-never” companies. All of the largest five outsourcers are have experienced steep falls in share prices over the past four years.

This year, investors have made £68m so far this year placing bets on Interserve’s falling share price.

The ability of investors to rapidly divest, or indeed benefit from a company’s collapse demonstrates precisely how corporate law acts perniciously to eradicate workers’ rights.

Shareholders’ rights are used perniciously to eradicate workers’ rights. Moreover, shareholders’ rights are protected even when vital health infrastructure like the Royal Liverpool Hospital is placed in jeopardy.

Britain’s bankrupt outsourcing sector demonstrates the fallacy of shareholder oversight. Ongoing discussions of placing workers on boards, or developing new modes of corporate governance don't get to the heart of the matter.

In order to to protect workers’ rights, pensions and basic services, we don’t merely need to end outsourcing; we need to rethink the issue of shareholders’ rights.

We need to look seriously at how we meaningfully restrict the right to profit from financial and social catastrophe.

Originally published by the Morning Star