Systemic Failure Archive and Research

Carillion Collapse (UK, 15 January 2018)

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Summary

On 15 January 2018 Carillion — the UK’s second-largest construction and outsourcing firm, holding hundreds of public contracts from hospitals and schools to prisons and defence — collapsed into compulsory liquidation with liabilities approaching £7 billion and around £29 million of cash. It had roughly 43,000 employees, some 30,000 suppliers, and pension obligations to 27,000 people. Months earlier its auditors had signed the accounts as a going concern; the year before, it had paid a record dividend. A joint parliamentary inquiry summarised its rise and fall as a story of recklessness, hubris and greed. For this archive it is a case in which an organisation’s account of its own health — its financial statements — diverged steadily from reality, while the checks meant to catch that divergence looked on.

Systemic Features

  • The representation diverged from the reality. Carillion’s accounts presented an optimistic picture — aggressive assumptions about contract revenue and about the goodwill accumulated through acquisitions — that bore little relation to the cash the business actually generated. The organisation’s self-model (its accounts) was what everyone trusted, and it was wrong: £845m was written off its contract values four months after a clean audit (see organisations as cognitive systems).
  • The checks that failed. Audit exists to keep an organisation honest about its own state. KPMG audited Carillion for nineteen years without once qualifying its opinion; internal audit and turnaround advisers added further layers that did not catch the problem. When the subsystem meant to detect a divergence between representation and reality is captured or complacent, that divergence can run for years.
  • Optimising the visible signal. The board raised the dividend every year “come what may,” paying out more than the company generated in cash while borrowing rose and the pension deficit grew — an organisation optimising the visible signals (dividend, share price, executive bonus) at the expense of the unmeasured obligation, the surrogation pattern also seen at Mid Staffordshire.
  • Latent conditions in the balance sheet. A relentless dash for cash — acquisitions, rising debt, and reverse factoring (paying suppliers late, or early for a fee) to disguise borrowing — built latent fragility into the balance sheet that was invisible in good conditions and fatal when a few large contracts went wrong (see latent conditions).
  • Outsourcing contagion. Because Carillion had been coupled tightly to the delivery of public services and to a supply chain of 30,000 firms, its private collapse propagated into schools, hospitals and thousands of small businesses — an illustration of how far the failure of one optimised node travels when public functions are concentrated in it (see tight coupling).

Cascading Systems Affected

  • Public services (hundreds of government contracts — hospitals, schools, prisons, defence, HS2)
  • The supply chain (around 30,000 suppliers, some pushed into insolvency)
  • Employees and pensioners (around 43,000 staff; 27,000 pension members; 11 of 13 schemes entering the Pension Protection Fund)
  • Public finances (the costs of the liquidation)
  • Confidence in corporate audit and governance

Impacts

  • Liquidation on 15 January 2018 with almost £7bn in liabilities and about £29m in cash, months after a going-concern audit and a year after a record £79m dividend.
  • A joint inquiry by the Business and Work and Pensions Committees (May 2018) found recklessness, hubris and greed, systematically manipulated accounts, contempt for suppliers, and chronically passive regulators (the Financial Reporting Council and the Pensions Regulator).
  • The statutory audit market was referred to the Competition and Markets Authority; the case fed reforms to audit and corporate governance and long-running investigations into KPMG and former directors.
  • Frank Field’s verdict — that it was not only Carillion but the whole system of corporate accountability that was built on sand — framed the collapse as symptomatic rather than isolated.

Further Reading / Sources

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