Corporate Governance – A Case Study of Tesco Accounting Scandal 2014

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Introduction

In present times, the subject of corporate governance is the most crucial one and a large number of corporate scams have recently been reported. This is due to a lack of attention paid by the board of directors, auditors, and other regulatory bodies, making it problematic for shareholders and stakeholders of a company to think strategically for the betterment of the company.

According to Bebchuk, Cohen, and Ferrell (2008, p.783), corporate governance is defined as the set of rules and regulations, and practices that can be implied on the company so as to control the business operations. The corporate governance of a company is mainly concerned with maintaining a balance between the company operations and the interests of stakeholders and shareholders of a company (Bhagat and Bolton, 2008, p.257).

However, there are recent additions in the corporate governance scams amongst which the accounting scandal of Tesco PLC 2014-2015 is the most prominent one. The aforementioned UK retailing business came under the regulatory scanner because of the scandal of overstating the profits of the company; where nearly around £263 million worth of profits were overstated (TheGuardian.com, 2014).

This essay highlights the lack of corporate governance while exploring major loopholes in the corporate structure of the company which resulted in this major accounting scandal. A conclusion is presented in the end while summarising major findings of the essay and effective recommendations are presented in this essay for the companies to avoid such corporate governance failures in the future.

Discussion

Overview of the case

In the year 2014, Tesco, UK’s largest retailing giant, was plunged deeper into the crises which resulted in the suspension of four senior executive directors of the company. The suspension was followed by the scandal of overstating the company profits by £250m (TheGuardian.com, 2014). Tesco had overstated the first-half profits of the company to be £1.1bn, but later on, it was revealed that the company had experienced a profit of £263m. This overstatement of the profits in the forecasted profit figures was to attract shareholders and to increase investments and funds to the retailer (FinancialTimes.com, 2014).

After the accounting scandal in Tesco PLC, the legal authorities and board of directors significantly took this matter under consideration and wiped off £2bn of the net value from the UK’s biggest retailing company. Following the accounting fraud, Tesco PLC was alleged to pay a £500m fine by the end of the year and more than 125 investors filed against the accounting fraud made by Tesco PLC and claimed that the company had been lying to gain funds and investments (TheTelegraph.co.uk, 2014).

 

Failure of Corporate Governance

Tesco PLC has been known for its corporate governance framework and its commitment to safety and ethics towards the environment as well as the people. However, the accounting scandal of Tesco PLC in 2014 has been reported to be one of the influential events that declined the overall reputation of the company. Because of this corporate governance failure, several people of the company were suspended including four executives as well that were engaged in the accounting fraud (Awolowo, 2016, p.23).

Moreover, the audit committee and company (Deloitte) were also reviewed and brought under the consideration after the incident. The major corporate governance failure, in this case, is because of the massive process failure of Tesco PLC. More importantly, the resignation of the Chief Finance Office just before the accounting scandal brought the headlines left the company with no CFO (TheTelegraph.co.uk, 2014).

Additionally, the resignation of the CFO followed with the resignation of several other great senior executives which is the case of pure poor corporate governance. The board of directors and the non-executive directors paid no attention to the inflated and overstatement of profits to grab the attention of shareholders.

Similarly, the external audit committee, PwC, and the internal audit committee of the company were equally responsible for their lack of activeness in this matter. However, the EU Audit Directive and Code of Ethics pose a strong push on the internal audit committees of the company, including their role on financing, reporting, and disclosing of honest information to the shareholders and stakeholders of the company (Müller, 2015).

It is evident that the role of the board of directors to have vigilant corporate governance is the prominent one which implies that in order to establish excellent corporate governance, it is necessary that the company board of directors are the key players in maintaining effective corporate governance (Bhagat and Bolton, 2008).

The Board of directors of the company is responsible to establish the key vision and mission of the company while setting strategies to obtain a nominal position in the market (Woods, 2007). However, this is not in the case of Tesco PLC. The board of directors was ignoring the Code of Ethics and EU Audit Directives which led to accounting fraud. Moreover, the board of directors of the company failed to take strategic decisions and raise their voice against the irregularities while focusing their recognition on revenue generation.

According to Ismail (2017), the UK Code of Governance provides provisions for the audit committees as well which ensures that the audit committee of the company is responsible for maintaining integrity in the financial statements of the company, along with reviewing the financial controls, judgments, and operations of the company so as to avoid the mishaps or misstatements in the financial statements.

However, in the case of Tesco PLC, the audit company of the company PwC paid no attention to the misstatement hence this led to the removal of PwC from the external audit committee of Tesco PLC (Müller, 2015). According to Courteau et al. (2017, p.1), the internal and external audit committee of the company is responsible to manage the financial activities such as reporting, external and internal audit, disclosure, and monitoring the regulatory operations of the financials of the company.

However, the audit committee of Tesco PLC has long been avoiding their responsibilities which resulted in the accounting scandal of Tesco PLC in 2014. According to Kukreja and Gupta (2016), the disqualification or resignation of the potential board members also results in the failure of corporate governance. This may be in the case of Tesco PLC. The accounting scandal in 2014 broke out soon before the resignation of the CFO of the company and left Tesco with no supervision of the CFO, however, the scandal led to the dismissal of three responsible board members which included the chairman, Richard Broadbent, and CEO Phillip Clarke as well.

 

Corporate Governance – A theoretical perspective

In the light of stakeholder theory, corporate governance can be seen as the collection of policies and principles that are necessary to maintain the morals and ethics of conducting a business while valuing the stakeholders and their interests. According to Courteau et al. (2017, p.1), stakeholders theory is known for its managerial side and declares that the company and the board of directors are responsible to value the interests of the stakeholders while valuing the morals and ethics of conducting the business (Alpaslan, Green and Mitroff, 2009).

In the case of Tesco PLC, the company has failed to value the stakeholders’ interests during the governance process. The board of directors failed to value the interest of their shareholders while disclosing the fake information and overstated the company profits to gin investments and profits from the investors. Similarly, the company audit committee of Tesco PLC also paid no attention to the values of its stakeholders which led to the fraud (TheGuardian.com, 2014).

Lessons Learned

The weak corporate governance structure of Tesco PLC and no attention to the overstatement of profits results in such fraud which not only penalizes the company with extra charges, but it also affects the overall market reputation of the company in the eyes of the shareholders and customers. Because of the accounting fraud of Tesco PLC, it has been evident that the internal and external board of directors of the company are responsible to make strategic decisions for the avoidance of such mishaps in the reporting or disclosure of financial statements (Kukreja and Gupta, 2016).

Moreover, it is also recommended that the company must be including effective regulations and viable accounting practices so as to avoid such fraud. Similarly, good leadership and governing practices should also be incorporated within the corporate governance of the company in order to keep the employees on track to meet organisational goals while meeting and valuing the stakeholders’ interests and legal rights. If the corporate structure and board of directors of Tesco PLC could have valued the stakeholders’ values and concerns while keeping the personal gains for the company aside, the company might not have indulged in such serious accounting fraud.

Conclusion

As a concluding statement, it has been observed that Tesco PLC has been known for its misstatement of profits in accounting books to grab the attention and investments of the shareholders to increase profits. This has occurred because of a weak corporate governance structure and a lack of attention from the board of directors and audit committee to this issue. Hence it can be recommended that the company should have an effective corporate governance structure with the inclusion of Governance Code provisions and potential board members in order to avoid such frauds and scandals.

References

• Abdullah, H. and Valentine, B., 2009. Fundamental and ethics theories of corporate governance. Middle Eastern Finance and Economics, 4(4), pp.88-96.
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• Awolowo, I.F., 2016. Financial Statement Fraud: The Need for a Paradigm Shift to Forensic Accounting. system, 7(10), p.23.
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• FinancialTimes.com, 2014. Available at: https://www.ft.com/content/71118e80-4a20-11e4-bc07-00144feab7de
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• TheGuardian.com, 2014. Available at: https://www.theguardian.com/business/live/2014/sep/22/tesco-launches-inquiry-after-overstating-profit-forecasts-by-250m-business-live
• TheTelegraph.co.uk, 2014. Available at: https://www.telegraph.co.uk/finance/newsbysector/epic/tsco/11181686/Tesco-crisis-what-you-need-to-know.html
• Woods, M., 2007. Linking risk management to strategic controls: a case study of Tesco plc. International Journal of Risk Assessment and Management, 7(8), pp.1074-1088.