There’s a grimly familiar story behind Thomas Cook’s collapse

The holiday provider's collapse highlights corporate governance and regulatory failures, says Prem Sikka.

The House of Commons Business, Energy and Industrial Strategy Committee is to investigate the collapse of Thomas Cook. For good reasons, it will be examining the recurring failures in corporate governance, accounting, auditing and regulation.

Let’s take a look.

Gravy train

Thomas Cook has been in a precarious financial position for the last decade. It has had to rely upon emergency loans and refinancing packages, though it secured £425m from a rights issue in 2013. Meanwhile, the gravy train for directors has continued – they extracted £47m in pay and perks in the years before the company’s collapse. Its part-time non-executive directors collected between £60,000 and £106,000 in 2018. The non-executive chairman raked in £307,000. Such riches are hardly justified by the company’s performance.

In 2017, the company reported profit of £9m profit which turned into a loss of £163m for 2018. For six months to 31 March 2019, it reported a loss of nearly £1.5bn. The company was in no position to deal with a £3.1bn black hole in its finances and liquidation beckoned.

The result? Some 9,000 UK jobs are lost. Supply chain creditors, customers and HMRC will be the biggest losers from the liquidation.

Thomas Cook’s accounts have been a mish-mash of the so-called “exceptional” or what the company preferred to call “one-off” costs. They reduced the 2018 ‘profit from operations’ by £153m (£99m, 2017). The labelling of some costs as ‘exceptional’ enabled the company to bury the bad news which makes it very difficult for external parties to assess the company’s performance.

Earnings before Interest and Tax (EBIT) were a major factor in the calculation of executive bonuses and performance related pay. So the exclusion of ‘exceptional’ items from this would have inflated EBIT and performance related executive pay.

Financial engineering?

Poor accounting of ‘goodwill’ was a factor in the demise of Carillion, and is a factor for Thomas Cook as well. In accounting, goodwill is the difference between the price paid for an acquisition and its net assets. The difference may represent intangible advantages or the ability to earn superior returns.

The 2018 accounts showed goodwill at £2,585m (£2,227m, 2017). Most of it arose from the 2007 merger with MyTravel. However, Thomas Cook had been in financial difficulties, and that did not justify the balance sheet value of goodwill.

Instead, the accounting standards issued by the Financial Reporting Council (FRC) enable companies to construct models and they can show goodwill in their balance sheets almost indefinitely. Thomas Cook did this until September 2018. After the November 2018 profit warning, Thomas Cook’s interim accounts to 31 March 2019 reduced the value of its goodwill by £1,104m.

The failure to write-down worthless goodwill in earlier years inflated the company’s balance sheet, over-reported its profits and enabled directors to collect higher performance related pay.

Auditors

For the period 2008 to 2016, Thomas Cook accounts was audited by PricewaterhouseCoopers (PwC) . The same firm also audited BHS when its audit partner spent two hours on the audit and 31 hours doing consultancy. At Thomas Cook, PwC collected £3m for audit and another £1m for consultancy for 2015 and 2016.

Providing both services necessarily compromises auditor independence. Whatever the causes, despite its precarious financial position, Thomas Cook continued to receive a clean bill of health.

Ernst & Young became auditors in 2017. In 2018, the firm collected £3m for audit and £1m for consultancy. Its audit report merely amplified the going concern and other uncertainties identified by directors.

The FRC says that only 65% of the audits performed by PwC are satisfactory, but there have been no reforms. And despite common scandals, there is no public information about the time that auditors spent on the job, composition of the audit team, questions asked by the auditors, managerial responses or anything else.

Regulators: asleep at the cockpit?

In 2017, Monarch Airlines collapsed and the government repatriated thousands of stranded passengers. No procedures appear to have been introduced since to ensure that the sudden demise of an airline does not lead to chaos. No regulator monitors the financial position of airlines to ensure that they have adequate capital to meet their contractual obligations, partly as the UK lacks a central enforcer of company law.

In a fragmented regulatory environment, the FRC is considering launching an investigation into the accounts of Thomas Cook…but don’t hold your breath. Its report on the audit failures at Carillion, which collapsed in January 2018, is yet to appear. The FRC itself is arguably culpable as its rules permit companies to engage in dubious accounting practices.

Business Secretary Andrea Leadsom has urged the Insolvency Service to prioritise investigation of the collapse of Thomas Cook, but again, don’t expect an outcome soon. We are still awaiting reports on the collapse of Carillion and BHS.

The company had the usual collection of hand-picked non-executive directors, audit committees, remuneration committees, external auditors and sundry advisers, and none had the independence to deal with fat-cattery, risks or financial engineering. Such issues were raised by the 2007-08 banking crash, the demise of BHS, Carillion. Patisserie Valerie and others, but have not been addressed.

Thomas Cook is the familiar story of regulatory inertia weak corporate governance.

Prem Sikka is Professor of Accounting at University of Sheffield and Emeritus Professor of Accounting at University of Essex. He is a Contributing Editor to LFF and tweets here.

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5 Responses to “There’s a grimly familiar story behind Thomas Cook’s collapse”

  1. David Lindsay

    Bailouts just make the bailed out come back for more. From 1948 to 1972, Thomas Cook was in public ownership. Think on.

  2. Patrick Newman

    Another excellent analysis of cowboy capitalism. So little bothered is the government about these spectacular failures that Grant Shapps (AKA Michael Green) was caught out recycling Graying’s statement occasioned by the Carillion collapse. The management of Thomas Cook must have known many months before the collapse that the position was becoming terminal but chose to hide the prognosis from staff and shareholders – there was no catastrophic loss of business. They must have taken carefully planned steps to prevent the truth from emerging. Liquidation meant sudden irreversible termination of operations whereas going into administration would have given a chance for a more orderly wind down and possibly for some of the business to be continued/sold on! If that could have been facilitated by the government underwriting a small £250m loan think of all the cost and misery suffered by staff and customers that could have avoided.

  3. steve

    Heard an interview with someone whose partner works/ed for Thomas Cook. He explained how, some time ago, she’d had to re-apply for her job on less favourable conditions.

    No doubt a director was awarded a massive £handout for overseeing this ‘re-structuring’.

    Not only is capitalism failing, it routinely humiliates the employees who are supposed to make it work.

  4. Tom Sacold

    A government funded bail-out would have broken the EU Single Market rules.

  5. Dave Roberts

    I think Prem is “Cooking the books here”, geddit?

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