If despite predatory practices and huge extraction of returns, private companies are guaranteed to be rescued by the state, why should directors act responsibly?

Prem Sikka is an Emeritus Professor of Accounting at the University of Essex and the University of Sheffield, a Labour member of the House of Lords, and Contributing Editor at Left Foot Forward.

The 1989 privatisation of England’s water industry is “an organised rip-off” and an unmitigated disaster. Water Companies have neglected investment in infrastructure and dumped tons of raw sewage in rivers, lakes and seas. As monopoly suppliers they have levied inflation-busting charges on customers; paid over £85bn in dividends and borrowed over £65bn to finance them. Over 28% of sales revenues vanish in servicing debts.  Major companies have gearing ratios ranging from 500% to over 1,000%, and are struggling make debt repayments. Water regulator Ofwat and the Environment Agency have done little to curb predatory practices.

A crisis point has been reached. Water shareholders are writing off investment, debt is rated as junk, and Thames Water, England’s largest water company, is actively seeking to restructure its debts.

Special Administration Regime

Privatisation can only be ended by the state, but governments in bed with corporate interests are delaying the inevitable. Legislation for putting water companies into Special Administration Regime (SAR) is already in place. It enables the Secretary of State to put a failing water company into special administration whilst continuing to provide water and sewage services to customers. It enables the special administrator to ‘hive-down’ the operating business and assets into a new entity, facilitating a sale of a going concern business to a new purchaser and potentially leaving unwanted assets and liabilities behind in the seller group. Inevitably, shareholders and creditors will lose some value, but why would another buyer step in without guarantee of profits and subsidies to build infrastructure?

The SAR regime may be seen as a form of temporary nationalisation, but a Minister told parliament: “We have no plans to nationalise Thames Water or other water companies”.

Special Measures

The government’s strategy is to manage public anxieties and fatten-up failed companies for (re)privatisation. This is facilitated by the Water (Special Measures) Bill currently going through parliament. Clause 10 of the Bill enables Ministers to do almost anything to restructure water companies and hand them back to the private sector. It enables Ministers to modify water company licences. The explanatory notes accompanying the Bill state that

“The modifications can require a water company to raise amounts of money determined by the Secretary of State from its consumers, and to pay those amounts to the Secretary of State to make good any shortfall…”

What could the shortfall relate to? The Bill does not explain but it could be the cost of government interventions to make the company fit for purpose or resale. It could include cost of cleaning-up rivers, seas and lakes, writing off liabilities, providing sweeteners to potential buyers, and funds for investment, loans and guarantees. It is hard to see how companies are going to make the proposed £260bn investment in infrastructure without massive hikes in customer charges and/or public subsidies.

The government has stated that: “These powers would never be used to pay bondholders, shareholders or creditors … we do not expect customers to pay the price for water companies’ mismanagement … measures in the Water Bill will protect taxpayers”.

At the same time, the government has stated “that that the Secretary of State may provide financial assistance”.

It is hard to reconcile these statements.

The press release accompanying the Bill omits discussion of any of above issues. The Water (Special Measures) Bill also contains measures to improve accountability, governance and regulatory compliance of water companies. Regulators can bring criminal charges against law-breaking water executives, including imprisonment for failing to co-operate or obstruct investigations.

Since 2020, water chief executives have paid themselves over £41m in bonuses, and regulators will be empowered to ban bonuses for persons holding senior roles where companies fail to meet required standards relating to consumer matters, the environment, financial resilience or criminal liability. The government promises that regulators will consult experts covering areas such as the environment, public health, consumers, investors, engineering, economics and campaigners.

Special Measures are not so Special

The proposed governance reforms are fundamentally flawed. They rely upon regulatory bodies, such as Ofwat and the Environment Agency, to invigilate companies even though they have already failed in that task for the last 35 years. None owes a ‘duty of care’ to people.

For any system of regulation to be effective, there needs to be a distance between regulators and the regulated. However, that is not the case in the water industry. For example, two-thirds of England’s biggest water companies employ key executives who had previously worked at Ofwat. Executives of water companies and regulators regularly meet in hotels and private members’ clubs to discuss how to quell public anger over bill rises and sewage dumping. Collusion and cognitive capture is the order of the day.

Regulators are too close to the industry, as evidenced by the Pricing formula, codenamed PR24, used by Ofwat. It takes no account of the level of sewage dumping, unplugged leaks, lack of investment or frequency of regulatory sanctions. It uses a weighted average cost of capital based on fictitious gearing levels to inflate returns to shareholders. It guarantees real returns to companies and does little to protect customers or the environment. The regulatory independence is undermined by the regulator’s secondary statutory objective to promote growth and competitiveness of the industry. This conflicts with the requirement to protect customers and the environment.

Ministers claim that: “customers will have the power to summon board members and hold water executives to account through new customer panels with teeth”. 

These panels will be handpicked by companies and/or regulators and will have no independence. If the government is serious about customer representations, it must ensure that at least 50% of the unitary board of water companies and regulators is directly elected by customers. Thus, they will be accountable to stakeholders and cannot be bullied or silenced by Ministers, regulators or companies.

Curbs on executive bonuses may excite some but won’t be effective. Any link to “financial resilience” requires regulators to specify and enforce optimal gearing/leverage levels, borrowing capacities, credit ratings, working capital ratios, capital adequacy  and routinely undertake stress tests. How exactly will “resilience” be secured – by exploiting customers or shareholders providing a strong capital base? Ofwat have never shown any interest in such matters and has no independence or capacity to monitor or enforce the required financial standards. The Bill provides no details and matters will inevitably be negotiated behind closed-doors to the lowest common denominator.

Companies can bypass any bonus ban by increasing the basic salary of executives. Companies such as Thames Water are part of a complex corporate structure. It is perfectly feasible for their controllers to offer executives multiple directorships to compensate for loss of any bonus. It isn’t just bonuses, salaries may be undeserved too. The best way to deal with that is to empower customers to vote on executive pay. If customers are satisfied that executives have served the public interest they would approve salaries and even bonuses for extraordinary performance.

Regulators bringing criminal charges against law-breaking water executives are a good idea but the Bill camouflages reality. In practice, most of the sewage dumping is authorised by regulators as poor infrastructure can’t cope with the flows. Directors also have insurance to cover them for negligence in the pursuit of corporate objectives. The cost is woven into customer charges. The chances of directors personally bearing penalties are low, assuming that regulators succeed in securing convictions.

The Bill does not constrain water company ability to pay dividends. In March 2023, Ofwat announced that it is taking powers to enable it to stop the payment of dividends if they would risk the company’s financial resilience, and take enforcement action against water companies that don’t link dividend payments to performance. Despite sewage dumping and unplugged leaks, companies have continued to pay dividends. Under the Companies Act 2006, dividends can only be paid out of distributable reserves, which are essentially realised profits, but water companies do not disclose their distributable reserves. Such reserves are routinely inflated by financial engineering, such as capitalisation of some interest payments and repair and maintenance costs. Ofwat has taken no steps to curb financial engineering.

The Water (Special Measures) Bill may make minor difference but it essentially is part of political manoeuvrings designed to avoid bringing the failed water industry into public ownership as neoliberal state continues to guarantee corporate profits.

Private ownership of monopolies can’t resolve the crisis which is due to profiteering, excessive dividends, exploitation of customers and lack of investment in infrastructure. The new owners would enjoy a state guaranteed monopoly and want a return on investment. Thus, a continuing crisis and conflict with the general public is inevitable.

The Bill provides a thinly disguised framework for bailing out (and in) companies and returning then to the private sector. Cost will be borne by customers and/or the public purse. Reforms to governance lack details and their enforceability must be doubted. Reprivatisation introduces new moral hazards. If despite predatory practices and huge extraction of returns, private companies are guaranteed to be rescued by the state, why should directors act responsibly?

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