Tescos Accounting Scandal of 2014 - Research Proposal Example

Research on TESCO’S accounting scandal of 2014 Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission Words: 3529 Abstract Tesco’s accounting scandal of 2014 got the attention of world’s media on September 22, 2014. This research focuses on determining the extent to which the failure of corporate governance contributed to Tesco’s scandal. The introduction part the study places the concept of corporate governance broadly in a global overview and its main elements of transparency and accountability are stressed. The topic of the research is stated as ‘to investigate Tesco’s accounting scandal of 2014 and how the company can prevent that from happening again in the future, around which the research questions have several loopholes existed. Literature review for the research has been done where currently published materials related to Tesco’s scandal as well as corporate governance issues. Most of the resources used for literature review place the context of corporate governance for Tesco before, during and after the 2014 scandal. The literature has then been critically reviewed by comparing and contrasting the various resources to come with findings and recommendations for the topic of the research. The research has used the methodology of secondary qualitative sources of data. The conclusions indicate that Tesco’s scandal was mainly caused by the failure of corporate governance, and the ways to avoid the same have been highlighted. Table of Contents Abstract ii Table of Contents iii 1.0 Introduction 1 1.1 Statement of the problem 2 1.2 Research questions 2 1.3 significance of the study 2 2.0 Literature Review 3 3.0 Research Methodology 7 3.1 Instrumentation and data collection 8 3.2 Data analysis 8 3.3 Advantages and disadvantages of the methodology 8 4.0 Presentation of results and discussion 9 5.0 Conclusions 12 6.0 References 13 1.0 Introduction Corporate governance refers to the framework of practices and rules adhered to by a board of directors of a corporation in controlling and directing the company affairs to enhance accountability, transparency and fairness in the company’s relationships with its stakeholders. The stakeholders include the management, board of directors, auditors, creditors among other stakeholders (Arcot, 2010). This framework provides the basic structure on which the company’s objectives are set, the means by which the objectives are achieved, and the mechanism for monitoring and controlling performance. Thus, the main elements of a good corporate governance include accountability of the management and boards to shareholders, transparency in corporate structure and operations; and corporate responsibility to the stakeholders.The concepts of disclosure and transparency are the core aspects of corporate governance. Companies across the globe acknowledge that corporate governance is fundamental to the growth of a company and creates efficiency in operational performance.There have been several frauds and scams in the corporate world which have been associated with issues of corporate governance. In the light of these failures, corporate governance has since assumed more importance and awareness among people globally due to its impact on the shareholders and other affected stakeholders (Bebchuk&Weisbach, 2010). The corporate failures have signaled a lack of proper structures of governance and objectivity by the top management. In the United Kingdom, the issue of modern corporate governance was highlighted by Tesco’s accounting scandal of 2014. The scandal attracted a lot of attention because Tesco is one of the largest companies in the UK, and its corporate image had been reputable before the scandal, according to (Awolowo, 2016). Tesco was founded in 1919 by Jack Cohen from a market stall in London’s East End. Over the years Tesco has grown and now operate in 12 countries around the world, employing over 530,000 people and serving tens of millions of customers every week. 1.1 Statement of the problem The main aim of the research was to investigate Tesco’s accounting scandal of 2014 and how the company can prevent that from happening again in the future. It mainly focused on the failure of corporate governance as the cause of the scandal. 1.2 Research questions The following three research questions guided the research: a) To what extent was corporate governance failure responsible for the accounting scandal at Tesco in 2014? b) How can corporate governance be further enhanced in corporations without stifling their growth? c) What should Tesco do to prevent such an accounting scandal in the future? 1.3 significance of the study This study helped in understanding how Tesco’s corporate governance failure caused 2014 accounting scandal. The findings of the research would not only help Tesco to avoid such a scandal in future, but they would also help other companies to strengthen their corporate governance structures to avoid such experiences. The research on Tesco revealed that corporate governance is a daily undertaking that should not be undermined by companies since it is a necessity for continued operation. 2.0 Literature Review According to (Müller, M., 2015), Tesco is the largest retailer in the United Kingdom, and the second largest grocery and retailer in the world after Walmart. The multinational retail giant has its headquarters in England. Tesco got the public in shock on September 22, 2014 when it reported that it had materially overstated its profits by 263 million. Earlier, the company had issued a profit warning on August 29, 2014 with estimated profits of 1.1 billion. The new report showed that the profits were actually supposed to be 850 million. The company had recorded 1.6 billion in 2013 and now it was about to record almost half in 2014, causing alarms in the performance of the company. Investigations revealed that accounting malpractice was caused by irregularities in revenue recognition in the half-year results. This was the worst financial crisis that hit the company in its 95-year history of operations. PricewaterhouseCoopers (PwC), Tesco’s external auditors, had warned the company of possible material risk of manipulation of ‘commercial income’ (rebates, promotional payments and rebates) in the previous audit report, (Tricker, 2015). PwC has been Tesco’s external auditor since 1983, and this brings about familiarity threat to auditor independence for the more than 30 year period of auditor identification with the company. Therefore, the auditor might have considerably lacked professional skepticism to objectively review the company’s financial reports as they should have. However, only full year financial statements of a company are subjected to a full audit. Half-year financial statements are subjected to review audit assignments, and therefore, it was less likely that PwC auditors would realize the errors. Moreover, audit committees are essential aiding the work of the auditors, especially for the half-year results’ audit. Surprisingly, the chairman of the internal audit committee for Tesco was also worked as an auditor with PwC (Shil, 2014). This greatly questions the independence and objectivity of PwC audit assignments at Tesco. The audit committee of a company is very crucial in enhancing the internal controls within the company to be able to achieve the set objectives while adhering to the accepted accounting principles as well as managerial ethics. This shows that there was a breach of the principles of corporate governance in the structuring and functioning of Tesco’s audit committee, and the external audit firm was not to blame for the company’s financial crises (Müller, 2015). Scrutiny of the company’s books of account following the warning of a whistle-blower disclosed that payments to the company from suppliers had been overstated operation costs were being understated (Awolowo, 2016). This led to misleadingly boosting of the company’s profits by 263 million for the first half of the year. The payments from suppliers for in-store promotions and bonus payments made by suppliers to the retailer after hitting the target sales were deemed to have been overly accelerated (Awolowo, 2016). This was a breach of the proper accounting policies that was meant to foster a false image of the company to the shareholders and the general stakeholders. Tesco had been earlier accused by accountancy and financial analysts for overstating profits by early booking of rebates and bonuses from the suppliers. In the retail industry it common for the retailers to agree with suppliers at the beginning of the year for a cost price, but the discount is to be received later. Consequently, the news had very devastating effects on the company as the market reacted very fast as, by October 7, 2014, about 2billion had been knocked off the company’s value. The share price of the entity had been slushed by about 15 percent, the lowest level in more than a decade worsening the situation. This was after investors turned their backs to the company following the revelations that tarnished the company’s public image of declined profits and sales. The company had been previously experiencing a decline in profits as witnessed by successive profit warnings, and the disclosure of this scandal marked the darkest moment of the company in its history. Too many questions arose as to how such an enormous company could find itself in such a mess. Perhaps it was the negligence on the part of the company’s board of directors. The scandal came shortly after the ousting of the former boss of the company, Philip Clarke. Immediately after the disclosure of the mess, the current boss Dave Lewis ordered for independent, and compressive investigation of the issue and subsequently sent home four of the firm’s executives, including the chief in charge of Britain business, the largest unit of the company. Some analysts fault Mr. Clarke’s predecessor Sir Terry Leahy, who had increased the company’s lead over its competitors by building too many stores and ill-judged penetration into foreign markets such as America (Shil, 2014). As a result, the company’s profitability had drastically fallen by about one-third during the period between 1998 and 2010.As Mr. Clarke focused on upgrade, and as a result, Tesco’s prices went up to an extent of scaring away its customers and losing grip in UK market. This was a threat to Tesco as there are ‘hard discounters’ such asAldi and Lidlin the market who sell their goods relatively cheaper without compromise of the quality. Mr. Lewis had promised to initiate investigations to know whether the practice had been going on for some time. The company’s acknowledgment of overstating its profits raised many concerns about the composition of its board, adherence to the appropriate accounting policies as well as issues of corporate governance. According to (Müller, 2015 and (Shil, 2014)), before the appointment of two new non-executive directors on October 7, 2014, Tesco’s board of directors had no non-executive director with knowledge or experience of the retail business. This lack of appropriate experts within the board is a clear indication that the decisions of the company’s executives could not be effectively questioned or challenged.This compromised the principle of effectiveness enshrined the UK code of corporate governance 2012 that requires directors to have the relevant skills and knowledge. The company had also stayed for several weeks without a finance director and chief finance officer, an indication of poor succession planning. The chief finance officer is responsible for oversight of internal control of financial records, and the absence of one means a rot in the system. The four executives who were suspended are the managing director for Tesco UK, the UK finance director, the commercial director, and the director responsible for sourcing. The suspension of the directors would pave the way for independent forensic investigations, as they must have been failed to execute their duties diligently (Wiśniewski&Kozłowski, 2014). The investigations were conducted by Deloitte assisted by Freshfields Lawyers and went beyond paperwork to examining the executives’ emails as well as their laptops. The previous finance director had resigned in April 2014, although he had remained on the payroll, according to (Shil, 2014). This also raises a question of corporate governance as the remuneration of a director who is not in service at a company should be stopped with immediate effect. The research established that the blame for Tesco’s crisis should be cast on the company’s board of directors. The management is responsible for detecting anomalies in the company and act appropriately. It was impossible for such an overstatement of profits to occur without the knowledge of the management. Just as analysts and the media foresaw Tesco’s crisis, the company’s chairman and board of directors should have detected it and act appropriately. When he was grilled over the scandal, Sir Richard Broadbent, the board chairman said that it was the duty of the shareholders to decide. This was a clear indication that he already knew the answer. This was indeed massive failure in corporate governance. 3.0 Research Methodology The research adopted qualitative and descriptive nature due to the nature of the research as it involved a case study. The major reason for adoption of qualitative approach resulted from the merit that it provides a platform for in-depth study and analysis of case, coming up with more accurate information necessary to arrive at conclusive research. The topic for this research was “Tesco’s accounting scandal of 2014 and how the company can prevent that from happening again in the future.”The research was basically based on secondary data obtained from credible sources. The research method was more of an ethical enquiry paying particular attention at Tesco’s ethical shortcomings with a view of making recommendations to improve them. The secondary source of our data was drawn from publications. The research used current published books and journal (published in 2010 and onwards) available in the library that give light on issues of corporate governance. In addition, articles from journals and magazines among other periodicals were used. The aim is to capture the secondary information about corporate governance issues and assist in concluding and developing recommendation for the research topic and answering the stated research questions. Online eBooks, articles and journals among other e-based resources like blogs was greatly used in this research. 3.1 Instrumentation and data collection The data was collected from secondary sources. The research involves a case study and thus it dictates use of a qualitative approach. The research made use of data repositories on previous studies on corporate governance and other sources containing information about the Tesco’s accounting scandal of 2014. Websites, newspaper reviews, published journals and books, documents and literature were extensively used. The qualitative research methodology adopted entailed use of multi-staged data collection approach to progressively investigative the subject of the case study. 3.2 Data analysis The unit of analysis of this was the failure of corporate governance in Tesco’s accounting scandal of 2014. The contents of the data collected were carefully analyzed to draw patterns of thought that would support the existing theories about the topic of the research, as well as generating knowledge that would be used for further researches on the same area. Logical conclusions and recommendations were drawn from the findings of the research, which would be used to adequately address the research questions of the study. 3.3 Advantages and disadvantages of the methodology The secondary qualitative methodology of data collection and analysis has several advantages. Firstly, it saves time as a lot of data can easily be obtained from the secondary sources about Tesco’s scandal and the related theories of corporate governance. Secondly, the datasets are important for data comparison and generalization of the research that would have otherwise been difficult with the primary quantitative approach. Thirdly, there was no direct interaction with the population of study. It would have been difficult to reach Tesco’s directors or shareholders to obtain primary information. However, the methodology also has some disadvantages. First, there was limited control over the populations under study. Second, the information contained in the data sets might not have been complete as the primary researchers might have had different objectives. Third, the manner in which the secondary data was presented may not be suitable for analysis by the secondary researcher. 4.0 Presentation of results and discussion The various secondary sources of data used for collection and analysis of data on ‘Tesco’s accounting scandal of 2014 and how the company can prevent that from happening again in the future’ brought about various findings on the topic in addressing the research questions. It was found out from the research that corporate governance failure was responsible for Tesco’s accounting scandal of 2014. The findings of the research revealed that there was a gap in the corporate governance structures of Tesco, without which the company would not have experienced the accounting scandal. It was unusual for the Tesco’s boss and the board of directors to fail to realize such a huge misstatement of its financial statements that would later plunge the company into a crisis. It was found out that material overstatement of the profits of the company had been cumulative and that it was not a single-period affair. Internal control systems based on corporate governance were insufficient and ineffective to detect the accounting errors. The inefficiencies were caused by failure to adhere to the UK code of governance guiding the structuring and functioning of boards of directors of companies. Several sources studied indicate that Tesco’s board was composed of directors who had no relevant knowledge and skills in the operation of a retail supermarket. Other sources relate the scandal to a lack of auditor independence and objectivity by Tesco’s external auditor (PwC). However, regarding its further widely argued that the unqualified audit of the previous audit was caused by the incompetence of Tesco’s audit committee, whose composition and functioning was unethical in terms of corporate governance. That said, it can then be concluded that failure of corporate governance was the greatest cause of Tesco’s accounting scandal of 2014. It has been found out from the research that corporate governance is an important aspect in the running of a corporation, and it can be enhanced without stifling the organization. Structures of corporate governance within an organization can be properly aligned with the company objectives to ensure smooth running and performance control. The board of directors should be composed of individual who have expertise in the field in which the company operates. As already mentioned in the case of Tesco, the board was made of Directors none of whom had the knowledge of a supermarket. Corporate governance in an organization can also be enhanced by ensuring ethical structuring and functioning of internal units such as committees of directors. For example, the audit committee should be made up of non-executive independent directors who have no personal interests at the center. The research found out that the chairman of Tesco’s audit committee also worked with the company’s external auditor, PwC and thus the validity of the audit reports by the auditor was questionable. Also, the audit committee should ensure oversight of the company’s accounting functions to detect any potential threats of misstatements. The management should maintain healthy relationships with all the stakeholders to the company, and more importantly, place shareholder wealth maximization at the core of their operations. The directors are employed by the shareholders, and they should, therefore, act in the best interests of the shareholders. It was found from the research that Tesco’s accounting scandal led to the fall of the share value by up to 11 percent, and this was a great loss for the company’s shareholders. Tesco can strengthen on the weaknesses that led the company to the 2014 scandal to avoid a repeat of the same in future. There were several loopholes that existed with the corporate governance structure of the company that incapacitated its operation as a going concern. According to the findings of this research, Tesco should embark on reconstituting its board of directors to align its composition with the objectives of the company by ensuring that all the directors have expertise in supermarket operations. The study applauds the approach of corporate governance by suspending the top executives who were linked to the scandal. Tesco should also strengthen its internal control systems by putting in place a competent audit committee and ensure its independence and objectivity. To ensure this, the members of the audit committee should be non-executive independent directors. The board of directors and the general management should be guided by the core principles of corporate governance which are disclosure and transparency. This would ensure that the management do not agency conflicts between them and all other interested stakeholders that could land the company in similar scandal in the future. The company should also review the length of stay in service of a director, because overstaying in the organization compromises the performance of a director. The company can as well consider changing its external auditor. PwC has audited Tesco for the last 34 years and such familiarity with the company might compromise the professional skepticism of the auditor. The key performance indicators would be increased share value, profitability, growth and increased trust in the company. The findings of this research can also be used to make recommendations on how the National Health Service of UK can improve its performance. The management of the corporation should be streamlined to its objectives. As it has been discussed, corporate governance is key to effective management and performance of any corporation. The NHS should therefore have a well-defined code of corporate governance that defines the relationship between its management and the interested stakeholders. There should be a well define mechanism of internal control to oversight the financial statement and enhance performance control to be able to detect any deviation from the set goals and provide a corrective procedures as well. 5.0 Conclusions Tesco’s accounting scandal of 2014 was caused by window dressing in which its half-year profits for 2014 were overstated by 263 million. It has been established from this research that the scandal was mainly caused by failure of corporate governance in the company. It is important for corporations to acknowledge the fact that a proper culture of corporate governance should be cultivated within an organization for it to experience a healthy growth that corporate governance Good corporate governance will help Tesco operate more efficiently, improve access to capital, mitigate risk and safeguard against mismanagement. It makes Tesco more accountable and transparent to investors and gives them the tools to respond to legitimate stakeholder concerns such as sustainable environmental and social development. If Tesco ensures firm structures of corporate governance, then it will be able to avoid getting into another similar scandal in the future. Other organizations such as the NHS can also implement the recommendations for Tesco so that they do not travel the same road as Tesco. Failure to by the organization to have a strong foundation of corporate governance may lead it to agency conflicts and possibly destroy its public image irreparably. Boards of directors and the managements of companies should learn from then failures of large multinational corporations which have been caused by the failures of corporate governance. Also, the various regulations and guidelines that have been put in place such as the UK Code of Corporate Governance of 2012 should adhere. Corporate governance contributes to development; increased access to capital; encourages new investments; boosts economic growth, and provides employment opportunities to the society in which the corporation operates. 6.0 References Arcot, S., Bruno, V. and Faure-Grimaud, A., 2010. Corporate governance in the UK: Is comply or explain approach working? International Review of Law and Economics, 30(2), pp.193-201. Awolowo, I.F., 2016. Financial Statement Fraud: The Need for a Paradigm Shift to Forensic Accounting system, 7(10), p.23. Bebchuk, L.A. and Weisbach, M.S., 2010. The state of corporate governance research. Review of Financial Studies, 23(3), pp.939-961. Blair, M.M. and Roe, M.J. eds., 2010. Employees and corporate governance. Brookings Institution Press. Council, F.R., 2010. The UK corporate governance code. London: Financial Reporting Council. Mallin, C.A. ed., 2011. Handbook on international corporate governance: country analyses. Edward Elgar Publishing. Müller, M., 2015.Critical Analysis of The Financing Policies of Tesco plc. Tricker, R.B., 2015. Corporate governance: Principles, policies, and practices. OUP Oxford. Shil, S., 2014. Positive Accounting Theory and Changes in Accounting Principles: An Exploratory Inquiry into Bangladeshi Listed Companies.Independent Business Wiśniewski, J. and Kozłowski, A.R., 2014. Challenges for Social Responsibility in Activities for Economic Development.Review, 7(2), p.70. Read More