Governance issues at Tesco

This article was previously published on the Leadership Foundation website.

The food retailer, Tesco, has rarely been out of the news in the last month. The company’s admission that it had over-stated its half-year profits by £250m, has raised questions about the composition of the company’s board of directors and the use of inappropriate accounting policies.

Prior to the appointment of two new non-executive directors on 7 October 2014, Tesco’s board had no non-executive directors with retail experience. This weakness in domain knowledge suggested the board was unlikely to have the necessary knowledge and expertise to effectively question and challenge the company’s executives.

While the external auditors in the company’s 2014 Annual Report and Financial Statements discussed the ‘risk of manipulation’ in the recognition of commercial income, this did not prevent the company’s first-half figures for 2014 prematurely recognising income and anticipating cost savings. The accounting treatment adopted was, one assumes, accepted by the Audit committee, and the profit figures subsequently signed-off by the board. The issue only subsequently emerged when one of the company's own employees questioned the accounting treatment.

Hugh Wilmot writing in the Financial Times suggests the issues of board composition and income recognition point to failures in the current system of corporate governance. He points out that the UK corporate governance code does not require non-executive directors to have relevant experience, and that the adoption of inaccurate estimates of commercial income reflects a ‘failure to establish adequate regulatory mechanisms for curbing abuses of corporate power.’ He suggests reform is urgently needed.

Issues for governing bodies to consider

• Does the membership of the governing body include governors with deep knowledge and expertise of higher education?
• Do the auditors and the audit committee question and challenge the executive where the figures presented are estimates based on assumptions about events that are inherently uncertain? 

Subsequent developments:

• On 22 October 2014, Tesco updated investors on its profits. The company indicated that its profits had been overstated by £263m, against an initial estimate of £250m. The overstatement was the result of the incorrect recognition of income, which had occured over a number of years. Together with updating investors on its results, the company announced that the Chairman of the Board would be stepping down from his position in order to draw a line under the affair.
• On 29 October 2014 the UK's Serious Fraud Office announced it had launched a criminal investigation into the alleged accounting irregularities at Tesco.