Tesco PLC: Analysis of Corporate Governance Failure and Legal Issues

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This report examines the 2014 corporate governance failure at Tesco PLC, focusing on the accounting scandal where profits were overstated, leading to significant financial repercussions and reputational damage. The report delves into the overview of the case, highlighting the overstatement of profits and the subsequent investigation. It analyzes the specific failures in corporate governance, identifying key contributing factors such as incompetent management, failure to follow internal regulations, inadequate risk management, and ineffective auditing. The report further explores the criminal liability of a corporation in such failures, referencing the identification principle and relevant UK law. It also discusses models and principles of good corporate governance and the responses from both corporate and governmental bodies, along with the legal issues involved. Finally, the report proposes solutions to prevent similar failures in the future, emphasizing improved management, stricter adherence to ethical codes, and enhanced internal controls, concluding with a summary of the key findings and recommendations.
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Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................4
Overview of the Case Scenario..............................................................................................4
Failure of Corporate Governance...........................................................................................4
Reasons Behind Corporate Governance Failure in Tesco PLC..............................................5
Criminal Liability of a Corporation in Failure of Corporate Governance..............................6
Models and Principles of Good Corporate Governance.........................................................8
The Corporate and Governmental Responses to this Scandal and Also the Legal Issues
Involved..................................................................................................................................9
Propose Certain Solutions to Avoid Such types of Failures in Corporate Governance in Future
..............................................................................................................................................10
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13
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INTRODUCTION
The Corporate governance is basically the combinations of various rules, regulations
and other laws which needs to be followed so that a business can carry on its activities and
manage all these in a smooth and efficient manner. As due to various scams & scandals in the
corporate world in the recent few years corporate governance has gained importance in a
significant manner. The main reason behind the failure of corporate governance is that the higher
authorities of the company does not give much attention which creates a complex situation for
shareholders & stakeholders and the betterment and growth of the company hindered. The
situation of corporate governance arise when there is imbalance between the operations of the
company and interests of shareholders & stakeholders of the organisation.
There are various scandals concerning failure of corporate governance and one of those is
of Tesco Plc in the year 2014 in which their accounting department has done a scandal, which is
the one of the most crucial example in the recent era. This was a failure of corporate governance
because it was overstating it profit which lead to the business coming under the scanner of
regulatory authority. Here the researcher will try to focus upon Tesco PLC's failure of corporate
governance highlighting its reasons and what all legal issues were posed.
MAIN BODY
Overview of the Case Scenario
In 2014 there was a scandal disclosed in the Tesco PLC which set an important instance
of the failure of corporate governance1. It also lead to suspending the four senior most directors
of the company. In this it was found that the Tesco PLC was showing more profits than its actual
profit in its accounting statement by £250m. The company has showed the profit of amount
£1.1bn whereas the actual profit was of £263m. This overstating of the profit was done for the
purpose so that the people and shareholders gets attracted to the company which will lead to the
increase in the investment by them. After this scandal came into limelight the Board of Directors
and other authorities took the matter seriously. After this the fine of £500m was imposed upon
the Tesco PLC and many investors has filed the case against the company on the ground of fraud
1 Luigi Zingales, Corporate Governance (2017).
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committed by Tesco PLC by claiming that this overstating of profit has been done to obtain
funds and increase the investment in the company.
Failure of Corporate Governance
Tesco PLC is such a business organisation which is considered as having the best system
of corporate governance. Also its image in the eyes of people is also very good because it is also
a leading firm which contributes to the Social Corporate Responsibility and take care of safety
measures and also works in such a way so that environment can be protected. However the
scandal which took place in the year 2014 was a shocking one and it was one of the most crucial
case of failure in the corporate governance in such a big firm2. Because of the disclosure of this
scandal the company has suffered in the term of its reputation in the eyes of general public. Due
to this failure of corporate governance in the Tesco PLC many employees were suspended as
they were actively involved in the scandal including four senior most directors of the
organisation. Due to this failure the Tesco PLC as well as its Audit Committee were also
inspected and it came under the purview of consideration. There were various reasons because of
which this business organisation has faced this failure in its corporate governance which is
discussed further.
Reasons Behind Corporate Governance Failure in Tesco PLC3
In every company there are various similar reasons because of which the corporate governance
fails. The main reasons because of this failure happens are actions of the company, negligence by
the directors of the company upon the management. These reasons individually as well as
collectively lead to the failure of corporate governance which lead to the financial as well as
ethical failures in the corporation. The following are the reasons for each company leading to the
failure of the corporate governance:
Incompetent Management.
Regulations and procedures established for internal regulations are not followed.
Risk Management has been paid very less attention.
Lack of defining the duties and responsibilities.
The audit of the corporation is inefficient
2 Indrajit Dube, 'Is Corporate Governance The Answer To Corporate Structural Failure?' [2018] SSRN
Electronic Journal.
3 A.M.I. Lakshan and W.M.H.N. Wijekoon, 'Corporate Governance And Corporate Failure' (2015) 2
Procedia Economics and Finance.
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Bribing the audit officials to maintain the accounts inconsistent with the reality
The one of the main reason why this failure has taken place in such a reputed firm is
because of the failure in the working process of Tesco PLC. The one of the main reason of this
failure is that at that time when this scandal took place the post of Chief Finance Officer was
vacant as just before this scandal was disclosed to the general public the Chief Finance Officer
has given its resignation. Also when the CFO gave his resignation from his position there were
also various other senior members in the company who also submitted their resignation which
shows that the corporate governance was in a poor manner in the company. The other reason of
this failure was that the directors of the company were showing very less attention to the fact that
the profit has been overstated to the shareholders to enhance their interest in the company. It is a
proved fact that board of directors plays a crucial and most important role in establishing the
corporate governance in the efficient manner. It is the most important duty of directors to see that
all the departments in the company are working in a proper manner and no mischief has been
played by the officials of the company. It is also the duty of the directors to establish the goals
and objectives of the company in such a way so that it will help the business organisation to
obtain a strong position in the market. Due to the negligent acts of the directors of Tesco PLC
this scandal has happened. Here in this case of Tesco PLC the directors were highly ignorant
about this failure and also ignoring the Code of Ethics and EU Audit Directives due to which this
fraud has been happened. The focus of the directors were more on their revenue generation rather
than inspecting the irregularities that are taking place in the Tesco PLC4.
Also the audit committee of the company was also equally responsible for this failure
because they were also negligent while auditing the accounts of the company. It is also highly
possible that all the members of Tesco PLC were aware of this mischief but everybody was only
interested to ensure their personal gains and nobody was serious about the reputation of the
company5.
In the given case of Tesco Plc also these above mentioned reasons has lead to the failure
of corporate governance. Here in this case also the directors were so negligent about the
4 Kingsley Opoku Appiah and Amon Chizema, 'Remuneration Committee And Corporate Failure' (2015) 15
Corporate Governance: The international journal of business in society.
5 Susan Parker, Gary F. Peters and Howard F. Turetsky, 'Corporate Governance And Corporate Failure: A
Survival Analysis' (2015) 2 Corporate Governance: The international journal of business in society.
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functioning of the management of the company which has given the chance to the employees and
other members of the management to overstate the actual profit for attracting the investors. Also
the auditing committee internal as well as external was at fault due to which this failure has
happened. It shows that the management of the Tesco Plc was incompetent to prevent this failure
of corporate governance. In this case it was the duty of the higher officials of the company to
maintain transparency in maintaining the account statements of the company so that stakeholders
should having more trust and the failure in the corporate governance can be avoided.
Criminal Liability of a Corporation in Failure of Corporate Governance6
As per the law of UK it is a settled fact because of application of various laws and
decided landmark judgements a company will be having a separate legal entity in the market
from its directors and shareholders. The landmark judgement regarding which establishes the
company as an artificial legal person is Solomon vs Solomon. By establishing the separate legal
entity of the company it can be understood that a corporation “Can sue or can be sued”. If a
company commits a crime it must be proved that company has committed an act which is
prohibited by the law and while doing this act the company was having the guilty mind or
intention to commit that offence. As the company is an artificial personality and not a living
human being so it is not possible for the company to form a guilty intention. To make the
company liable for its criminal acts Identification Principle must be used which means that
while determining the guilty mind of the company it must be seen that who was controlling the
company and who all are “Directing Mind and Will” of the corporation. It can be easily
understood that by usage of this identification principle the actions of the owners, directors and
the managers of the corporation who are liable for carrying out the day to day activities in the
company can be determined. It means if it is proved that the company's upper officials has done
this criminal act with their guilty mind the company will be held liable for the criminal act and it
can be prosecuted for the offence as the principal offender. The constitutional documents of the
company that majorly are “Memorandum of Association” & “Articles of Association” must
be reviewed while determining the directing mind and will of the company. Many a times in the
practical situations this principle can make difficult to punish a company for a criminal act.
Majorly in large corporations where the directors and the upper management of the company will
6 Philip Stiles and Bernard Taylor, 'Maxwell ? The Failure Of Corporate Governance' (2015) 1 Corporate
Governance: An International Review.
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be not aware of the offences taking place in the company due to their negligent behaviour or
because of some other reasons it becomes difficult for the prosecuting authorities to make liable
the company for that criminal offence. To resolve these types of situations various laws has been
legislated by the UK Parliament to prosecute the corporations for various criminal offences.
Also at the time when the corporate governance gets failed in the corporations these
various laws can be used for imposing fines upon the companies and also the directors and the
owners of the company can be imprisoned as in reality they were the people who has committed
the crime in the name of the company. On the failure of corporate governance it must be seen
that whether this failure has happened because of the negligent nature of the upper management
or it was intentional to satisfy the personal needs of the owners of the corporation. While
prosecuting a company or any of its directors for the failure of corporate governance it must be
seen whether the company has taken the appropriate measures to ensure the corporate
governance or not. For ensuring the corporate governance in a company the directing minds and
the will of the company should follow the various guidelines issues by HMRC so that these
crimes does not happen in the company. For instance HMRC has issued certain guidelines to
prevent the tax evasion. By following these guidelines a company can ensure the smooth
functioning of its corporate governance and it will also lead in preventing the failure of corporate
governance in the company. It is also a proven fact that majorly the failure of corporate
governance happens in those companies only where either the upper management is so negligent
about the violations of these laws by the employees or the upper management himself is involved
in all those criminal acts7.
Failure of corporate governance can also make the company vicariously liable for the acts
done by its employees. The situation may arise where the employees has done any criminal
offence in the scope of their employment which has lead to the failure of corporate governance in
the company. In that case the company will be vicariously liable as same as the natural person.
For instance if Mrs Rose is the employee of ABC Ltd and she has committed the act of fraud
with one of the clients in the scope of her employment. The company can be held criminally
liable for the acts of Mrs Rose by applying the principle of vicarious liability. It must be taken
into consideration while making the company vicariously liable that the act committed must be
in the scope of employment and not in the personal capacity of the employee.
7 Andrew Johnston, EC Regulation Of Corporate Governance (Cambridge University Press 2018).
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While making a corporation criminally liable for commission of any offence it must be
taken into consideration by the prosecuting authority that sufficient evidences are present to
prosecute the corporation and the prosecution will be in the public interest. Generally when the
failure of corporate governance happens at the end the investors and the stakeholders suffers the
most because they are the person who have invested their hard earned money in the company and
due to this failure they have lost their investment.
In the corporation generally the major reasons for failing of the corporate governance
happens because of happening of certain crimes such as fraud, tax evasion, money laundering
issues and bribery8.
Models and Principles of Good Corporate Governance
Majorly the corporate governance in every country is influenced by the its culture,
societal and political factors. It is a proven fact if the company will be having the good corporate
governance it will lead to increase the trust between the stakeholders of the company as well as
improve the performance of the company but if the company's corporate governance fails it can
have the disastrous effects upon the brand value of the company as well as on the economy of a
country. That is why there is a need of the strong corporate governance and the corporate
governance must be framed in such a way so that there are very minimal chances of its failure.
While framing the corporate governance in the company various things has to be considered so
that it helps in the smooth functioning of the company. There must be focus upon the protection
of the rights of the shareholders and their treatment should be equitable as these are the people
who are responsible for the growth of the company. If the rights of these shareholders will not be
protected by the company it may affect the company in a negative manner which can hinder the
growth of the company. Also the company must follow all the existing laws so that the rights of
the stakeholders should also be protected. There must be also the transparency in the working of
the company and shareholders and stakeholders must be having the proper knowledge about the
working of the company. It has been seen that in a company if the transparency and proper
disclosure of its financial accounting system is absent, the chances of failure of corporate
governance remains high. Also it is also one of the basic principle to ensure a successful
corporate governance to ensure that its management should be monitored effectively by the
board of directors because it has seen that in majority of the companies the failure of the
8 John Zinkin, Challenges In Implementing Corporate Governance (Wiley 2017).
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corporate governance takes place because the directors are very much negligent about the acts of
its management and employees. The investors from overseas also wants to invest their money in
such a company only where the corporate governance is of strong nature. To attract the overseas
investors, it is also the duty of the government of the country to legislate such laws which
ensures that their country is having one of the best frameworks for the corporate governance.
Having the strong framework of the corporate governance will lead to attracting more investors
because the investors will be satisfied that their rights will be protected and the risk of loss of
their money will be least in nature.
The Corporate and Governmental Responses to this Scandal and Also the Legal Issues Involved
The Tesco PLC after knowing about the scandal of overstating the profit has dismissed
three of its board members including the chairman & the CEO of the company. The company has
also ordered the reviewing of this failure which has been done due to the officials of the
company and it was ordered that review must be made by Deloitte and Freshfields(Law Firm).
Also the eight directors were suspended by the Tesco PLC9.
Regarding the government response on this scandal which was done in the company three
executives of the Tesco PLC were charged by the Serious Fraud Office. The company has came
up with the agreement with the Serious Fraud Office mentioning that it will pay the
compensation amount to its stakeholders and investors amounting £129 million. The Financial
Conduct Authority has stated that the Tesco PLC has done the abuse of market conditions and
imposing the fine upon it will act as a deterrence for other companies also for future. The three
executives who were dismissed and it was alleged that they have done the “White Collar
Crime” were charged for the fraud and court proceedings were started against them. Although
all the charges against these three officials were not proven and they were held innocent and got
acquitted.
The legal issues here involved is that the directors were ignoring the Code of Ethics and
EU Audit Directives. Also the the provisions of Corporate Governance Code were not
followed by the company. Also the case of Fraud has been started by many of its customers
against the Tesco PLC. It must be considered that it is a mandatory provision in the UK Code of
Corporate Governance which establishes the audit committee for the company for the purpose
9 Philip Stiles and Bernard Taylor, 'Maxwell ? The Failure Of Corporate Governance' (2016) 1 Corporate
Governance: An International Review.
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that these companies ensures that all the financial statements of the company are in proper and
genuine manner and to inspect the various operations of the company. But the audit committee
has also not given the required attention upon the mismanaged financial accounts of the Tesco
PLC which has lead to such a big scandal.
The Tesco PLC has tried many ways to regain its brand value back and worked upon
Restoring the Trust” in the eyes of its investors10.
Propose Certain Solutions to Avoid Such types of Failures in Corporate Governance in Future
It is a proven fact that these failure in the corporate governance take place when the upper
officials of the company fails to supervise the management of the company. When the board of
directors fails to follow the basic principles of government this condition can arise. All the
corporations must improve their corporate governance in order avoid the harm related to
financial, reputational as well as the legal. To ensure a strong corporate governance a company
must follow the following ways to enhance the corporate governance in the company:
Increasing Diversity in the Board
Generally it is seen that the members of the board of directors come from the same
background. Increasing the diversity will lead to increase the performance of company and it will
also lead to the strong corporate governance. Through various studies it has also been found that
diversity in gender leads to the improvement of financial performance.
Competent Members should be Appointed in the Board
Whenever the members in the boards will be appointed it should appoint the competent
members who must posses the adequate knowledge and skills to handle the management as well
as the market conditions.
Ensuring Timely Information
Whenever the proper and timely information will be provided by the management of the
company to the board of directors it will enhance the supervision and decision making in the
affairs of the company. It is also the duty of the directors to demand the information from the
management of the company from time to time.
Risk Management should be Prioritized
The priority of the board of directors of any company should be management of all the
possible risks which a company can face in the short as well as long term. Either it is concerned
10 Emerald Group Publishing., Corporate Governance (Emerald Group Publishing 2015).
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with the financial risks or any other risks, the effective management of all these risks will act as
an advantage while making the better decisions which will lead in minimising the loss.
The upper management of the company must be aware of all the happenings which are
going on in the organisation. The main reason for having a scandal in a business organisation is
that the directors of the company were negligent and were not controlling the acts of their
employees. This lack of attention by the directors can create a communication gap and will lead
for the creation of a loophole which will lead to the happening of such scandals.
Also the proper auditing of the accounts of the company must be done from time to time
by the auditing committee because it will ensure the transparency regarding the company and
possibility of these scandals will remain very low.
The employees of the company must be treated by the management of the company so
that the employee becomes loyal to the business organisation while discharging its duties. If the
employee will act as loyal the possibility of indulging them in such scandals will decrease in a
significant manner.
All the provisions of the UK Code of Corporate Governance should be strictly followed
by the business organisation to ensure that there will not be any such failures related to the
corporate governance.
Rewarding the employees from time to time is also a very good solution to avoid such
scandals because it is the proven fact that these scandals happen because of the want of extra
money which can be compensated by the company through rewards as per their performance and
these rewards will encourage the employees to work in an efficient manner. These rewards will
also discourage the employees to get involved in such corporate scandals.
As the Tesco PLC was having a weak structure of corporate governance thus it has faced
the negative results in the terms not only of depositing the fines but also the loss of the reputation
of the company. It has sowed the seed of doubt in the minds of investors and shareholders
regarding the genuineness of the Tesco PLC. The above recommendations must be applied by
the company so that it can avoid such scandals which lead to the failure of corporate governance
in the future. It is also recommended for Tesco PLC that there must be effective regulations for
corporate governance and also accounting system must be transparent to avoid such
circumstances11. There must be the good leadership qualities present in the management of the
11 Robert A. G Monks and Nell Minow, Corporate Governance (Wiley 2019).
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Tesco PLC so that the goals of the company can be achieved. Also the focus must be based upon
protecting the “Rights & Interests” of the shareholders and customers to rebuild the brand value
of the Tesco PLC. The Management of Tesco PLC must consider about the benefits of its
employees as well as its stakeholders instead of making their own personal gains.
CONCLUSION
By doing the above study of the accounting scandal that has took place in Tesco PLC
leading to the failure of corporate governance, it can be concluded that this scandal was done for
the purpose to attract the more investors and shareholders for the purpose to increase the profit.
Here many directors were also involved in this scandal who have done this for their personal
gains but the other directors of the Tesco PLC remained ignorant about all these happenings.
This failure has happened in the Tesco PLC shows that there is weak corporate governance
structure in the company which needs to be improved. The Tesco PLC must ensure that the
company is following all the legal requirements given under the Code of Corporate Governance
and the potential members of the upper management should keep an eye upon all the activities
going on in the company.
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