BHS collapse: how capitalism is eating itself

Earlier this week, BHS formally went into administration. While the collapse is a story about a failing company in difficult economic times, it’s a clear example of the fundamental failure of modern shareholder capitalism.

This model has allowed shareholders to prioritise a set of narrow interests, over running a stable and sustainable business that considers the interest of its workers, suppliers, the environment, and wider society. Namely profit maximisation at any cost.

These steps led BHS to financial collapse – and they’re being repeated again and again elsewhere.

1. Shareholders taking money that isn’t there

The beginning of BHS’s woes can be traced back to 2000, when Sir Philip Green bought the company for an estimated £200 million. Green has since pocketed over £586m from BHS in dividends, rental charges and interest payments.

Special scrutiny should be given to the huge £1.2 billion dividend pay-out from the holding company Taveta Investments Ltd in 2005. Of this, about £400m can be traced from BHS activity – an amount larger than the group’s profits of £250m that year.

This money was not available to be taken from company reserves and could only have been legal if the future profits of the business were near enough certain – now clearly not the case.

Huge questions remain around how PricewaterhouseCooper, their auditor, could legally sign-off this payment, and why more wasn’t reinvested into the company. The numbers simply don’t add up.

2. Big company buy-outs, financed by debt

Recent stories have highlighted how big companies – like Boots or Manchester United Football Club – were financed by borrowing huge amounts in the company’s name.

Financing a buy-out in this way can essentially cripple a company, placing the burden of meeting high debt repayments onto the company itself, rather than the buyer.

So that BHS could pay out a huge dividend in 2005, Taveta Investments Ltd was saddled with over £1bn of debt. This made the prospect of recovery even harder: BHS now needed to generate a profit to re-structure and modernise, but also to meet debt interest payments.

This could be one of the main reasons why BHS never paid out another dividend beyond 2005.

3. Passing on the protection of workers

The state of BHS’s pension fund is now one of the main concerns facing the company’s employees, past and present.

During Green’s time in charge, a pension fund in surplus of £5m was transformed into one with a black hole of £571m – something he will have to explain to MPs on the Work and Pensions Committee.

It’s likely that near 20,000 members of the two BHS retirement schemes will enter the Pension Protection Fund (PPF) – a government-backed lifeboat for failed pension schemes.

Taxpayers would only be directly paying for these pensions if the PPF ran out of money completely and needed propping up – which is unlikely. But this still effectively passes pension payments away from BHS and onto other smaller businesses. Not to mention that many workers entitlements will be cut by at least 10 per cent.

4. Profit over public interest: corporate governance isn’t suitable

Company law still allows directors to treat companies as their own, and do with them as they please. It’s worth keeping in mind that directors are also shareholders. Although directors are encouraged to take other stakeholders into account, ​‘employees, creditors and local communities are helpless, as the law permits shareholders to extract as much cash as possible’.

It is worth considering that, in the case of BHS if other stakeholders had been consulted, this situation could have been avoided.

Rather than the huge extraction of profits and the pilling of debt on the company, more money might have been reinvested into the business or the pension pot might have stayed healthy.

How can the government stop this happening again?

The UK government has had its say on BHS, and is investigating the pensions crisis. But unless it makes some structural changes, this same thing is likely to happen elsewhere. It should:

• Limit the ability to pay dividends: stop companies from paying dividends by getting into additional debt or paying out more than their net profit or cash reserves.
• Stop conflicts of interest in financial management: by banning the financial auditors of a company from selling it consultancy. There should also be a mandatory change in auditor every five years.
• Reform the tax system: so that debt is no longer favoured, by making debt repayments deductible from tax. This should encourage other forms of investment that do not place huge repayment burdens on the company.
• Modernise UK law: so that companies are seen as entities designed to act in the interests of the communities, organisations and environment they effect, as well as their shareholders.

A buyer may well be found for BHS, and some, or even all, may be saved. But even if this is possible, it’s essential that we recognise this is part of a wider problem.