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Carillion Co. collapses but they always had cash for Dividends and big bonuses

Updated: Feb 19, 2019




"LONDON (Reuters) - Collapsed British firm Carillion, which has come under political fire for paying dividends while racking up big debts and a pension deficit, has handed more than $1 billion (727 million pounds) to shareholders since it was created 19 years ago, a Reuters analysis shows."


When I read these lines, one thing came to my mind: Share Option scheme for Directors.


Why paying dividends when you have various red signals which tell you the company has financial problems? Why not use the cash flow for paying off debts and employees pensions?

- Maybe because Directors insisted on wanting their bonuses/dividends??


We all know that when a company goes well or when it goes bad and has financial problems the members of the board are thrown into the spotlight.  


This Company scandal helps me to illustrate what impact option share scheme may have to the company, shareholders and stakeholders. 

The way Carillion managed its debts led me to think that they had serious cash flow problems. And this is not a recent situation, it began a while ago and in my opinion the Board of Directors was aware of the ongoing problem.

Why do you think most of shareholders and directors started selling their shares over a year ago before the financial problem was publicly announced?


Having cash flow problems means that the company (Carillion or any another company) doesn't have sufficient funds to pay bonuses, especially to the Directors. So what's the best way to gives bonus without cash flow movement? Of course, Share Option Scheme!


And Rm2 tells us this: 

"if your employees or directors are rewarded through shares rather than cash bonuses, it’s very much in their interests to focus on the company’s performance in the long term. A return of 1p for every £1.00 shares is not an outcome that any shareholder looks to achieve."


In my opinion before giving Options as bonus through the Share Option Scheme to any Director, the 3 main factors must be considered are:


FIRST FACTOR


As Rm2 said, Directors will act in the best and professional way to make earnings grow. And do you know why? Because their interest changed and all they want now is to ensure the share value grow which will give them high dividends based on the shares they have. 


This point can be viewed positively from a shareholder perspective, i.e. as long as the share value grow the shareholders' wealth grow as well and that means the Director's performance will be viewed positively. 


But here is the other side of the coin:

Directors may be more willing to manipulate the Accounts in order to show high earnings which will lead to an increased share value (ex: Parmalat Co. scandal).


In my opinion, Directors are more willing to retain cash in order to be able to distribute Dividends, hence the reason why certain debts may not be paid (ex: Carillion Co. scandal).


SECOND FACTOR


When Directors own shares in the company they identify themselves more with the shareholders.

And what is the aim of shareholders? Obviously to increase their wealth. Directors being themselves shareholders will have similar aims. So you can see that Directors aims are switched from company's performance to increasing the wealth via the shares they own in the company. And they are willing to take risks in order to achieve that. 


THIRD FACTOR


Director shareholders can easily become more risk takers in order to increase their wealth which can go against the will of risk averse shareholders.


Share option scheme is a performance based remuneration which means that the Directors are not investing their now personal capital in the company and therefore cannot be considered to be at the same level as ordinary shareholders who are putting their own money at risk by investing in the company. This would explain why Directors can afford to take higher risk as opposed to other shareholders who invested from their own pockets.


My conclusion


We always think that a Share Option Scheme is a good bonus incentive as cash is not involved and that it may incentivise Director to align themselves to shareholder's objectives. However, I believe that Share Options Schemes are not always the best reward. 


I hope this article succeed to give you an idea about the danger that lies into Share Option Scheme, and how that scheme can be negative for the company and positive for Director instead of the other way round. 


What do you think of share option schemes? 


References:

(https://uk.reuters.com/article/uk-carillion-restructuring-dividends/collapsed-carillions-dividends-totalled-1-billion-idUKKBN1F5266)

(https://www.rm2.co.uk/resources/blog/carillion-lessons-learned-share-schemes)

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