Improvident

Investors in Provident Financial might wish that these were hypothetical questions. Alas not. Until June this year, Provident’s market capitalisation was about £3bn more than it had been five years earlier. During this time, Peter Crook, its chief executive, had received about £30m in pay. Then in June, the first profit warning scrapped the dividend; the second one, just a couple of months later, scrapped Mr Crook’s career. He resigned after having led the group for 10 years. Investors long in the stock cashed out; those short in the stock cashed in; and in two short sharp shocks, Provident’s value had shrunk to where it had been back in 2012.

Execution

The case for investing in Provident had been that it ran a stable core business whose predictable cash generation allowed it to invest in its businesses, be highly geared and still pay a generous dividend. Since 1880, this had depended on self-employed agents knocking on doors every week to collect loan instalments from 'non-standard' (for which you might read 'sub-prime') borrowers. The rationale is meeting a social need: financial inclusion, to help those on low incomes to pay unexpected bills. So small loans, friendly chats, flexible repayments. Being a people business that depended on longstanding close relationships gave Provident a competitive moat. 

But this model is labour-intensive and difficult to scale up, so Mr Crook spearheaded an expansion through an online version (Satsuma), credit cards (Vanquis) and vehicle finance (Moneybarn). For this, his pay package – that is, the maximum that he could earn every year – averaged almost £4.5m a year.

With lenders increasingly squeezed by banking regulations, Provident could see questions arising about how well it controlled its agents, many of whom had been home-credit borrowers themselves. It needed to train and manage them better – get them to use smartphones, use credit scoring techniques and add to its central customer-prospects database. And reading between the lines, it seems that they needed more business-oriented people. 

So in January Mr Crook bit the bullet. He announced a consultation about replacing the 4,500 self-employed debt-collection agents (already down from 10,000 in 2013) with 2,500 full-time employees called “customer experience managers”. But he and his team failed to carry the agents with them. Faced with losing their social status amongst their community, some walked. Weekly collections became overdue. Other agents stopped co-operating – what else could the company mean by this sparkling turn of phrase: “The routing and scheduling software deployed to direct the daily activities of the CEMs has presented some early issues, primarily relating to the integrity of the data”? But that’s not all: in July, the new software proved to be too centralised and inflexible; or in company-speak: “the prescriptive nature of the new operating model has not allowed sufficient local autonomy to prioritise resource allocation during this period of recovery”. Oh, and just for good measure, Vanquis Bank has a little local difficulty with the Prudential Regulation Authority as well. 

Provident had moved with the times, but the times had not moved with it; Mr Crook stepped down and in just two months three-quarters of the value of the company had evaporated.

Aftermath

So what about corporate governance?  Was the operational change in the doorstep lending business the right strategy? If not, all the directors should share accountability. One view is that it was the right thing to do; it was the execution that was botched. That shifts the blame to the executives, and ultimately to Mr Crook. It suggests a failure of relationships between the agents and their in-house managers and also either a failure of these managers to speak out or else to be listened to by those higher up in the organisation.

Another potential red flag is succession. Manjit Wolstenholme, who has chaired Provident for three years, has temporarily replaced Mr Crook. This means that she has switched from a part-time overview role into the far more onerous one of being responsible for all the day-to-day management of the group. In fairness, she has moved fast, recruiting Chris Gillespie back into his old job of running the doorstep lending business (he left for pastures new in 2013), and drafting in Satsuma’s boss as his deputy, with support on project management from Provident’s head of corporate finance. 

Restoring debt collection is the obvious priority; the unknown is how many agents have been snapped up by rivals, such as Morses Club or Non-Standard Finance. Lose an agent and you lose their customers, too, estimated at up to 200 per agent. In his blog, Neil Woodford, a major shareholder in Provident, says he expects Provident’s consumer credit division to stabilise with a smaller customer base – how much smaller remains to be seen. The risk of draining a moat is that it leaves merely a ditch.

Pay paradox

You might have spotted that something fails to add up here.  How could Mr Crook have received £30m between 2012 and 2016 if the maximum he could earn averaged almost £4.5m? This is what Provident Financial published in its annual reports:

*The figures for 2012 and 2013 have been estimated from published data to fit the standard format that applied for pay from 2014 onwards.

So although Provident Financial told its shareholders that Mr Crook could earn no more than £4.5m a year, he ended up receiving an average of £6m.

Jumping to conclusions

This apparent anomaly goes to the heart of the disquiet about executive pay and has prejudiced thinking, including that of the current Government, about corporate governance. Both pay and governance must be out of control, ministers assume; a recent white paper has promised to impose greater regulation.

What’s going on? The answer lies not in lack of control, but in just the opposite. First, to align risks run by executives with shareholders, most of executive pay is in shares – share prices then bloat or shrink what has been awarded. Then, to deter short-termism, performance is assessed over several years and the award adjusted. The white paper suggests that a five-year period for this should become compulsory, which many companies effectively do already. What this assessment and holding period does – and this is the bit that is so widely misunderstood – is that it creates a time-shift.

This time-shift divides pay between different years. This results in two definitions: the range of pay that could be earned in a single year (the pay package) and what was actually received (the single figure of total remuneration). This single figure is a blend of pay earned in different years including any bloating (or shrinking) due to share price movements. Both of these are defined by regulation. 

So, in 2014, for example, Mr Crook could earn up to £4.161m. During 2014, he was awarded a bonus and so was paid £1.767m. In addition, he was awarded shares under two share plans – when they were awarded their maximum value was £2.4m, but they were not included in the single figure until the 2016 annual report. By then, Provident’s share price had bloated their expected value to £4.4m.  

The Single Figure published for 2016 took this £4.359m originating from 2014 and added on the salary, benefits, pension and bonus paid for 2016, making £6.315m. (Just to complicate matters further, the shares were not due to vest until April 2017 so the share price had to be estimated for the annual report.)

This begs an issue ducked by the white paper: since share prices move in mysterious ways, current corporate governance confuses people by distorting perceptions of what is earned. The value of the share award when it is made is pay; arguably, the forced investment that is tied to it (by insisting that the shares are held back for a few years) is not. A clearer definition of pay is needed.

Just desserts?

So what of the financial sacrifice demanded from Mr Crook? This is where holding pay back can hit hard. The remuneration committee has made it clear that, apart from a pension credit, Mr Crook will be paid nothing further in 2017 and there will be no payment for loss of office. The trashing of Provident’s performance has forfeited all his outstanding share awards. At the old share price of £30, that equates to a loss for him of about £8m. He will retain shares from awards not subject to performance conditions, but they could yet be clawed back. He also owned Provident shares in his own right – far more than he was required to own. These mostly came from share awards that had matured over past years. With the fall in share price, their loss in value is about £5m.

Not exactly rewards for failure, then. Tough corporate governance in action, perhaps? But the real penalty for Mr Crook has nothing to do with money. It’s the regret that after painstakingly building up the business – and his own reputation – for over 10 years, it had to come to this.