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Tesco Chairman to Step Down as Overstatement of Profit Grows

A Tesco in Scotland. The grocery chain’s accounting is under scrutiny.Credit...Jeff J Mitchell/Getty Images

LONDON — There was a time when Tesco, Britain’s largest grocery chain and the world’s third-largest retailer by sales, was a darling.

Warren E. Buffett scooped up a major stake in it. The British pop star Lily Allen sang about a woman walking down the street “with her Tesco bags.” A Telegraph newspaper cartoon ridiculed the chain’s ubiquity with a policeman giving directions by saying “go past two Tescos, right at the Tesco and it’s opposite Tesco.”

But in recent years Tesco has been weakened by big industry shifts and management turmoil, resulting in a shrinking market share and dwindling stock price, which has fallen almost 50 percent this year.

And then on Thursday, the company revealed that things were even worse than anyone on the outside realized. So much so, that the chairman, Richard Broadbent, said he would resign.

Announcing the results of an internal investigation into an overstatement of profits, Tesco said that an accounting problem reached back even further than was known when the company disclosed it last month.

The problem, which first surfaced from a whistle-blower, came to the attention of the new chief executive, Dave Lewis, almost as soon as he took the job in September, brought in a month earlier than intended by a board eager to put the company’s problems behind it.

In total, Tesco said Thursday it had overstated profits by 263 million pounds, or about $423 million. Of that shortfall, £118 million related to the first half of this year, with an additional £145 million linked to the past two years. The discrepancy, the company said, was from how it accounted for income from suppliers, a notoriously gray area for retailers — but a line that Tesco executives had evidently blurred even further.

Tesco declined to provide many details of what its inquiry had uncovered, in part because the accounting discrepancies are now under investigation by a government regulator, the Financial Conduct Authority.

The company said that the £263 million shortfall would be reflected in its current-year earnings and that it did not expect any further charges from the accounting issue.

Mr. Broadbent, who has been on the board since July 2011 and chairman since November 2011, said the issue was a matter of “profound regret” for him, for the board and for the company.

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Richard Broadbent, Tesco’s chairman, after interim results were announced on Thursday.Credit...Suzanne Plunkett/Reuters

“This is not a happy day,” he told a group of reporters.

Mr. Lewis, the new chief executive, said that there was no timeline for Mr. Broadbent’s departure and that the company was conducting a strategic review of all its operations. He did not give a deadline for that review.

As part of the day’s gloomy news, the company announced a sharp decline in its first-half operating results.

Trading profit, an industry measure of sales, fell 41 percent from a year earlier, to £937 million. British same-store sales declined 4.6 percent on strong competition in the grocery sector.

“We can never recall a period so damaging to the reputation of the company,” Clive Black, an analyst at Shore Capital, wrote in a note to clients on Thursday. The disclosure that the accounting problems were not limited to this year, he wrote, “raises all sorts of questions to our minds as to what has gone on in prior years.”

On Thursday, Moody’s Investors Service and Fitch Ratings downgraded Tesco’s debt to a notch above junk status.

It was hardly the welcome Mr. Lewis had been hoping for when he was hired from the consumer products company Unilever. Originally, he was to join Tesco on Oct. 1, and his chief financial officer, plucked from the British retailer Marks & Spencer, was to start Dec. 1. But as things at Tesco started to come apart during the summer, Mr. Lewis was asked to start early.

In his first week, he met 3,000 employees and received and read emails from 2,000 people. “I asked people to reach out to me,” he said. “The passion is tangible and very real, and I feel it everywhere I go.”

On Sept. 19, Tesco’s general counsel brought Mr. Lewis disturbing news: A whistle-blower suggested that the company’s first-half profit estimate, announced on Aug. 29, might have been overstated by £246 million.

The apparent trouble spot, so-called commercial income — money that suppliers pay in exchange for special merchandising promotions or as price rebates — is a notoriously slippery part of grocery-store accounting. In the company’s last annual report, Tesco said that its auditor, PricewaterhouseCoopers, had raised questions about the commercial income accounting but that the company’s audit committee had concluded it was not a problem.

After the general counsel’s report, emergency meetings were convened and an “intense weekend ensued,” Mr. Lewis recalled on Thursday.

On Monday, Sept. 22, the company announced the shortfall.

Mr. Lewis called Marc Bolland, the chief executive of Marks & Spencer, and asked if Alan Stewart, the incoming chief financial officer, could come early. Mr. Bolland gave his blessing.

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Dave Lewis, the chief executive of Tesco, on Oct. 23. Mr. Lewis said that there was no timeline for Richard Broadbent’s departure.Credit...Suzanne Plunkett/Reuters

Almost immediately, the Financial Conduct Authority of Britain opened a formal investigation. Tesco began its own inquiry, led by the accounting firm Deloitte and the law firm Freshfields Bruckhaus Deringer, and over the next few weeks, eight executives were asked to step aside.

On Thursday, the company, the world’s third-biggest retailer behind Walmart and Carrefour, announced the results of that internal investigation. Mr. Lewis said that no individual had made any personal financial gain from the misstatements. And though he offered no motive, it appears to a case of managers trying to make their quarterly numbers.

Tesco’s statement said Deloitte had confirmed to the company that “amounts have been pulled forward or deferred, contrary to Tesco Group accounting policies; there have been similar practices in prior reporting periods and the current and prior practices appear to be linked as income pulled forward grew period by period.”

While Deloitte was able to help the company find out how much was at stake with the accounting missteps, it is up to the government investigation to determine who did what and why, company executives said.

Mr. Broadbent, who before joining the Tesco board had worked mainly in banking and government, said he chose to leave to “draw a line” under what had happened.

“My decision reflects the important principle of accountability on behalf of the board,” he said.

Mr. Lewis tried to define some of that future, but the market’s reaction — the stock fell 6.5 percent on Thursday — suggest his efforts left the market unimpressed.

One major challenge is to stop the company’s deteriorating market share, eroded from below by discounters underpricing Tesco and from above by fancy grocery stores like Waitrose where shoppers are willing to spend a bit more for higher-quality fare.

Analysts say Tesco has little choice but to respond by cutting prices further.

This month, the HSBC analyst David McCarthy said Tesco needed to spend £3 billion to cut its food prices by 5 to 6 percent, increase staff and improve the quality of its products. He predicted it would take six years to accomplish.

Tesco’s share of the British grocery market has fallen to 28.8 percent in 2014 from 30.1 percent in 2013. During that period, Waitrose’s share has grown to 5.2 percent, from 4.9 percent, according to Kantar Worldpanel. And Aldi, a privately held German discounter, rose a percentage point to 4.8 percent.

Kantar released grocery store sales data on Tuesday, noting that Waitrose increased sales by 6.8 percent in the last year, continuing a monthly rise that dates back to March 2009. Aldi expanded its sales by 27 percent in the last year.

Meanwhile Kantar noted that Tesco was doing better by not doing worse. Its sales, Kantar said, seem “to be turning a corner as sales are down 3.6 percent, which is the grocer’s best figure posted since June.”

A correction was made on 
Oct. 23, 2014

An earlier version of this article misstated the trading profit in Tesco’s first-half results released Thursday. It fell to £937 million, not £927 million. An earlier version also misstated the details of an auditor’s review of Tesco’s booking of payments from suppliers. The auditor, PricewaterhouseCoopers, raised questions about the payments, and the Tesco board’s audit committee subsequently concluded they were not problematic. PricewaterhouseCoopers did not give the company “a clean bill of health.”

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A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: Growing Scandal Claims Tesco’s Chairman. Order Reprints | Today’s Paper | Subscribe

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