Section B – TWO questions ONLY to be attempted After a recent financial crisis in the coun

Section A – This ONE question is compulsory and MUST be attempted

P&J is a long established listed company based in Emmland, a highly developed and relatively prosperous country. For the past 60 years, P&J has been Emmland’s largest importer and processor of a product named X32, a compound used in a wide variety of building materials, protective fabrics and automotive applications. X32 is a material much valued for its heat resistance, strength and adaptability, but perhaps most of all because it is flexible and also totally fireproof. It is this last property that led to the growth of X32 use and made P&J a historically successful company and a major exporter.

X32 is mined in some of the poorest developing countries where large local communities depend heavily on X32 mining for their incomes. The incomes from the mining activities are used to support community development, including education, sanitation and health facilities in those developing countries. The X32 is then processed in dedicated X32 facilities near to the mining communities, supporting many more jobs. It is then exported to Emmland for final manufacture into finished products and distribution.

Each stage of the supply chain for X32 is dedicated only to X32 and cannot be adapted to other materials. In Emmland, P&J is the major employer in several medium-sized towns. In Aytown, for example, P&J employs 45% of the workforce and in Betown, P&J employs 3,000 people and also supports a number of local causes including a children’s nursery, an amateur football club and a number of adult education classes. In total, the company employs 15,000 people in Emmland and another 30,000 people in the various parts of the supply chain (mining and processing) in developing countries. Unlike in Emmland, where health and safety regulations are strong, there are no such regulations in most of the developing countries in which P&J operates.

Recently, some independent academic research discovered that X32 was very harmful to human health, particularly in the processing stages, causing a wide range of fatal respiratory diseases, including some that remain inactive in the body for many decades. Doctors had suspected for a while that X32 was the cause of a number of conditions that P&J employees and those working with the material had died from, but it was only when Professor Harry Kroll discovered how X32 actually attacked the body that the link was known for certain. The discovery caused a great deal of distress at P&J, and also in the industries which used X32.

The company was faced with a very difficult situation. Given that 60% of P&J’s business was concerned with X32, Professor Kroll’s findings could not be ignored. Although demand for X32 remained unaffected by Kroll’s findings in the short to medium term, the company had to consider a new legal risk from a stream of potential litigation actions against the company from employees who worked in environments containing high levels of X32 fibre, and workers in industries which used X32 in their own processes.

In order to gain some understanding of the potential value of future compensation losses, P&J took legal advice and produced two sets of figures, both describing the present value of cumulative future compensation payments through litigation against the company. These forecasts were based on financial modelling using another product of which the company was aware, which had also been found to be hazardous to health.

The finance director (FD), Hannah Yin, informed the P&J board that the company could not survive if the worst-case scenario was realised. She said that the actual outcome depended upon the proportion of people affected, the period that the illness lay undetected in the body, the control measures which were put in place to reduce the exposure of employees and users to X32, and society’s perception of X32 as a material. She estimated that losses at least the size of the best case scenario were very likely to occur and would cause a manageable but highly damaging level of losses.

The worst case scenario was far less likely but would make it impossible for the company to survive. Although profitable, P&J had been highly geared for several years and it was thought unlikely that its banks would lend it any further funds. Hannah Yin explained that this would limit the company’s options when dealing with the risk. She also said that the company had little by way of retained earnings.

Chief executive officer, Laszlo Ho, commissioned a study to see whether the health risk to P&J workers could be managed with extra internal controls relating to safety measures to eliminate or reduce exposure to X32 dust. The confidential report said that it would be very difficult to manage X32 dust in the three stages of the supply chain unless the facilities were redesigned and rebuilt completely, and unless independent breathing apparatus was issued to all people coming into contact with X32 at any stage. FD Hannah Yin calculated that a full refit of all of the company’s mines, processing and manufacturing plants (which Mr Ho called ‘Plan A’) was simply not affordable given the current market price of X32 and the current costs of production. Laszlo Ho then proposed the idea of a partial refit of the Aytown and Betown plants because, being in Emmland, they were more visible to investors and most other stakeholders.

Mr Ho reasoned that this partial refit (which he called ‘Plan B’) would enable the company to claim it was making progress on improving internal controls relating to safety measures whilst managing current costs and ‘waiting to see’ how the market for X32 fared in the longer term. Under Plan B, no changes would be made to limit exposure to X32 in the company’s operations in developing countries.

Hannah Yin, a qualified accountant, was trusted by shareholders because of her performance in the role of FD over several years. Because she would be believed by shareholders, Mr Ho offered to substantially increase her share options if she would report only the ‘best case’ scenario to shareholders and report ‘Plan B’ as evidence of the company’s social responsibility. She accepted Mr Ho’s offer and reported to shareholders as he had suggested. She also said that the company was aware of Professor Kroll’s research but argued that the findings were not conclusive and also not considered a serious risk to P&J’s future success.

Eventually, through speaking to an anonymous company source, a financial journalist discovered the whole story and felt that the public, and P&J’s shareholders in particular, would want to know about the events and the decisions that had been taken in P&J. He decided to write an article for his magazine, Investors in Companies, on what he had discovered.

Required:

(a) Define ‘social footprint’ and describe, from the case, four potential social implications of Professor Kroll’s discovery about the health risks of X32. (10 marks)

(b) Describe what ‘risk diversification’ means and explain why diversifying the risk related to the potential claims against the use of X32 would be very difficult for P&J. (10 marks)

(c) As an accountant, Hannah Yin is bound by the IFAC fundamental principles of professionalism.

Required:

Criticise the professional and ethical behaviour of Hannah Yin, clearly identifying the fundamental principles of professionalism she has failed to meet. (9 marks)

(d) Writing as the journalist who discovered the story, draft a short article for the magazine Investors in Companies. You may assume the magazine has an educated readership. Your article should achieve the following:

(i) Distinguish between strategic and operational risk and explain why Professor Kroll’s findings are a strategic risk to P&J; (8 marks)

(ii) Discuss the board’s responsibilities for internal control in P&J and criticise Mr Ho’s decision to choose Plan B. (9 marks)

Professional marks will be awarded in part (d) for the structure, logical flow, persuasiveness and tone of the article. (4 marks)

nce 1920. The current chief executive, Mr Gustav Lum, is the great grandson of the company’s founder and has himself been in post as CEO since 1998. Because the Lum family wanted to maintain a high degree of control, they operated a two-tier board structure: four members of the Lum family comprised the supervisory board and the other eight non-family directors comprised the operating board.

Despite being quite a large company with 5,000 employees, Lum Co never had any non-executive directors because they were not required in privately-owned companies in the country in which Lum Co was situated.

The four members of the Lum family valued the control of the supervisory board to ensure that the full Lum family’s wishes (being the only shareholders) were carried out. This also enabled decisions to be made quickly, without the need to take everything before a meeting of the full board.

Starting in 2008, the two tiers of the board met in joint sessions to discuss a flotation (issuing public shares on the stock market) of 80% of the company. The issue of the family losing control was raised by the CEO’s brother, Mr Crispin Lum. He said that if the company became listed, the Lum family would lose the freedom to manage the company as they wished, including supporting their own long-held values and beliefs. These values, he said, were managing for the long term and adopting a paternalistic management style. Other directors said that the new listing rules that would apply to the board, including compliance with the stock market’s corporate governance codes of practice, would be expensive and difficult to introduce.

The flotation went ahead in 2011. In order to comply with the new listing rules, Lum Co took on a number of non-executive directors (NEDs) and formed a unitary board. A number of problems arose around this time with NEDs feeling frustrated at the culture and management style. in Lum Co, whilst the Lum family members found it difficult to make the transition to managing a public company with a unitary board. Gustav Lum said that it was very different from managing the company when it was privately owned by the Lum family. The human resources manager said that an effective induction programme for NEDs and some relevant continuing professional development (CPD) for existing executives might help to address the problems.

Required:

(a) Compare the typical governance arrangements between a family business and a listed company, and assess Crispin’s view that the Lum family will ‘lose the freedom to manage the company as they wish’ after the flotation. (10 marks)

(b) Assess the benefits of introducing an induction programme for the new NEDs, and requiring continual professional development (CPD) for the existing executives at Lum Co after its flotation. (8 marks)

(c) Distinguish between unitary and two-tier boards, and discuss the difficulties that the Lum family might encounter when introducing a unitary board. (7 marks)

her for several years and, as well as being work colleagues, are personal friends with each other. At Jojo it is customary for the performance of all student accountants to be appraised after their first year of a training contract using a range of criteria including examination success, technical ability and professionalism. Three levels of outcome are possible:

1. ‘Good’, allowing students to continue with no issues;

2. ‘Some concerns’, meaning students are counselled and then allowed to continue; and,

3. ‘Poor’, where students are dismissed from the audit practice.

The appraisal committee is comprised of three people: managing partner Jack Hu, the training manager (both of whom are professional accountants) and the person responsible for human resources. The committee receives confidential reports on each student and makes decisions based on the views of relevant engagement partners and also exam results. It is normally the training manager who makes the recommendation and in most cases his appraisal is agreed and then acted upon accordingly. Because the appraisals are confidential between the student and the firm, the list of students and their appraisal categories are not publicised within the firm.

When the 2010 intake was being appraised last year, one student was appraised by the training manager as ‘poor’ but was not dismissed. Polly Shah was unpopular among other students because she was considered lazy and technically weak. She also failed a number of her exams. Other students who were appraised as ‘poor’ were dismissed, but Polly received a brief counselling session from Jack Hu and then returned to her duties. Polly stayed for another year and then, having failed more exams, left Jojo to pursue other career interests outside accounting.

Polly’s departure triggered some discussion amongst Jojo’s partners as to why she had been retained when other poor performers had not. It later emerged that Jack Hu was a close friend of Polly’s parents and had enjoyed free holidays in the Shah family’s villa for several years. Because he was the managing partner, Mr Hu was able to insist on retaining Polly, despite the objections of the training manager and the human resources representative, although the training manager was reported to be furious at the decision to retain Polly.

Required:

(a) Define ‘conflict of interest’ and assess the consequences of Jack Hu’s behaviour after Polly Shah’s appraisal. (10 marks)

(b) Describe four ethical safeguards that could be used in Jojo to prevent a recurrence of the events like those described in the case. (8 marks)

(c) The case raises issues of the importance of senior management performance measurement. In a public company, this refers to directors, and in a privately-owned partnership like Jojo, it refers to partners. The managing partner (Mr Hu’s position) is equivalent to the role of chief executive.

Required:

Explain the typical criteria used in the performance measurement of individual directors and discuss the reasons why individual performance measurement of partners may be difficult to implement at Jojo. (7 marks)

Section B – TWO questions ONLY to be attempted

John Louse, the recently retired chief executive of Zogs Company, a major listed company, was giving a speech reflecting on his career and some of the aspects of governance he supported and others of which he was critical. In particular, he believed that board committees were mainly ineffective. A lot of the ineffectiveness, he said, was due to the lack of independence of many non-executive directors (NEDs). He believed that it was not enough just to have the required number of non-executive directors; they must also be ‘truly independent’ of the executive board. It was his opinion that it was not enough to have no material financial connection with a company for independence: he believed that in order to be truly independent, NEDs should come from outside the industry and have no previous contact with any of the current executive directors.

In relation to risk committees, he said that in his experience, the company’s risk committee had never stopped any risk affecting the company and because of this, he questioned its value. He said that the risk committee was ‘always asking for more information, which was inconvenient’ and had such a ‘gloomy and pessimistic’ approach to its task. He asked, ‘why can’t risk committees just get on with stopping risk, and also stop making inconvenient demands on company management? Do they think middle managers have nothing else to do?’ He viewed all material risks as external risks and so the risk committee should be looking outwards and not inwards.

Since retiring from Zogs, Mr Louse had taken up a non-executive directorship of SmallCo, a smaller private company in his town. In a meeting with Alan Ng, the new chief executive of Zogs, Mr Ng said that whilst risk management systems were vital in large companies like Zogs, fewer risk controls were needed in smaller companies like SmallCo.

Required:

(a) Define ‘independence’ in the context of corporate governance and critically evaluate Mr Louse’s comment that greater independence of non-executive directors is important in increasing the effectiveness of board committees. (8 marks)

(b) Describe the roles of a risk committee and criticise Mr Louse’s understanding of the risk committee in Zogs Company. (9 marks)

(c) Assess whether risk committees and risk mitigation systems are more important in larger companies, like Zogs, than in smaller companies like SmallCo. (8 marks)

Section A – This ONE question is compulsory and MUST be attempted

Hayho is a large international company with direct investments in 65 countries. It is a manufacturer of high technology products, with each Hayho factory typically employing over 3,000 people. Hayho factories also support local supply chains employing many more people so each Hayho plant is considered a vital part of the regional economy in which it is located.

Several years ago, Hayho was widely criticised for its operations in Arrland, a developing country with an oppressive and undemocratic government. Investigative journalists produced material showing the poor conditions of workers, and pollution around the Hayho factories in Arrland. They also showed evidence suggesting that Hayho had paid bribes to the Arrland government so that local opposition to the Hayho operation could be forcefully stopped. After this episode, the company became very sensitive to criticism of its operations in developing countries. A press statement at the time said that Hayho, in future, would always uphold the highest standards of integrity, human rights and environmental protection whilst at the same time ‘responsibly’ supporting developing countries by providing jobs and opportunities to enable greater social and economic development.

The board of Hayho is now deciding between two possible large new investments, both directly employing about 3,000 people. Both options have a number of advantages and disadvantages and Mr Woo, Hayho’s finance director, has recently made clear that only one can be chosen at this stage. The two options are of similar investment value and are referred to as the ‘Jayland option’ and the ‘Pealand option’.

The ‘Jayland option’ is to build a new large factory in Jayland and to recruit a completely new local workforce to work in it. Jayland is a developing country with few environmental and labour regulations. It has a poorly developed education and training system, and is generally considered to be undemocratic. Its president, Mr Popo, has been in office since he seized power in a military coup 30 years ago. Human rights organisations say that he maintains order by abusing the rights of the people and cruelly suppressing any dissent against him. In early exploratory talks between Hayho and the Jayland government, Hayho was given assurances that it could pursue its activities with little regulation from the government as long as the Jayland president, Mr Popo, received a personal annual ‘royalty’ (effectively a bribe) for allowing Hayho to operate in his country.

Finance director Mr Woo said that some stakeholders would probably criticise Hayho, perhaps in the international media, for investing in Jayland. Hayho may be accused of supporting the dictatorship of Mr Popo in that country, especially if the ‘royalty’ was ever discovered. Mr Woo calculated that the NPV (net present value) of projected pretax returns of the Jayland option over a ten-year period was $2 billion but that there was also a risk of potential political instability in Jayland during the lifetime of the investment.

The ‘Pealand option’ is to buy an existing plant in Pealand which would then be refurbished to facilitate the manufacture of Hayho products. This would involve ‘inheriting’ the workforce of the previous owners. Pealand is a ‘new democracy’, and a transitional economy, having gained its independence ten years ago. In an attempt to purge the corrupt business practices associated with its past, the Pealand government has become very thorough in ensuring that all inward investments, including Hayho’s factory purchase, meet exacting and demanding standards of environmental protection and work conditions. Mr Woo, the finance director, said that the NPV of projected pre-tax returns over a ten-year period was $1 billion for the Pealand option but that the risk of political instability in Pealand was negligible. Both of the returns, the forecast $2 billion for Jayland and the $1 billion for Pealand, were considered to be acceptable in principle.

Mr Woo also said that there were issues with the two options relating to the effectiveness of necessary internal controls. Whichever option was chosen (Jayland or Pealand), it would be necessary to establish internal controls to enable accurate and timely reporting of production and cost data back to head office. So a number of systems would need to be put in place to support the production itself. One staff member, Emily Baa, who had previously worked in Jayland for another company, gave her opinion to the board about some of the issues that Hayho might encounter if it chose the Jayland option. She said that Jayland was very under developed until relatively recently and explained how the national culture was unfamiliar with modern business practice and behaviour. She said that property security may be a problem and that there was a potential risk to assets there. She also said that, in her opinion, there was a lack of some key job skills among the potential workforce in Jayland such as quality control and accounting skills. She explained that quality control skills would be necessary to ensure product specifications were met and that accounting skills would be necessary for the provision of internal and external reporting. As a manufacturer of very technologically advanced products, a number of stringent international product standards applied to Hayho products wherever in the world they were produced.

Meanwhile, news that Hayho was considering a large investment in Jayland leaked out to the press. In response, Hayho’s chief executive, Helen Duomo received two letters. The first was from a prominent international human rights lobbying organisation called ‘Watching Business’ (WB). In the letter, the lobby group said that because of its ‘terrible track record’ in Arrland and elsewhere, Hayho was being carefully monitored for its ‘unethical business practices’. WB said its interest in Hayho’s activities had been rekindled since it had received intelligence about the possible investment in Jayland and warned Mrs Duomo not to make the investment because it would provide credibility for the ‘brutal dictatorship’ of Mr Popo.

Whilst Mrs Duomo, known for her forthright manner, would normally dismiss threats from groups of this type, she knew that WB had a lot of support among senior politicians and legislators in many parts of the world. She believed that WB could achieve some power through mobilising public opinion through effective use of mass media, such as newspapers and television. WB was also respected as a research organisation and its advice was often sought by politicians and trade organisations.

Mrs Duomo said she was frustrated whenever anybody got in the way of her accountability to the Hayho shareholders, but that some interests could not be ignored because of their potential to influence. WB fell into this category.

The second letter she received was from the head of Quark Investments, Hayho’s single biggest institutional shareholder. The letter sought to remind Mrs Duomo that the Hayho board was employed by its shareholders and that Mrs Duomo should be determined and resolute in maximising shareholder returns. The letter encouraged the board not to be diverted by ‘well meaning but misinformed outsiders concerned with things that were actually none of their business’.

Aware that she had to manage two competing demands placed on her, Mrs Duomo sought advice from Emily Baa, who had experience of life in Jayland. So she asked Emily Baa to prepare some notes for the next board meeting to clarify whom the board of Hayho was actually accountable to and how it might respond to the letter from WB.

Required: (a) Explain ‘risk appetite’ and demonstrate how different risk appetites might affect the selection of investments between Jayland and Pealand. (6 marks)

(b) Use the AAA (American Accounting Association) seven-step model to examine the ethical decision whether to select the Jayland option or the Pealand option. (14 marks)

(c) Describe the general purposes of an internal control system and, based on Emily Baa’s views, assess the main internal control challenges that Hayho might encounter if it chose the Jayland option. (12 marks)

(d) Prepare briefing notes from Emily Baa to prepare chief executive of Hayho, Helen Duomo, for the board meeting as requested in the case. The notes should cover the following:

(i) A discussion of the meaning of accountability at Hayho and of how the Mendelow framework can be used to predict the influence of the Watching Business pressure group; (7 marks)

(ii) A brief explanation of the agency relationship between the board of Hayho and Quark Investments, and advice on why the demands from Watching Business should be carefully considered. (7 marks)

Professional marks will be awarded in part (d) for the clarity, flow, persuasiveness and structure of the briefing notes. (4 marks)

tory, it obtained planning permission to build it on an adjacent field. The local government authority was keen to attract the new jobs that would go with the expansion and so granted the permission despite the objections of a number of residents, who were concerned that the new factory extension would mean the loss of a children’s play area.

When the board of Biggo met after the building approval had been given, the chief executive read out a letter from Albert Doo, leader of the local government authority, saying that although permission to build had been given, the company should consider making a sizeable contribution towards creating a new children’s play area in a nearby location. Mr Doo said that Biggo ‘should recognise its social responsibility’. He said that the company should consider itself a citizen of society and should, accordingly, ‘recognise its responsibilities as well as its legal rights’.

One of Biggo’s directors, Robert Tens, said he thought the request was entirely reasonable given the displacement of the play area. He also said that they could use the donation strategically to help cultivate the company’s reputation locally to help in future recruitment. It might also, he said, help to reduce resistance to any future expansion the company might need to make.

Margaret Heggs, in contrast, argued that the company should not make the donation as it was likely that company profits would be low in the current year. She said that the acquisition of the land and the gaining of planning permission were done through the normal legal channels and so the company had no further contractual or ethical duties to the local government, nor to the local community. She said that Biggo provided local employment and produced excellent products and so it was unreasonable for the request for a donation to have been made. ‘This board is accountable to the shareholders of Biggo and not to the local community or the local government authority’, she said.

Required:

(a) Explain the meaning of ‘rights’ and ‘responsibilities’ in the context of Biggo and describe how these terms are interpreted at the two ends of the Gray, Owen & Adams ‘continuum’. (10 marks)

(b) Justify, using evidence from the case, which of Gray, Owen & Adams’s positions are best described by the comments made by Robert Tens and also Margaret Heggs. (6 marks)

(c) Define ‘social responsibility’ as used by Albert Doo. Contrast how short and long-term shareholder interest perspectives may affect Biggo’s attitude to the requested contribution for the children’s play area. (9 marks)

rring it from government control to private ownership by issuing and selling shares), there was a period of transition as the new board took shape. A great deal of internal reorganisation and culture change was deemed necessary as the company moved to the private sector. The new company, called Dale Gas, set up a committee structure in readiness to comply with stock exchange listing rules. During this transitional period, some directors left and new ones, more familiar with operating in listed companies but unfamiliar with the gas industry, joined the board.

It was unanimously agreed by the new board that the previous chief executive, Helen Evans, should continue in her role after the privatisation. Tom Nwede, a fund manager at XY Investments, one of the company’s major new institutional shareholders, said that the company would be exposed to higher market risk if she were to leave the company, so it was very important that she stayed on. She was seen as a highly competent CEO with excellent strategic and communication skills. She commanded the confidence and trust of the employees and also the new institutional investors.

One of the first actions of the new remuneration committee was to propose a doubling of Mrs Evans’s salary. The committee said that she had been underpaid when the company was state-controlled because of government constraints on the salaries of public servants. The committee said that she now needed to receive a salary commensurate with the importance of the job and in line with other public listed companies of similar size. This proposal was widely publicised. Some criticised it on the basis that if her previous salary was considered sufficient then, why was it now felt necessary to double her rewards after privatisation?

Her new salary was put to the vote at the company’s first annual general meeting after privatisation. Although many small shareholders (some protesting at the AGM itself) voted against her salary increase, it was easily passed by the proxy votes of the large institutional shareholders who did not attend the meeting in person. Tom Nwede, the XY Investments fund manager, said that the votes of the institutional shareholders were crucial in ensuring that Mrs Evans was retained, thereby mitigating market risk.

Required:

(a) Explain the purposes of a chief executive’s reward package and review the factors that might influence the level of reward for Mrs Evans after the privatisation. (10 marks)

(b) Define ‘market risk’ and justify, giving reasons, Tom Nwede’s belief that retaining Mrs Evans was crucial in mitigating market risk. (10 marks)

(c) Define, and explain the advantages of, ‘proxy voting’ in the context of the case. (5 marks)

Section B – TWO questions ONLY to be attempted

There has been a debate in the country of Geeland for some years about the most appropriate way to regulate corporate governance. Several years ago, there were a number of major corporate failures and ‘scandals’ caused in part by a number of single powerful individuals dominating their boards. Business leaders and policy-makers were sceptical about a rules-based approach, and this led the Geeland stock exchange to issue guidance in the ‘Geeland Code’ as follows:

‘Good corporate governance is not just a matter of prescribing particular corporate structures and complying with a number of rules. There is a need for broad principles. All stakeholders should then apply these flexibly to the varying circumstances of individual companies.’

Given the causes of the Geeland corporate governance failures, there was a debate about whether the separation of the roles of chairman and chief executive should be made a legal requirement. This resulted in the stock exchange issuing guidance that whilst a rules-based or ‘box ticking’ approach would specify that ‘the roles of chairman and chief executive officer should never be combined… We do not think that there are universally valid answers on such points.’

One company to take advantage of the flexibility in Geeland’s principles-based approach was Anson Company. In July 2010, Anson Company announced that it had combined its roles of chairman and chief executive in a single role carried out by one individual. In accordance with the Geeland listing rules, it made the following ‘comply or explain’ statement in its 2011 annual report:

‘Throughout the year the company complied with all Geeland Code provisions with the exception that from 1 July 2010 the roles of chairman and chief executive have been exercised by the same individual, William Klunker. We recognise that this has been out of line with best practice. We understand the concerns of shareholders but believe that we have maintained robust governance while at the same time benefiting from having Mr Klunker in control. On 31 July 2012 Mr Klunker will step down as executive chairman, remaining as chairman until we conclude our search for a non-executive chairman to succeed him, no later than March 2013.’

Required:

(a) Briefly distinguish between rules and principles-based approaches to corporate governance. Critically evaluate the Geeland stock exchange’s guidance that ‘all stakeholders should then apply these flexibly to the varying circumstances of individual companies.’ (12 marks)

(b) Explain why a separation of the roles of chairman and chief executive is considered best practice in most jurisdictions. (8 marks)

(c) Assess the ‘comply or explain’ statement made by Anson Company in its 2011 annual report. (5 marks)

Section A – This ONE question is compulsory and MUST be attempted

Coastal Oil is one of the world’s largest petrochemical companies. It is based in Deeland and is responsible alone for 10% of Deeland’s total stock market value. It employs 120,000 people in many countries and has an especially strong presence in Effland because of Effland’s very large consumption of oil and gas products and its large oil reserves. Coastal Oil is organised, like most petrochemical companies, into three vertically integrated business units: the exploration and extraction division; the processing and refining division; and the distribution and retailing division.

Because of the risks and the capital investment demands, Coastal Oil has joint venture (JV) agreements in place for many of its extraction operations (i.e. its oil and gas rigs), especially those in the deep-water seas. A joint venture is a shared equity arrangement for a particular project where control is shared between the JV partners. In each of its JVs, Coastal Oil is the largest partner, although operations on each rig are divided between the JV member companies and the benefits are distributed according to the share of the JV.

As a highly visible company, Coastal Oil has long prided itself on its safety record and its ethical reputation. It believes both to be essential in supporting shareholder value. Its corporate code of ethics, published some years ago, pledges its commitment to the ‘highest standards’ of ethical performance in the following areas: full compliance with regulation in all jurisdictions; safety and care of employees; transparency and communication with stakeholders; social contribution; and environmental responsibility. In addition, Coastal Oil has usually provided a lot of voluntary disclosure in its annual report and on its website. It says that it has a wide range of stakeholders and so needs to provide a great deal of information.

One of the consequences of dividing up the different responsibilities and operations on an oil or gas rig is that Coastal Oil does not have direct influence over some important operational controls. The contractual arrangements on any given oil rig can be very complex and there have often been disagreements between JV partners on some individual legal agreements and responsibilities for health and safety controls. Given that Coastal Oil has JV interests in hundreds of deep-water oil and gas rigs all over the world, some observers have said that this could be a problem should an accident ever occur.

This issue was tragically highlighted when one of its deep-water rigs, the Effland Coastal Deep Rig, had an explosion earlier this year. It was caused by the failure of a valve at the ‘well-head’ on the sea floor. The valve was the responsibility of Well Services, a minor partner in the JV. Eight workers were killed on the rig from the high pressure released after the valve failure, and oil gushed into the sea from the well-head, a situation that should have been prevented had the valve been fully operational. It was soon established that Well Services’ staff failed to inspect the valve before placing it at the well-head at the time of installation, as was required by the company’s normal control systems. In addition, the valve was attached to a connecting part that did not meet the required technical specification for the water depth at which it was operating. The sea bed was 1,000 metres deep and the connecting part was intended for use to a depth of up to 300 metres. There was a suggestion that the need to keep costs down was a key reason for the use of the connecting part with the inferior specification.

Reports in the media on the following day said that the accident had happened on a rig ‘belonging to Coastal Oil’ when in fact, Coastal Oil was technically only a major partner in the joint venture. Furthermore, there was no mention that the accident had been caused by a part belonging to Well Services. A journalist did discover, however, that both companies had operated a more lax safety culture on the deep-water rigs than was the case at facilities on land (the ‘land-side’). He said there was a culture of ‘out of sight, out of mind’ on some offshore facilities and that this meant that several other controls were inoperative in addition to the ones that led to the accident. Information systems reporting back to the ‘land-side’ were in place but it was the responsibility of management on each individual rig to enforce all internal controls and the ‘land-side’ would only be informed of a problem if it was judged to be ‘an exceptional risk’ by the rig’s manager.

The accident triggered a large internal argument between Coastal Oil and Well Services about liability and this meant that there was no public statement from Coastal Oil for seven days while the arguments continued. Lawyers on both sides pointed out that liability was contractually ambiguous because the documentation on responsibilities was far too complex and unclear. And in any case, nobody expected anything to go wrong. In the absence of any official statement from Coastal Oil for those seven days, the media had no doubts who was to blame: Coastal Oil was strongly criticised in Effland with the criticism growing stronger as oil from the ruptured valve was shown spilling directly into the sea off the Effland coast. With no contingency plan for a deep-water well-head rupture in place, the ruptured valve took several months to repair, meaning that many thousands of tonnes of crude oil polluted the sea off Effland. Images of seabirds covered in crude oil were frequently broadcast on television and thousands of businesses on the coast reported that the polluted water would disrupt their business over the vital tourist season. Public statements from Coastal Oil that it was not responsible for the ruptured valve were seemingly not believed by the Effland public. Senior legislators in Effland said that the accident happened on ‘a rig belonging to Coastal Oil’ so it must be Coastal Oil’s fault.

A review by the Coastal Oil board highlighted several areas where risk management systems might be tightened to reduce the possibility of a similar accident happening again. Finance director, Tanya Tun, suggested that the company should disclose this new information to shareholders as it would be value-relevant to them. In particular, she said that a far more detailed voluntary statement on environmental risk would be material to the shareholders. The annual report would, she believed, be a suitable vehicle for this disclosure.

Because of the high media profile of the event, politicians from Effland involved themselves in the situation. Senator Jones’s constituency on the coast nearest the rig was badly affected by the oil spill and many of his constituents suffered economic loss as a result. He angrily retorted in a newspaper interview that Coastal Oil’s CEO, Susan Ahmed, ‘should have known this was going to happen’, such was the poor state of some of the internal controls on the Effland Coastal Deep Rig.

As the oil spill continued and the media interest in the events intensified, CEO Mrs Ahmed was summoned to appear before a special committee of the Effland national legislature ‘to explain herself to the citizens of Effland’. The Coastal Oil board agreed that this would be a good opportunity for Mrs Ahmed to address a number of issues in detail and attempt to repair some of the company’s damaged reputation. The board agreed that Mrs Ahmed should provide as full a statement as possible on the internal control failures to the special committee.

Required:

(a) Describe the general purposes of a corporate code of ethics and evaluate Coastal Oil’s performance against its own stated ethical aims as set out in its code of ethics. (10 marks)

(b) Explain, using examples, the difference between voluntary and mandatory disclosure, and assess Tanya Tun’s proposition that additional voluntary disclosure on environmental risk management would be material to the shareholders. (10 marks)

(c) In preparing to appear before the special committee of the Effland national legislature, CEO Mrs Ahmed has been informed that she will be asked to explain the causes of the accident and to establish whether she can give assurances that an accident of this type will not re-occur.

Required:

Prepare a statement for Mrs Ahmed to present before the committee that explains the following:

(i) The internal control failures that gave rise to the accident; (10 marks)

(ii) The difference between subjective and objective risk assessment (using examples). Argue against Senator Jones’s view that Mrs Ahmed ‘should have known this was going to happen’; (8 marks)

(iii) ‘Health and safety’ risk and the factors that can increase this risk in an organisation; (4 marks)

(iv) Why Coastal Oil cannot guarantee the prevention of further health and safety failures, using the ALARP (as low as reasonably practicable) principle; (4 marks)

Professional marks will be awarded in part (c) for logical flow, persuasiveness, format and tone of the answers. (4 marks)

students, contains the following advice.

‘A professional accountant in business or an immediate or close family member may be offered an inducement. Inducements may take various forms, including gifts, hospitality, preferential treatment, and inappropriate appeals to friendship or loyalty. Offers of inducements may create threats to compliance with the fundamental principles [of professionalism].’

Executive director and qualified accountant Ann Koo was in charge of awarding large outsourcing contracts for a large public listed company. When her family fell into debt, she looked for a way to make some additional income. When her company was seeking to place a contract for a large outsourced service, without inviting other tenders from which to select, she accepted a bid from one supplier who said it would pay her $50,000 as a ‘thank you’ once the contract was awarded. She justified her behaviour by reminding herself that she obtained her job partly because she was an accountant and that she had worked extremely hard to obtain her accounting qualification. She believed she was entitled to make a ‘higher personal return’ on her investment of time and effort in her accountancy training and through successful qualification as a professional accountant.

Required: (a) Briefly describe the five types of ethical threats in the IFAC code of professional ethics (2009) and discuss how accepting excessive ‘gifts’ or ‘hospitality’ can give rise to some of these threats within this case. (9 marks)

(b) Criticise Ann Koo’s beliefs and behaviour, and explain why accepting the $50,000 conflicts with her duty to uphold the public interest. (10 marks)

(c) The IFAC code also highlights the need for: ‘up-to-date education [for directors] on ethical issues and the legal restrictions and other regulations around potential insider trading.’

Required:

Explain what ‘insider dealing/trading’ is and why it is an unethical and often illegal practice. (6 marks)