Branscombe Co has been supplying and fitting premium bathrooms and kitchens in hotel chain

Section B – TWO questions ONLY to be attempted

Plantex is a large international pharmaceutical company which has been at the forefront of research into developing cures for many tropical diseases. The nature of its business means that continuous and significant financial investment is required for research and development activities, for which its shareholders expect sizeable returns.

At a recent meeting of the board of Plantex, the finance director, Rachel Tang, submitted a paper on integrated reporting <IR> for discussion and consideration. She advised the board that Plantex had only ever disclosed the minimum information which it was required to by law, but recent developments in the International Integrated Reporting Framework has made a very strong case for broadening the amount of published corporate information.

The primary objective of <IR> is to demonstrate the clear link between a firm’s competitive strategy, governance system and financial performance, alongside the social, environmental and economic context within which the firm operates. Rachel Tang claimed that by integrating these different areas, the board of Plantex would be in a far better position to allocate its valuable resources more effectively and thereby make more environmental and socially sustainable decisions.

The chairman was highly supportive of the proposal as he had been trying to encourage a corporate citizenship agenda at recent board meetings. He suggested that <IR> would demonstrate that Plantex took corporate social responsibility seriously by being more transparent, accountable and responsive to its stakeholders’ demands.

Rachel Tang further asserted that <IR> would have the effect of simplifying published financial information, with excessive detail being removed and critical information being highlighted. If Plantex voluntarily adopted <IR> , its shareholders, and other stakeholders, would better understand how the firm was really performing and so be able to make a meaningful assessment of the firm’s long-term strategy. This openness could encourage further investment and strengthen the firm’s competitive position.

The chief executive, Stanley Broadway, suggested that this all sounded very good in theory, but he found it hard to justify the extra expense without any recognisable return to shareholders. He said it was ‘just another costly management fad that distracted the company from its real purpose – making money for its shareholders!’

Required:

(a) Explain the concept of corporate citizenship and assess the rights and responsibilities of Plantex as a corporate citizen of society. (7 marks)

(b) Describe the differing opinions about integrated reporting of Rachel Tang and Stanley Broadway and assess them using the relevant Gray, Owen & Adams positions on social responsibility. (6 marks)

(c) (i) Describe the advantages to Plantex and its stakeholders of adopting . (6 marks)

(ii) Explain how using an approach will provide information about the six capitals including the resources and relationships on which Plantex depends. (6 marks)

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

Care Services Company (CSC) is a private company, owned by Dr Sam Tan and his wife, Sonja. Sam, a qualified medical doctor, has been involved with the care of elderly and vulnerable adults for over 30 years and set up CSC five years ago to try to improve the quality of care in his locality and to also build a business which he could then sell when he retired. The company employs 180 people in total with 165 of those being the carers who visit service users (usually the elderly, disabled or those with learning difficulties) in their own homes to help with personal needs.

The services provided by CSC are outsourced to them by the local government authority and the government health service. CSC receives funding from these bodies in line with national government policy which determines that care is best delivered by specialist companies such as CSC, rather than directly by the government. Contracts to care providers such as CSC are awarded on a three-year basis. The criteria for provider selection are partly on the basis of cost and partly on the basis of the perception of the quality of the care provided.

Because they deliver important social services and health care, CSC and other companies providing personal care are subject to a rigorous regulatory regime. These regulations apply to all care services, whether provided directly by the government or by companies such as CSC who provide the outsourced care services. All carers, for example, must undergo compulsory training on a wide range of issues. Each potential employee must be checked for past criminal convictions, whilst high standards of hygiene and professional behaviour are expected at all times.

As time passed, rival care service companies entered the market. As a result, CSC experienced increased competition for contracts and it lost some of its care contracts with some government agencies to competitor care providers. Because the award of contracts was partly based on the perception of the company itself, and not just its care quality, Dr Tan came to believe that the governance of the company might be something which should be reconsidered. He believed that the perception of sound governance was necessary to ensure confidence in its services from both its service users and those government bodies outsourcing the service.

Accordingly, he decided to adopt best practice in corporate governance with the creation of a small executive board augmented by the appointment of a number of non-executive directors, along with a committee structure. Natasha Mbana, the current co-ordinator of the company’s care services, was made chief executive and Dr Tan proposed that he himself might become the new non-executive chairman. Over time, a total of five non-executive directors were appointed to the board of CSC and they were each paid a small annual fee for their services. All of the non-executives were retired members of large public listed company boards with little experience of public sector service delivery. They all lived in the locality in which CSC was based and Dr Tan believed their presence on the board would look impressive when it came to CSC renewing its service contracts.

As a company fulfilling public sector contracts for care service delivery, pay rates for carers are often relatively low. This also applies to the financial rewards of the senior management in CSC who receive much less in salary and benefits than those with equivalent responsibilities in the private sector. CEO Natasha Mbana says that she accepts a lower level of reward because she believes in the ‘public sector ethos’ and believes that CSC provides a vital public service. When the new non-executive directors saw what she earned, they noted that she was on much less than the market rate for a chief executive and that she should receive a substantial increase in her rewards to recognise her contribution to the company. Dr Tan said that this might not be possible and that the new non-executive directors should recognise that rewards in the public sector are often much less than those in large listed companies.

Last year, a problem arose for care providers when a small number of companies were exposed by the media for very poor practice. CSC was not implicated in the allegations, but some other companies in the industry were accused of making inadequate or very brief visits to service users, or missing out visiting some service users altogether, under time pressure to see other service users. Most service delivery contracts specified a minimum visit period of 30 minutes per patient and that carers needed to provide a minimum standard of care on each visit, including attending to the service user’s personal needs, food, drinks and medication. But because of the pressure to complete their other duties, carers sometimes ignored these minimum periods and thereby failed to fulfil service users’ personal needs.

This meant that affected service users were left in discomfort, without food, water and medicines, and sometimes in considerable pain. This caused a lot of anger among the public, and led the country’s health minister to ask about the internal controls in care provider companies. The health minister expressed the view that the most vulnerable in society had been let down badly, and the reputation of the care industry was badly damaged. Many companies, including CSC, became aware of public resentment and, in some cases, public hostility.

The manager of ‘We care’, another care supplier, went on television to explain that there were a number of structural problems with providing care under the government contracts. He said it was difficult to recruit carers and the low pay often meant that it was difficult to retain them. Furthermore, the pressure to deliver the outsourced care services was intense with carers having to hurry from one service user to another to complete their work. It was no surprise, he said, that service users often received less care than they needed because the demands on each carer were so high.

Aware that this scandal threatened the reputation of the whole care services industry, Dr Tan decided that it might be beneficial for CSC to develop and publish a code of ethics which would apply to the company and all of its carers. He was aware that the reputation of all care providers might be affected by the bad practice of a few companies and he wanted to ensure that CSC was well-thought of so it could compete successfully for future contracts and continue to enjoy the support of its service users.

In response to the negative publicity, a number of care providers held a conference and it was decided that Dr Tan, as a doctor and a senior figure in the industry, should write to the health minister on behalf of them all. In particular, they asked Dr Tan to address the issues of the internal controls in care provisions and the measures which providers would be undertaking to ensure there would be no repetition of any bad practices. They thought this a worthwhile measure to attempt to convince the health minister that providers had addressed his concerns.

Required:

(a) Explain the meaning of corporate governance and agency relationships, and contrast how the objectives of corporate governance differs between a large listed company and a smaller company delivering public sector services such as Care Services Company (CSC). (8 marks)

(b) The non-executive directors believed that Natasha Mbana was underpaid in her position as chief executive officer (CEO) of Care Services. Required: Explain what ‘market rate’ means and explain why Natasha Mbana’s rewards as CEO of a public sector service provider are likely to be lower than for a CEO of a large listed public company. (10 marks)

(c) Explain the importance of reputation to CSC, and discuss the potential benefits of the proposed corporate code of ethics for CSC. (12 marks)

(d) Draft a letter from Dr Sam Tan to the government health minister, which includes the following:

(i) An explanation of the importance of internal controls in CSC and other care service providers. (8 marks)

(ii) A proposal recommending suitable internal control changes which would help to address the service delivery failures described in the case. (8 marks)

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

of food labelled as containing only high quality meat. The company enjoys the trust and confidence of its customers because of its reputation for high quality products. One day, when passing through one area of the plant, Mahmood noticed some inferior meat being mixed with the normal product. He felt this must be unauthorised so he informed his supervisor, the factory manager, who told Mahmood that this was in fact a necessary cost reduction measure because company profits had been declining in recent months. Mahmood later found out that all stages of the production process, from purchasing to final quality control, were adapted in order to make the use of the inferior meat possible.

The factory manager told Mahmood that the inferior meat was safe for humans to eat and its use was not illegal. However, he told Mahmood that if knowledge of the use of this meat was made public, it would mean that customers might stop buying the products. Many jobs could be lost, probably including Mahmood’s own. The factory manager ordered Mahmood to say nothing about the inferior meat and to conduct his job as normal. Mahmood later discovered that the main board of Tzo was aware of the use of the inferior meat and supported its use in seeking to reduce costs and maintain profits. In covering up the use of the inferior meat, the factory produced a fraudulent quality control report to show that the product was purely based on high quality meat when the company knew that this was not so.

When Mahmood heard this, he was very angry and considered telling an external source, such as the local newspaper, about what he had seen and about how the company was being dishonest with its customers.

Required:

(a) Explain how Mahmood might act, in each case, if he were to adopt either conventional or post-conventional ethical assumptions according to Kohlberg’s definitions of these terms. Your answer should include an explanation of these two terms. (8 marks)

(b) Construct an ethical case for Mahmood to take this matter directly to an external source such as a newspaper. (8 marks)

(c) Some jurisdictions have a compulsory regulatory requirement for an auditor-reviewed external report on the operation and effectiveness of internal controls (such as s.404 of Sarbanes Oxley).

Required:

Explain how such a requirement may have helped to prevent the undisclosed use of the inferior meat at Tzo Company. (9 marks)

services market among local businesses. Because Deetown is a relatively isolated area, many clients rely on Hum and Hoo for accounting and technical advice over and above the annual audit. This has meant that, over time, Hum and Hoo has also developed expertise in compliance advice, tax, strategy consulting and other professional services.

Because non-audit work is important to Hum and Hoo, staff have ‘business growth’ criteria strongly linked with bonuses and promotion. This means that many of the professional accountants in the firm actively seek to increase sales of non-audit services to businesses in the Deetown area, including from audit clients. The culture of the firm is such that everybody is expected to help out with any project which needs to be done, and this sometimes means that staff help out on a range of both audit and non-audit tasks. The lines between audit and non-audit services are sometimes blurred and staff may work on either, as workload needs demand. Managing partner Cherry Hoo told staff that the non-audit revenue is now so important to the firm that staff should not do anything to threaten that source of income.

Cherry Hoo said that she was thinking of beginning to offer a number of other services including advice on environmental reporting and the provision of environmental auditing services. She said she had spoken to local companies which were looking to demonstrate their environmental sustainability and she believed that environmental reporting and auditing might be ways to help with this. She said she was confused by the nature of environmental reporting and so was not sure about what should be audited.

Required:

(a) Explain ‘ethical threat’ and ‘ethical safeguard’ in the context of external auditing, and discuss the benefits of effective ethical safeguards for Hum and Hoo. (8 marks)

(b) Explain ‘environmental audit’ and assess how environmental reporting and auditing might enable companies to ‘demonstrate their environmental sustainability’ as Cherry Hoo suggested. (8 marks)

(c) Some corporate governance codes prohibit audit firms such as Hum and Hoo from providing some non-audit services to audit clients without the prior approval of the client’s audit committee. This is because it is sometimes believed to be against the public interest.

Required:

Explain ‘public interest’ in the context of accounting services and why a client’s audit committee is a suitable body to advise on the purchase of non-audit services from Hum and Hoo. (9 marks)

Section B – TWO questions ONLY to be attempted

Bob Wong was fortunate to inherit some money and decided he wanted to invest for the long term in one or more investments so he would have a higher income in retirement. He was not a specialist in accounting and had little understanding of how investments worked.

Bob studied an investment website which suggested that he needed to be aware of the level of risk in an investment and also that he needed to know what his basic attitude to risk would be. This meant he needed to decide what his risk appetite was and then select investments based on that.

When Bob studied share listings in newspapers, he noticed that they were subdivided into sectors (e.g. banks, pharmaceuticals, mining, retail). He noticed that some sectors seemed to make higher returns than others and he wanted to know why this was. One website suggested that risks also varied by sector and this was partly explained by the different business and financial risks which different sectors are exposed to.

One website said that if a potential investor wanted to know about any given company as a potential investment, the company’s most recent annual report was a good place to start. This was because, it said, the annual report contained a lot of voluntary information, in addition to the financial statements. Bob could use this information to gain an understanding of the company’s strategy and governance. The website suggested that the contents of the corporate governance section of the annual report would be particularly helpful in helping him decide whether or not to buy shares in a company.

Required:

(a) Explain ‘risk appetite’ and ‘risk awareness’, and discuss how Bob’s risk appetite might affect his choice of investments.

(8 marks) (b) Explain ‘business risk’ and ‘financial risk’ and discuss why risks might vary by sector as the website indicated. (8 marks)

(c) Distinguish, with examples, between mandatory and voluntary disclosure in annual reports, and assess the usefulness of corporate governance disclosure to Bob in selecting his investments. (9 marks)

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

Several years ago, World Justice, a well-known charity, published a report on the activities of three major food companies in their marketing of manufactured baby foods in some of the poorer developing countries. The report, provocatively called ‘Killer Companies’, said it had evidence that the three companies were ‘aggressively mis-selling’ manufactured baby food products in these poorer countries. It was argued in the report that several problems arose with the use of these products in poorer countries which negatively affected the health of the babies, with many babies reportedly dying as a result. These problems included the use of contaminated water in the preparation of the baby food, an inability of parents to read the instructions, making up product at insufficient concentrations (thereby malnourishing the child) and aggressive selling to health facilities in those countries. Doctors often advised against the use of these products for babies because natural feeding solutions were considered safer and more beneficial in most cases.

When the ‘Killer Companies’ report was published, it was widely reported upon and received a lot of social and political attention. Two of the three companies named in ‘Killer Companies’ immediately decided to withdraw from the business but the third company, Xaxa Company (Xaxa hereafter), recognised what it believed to be an opportunity to take the market share left by the other two. It set about increasing its production capacity accordingly. When asked by journalists why Xaxa had not also withdrawn from the criticised business activity, the chief executive issued a press statement saying that it was a profitable business opportunity and, as the steward of shareholder value, he owed it to the shareholders to maximise their returns.

When it became widely known that Xaxa had decided to expand and develop its baby food business in poorer developing countries, Mothers Who Care (MWC), a national charity concerned with infant nutrition, organised a campaign against Xaxa. Strongly believing in the natural feeding of infants, MWC initially organised protests outside the Xaxa head office and also encouraged the public to boycott a wide range of Xaxa products in addition to the baby food products. MWC members started to use the phrase, ‘Xaxa kills babies’ in the hope that it would become widely adopted.

As one of the country’s largest companies and operating in many countries, Xaxa has a large issued share volume with the majority being held by institutional investors. Whilst the overall group profits remained strong, some shareholders began to feel concerned about the baby food issue. One prominent fund manager, Hugh Oublie, organised a meeting for institutional shareholders holding large volumes of Xaxa shares and 50 such institutional shareholders attended the meeting. The group became known as the ‘Oublie Group’. Although all members of the Oublie Group wanted to retain their holdings in Xaxa because of the otherwise good returns, a number of questions were framed which they decided to put to the Xaxa management:

(i) could the company explain the strategic logic of pursuing the baby food business in poorer developing countries?

(ii) was the board concerned about potential reputational damage with phrases such as ‘Xaxa kills babies’ being used widely and in the media?

(iii) would the Xaxa board consider withdrawing from the baby food business in poorer developing countries because of the alleged health impacts on children in those countries?

The company issued a statement through its investor relations department, replying that the strategic logic was based on what activities provided the most profit to shareholders regardless of the effects on other claims against the company strategy. Second, the board was not concerned with reputation risks because it believed that these were ‘temporary concerns’ which would soon be forgotten. Third, no, the board would not withdraw from the baby food market in those countries because, with the loss of two competitors, profit margins were likely to be higher and competition less. The Oublie Group expressed its dissatisfaction with this reply and said it might seek to influence the appointment of non-executive directors (NEDs) to the Xaxa board to increase the scrutiny of the executive members and their discussions on the subject.

Hugh Oublie appeared on television to say that he felt the board of Xaxa lacked balance. He said that, although profitable and a good employer in its home country, the non-executive scrutiny of company strategy had been poor for some time and the board had no meaningful sense of ethics at all. He believed that all of the executive board was dedicated to the mission to produce what he called ‘profit at any social cost’. He further believed that none of the non-executive board members was strong enough to question the strategy and raise the problem of baby food as an ethical issue. It was this lack of non-executive scrutiny which Hugh Oublie believed was a major cause of Xaxa’s unwillingness to reconsider its baby food activity. He said that he had been a long-serving observer and shareholder of Xaxa and he had noticed the company becoming more inward-looking and self-reliant in recent years. He believed this trend was very unhelpful. In addition, he expressed concerns, on behalf of the Oublie Group, about the strategic management of Xaxa and his belief that the board lacked concern for medium-term business risks brought about by the baby food marketing.

As World Justice and MWC continued their campaigns against Xaxa, some other groups became aware of the baby food situation in poorer developing countries. A television programme reported how Xaxa products were actually being used in some of the poorer countries. It claimed to confirm the problems highlighted in ‘Killer Companies’ and it highlighted a number of other Xaxa products which consumers might stop buying if they wanted to put pressure on Xaxa’s management to change their policy on baby food.

Partly in response to these pressures, the Xaxa board decided to consider two new initiatives. The first of these was to consider introducing a corporate code of ethics. By carefully drafting this and placing it prominently on its website, the board believed that it could achieve a number of favourable outcomes including improving its reputation.

The second initiative was to consider instituting a full risk audit system in response to the negative publicity it had experienced, especially from MWC, whose members were considered to be natural customers of Xaxa’s other products. Private research commissioned by Xaxa showed that the baby food business was damaging Xaxa’s reputation and possibly the willingness of some talented people to apply for jobs with the company. Political support for other company plans had also suffered, such that a recent planning application to set up a new factory by Xaxa, in a business area with no connection with baby food, had received opposition. Protestors, mainly local activists and MWC members, opposed the application with placards saying ‘Xaxa kills babies’. Because the idea of risk auditing was a new initiative for Xaxa, the board has asked a local consultancy to produce guidance on the benefits of risk audit and the benefits of an external, rather than an internal, risk audit.

Required:

(a) The underlying principles of corporate governance include transparency, judgement and reputation. Explain these three terms and assess the Xaxa board’s performance against each one. (9 marks)

(b) Explain the purposes of a corporate code of ethics and examine how the adoption of such a code might make Xaxa reconsider its marketing of baby food in poorer developing countries. (11 marks)

(c) Institutional investors are potentially influential stakeholders in a company such as Xaxa.

Required:

(i) Explain why institutional investors might attempt to intervene in the governance of a company. (ii) Discuss the reasons why the Oublie Group should attempt to intervene in the governance of Xaxa following the events described in the case.

Note: The total marks will be split equally between each part. (10 marks)

(d) Produce notes from the consulting company for the Xaxa board in response to its need for guidance on risk audit. The notes should address the following:

(i) Discuss, in the context of Xaxa, the stages in a risk audit. (8 marks)

(ii) Distinguish between internal and external risk audit, and discuss the advantages for Xaxa of an external risk audit. (8 marks)

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

cting two towns. Route A involved cutting a channel through an area designated as being of special scientific importance because it was one of a very few suitable feeding grounds for a colony of endangered birds. The birds were considered to be an important part of the local environment with some potential influences on local ecosystems.

The alternative was Route B which would involve the compulsory purchase and destruction of Eddie Krul’s farm. Mr Krul was a vocal opponent of the Route B plan. He said that he had a right to stay on the land which had been owned by his family for four generations and which he had developed into a profitable farm. The farm employed a number of local people whose jobs would be lost if Route B went through the house and land. Mr Krul threatened legal action against RDC if Route B was chosen.

An independent legal authority has determined that the compulsory purchase price of Mr Krul’s farm would be $1 million if Route B was chosen. RDC considered this a material cost, over and above other land costs, because the projected net present value (NPV) of cash flows over a ten-year period would be $5 million without buying the farm. This would reduce the NPV by $1 million if Route B was chosen.

The local government authority had given both routes provisional planning permission and offered no opinion of which it preferred. It supported infrastructure projects such as the new railway line, believing that either route would attract new income and prosperity to the region. It took the view that as an experienced railway builder, RDC would know best which to choose and how to evaluate the two options. Because it was very keen to attract the investment, it left the decision entirely to RDC. RDC selected Route A as the route to build the new line.

A local environmental pressure group, ‘Save the Birds’, was outraged at the decision to choose Route A. It criticised RDC and also the local authority for ignoring the sustainability implications of the decision. It accused the company of profiting at the expense of the environment and threatened to use ‘direct action’ to disrupt the building of the line through the birds’ feeding ground if Route A went ahead.

Required:

(a) Use Tucker’s ‘five question’ model to assess the decision to choose Route A. (10 marks)

(b) Discuss the importance to RDC of recognising all of the stakeholders in a decision such as deciding between Route A and Route B. (8 marks)

(c) Explain what a stakeholder ‘claim’ is, and critically assess the stakeholder claims of Mr Krul, the local government authority and the colony of endangered birds. (7 marks)

se in products failing the final quality checks. These checks were carried out in the QC (quality control) laboratory, which tested finished goods products before being released for sale. The product failure rate had risen from 1% of items two years ago to 4% now, and this meant an increase of hundreds of items of output a month which were not sold on to Yaya’s customers. The failed products had no value to the company once they had failed QC as the rework costs were not economic. Because the increase was gradual, it took a while for Mr Janoon to realise that the failure rate had risen.

A thorough review of the main production operation revealed nothing that might explain the increased failure and so attention was focused instead on the QC laboratory. For some years, the QC laboratory at Yaya, managed by Jane Goo, had been marginalised in the company, with its two staff working in a remote laboratory well away from other employees. Operations director Ben Janoon, who designed the internal control systems in Yaya, rarely visited the QC lab because of its remote location. He never asked for information on product failure rates to be reported to him and did not understand the science involved in the QC process. He relied on the two QC staff, Jane Goo and her assistant John Zong, both of whom did have relevant scientific qualifications.

The two QC staff considered themselves low paid. Whilst in theory they reported to Mr Janoon, in practice, they conducted their work with little contact with colleagues. The work was routine and involved testing products against a set of compliance standards. A single signature on a product compliance report was required to pass or fail in QC and these reports were then filed away with no-one else seeing them.

It was eventually established that Jane Goo had found a local buyer to pay her directly for any of Yaya’s products which had failed the QC tests. The increased failure rate had resulted from her signing products as having ‘failed QC’ when, in fact, they had passed. She kept the proceeds from the sales for herself, and also paid her assistant, John Zong, a proportion of the proceeds from the sale of the failed products.

Required:

(a) Explain typical reasons why an internal control system might be ineffective. (5 marks)

(b) Explain the internal control deficiencies that led to the increased product failures at Yaya. (10 marks)

(c) Discuss the general qualities of useful information, stating clearly how they would be of benefit to Mr Janoon, and recommend specific measures which would improve information flow from the QC lab to Mr Janoon. (10 marks)

Section B – TWO questions ONLY to be attempted

After a recent financial crisis in the country of Oland, there had been a number of high profile company failures and a general loss of confidence in business. As a result, an updated corporate governance code was proposed, with changes to address these concerns.

Before the new code was published, there was a debate in Oland society about whether corporate governance provisions should be made rules-based, or remain principles-based as had been the case in the past. One elected legislator, Martin Mung, whose constituency contained a number of the companies that had failed with resulting rises in unemployment, argued strongly that many of the corporate governance failures would not have happened if directors were legally accountable for compliance with corporate governance provisions. He said that ‘you can’t trust the markets to punish bad practice’, saying that this was what had caused the problems in the first place. He said that Oland should become a rules-based jurisdiction because the current ‘comply or explain’ was ineffective as a means of controlling corporate governance.

Mr Mung was angered by the company failures in his constituency and believed that a lack of sound corporate governance contributed to the failure of important companies and the jobs they supported. He said that he wanted the new code to make it more difficult for companies to fail.

The new code was then issued, under a principles-based approach. One added provision in the new Oland code was to recommend a reduction in the re-election period of all directors from three years to one year. The code also required that when seeking re-election, there should be ‘sufficient biographical details on each director to enable shareholders to take an informed decision’. The code explained that these measures were ‘in the interests of greater accountability’.

Required:

(a) Examine how sound corporate governance can make it more difficult for companies to fail, clearly explaining what ‘corporate governance’ means in your answer. (10 marks)

(b) Martin Mung believes that Oland should become a rules-based jurisdiction because the current ‘comply or explain’ approach is ineffective as a means of controlling corporate governance.

Required:

Explain the difference between rules-based and principles-based approaches to corporate governance regulation, and argue against Martin Mung’s belief that ‘comply or explain’ is ineffective. (8 marks)

(c) Explain what ‘accountability’ means, and discuss how the proposed new provisions for shorter re-election periods and biographical details might result in ‘greater accountability’ as the code suggests. (7 marks)

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)