1 December 2014 June 2015 Edition STUDY QUESTION BANK ACCA Paper P1 GOVERNANCE, RISK AND ETHICS ATC International became a part of Becker Professional Education in ATC International has 20 years of experience providing lectures and learning tools for ACCA Professional Qualifications. Together, Becker Professional Education and ATC International offer ACCA candidates high quality study materials to maximize their chances of success.
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3 ACCA PAPER P1 GOVERNANCE, RISK AND ETHICS STUDY QUESTION BANK For Examinations to June DeVry/Becker Educational Development Corp. All rights reserved. (i)
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5 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) CONTENTS Question Page Answer Marks Date worked SCOPE OF GOVERNANCE 1 Corporate Governance Public Service AGENCY RELATIONSHIPS AND THEORIES 3 Agents and Objectives Stakeholder Theory BOARD OF DIRECTORS 5 Alliya Yongvanich (ACCA D07) TQ Company (ACCA J09) BOARD COMMITTEES 7 Nominations Committee Tomato Bank (ACCA J10) APPROACHES TO CORPORATE GOVERNANCE 9 Corporate Governance Standards (ACCA D02)* CORPORATE SOCIAL RESPONSIBILITY 10 Objectives of Companies (ACCA D03)* Principles of CSR MANAGEMENT CONTROL SYSTEMS 12 Bateleur Zoo Gardens (ACCA J04)* VCF INTERNAL AUDIT AND COMPLIANCE 14 Internal Audit Effectiveness Flight Investments REPORTING ON INTERNAL CONTROL 16 Reporting on Internal Control Systems IDENTIFYING, ASSESSING AND CONTROLLING RISK 17 Ferry (ACCA J03)* Southern Continents Company (ACCA D07) H&Z Company (ACCA J09) ETHICAL THEORIES 20 Ethical Theories Ethical Management DeVry/Becker Educational Development Corp. All rights reserved. (iii)
6 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Question Page Answer Marks Date worked ETHICS AND SOCIAL RESPONSIBILITY 22 Responsibility to be Ethical Ethical Dilemmas Prominent Football Club (ACCA D07) PROFESSIONS AND THE PUBLIC INTEREST 25 Boleyn & Co PROFESSIONAL PRACTICE AND CODES OF ETHICS 26 Steering Committee CFO CONFLICTS OF INTEREST AND UNETHICAL BEHAVIOUR 28 Van Buren Co (ACCA J08) INTEGRATED REPORTING AND SUSTAINABILITY 29 PAIB Unsustainable Behaviour CASE STUDIES 31 Worldwide Minerals (ACCA D07) Hesket Nuclear (ACCA J10) ZPT (ACCA D10) FURTHER PRACTICE QUESTIONS 34 Corporate governance guidelines (ACCA D02) Kellog Environmental issues Professors West & Leroi (ACCA J08) Ann Koo (ACCA J11) * Modified questions and answers from an ACCA paper other than P1. Tutorial note: The specific references to academic and literature sources in the current examiner s answers (ACCA from D07 onwards) are for illustrative purposes only and do not mean that candidate answers need to refer to those sources in order to achieve good marks. Solutions: Each solution is indicative of the style and quality of the answer expected by the examiner. They may not be indicative of the length of answer expected as such suggested solutions usually contain far more detail than is needed to obtain a good pass. For example, a 10-mark scenario-based question requiring practical analysis and application may have a solution with sufficient detail to obtain 15 marks; whereas the answer to a 5-mark explanation of a theoretical model will be unlikely to have more marks available than indicated. Once attempted, answers to each question should be carefully reviewed as an essential part of the process of being well prepared. (iv) 2014 DeVry/Becker Educational Development Corp. All rights reserved.
7 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) Question 1 CORPORATE GOVERNANCE There are many different definitions and explanations of the term corporate governance. Required: (a) Briefly describe the meaning of corporate governance. (5 marks) (b) Identify the elements that are generally common to most UK corporate governance codes. (5 marks) (c) Explain the key underpinning concepts of corporate governance. (15 marks) Question 2 PUBLIC SERVICES (25 marks) Corporate governance has been defined as the way in which organisations are directed and controlled. This implies that the principles of corporate governance may be applied to any organisation, not just corporate bodies. Required: (a) (b) Describe the basic features of an organisation within the public service as compared to a corporate body. (5 marks) Describe how the concepts of corporate governance can be applied to organisations other than corporate bodies. (10 marks) Question 3 AGENTS AND OBJECTIVES (15 marks) Goal congruence is accordance between the objective of agents acting within an organisation and the objectives of the organisation as a whole. Managers can be encouraged to act in shareholders best interests through incentives which reward them for good performance but punish them for their poor performance. Required: (a) Explain agency theory as a mechanism for managing a business. (6 marks) (b) Describe and comment on four examples of rewards or incentives that may encourage managers to act in the best interests of shareholders. (8 marks) (c) Critically evaluate the relevance of agency theory today. (6 marks) (20 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 1
8 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Question 4 STAKEHOLDER THEORY Agency theory only considers the relationship between directors and shareholders. It does not take into consideration stakeholders. Required: (a) Explain the term stakeholder. (4 marks) (b) Describe what is meant by stakeholder theory. (6 marks) (c) For an international airport (e.g. Heathrow London Airport), identify the potential stakeholders and their possible interests. (10 marks) Question 5 ALLIYA YONGVANICH (20 marks) At a recent international meeting of business leaders, Seamus O Brien said that multi-jurisdictional attempts to regulate corporate governance were futile because of differences in national culture. He drew particular attention to the Organisation for Economic Co-operation and Development (OECD) and International Corporate Governance Network (ICGN) codes, saying that they were, silly attempts to harmonise practice. He said that in some countries, for example, there were family reasons for making the chairman and chief executive the same person. In other countries, he said, the separation of these roles seemed to work. Another delegate, Alliya Yongvanich, said that the roles of chief executive and chairman should always be separated because of what she called accountability to shareholders. One delegate, Vincent Viola, said that the right approach was to allow each country to set up its own corporate governance provisions. He said that it was suitable for some countries to produce and abide by their own very structured corporate governance provisions, but in some other parts of the world, the local culture was to allow what he called, local interpretation of the rules. He said that some cultures valued highly structured governance systems while others do not care as much. Required: (a) Explain the roles of the chairman in corporate governance. (5 marks) (b) (c) Assess the benefits of the separation of the roles of chief executive and chairman that Alliya Yongvanich argued for and explain her belief that accountability to shareholders is increased by the separation of these roles. (12 marks) Critically evaluate Vincent Viola s view that corporate governance provisions should vary by country. (8 marks) Question 6 TQ COMPANY (25 marks) TQ Company, a listed company, recently went into administration (it had become insolvent and was being manager by a firm of insolvency practitioners). A group of shareholders expressed the belief that it was the chairman, Miss Heike Hoiku, who was primarily to blame. Although the company s management had made a number of strategic errors that brought about the company failure, the shareholders blamed the chairman for failing to hold senior management to account. In particular, they were angry that Miss Hoiku had not challenged chief executive Rupert Smith who was regarded by some as arrogant and domineering. Some said that Miss Hoiku was scared of Mr Smith DeVry/Becker Educational Development Corp. All rights reserved.
9 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) Some shareholders wrote a letter to Miss Hoiku last year demanding that she hold Mr Smith to account for a number of previous strategic errors. They also asked her to explain why she had not warned of the strategic problems in her chairman s statement in the annual report earlier in the year. In particular, they asked if she could remove Mr Smith from office for incompetence. Miss Hoiku replied saying that whilst she understood their concerns, it was difficult to remove a serving chief executive from office. Some of the shareholders believed that Mr Smith may have performed better in his role had his reward package been better designed in the first place. There was previously a remuneration committee at TQ but when two of its four non-executive members left the company, they were not replaced and so the committee effectively collapsed. Mr Smith was then able to propose his own remuneration package and Miss Hoiku did not feel able to refuse him. He massively increased the proportion of the package that was basic salary and also awarded himself a new and much more expensive company car. Some shareholders regarded the car as excessively expensive. In addition, suspecting that the company s performance might deteriorate this year, he exercised all of his share options last year and immediately sold all of his shares in TQ Company. It was noted that Mr Smith spent long periods of time travelling away on company business whilst less experienced directors struggled with implementing strategy at the company headquarters. This meant that operational procedures were often uncoordinated and this was one of the causes of the eventual strategic failure. (a) (b) (c) Miss Hoiku stated that it was difficult to remove a serving chief executive from office. Required: (i) (ii) Explain the ways in which a company director can leave the service of a board. (4 marks) Discuss Miss Hoiku s statement that it is difficult to remove a serving chief executive from a board. (4 marks) Assess, in the context of the case, the importance of the chairman s statement to shareholders in TQ Company s annual report. (5 marks) Criticise the structure of the reward package that Mr Smith awarded himself. (4 marks) (d) Criticise Miss Hoiku s performance as chairman of TQ Company. (8 marks) Question 7 NOMINATION COMMITTEE (25 marks) A Nomination Committee is a committee of the board of directors, with responsibility for identifying potential new members for the board of directors. Suitable candidates are recommended to the board, which then makes a decision about their appointment. Required: (a) State who should be the members of the Nomination Committee. (2 marks) (b) Explain the duties of the members of the Nomination Committee. (9 marks) (c) Suggest the advantages of a company having a separate nominations committee.(2 marks) (d) Explain how the risk of any conflict of interest arising between members can be minimised. (2 marks) (15 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 3
10 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Question 8 TOMATO BANK Five years ago, George Woof was appointed chief executive officer (CEO) of Tomato Bank, one of the largest global banks. Mr Woof had a successful track record in senior management in America and his appointment was considered very fortunate for the company. Analysts rated him as one of the world s best bankers and the other directors of Tomato Bank looked forward to his appointment and a significant strengthening of the business. One of the factors needed to secure Mr Woof s services was his reward package. Prior to his acceptance of the position, Tomato Bank s remuneration committee (comprised entirely of nonexecutives) received a letter from Mr Woof saying that because his track record was so strong, they could be assured of many years of sustained growth under his leadership. In discussions concerning his pension, however, he asked for a generous non-performance related pension settlement to be written into his contract so that it would be payable whenever he decided to leave the company (subject to a minimum term of two years) and regardless of his performance as CEO. Such was the euphoria about his appointment that his request was approved. Furthermore in the hasty manner in which Mr Woof s reward package was agreed, the split of his package between basic and performance-related components was not carefully scrutinised. Everybody on the remuneration committee was so certain that he would bring success to Tomato Bank that the individual details of his reward package were not considered important. In addition, the remuneration committee received several letters from Tomato Bank s finance director, John Temba, saying, in direct terms, that they should offer Mr Woof whatever he wants to ensure that he joins the company and that the balance of benefits was not important as long as he joined. Two of the non-executive directors on the remuneration committee were former colleagues of Mr Woof and told the finance director they would take his advice and make sure they put a package together that would ensure Mr Woof joined the company. Once in post, Mr Woof led an excessively aggressive strategy that involved high growth in the loan and mortgage books financed from a range of sources, some of which proved unreliable. In the fifth year of his appointment, the failure of some of the sources of funds upon which the growth of the bank was based led to severe financing difficulties at Tomato Bank. Shareholders voted to replace George Woof as CEO. They said he had been reckless in exposing the company to so much risk in growing the loan book without adequately covering it with reliable sources of funds. When he left, the press reported that despite his failure in the job, he would be leaving with what the newspapers referred to as an obscenely large pension. Some shareholders were angry and said that Mr Woof was being rewarded for failure. When Mr Woof was asked if he might voluntarily forego some of his pension in recognition of his failure in the job, he refused, saying that he was contractually entitled to it and so would be keeping it all. Required: (a) (b) (c) Criticise the performance of Tomato Bank s remuneration committee in agreeing Mr Woof s reward package. (10 marks) Describe the components of an appropriately designed executive reward package and explain why a more balanced package of benefits should have been used to reward Mr Woof. (10 marks) Construct an ethical case for Mr Woof to voluntarily accept a reduction in his pension value in recognition of his failure as chief executive of Tomato Bank. (5 marks) (25 marks) DeVry/Becker Educational Development Corp. All rights reserved.
11 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) Question 9 CORPORATE GOVERNANCE STANDARDS If there is a need for a uniform set of international accounting standards and international auditing standards, there is also a need for global corporate governance standards. Required: Discuss and reach a conclusion. Question 10 OBJECTIVES OF COMPANIES (15 marks) Discuss, and provide examples of, the types of non-financial, ethical and environmental issues that might influence the objectives of companies. Your answer should consider the impact of these non-financial, ethical and environmental issues on the achievement of primary financial objectives such as the maximisation of shareholder wealth. Question 11 PRINCIPLES OF CSR (15 marks) Today s corporations operate in an environment of intense media, investor, regulatory and public scrutiny. The financial scandals of recent years have created a significantly more constrained regulatory environment. At the same time, increasing public and stakeholder concern about the social and environmental impacts of business practices is forcing companies in many jurisdictions to come to terms with a much broader set of interests and expectations. (a) Explain why corporate social reporting (CSR) has become important. (7 marks) (b) Describe the main principles of corporate social reporting (CSR) that are necessary for a company to be socially responsible. (8 marks) Question 12 BATELEUR ZOO GARDENS (15 marks) The principal activity of Bateleur Zoo Gardens (BZG) is the conservation of animals. The zoo is registered as a charity, operating as a not-for-profit organisation. Approximately 80% of the zoo s income comes from admission fees, money spent in the food and retail outlets and animal sponsorship. The remainder comprises donations and investment income. Admission fees include day visitor entrance fees ( gate ) and annual membership fees. Day tickets may be pre-booked by credit card using a telephone booking hotline and via the zoo s website. Reduced fees are available (e.g. to students, senior citizens and families). Animal sponsorships, which last for one year, make a significant contribution to the cost of specialist diets, enclosure maintenance and veterinary care. Animal sponsors benefit from the advertisement of their names at the sponsored animal s enclosure DeVry/Becker Educational Development Corp. All rights reserved. 5
12 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Because of the declining economic situation within the country, the trustees requested the board to carry out a review of the control systems. Following the review, the board identified the following applicable risks that require further consideration and need to be actively managed: (i) (ii) (iii) (iv) (v) (vi) Reduction in admission income through failure to invest in new exhibits and breeding programs to attract visitors; Animal sponsorships may not be invoiced due to incomplete data transfer between the sponsoring and invoicing departments; Corporate sponsorships may not be charged for at approved rates either in error or due to arrangements with the companies. In particular, the sponsoring department may not notify the invoicing department of reciprocal arrangements, whereby sponsoring companies provide BZG with advertising (e.g. in company magazines and annual reports); Cash received at the entrance gate ticket offices ( kiosks ) may not be passed to cashiers in the accounts department (e.g. through theft); The ticket booking and issuing system may not be available; Donations of animals to the collection (e.g. from Customs and Excise seizures and rare breeds enthusiasts) may not be recorded. The trustees are also aware that whilst the board carried out the review, they (the trustees) need to fully understand that the board has a good grasp of how effective the control systems are. Required: (a) (b) Question 13 VCF Describe suitable internal controls to manage each of the applicable risks identified. (12 marks) Describe the areas of the control system the board should be assessing and the questions that the trustees can ask to assure themselves of the effectiveness of the control systems. (13 marks) (25 marks) VCF is a small listed company that designs and installs high technology computer numerical control capital equipment used by multinational manufacturing companies. VCF is located in one Pacific country, but almost 90% of its sales are exported. VCF has sales offices in Europe, Asia, the Pacific, Africa, and North and South America and employs about 300 staff around the world. VCF has annual sales of $200 million but the sales value of each piece of equipment sold is about $2 million so the sales volume is relatively low. Sales are always invoiced in the currency of the country where the equipment is being installed. The time between the order being taken and the final installation is usually several months. However, a deposit is taken when the order is placed and progress payments are made by the customer before shipment and upon delivery, with the final payment being made after installation of the equipment DeVry/Becker Educational Development Corp. All rights reserved.
13 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) The company has international patents covering its technology and invests heavily in research and development (R&D, about 15% of sales) and marketing costs to develop export markets (about 25% of sales). VCF s manufacturing operations are completely outsourced in its home country and the cost of sales is about 20%. The balance of costs is for installation, servicing and administration, amounting to about 15% of sales. Within each of these cost classifications the major expenses (other than direct costs) are salaries for staff, all of whom are paid well above the industry average, rental of premises in each location and travel costs. Area managers are located in each sales office and have responsibility for achieving sales, installing equipment and maintaining high levels of after-sales service and customer satisfaction. Although the head office is very small, most of the R&D staff are located in the home country, along with purchasing and logistics staff responsible for liaising with the outsource suppliers and a small accounting team that is primarily concerned with monthly management accounts and end of year financial statements. VCF has a majority shareholding held by Jack Viktor, an entrepreneur who admits to taking high risks, both personally and in business. The Board of four is effectively controlled by Viktor who is both Chairman and Chief Executive. The three other directors were appointed by Viktor. They are his wife, who has a marketing role in the business, and two non-executive directors, one an occasional consultant to VCF and the other a long-time family friend. Board meetings are held quarterly and are informal affairs, largely led by Viktor s verbal review of sales activity. Viktor is a dominating individual who exercises a high degree of personal control, often bypassing his area managers. Because the company is controlled by him, Viktor is not especially concerned with short-term profits but with the long term. He emphasises two objectives: sales growth to generate increased market share and cash flow; and investment in R&D to ensure the long-term survival of VCF by maintaining patent protection and a technological lead over its competitors. Viktor is in daily contact with all his offices by telephone. He travels extensively around the world and has an excellent knowledge of VCF s competitors and customers. He uses a limited number of nonfinancial performance measures, primarily concerned with sales, market share, quality and customer satisfaction. Through his personal contact and his twin objectives, Viktor encourages a culture committed to growth, continual innovation, and high levels of customer satisfaction. This is reinforced by high salary levels, but Viktor readily dismisses those staff not committed to his objectives. The company has experienced rapid growth over the last 10 years and is very profitable although cash flow is often tight. A high margin is achieved because VCF is able to charge its customers premium prices. The equipment sold by VCF enables faster production and better quality than its competitors can offer. Viktor has little time for traditional accounting. Product costing is not seen as valuable because the cost of sales is relatively low and most costs incurred by VCF, particular R&D and export marketing costs, are incurred a long time in advance of sales being made. R&D costs are not capitalised in VCF s statement of financial position. Although budgets are used for expense control and monthly management accounts are produced, they have little relevance to Viktor who recognises the fluctuations in profit caused by the timing of sales of low volume but high value capital equipment. Viktor sees little value in comparing monthly profit figures against budgets because sales are erratic. However, Viktor depends heavily on a spreadsheet to manage VCF s cash flow by using sensitivity analysis against his sales and cash flow projections. Cash flow is a major business driver and is controlled tightly using the spreadsheet model DeVry/Becker Educational Development Corp. All rights reserved. 7
14 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK The major risks facing VCF have been identified by Viktor as: competitor infringement of patents, which VCF always meets by instituting legal actions; adverse movements in the exchange rate between the home country and VCF s export markets, which VCF treats as an acceptable risk given that historically, gains and losses have balanced each other out; the reduction in demand for his equipment due to economic recession; a failure of continued R&D investment to maintain technological leadership; and a failure to control costs. Viktor considers that the last three of these risks are addressed by his policy of outsourcing manufacture and continuous personal contact with staff, customers and competitors. Required: (a) (b) Critically evaluate the internal controls within VCF (including those applied by Viktor). (20 marks) Write a report to the Board of VCF recommending improvements to the company s corporate governance, risk management strategy, and internal controls. (15 marks) (Including 2 professional marks) Question 14 INTERNAL AUDIT EFFECTIVENESS (35 marks) Internal audit has long been a part of good corporate governance. Today, a growing number of boards, audit committees and managements view the function as an important governance activity that offers significant benefits to the organisation. To achieve this potential, however, an internal audit must show superior levels of performance and effectiveness. Required: Explain what an internal audit function should do to be most effective as a key player in corporate governance. (15 marks) Question 15 FLIGHT INVESTMENT Arnie Row, managing director of Flight Investment (a private company) has contacted you, as his auditor, for advice regarding the establishment of an audit committee. The company operates a group of investment and property management companies with interests overseas and has a small internal audit department. Some companies are audited by other firms and some by other offices of your own firm. The board of Flight Investment comprises Arnie Row, the heads of three departments of the main activities undertaken by the group (property, investment and marketing) and a non-executive director (Arnie s brother-in-law, Dan Ackroyd) who rarely attends. Arnie himself is the driving force behind the business. When the idea of an audit committee was raised by an insurance company with a significant shareholding in Flight Investment, Arnie, with his usual enthusiasm, was keen that he should head the committee but was not too sure of its role. He wishes to keep his firm in line with current best corporate governance practice as it is his intention, at some stage in the future, to float the company. He has turned to you for guidance DeVry/Becker Educational Development Corp. All rights reserved.
15 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) Required: Draft for inclusion in a letter to Mr Row: (a) an explanation of the purposes of an audit committee; (8 marks) (b) suggestions for the composition of the committee; and (5 marks) (c) details of its responsibilities in relation to the internal and external auditors of Flight Investment and its subsidiaries. (12 marks) Question 16 REPORTING ON INTERNAL CONTROL SYSTEMS (25 marks) Many jurisdictions require listed companies to include a statement on their internal control systems in their annual reports and, in some cases, for their auditors to report on the procedures used. Required: Describe a comply or explain approach on reporting on internal control systems (e.g. the UK s Corporate Governance Code) as compared to a rules based approach (e.g. Sarbanes-Oxley). Question 17 FERRY CO Your firm has recently been approached by Ferry Co to carry out a business risk analysis. (20 marks) Three and a half years ago, Ferry purchased exclusive rights to operate a car and passenger ferry route for nine years. This offers an alternative to driving an additional 150 kilometres via the nearest bridge crossing. There have been several ambitious plans to build another crossing but they have failed through lack of public support and government funds. Ferry refurbished two 20-year-old roll on, roll off ( Ro-Ro ) boats to service the route. The boats do not yet meet the emission standards of Environmental Protection Regulations which come into force in 18 months time. Each boat makes three return crossings every day of the year, subject to weather conditions, and has the capacity to carry approximately 250 passengers and 40 vehicles. The ferry service carried just 70,000 vehicles over the last 12 months (prior year: 58,000 and 47,000 two years ago). Hot and cold refreshments and travel booking facilities are offered on the one hour crossing. These services are provided by independent businesses on a franchise basis. Ferry currently receives a subsidy from the local transport authority as an incentive to increase market awareness of the ferry service and its efficient and timely operation. The subsidy increases as the number of vehicles carried increases and is based on quarterly returns submitted to the authority. Ferry employs 20 full-time crew members who are trained in daily operations and customer-service, as well as passenger safety in the event of personal accident, collision or breakdown. The management of Ferry is planning to apply for a recognised Safety Management Certificate (SMC) in 12 months time. This will require a ship audit including the review of safety documents and evidence that activities are performed in accordance with documented procedures. A SMC valid for five years will be issued if no major non-conformities have been found DeVry/Becker Educational Development Corp. All rights reserved. 9
16 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Required: (a) (b) Identify and explain the business risks facing Ferry Co which should be assessed. (10 marks) Describe the processes by which the risks identified in (a) could be managed and maintained at an acceptable level by Ferry Co. (10 marks) Question 18 SOUTHERN CONTINENTS COMPANY (20 marks) The risk committee at Southern Continents Company (SCC) met to discuss a report by its risk manager, Stephanie Field. The report focused on a number of risks that applied to a chemicals factory recently acquired by SCC in another country, Southland. She explained that the new risks related to the security of the factory in Southland in respect of burglary, to the supply of one of the key raw materials that experienced fluctuations in world supply and also an environmental risk. The environmental risk, Stephanie explained, was to do with the possibility of poisonous emissions from the Southland factory. The SCC chief executive, Choo Wang, who chaired the risk committee, said that the Southland factory was important to him for two reasons. First, he said it was strategically important to the company. Second, it was important because his own bonuses depended upon it. He said that because he had personally negotiated the purchase of the Southland factory, the remunerations committee had included a performance bonus on his salary based on the success of the Southland investment. He told Stephanie that a performance-related bonus was payable when and if the factory achieved a certain level of output that Choo considered to be ambitious. I don t get any bonus at all until we reach a high level of output from the factory, he said. So I don t care what the risks are, we will have to manage them. Stephanie explained that one of her main concerns arose because the employees at the factory in Southland were not aware of the importance of risk management to SCC. She said that the former owner of the factory paid less attention to risk issues and so the staff were not as aware of risk as Stephanie would like them to be. I would like to get risk awareness embedded in the culture at the Southland factory, she said. Choo Wang said that he knew from Stephanie s report what the risks were, but that he wanted somebody to explain to him what strategies SCC could use to manage the risks. Required: (a) (b) (c) Describe four strategies that can be used to manage risk and identify, with reasons, an appropriate strategy for each of the three risks mentioned in the case. (12 marks) Explain the meaning of Stephanie s comment: I would like to get risk awareness embedded in the culture at the Southland factory. (5 marks) Explain the benefits of performance-related pay in rewarding directors and critically evaluate the implications of the package offered to Choo Wang. (8 marks) (25 marks) DeVry/Becker Educational Development Corp. All rights reserved.
17 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) Question 19 H&Z COMPANY John Pentanol was appointed as risk manager at H&Z Company a year ago and he decided that his first task was to examine the risks that faced the company. He concluded that the company faced three major risks, which he assessed by examining the impact that would occur if the risk were to materialise. He assessed Risk 1 as being of low potential impact as even if it materialised it would have little effect on the company s strategy. Risk 2 was assessed as being of medium potential impact whilst a third risk, Risk 3, was assessed as being of very high potential impact. When John realised the potential impact of Risk 3 materialising, he issued urgent advice to the board to withdraw from the activity that gave rise to Risk 3 being incurred. In the advice he said that the impact of Risk 3 was potentially enormous and it would be irresponsible for H&Z to continue to bear that risk. The company commercial director, Jane Xylene, said that John Pentanol and his job at H&Z were unnecessary and that risk management was very expensive for the benefits achieved. She said that all risk managers do is to tell people what can t be done and that they are pessimists by nature. She said she wanted to see entrepreneurial risk takers in H&Z and not risk managers who, she believed, tended to discourage enterprise. John replied that it was his job to eliminate all of the highest risks at H&Z Company. He said that all risk was bad and needed to be eliminated if possible. If it couldn t be eliminated, he said that it should be minimised. (a) (b) (c) The risk manager has an important role to play in an organisation s risk management. Required: (i) Describe the roles of a risk manager. (4 marks) (ii) Assess John Pentanol s understanding of his role. (4 marks) With reference to a risk assessment framework as appropriate, criticise John s advice that H&Z should withdraw from the activity that incurs Risk 3. (6 marks) Jane Xylene expressed a particular view about the value of risk management in H&Z Company. She also said that she wanted to see entrepreneurial risk takers. Required: (i) Define entrepreneurial risk and explain why it is important to accept entrepreneurial risk in business organisations; (4 marks) (ii) Critically evaluate Jane Xylene s view of risk management. (7 marks) Question 20 ETHICAL THEORIES (25 marks) Boris is struggling with his conscience. He is a senior accountant responsible for providing management information to several major budget holders in his organisation. He has developed a very good working relationship with this group of senior managers over the years and has a good understanding of their departments and the issues they face. One of these budget holders, Chris, has raised a problem about a capital project that is overrunning its approved budget. He has asked Boris to turn a blind eye to future costs, which he is going to charge to other codes, concealing the adverse variance DeVry/Becker Educational Development Corp. All rights reserved. 11
18 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Required: (a) Explain the ethical dilemma faced by Boris. (5 marks) (b) Provide an outline of the ethical theories (deontological and teleological) and ethical approaches (virtues, justice and rights-based) that help managers make ethical decisions and for each theory or approach give an example of its application in the public services. (10 marks) (15 marks) Question 21 ETHICAL MANAGEMENT The ultimate test of management is achievement and business performance (Peter Drucker). But how does this relate to ethical management, particularly when the manager is within the public sector? Required: (a) Explain the importance of ethical management within public services and provide an example of an ethical issue that would be a cause. (7 marks) (b) One of the principles of public life is accountability. Required: Outline ways in which employed professional accountants are accountable and give THREE examples of the difficulties they may face when demonstrating accountability. (8 marks) (15 marks) Question 22 RESPONSIBILITY TO BE ETHICAL Ultimately, the responsibility to be ethical resides in the individual. Required: (a) Give arguments in support of this assertion. (5 marks) (b) Outline the approaches that may be used by organisations to standardise ethical behaviour. (5 marks) (10 marks) Question 23 ETHICAL DILEMMAS At a recent public sector conference, one speaker (Professor Garcia) argued that emerging management concepts in the public sector are changing organisational. He claimed: Decentralisation, increased administrative discretion, a decrease in bureaucracy, flatter structures and empowered individuals and increased partnerships with the private sector are not only increasing risk innovation but the drive for economy and efficiency is putting profit before ethics. When quizzed from the audience to elaborate on his views he suggested that hospitals being told to delay treatments and soldiers being issued with defective equipment were just two examples of the arising. ethical dilemmas DeVry/Becker Educational Development Corp. All rights reserved.
19 STUDY QUESTION BANK GOVERNANCE, RISK AND ETHICS (P1) Answer 1 CORPORATE GOVERNANCE (a) (b) Corporate governance Tutorial note: Just giving one definition is not going to earn 5 marks. Notice how the answer starts by describing the fundamental task of governance and then moves onto example definitions and descriptions of how this fundamental task can be achieved. A fundamental task of governance (board of directors and executive committee) is to ensure a company s long-term survival by efficiently producing and marketing goods and services that are genuinely useful to people and create added value. This will be of benefit not only to the company s shareholders but also management, employees, suppliers, customers, government (tax collection) and the local community. Top management must map out the company s future and ensure that daily decisions and actions steer it in the right direction. Good corporate governance can be said to consist mainly of ensuring that the company fulfils its responsibilities. The Organisation for Economic Cooperation and Development (OECD) defines corporate governance as: The system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance. More simply, Solomon describes corporate governance as the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all stakeholders and act in a socially responsible way in all areas of their business activity. Even shorter and more succinct is the definition provided by Monks and Minow It is the relationship among various participants in determining the direction and performance of corporations. Elements for best practice Tutorial note: You do not need to know every single code a detailed understanding of the UK Corporate Governance Code will be sufficient. But it is important to appreciate the threads that run through all of the various codes. When considering most UK corporate governance codes (e.g. OECD, UK Corporate Governance Code, Singapore Code) there are a number of common themes that run throughout the codes. These themes include: A framework through which strategic, tactical and operational objectives are set (taking into account both internal and external influences) and performance is optimised. Strong internal control and risk management procedures. Corporate strategies set and executed in an ethical and effective way. Fairness, transparency, independence, integrity and accountability are essential to ensure market confidence and attract appropriate investment DeVry/Becker Educational Development Corp. All rights reserved. 1001
20 GOVERNANCE, RISK AND ETHICS (P1) STUDY QUESTION BANK Application of substance over form. Governance is top down driven and pervasive throughout the organisation. (c) No longer inward looking and no longer purely about money. Sustainable development and sustainability reporting had been evolving parallel to governance during the 1990s and both are now intrinsically linked. Underpinning concepts Governing bodies - and the board of directors in particular - must be guided by certain core principles, underpinning concepts, without which they are unlikely to add value or contribute to the fulfilment of their company s mission. Fairness The systems and values in the company must be balanced by considering all those that have an interest in the company and its future. There should be equality and evenhandedness in the directors deliberations with the ability to reach an equitable judgement in a given ethical situation. The rights of various groups (stakeholders) have to be acknowledged and respected. For example, minority shareowner interests must receive equal consideration to those of the dominant shareowner(s). Openness/transparency The ease with which stakeholders are able to make meaningful analysis of a company s actions, its economic fundamentals and the non-financial aspects pertinent to that business. Reflects whether or not investors and other stakeholders obtain a true picture of what is happening inside the company. Strong controls and systems have to be in place to be able to capture, analyse and present reliable information on a timely basis to facilitate the appropriate level of openness and transparency Often used as a measure of how good management is at making necessary information available in a candid, accurate and timely manner not only the statutory and listing disclosures required in financial statements, but also general reports (e.g. to financial institutions), press releases, sustainability reports, general corporate social responsibility (CSR) reporting and other voluntary information. Includes management developing, at all levels, the appropriate culture in the company. Independence The extent to which mechanisms have been put in place to minimise, or avoid, potential conflicts of interest that may exist. Examples include: separation of the roles of chief executive officer (CEO) and chairman of the board; independent non-executive directors (NEDs) to represent the interest of the shareholders and other stakeholders; independent NEDs balance on appointment and remuneration committees to counter potential abuse by executive directors; use of internal and external auditors reporting to audit committees ; and audit committees and limitation of non-audit work. The decisions made and internal processes established should be objective and not allow for undue influences or overt personal motivation to prevail. That is, the company should be run for the benefit of all stakeholders (shareholders being a primary grouping) DeVry/Becker Educational Development Corp. All rights reserved.
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Volume 9 No. 1 The real value of corporate governance (c) Copyright 2007, The University of Auckland. Permission to make digital or hard copies of all or part of this work for personal or classroom use