Section A This ONE question is compulsory and MUST be attempted 1 The scientists in the research laboratories of Swan Hill

Company (SHC, a public listed company) recently made a very important discovery about the process that manufactured its major product. The scientific director, Dr Sonja Rainbow, informed the board that the breakthrough was called the sink method . She explained that the sink method would enable SHC to produce its major product at a lower unit cost and in much higher volumes than the current process. It would also produce lower unit environmental emissions and would substantially improve product quality compared to its current process and indeed compared to all of the other competitors in the industry. SHC currently has 30% of the global market with its nearest competitor having 25% and the other twelve producers sharing the remainder. The company, based in the town of Swan Hill, has a paternalistic management approach and has always valued its relationship with the local community. Its website says that SHC has always sought to maximize the benefit to the workforce and community in all of its business decisions and feels a great sense of loyalty to the Swan Hill locality which is where it started in 1900 and has been based ever since. As the board considered the implications of the discovery of the sink method, chief executive Nelson Cobar asked whether Sonja Rainbow was certain that SHC was the only company in the industry that had made the discovery and she said that she was. She also said that she was certain that the competitors were some years behind SHC in their research. It quickly became clear that the discovery of the sink method was so important and far reaching that it had the potential to give SHC an unassailable competitive advantage in its industry. Chief executive Nelson Cobar told board colleagues that they should clearly understand that the discovery had the potential to put all of SHC s competitors out of business and make SHC the single global supplier. He said that as the board considered the options, members should bear in mind the seriousness of the implications upon the rest of the industry. Mr. Cobar said there were two strategic options. Option one was to press ahead with the huge investment of new plant necessary to introduce the sink method into the factory whilst, as far as possible, keeping the nature of the sink technology secret from competitors (the secrecy option ). A patent disclosing the nature of the technology would not be filed so as to keep the technology secret within SHC. Option two was to file a patent and then offer the use of the discovery to competitors under a licensing arrangement where SHC would receive substantial royalties for the twenty-year legal lifetime of the patent (the licensing option ). This would also involve new investment but at a slower pace in line with competitors. The license contract would, Mr. Cobar explained, include an improvement sharing requirement where licensees would be required to inform SHC of any improvements discovered that made the sink method more efficient or effective. The sales director, Edwin Kiama, argued strongly in favour of the secrecy option. He said that the board owed it to SHC s shareholders to take the option that would maximise shareholder value. He argued that business strategy was all about gaining competitive advantage and this was a chance to do exactly that. Accordingly, he argued, the sink method should not be licensed to competitors and should be pursued as fast as possible. The operations director said that to gain the full benefits of the sink method with either option would require a complete refitting of the factory and the largest capital investment that SHC had ever undertaken. The financial director, Sean Nyngan, advised the board that pressing ahead with investment under the secrecy option was not without risks. First, he said, he would have to finance the investment, probably initially through

debt, and second, there were risks associated with any large investment. He also informed the board that the licensing option would, over many years, involve the inflow of massive funds in royalty payments from competitors using the SHC s patented sink method. By pursuing the licensing option, Sean Nyngan said that they could retain their market leadership in the short term without incurring risk, whilst increasing their industry dominance in the future through careful investment of the royalty payments. The non-executive chairman, Alison Manilla, said that she was looking at the issue from an ethical perspective. She asked whether SHC had the right, even if it had the ability, to put competitors out of business. Required: (a) Assess the secrecy option using Tucker s model for decision-making. (10 marks) (b) Distinguish between strategic and operational risks, and explain why the secrecy option would be a source of strategic risk. (10 marks) (c) Mr. Cobar, the chief executive of SHC, has decided to draft two alternative statements to explain both possible outcomes of the secrecy/licensing decision to shareholders. Once the board has decided which one to pursue, the relevant draft will be included in a voluntary section of the next corporate annual report. Required: (i) Draft a statement in the event that the board chooses the secrecy option. It should make a convincing business case and put forward ethical arguments for the secrecy option. The ethical arguments should be made from the stockholder (or pristine capitalist) perspective. (8 marks) (ii) Draft a statement in the event that the board chooses the licensing option. It should make a convincing business case and put forward ethical arguments for the licensing option. The ethical arguments should be made from the wider stakeholder perspective. (8 marks) (iii) Professional marks for the persuasiveness and logical flow of arguments: two marks per statement. (4 marks) (d) Corporate annual reports contain both mandatory and voluntary disclosures. Required: (i) Distinguish, using examples, between mandatory and voluntary disclosures in the annual reports of public listed companies. (6 marks) (ii) Explain why the disclosure of voluntary information in annual reports can enhance the company s accountability to equity investors. (4 marks) (50 marks)

Section B TWO questions ONLY to be attempted 2 Happy and healthy is a traditional independent health food business that has been run as a family company for 40 years by Ken and Stef Potter. As a couple they have always been passionate campaigners for healthy foods and are more concerned about the quality of the foods they sell than the nancial detail of their business. Since the company started in 1970, it has been audited by Watson Shreeves, a local audit rm. Mr. Shreeves has overseen the Potters audit for all of the 40 year history (rotating the engagement partner) and has always taken the opportunity to meet with Ken and Stef informally at the end of each audit to sign off the nancial statements and to offer a brie ng and some free nancial advice in his role as what he calls, auditor and friend . In these brie ngs, Mr. Shreeves, who has become a close family friend of the Potters over the years, always points out that the business is pro table (which the Potters already knew without knowing the actual gures) and how they might increase their margins. But the Potters have never been too concerned about nancial performance as long as they can provide a good service to their customers, make enough to keep the business going and provide continued employment for themselves and their son, Ivan. Whilst Ken and Stef still retain a majority shareholding in Happy and healthy they have gradually increased Ivan s proportion over the years. They currently own 60% to Ivan s 40%. Ivan was appointed a director, alongside Ken and Stef , in 2008. Ivan grew up in the business and has helped his parents out since he was a young boy. As he grew up, Ken and Stef gave him more and more responsibility in the hope that he would one day take the business over. By the end of 2009, Ken made sure that Ivan drew more salary than Ken and Stef combined as they sought to ensure that Ivan was happy to continue in the business after they retired. During the audit for the year ended 31 March 2010, a member of Watson Shreeves was performing the audit as usual when he noticed a dramatic drop in the pro tability of the business as a whole. He noticed that whilst food sales continued to be pro table, a large amount of inventory had been sold below cost to Barong Company with no further rexplanation and it was this that had caused the reduction in the company s operating margin. Each transaction with Barong Company had, the invoices showed, been authorised by Ivan. Mr. Shreeves was certain Ken and Stef would not know anything about this and he prepared to tell them about it as a part of his annual end of audit meeting. Before the meeting, however, he carried out some checks on Barong Company and found that it was a separate business owned by Ivan and his wife. Mr. Shreeves s conclusion was that Ivan was effectively stealing from Happy and healthy to provide inventory for Barong Company at a highly discounted cost price. Although Mr. Shreeves now had to recommend certain disclosures to the nancial statements in this meeting, his main fear was that Ken and Stef would be devastated if they found out that Ivan was stealing and that it would have long-term implications for their family relationships and the future of Happy and healthy . Required: (a) Explain how a family (or insider-dominated) business differs from a public listed company and, using evidence from the case, explore the governance issues of a family or insider-dominated business. (10 marks) (b) Mr. Shreeves is a professional accountant and auditor. Explain why he is considered a professional by society and describe the fundamental principles (or responsibilities) of professionalism that society expects from him and all other accountants. (7 marks) (c) Discuss the professional and ethical dilemma facing Mr. Shreeves in deciding whether or not to tell Ken and Stef about Ivan s activity. Advise Mr. Shreeves of the most appropriate course of action. (8 marks)

3In a recent case, it emerged that Frank Finn, a sales director at ABC Co, had been awarded a substantial overinflation annual basic pay award with no apparent link to performance. When a major institutional shareholder, Swanland Investments, looked into the issue, it emerged that Mr. Finn had a cross directorship with Joe Ng, an executive director of DEF Co. Mr. Ng was a non-executive director of ABC and chairman of its remunerations committee. Swanland Investments argued at the annual general meeting that there was a problem with the independence of Mr. Ng and further, that Mr. Finn s remuneration package as a sales director was considered to be poorly aligned to Swanland s interests because it was too much weighted by basic pay and contained inadequate levels of incentive. Swanland Investments proposed that the composition of Mr. Finn s remuneration package be reconsidered by the remunerations committee and that Mr. Ng should not be present during the discussion. Another of the larger institutional shareholders, Hanoi House, objected to this, proposing instead that Mr. Ng and Mr. Finn both resign from their respective non-executive directorships as there was clear evidence of malpractice . Swanland considered this too radical a step, as Mr. Ng s input was, in its opinion, valuable on ABC s board. Required: (a) Explain FOUR roles of a remunerations committee and how the cross directorship undermines these roles at ABC Co. (12 marks) (b) Swanland Investments believed Mr. Finn s remunerations package to be poorly aligned to its interests. With reference to the different components of a director s remunerations package, explain how Mr. Finn s remuneration might be more aligned to shareholders interests at ABC Co. (8 marks) (c) Evaluate the proposal from Hanoi House that both Mr. Ng and Mr. Finn be required to resign from their respective non-executive positions. (5 marks) (25 marks)

4Mary Hobbes joined the board of Rosh and Company, a large retailer, as finance director earlier this year. Whilst she was glad to have finally been given the chance to become finance director after several years as a financial accountant, she also quickly realised that the new appointment would offer her a lot of challenges. In the first board meeting, she realised that not only was she the only woman but she was also the youngest by many years. Rosh was established almost 100 years ago. Members of the Rosh family have occupied senior board positions since the outset and even after the company s flotation 20 years ago a member of the Rosh family has either been executive chairman or chief executive. The current longstanding chairman, Timothy Rosh, has already prepared his slightly younger brother, Geoffrey (also a longstanding member of the board) to succeed him in two years time when he plans to retire. The Rosh family, who still own 40% of the shares, consider it their right to occupy the most senior positions in the company so have never been very active in external recruitment. They only appointed Mary because they felt they needed a qualified accountant on the board to deal with changes in international financial reporting standards. Several former executive members have been recruited as non-executives immediately after they retired from fulltime service. A recent death, however, has reduced the number of non-executive directors to two. These sit alongside an executive board of seven that, apart from Mary, have all been in post for over ten years. Mary noted that board meetings very rarely contain any significant discussion of strategy and never involve any debate or disagreement. When she asked why this was, she was told that the directors had all known each other for so long that they knew how each other thought. All of the other directors came from similar backgrounds, she was told, and had worked for the company for so long that they all knew what was best for the company in any given situation. Mary observed that notes on strategy were not presented at board meetings and she asked Timothy Rosh whether the existing board was fully equipped to formulate strategy in the changing world of retailing. She did not receive a reply. Required: (a) Explain agency in the context of corporate governance and criticise the governance arrangements of Rosh and Company. (12 marks) (b) Explain the roles of a nominations committee and assess the potential usefulness of a nominations committee to the board of Rosh and Company. (8 marks) (c) Define retirement by rotation and explain its importance in the context of Rosh and Company. (5 marks) (25 marks)