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December 2014–June 2015 Edition
STUDY QUESTION BANK
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ACCA
Paper P1 | GOVERNANCE, RISK AND ETHICS
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ACCA
PAPER P1
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GOVERNANCE, RISK AND ETHICS
STUDY QUESTION BANK
For Examinations to June 2015
®
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This training material has been prepared and published by Becker Professional Development
International Limited:
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Acknowledgement
Past ACCA examination questions are the copyright of the Association of Chartered Certified
Accountants and have been reproduced by kind permission.
(ii)
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
CONTENTS
Question
Page
Answer Marks
Date worked
SCOPE OF GOVERNANCE
1
2
Corporate Governance
Public Service
1
1
1001
1004
25
15
1
2
1007
1009
20
20
AGENCY RELATIONSHIPS AND THEORIES
Agents and Objectives
Stakeholder Theory
BOARD OF DIRECTORS
5
6
Alliya Yongvanich (ACCA D07)
TQ Company (ACCA J09)
2
2
1011
1014
25
25
3
4
1016
1018
15
25
Corporate Governance Standards (ACCA D02)*5
1020
15
5
5
1023
1025
15
15
5
6
1026
1029
25
35
8
8
1037
1039
15
25
9
1043
20
9
10
11
1045
1048
1050
20
25
25
11
12
1052
1054
15
15
BOARD COMMITTEES
7
8
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3
4
Nominations Committee
Tomato Bank (ACCA J10)
APPROACHES TO CORPORATE GOVERNANCE
9
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CORPORATE SOCIAL RESPONSIBILITY
10
11
Objectives of Companies (ACCA D03)*
Principles of CSR
MANAGEMENT CONTROL SYSTEMS
12
13
Bateleur Zoo Gardens (ACCA J04)*
VCF
INTERNAL AUDIT AND COMPLIANCE
14
15
Internal Audit Effectiveness
Flight Investments
REPORTING ON INTERNAL CONTROL
16
Reporting on Internal Control Systems
IDENTIFYING, ASSESSING AND CONTROLLING RISK
17
18
19
Ferry (ACCA J03)*
Southern Continents Company (ACCA D07)
H&Z Company (ACCA J09)
ETHICAL THEORIES
20
21
Ethical Theories
Ethical Management
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
(iii)
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Question
Page
Answer Marks
Date worked
ETHICS AND SOCIAL RESPONSIBILITY
22
23
24
Responsibility to be Ethical
Ethical Dilemmas
Prominent Football Club (ACCA D07)
12
12
13
1056
1057
1058
10
10
25
13
1060
20
PROFESSIONS AND THE PUBLIC INTEREST
25
Boleyn & Co
26
27
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PROFESSIONAL PRACTICE AND CODES OF ETHICS
Steering Committee
CFO
14
14
1063
1064
12
20
15
1066
25
16
16
1068
1071
25
10
16
18
21
1072
1076
1082
50
50
50
Corporate governance guidelines (ACCA D02) 23
Kellog
24
Environmental issues
24
Professors West & Leroi (ACCA J08)
24
Ann Koo (ACCA J11)
25
1087
1091
1094
1098
1100
30
25
25
25
25
CONFLICTS OF INTEREST AND UNETHICAL BEHAVIOUR
28
Van Buren Co (ACCA J08)
INTEGRATED REPORTING AND SUSTAINABILITY
29
30
PAIB
Unsustainable Behaviour
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CASE STUDIES
31
32
33
Worldwide Minerals (ACCA D07)
Hesket Nuclear (ACCA J10)
ZPT (ACCA D10)
FURTHER PRACTICE QUESTIONS
34
35
36
37
38
* 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.
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)
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(25 marks)
Question 2 PUBLIC SERVICES
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:
Describe the basic features of an organisation within the public service as compared to a
corporate body.
(5 marks)
(b)
Describe how the concepts of corporate governance can be applied to organisations
other than corporate bodies.
(10 marks)
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(a)
(15 marks)
Question 3 AGENTS AND OBJECTIVES
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.
(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.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. (6 marks)
(6 marks)
(20 marks)
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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:
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)
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(a)
(20 marks)
Question 5 ALLIYA YONGVANICH
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”.
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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)
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)
(c)
Critically evaluate Vincent Viola’s view that corporate governance provisions should
vary by country.
(8 marks)
(25 marks)
Question 6 TQ COMPANY
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.
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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.
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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)
Miss Hoiku stated that it was difficult to remove a serving chief executive from office.
Required:
Explain the ways in which a company director can leave the service of a board.
(4 marks)
(ii)
Discuss Miss Hoiku’s statement that it is difficult to remove a serving chief
executive from a board.
(4 marks)
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(i)
(b)
Assess, in the context of the case, the importance of the chairman’s statement to
shareholders in TQ Company’s annual report.
(5 marks)
(c)
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)
(25 marks)
Question 7 NOMINATION COMMITTEE
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)
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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.
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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.
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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)
Criticise the performance of Tomato Bank’s remuneration committee in agreeing Mr
Woof’s reward package.
(10 marks)
(b)
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)
(c)
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)
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©2014 DeVry/Becker Educational Development Corp. All rights reserved.
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.
(15 marks)
Question 10 OBJECTIVES OF COMPANIES
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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.
(15 marks)
Question 11 PRINCIPLES OF CSR
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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)
(15 marks)
Question 12 BATELEUR ZOO GARDENS
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.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 5
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:
Reduction in admission income through failure to invest in new exhibits and breeding
programs to attract visitors;
(ii)
Animal sponsorships may not be invoiced due to incomplete data transfer between the
sponsoring and invoicing departments;
(iii)
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);
(iv)
Cash received at the entrance gate ticket offices (“kiosks”) may not be passed to cashiers in
the accounts department (e.g. through theft);
(v)
The ticket booking and issuing system may not be available;
(vi)
Donations of animals to the collection (e.g. from Customs and Excise seizures and rare breeds
enthusiasts) may not be recorded.
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(i)
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:
Describe suitable internal controls to manage each of the applicable risks identified.
(12 marks)
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(a)
(b)
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)
Question 13 VCF
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.
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©2014 DeVry/Becker Educational Development Corp. All rights reserved.
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.
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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.
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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.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 7
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.
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
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)
Critically evaluate the internal controls within VCF (including those applied by Viktor).
(20 marks)
(b)
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)
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(35 marks)
Question 14 INTERNAL AUDIT EFFECTIVENESS
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.
8
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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)
(25 marks)
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Question 16 REPORTING ON INTERNAL CONTROL SYSTEMS
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).
(20 marks)
Question 17 FERRY CO
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Your firm has recently been approached by Ferry Co to carry out a business risk analysis.
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.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 9
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Required:
(a)
Identify and explain the business risks facing Ferry Co which should be assessed.
(10 marks)
(b)
Describe the processes by which the risks identified in (a) could be managed and
maintained at an acceptable level by Ferry Co.
(10 marks)
(20 marks)
Question 18 SOUTHERN CONTINENTS COMPANY
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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.
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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)
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)
(b)
Explain the meaning of Stephanie’s comment: “I would like to get risk awareness
embedded in the culture at the Southland factory.”
(5 marks)
(c)
Explain the benefits of performance-related pay in rewarding directors and critically
evaluate the implications of the package offered to Choo Wang.
(8 marks)
10
(25 marks)
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
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.
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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)
The risk manager has an important role to play in an organisation’s risk management.
Required:
Describe the roles of a risk manager.
(4 marks)
(ii)
Assess John Pentanol’s understanding of his role.
(4 marks)
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(i)
(b)
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)
(c)
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)
(25 marks)
Question 20 ETHICAL THEORIES
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.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 11
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
Required:
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“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?
(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:
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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
ethical dilemmas arising.
12
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Answer 1 CORPORATE GOVERNANCE
(a)
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.
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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”.
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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”.
(b)
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.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1001
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
(c)

Application of substance over form.

Governance is top down driven and pervasive throughout the organisation.

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
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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.
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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).
1002
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Probity and honesty – This is fundamental to corporate governance systems (regardless of
their origin) involving integrity, honour, virtue and fair dealing.
It implies not misleading stakeholders (e.g. shareholders, the market, employees). At a higher
level, the CEO provides all appropriate information to fellow executive directors and NEDs.
Responsibility – Pertains to behaviour that allows for corrective action and for penalising
mismanagement. It is a willingness by management to accept liability for the outcome of
governance decisions.
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Responsible management would, when necessary, put in place what it would take to set the
company on the right path no matter how painful this may be (e.g. dismissing an
underperforming CEO) or against their own interests (e.g. the CEO realising that it is time for
them to go).
Whilst the board is ultimately accountable to the company shareholders, recent corporate
governance development means that it must act responsively to, and with responsibility
towards, all stakeholders of the company.
With regard to shareholders, it is argued that they have responsibilities as owners. That is to
use the available mechanisms (e.g. annual general meetings and voting) to query and assess
the actions of management.
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Accountability – Individuals or groups in a company, who make decisions and take actions
on specific issues, need to be accountable for their decisions and actions. Mechanisms must
exist and be effective to allow for accountability. These provide investors with the means to
query and assess the actions of the board and its committees.
But accountability is a two way process – directors must provide the necessary information
(e.g. through annual financial statements) and opportunities to shareholders (e.g. annual
general meeting or specific meetings with institutional investors) to be able to hold the
directors accountable for their actions. As discussed above, shareholders have responsibilities
as owners.
Judgement – Entities operate in a complex and diverse range of events, activities and
environments. Achieving objectives requires a series of decisions to be made based on a solid
and sound judgement of the relevant information and environments the entity operates in. An
entity’s management must be able to consider numerous issues and interrelationships, give
each due consideration, reach meaningful conclusions (that will enhance the prosperity of the
entity) and communicate/enact such conclusions.
This implies managers have a thorough understanding of the entity, its operations, business
environment and risks/opportunities as well as the necessary and appropriate skills to
maximise benefits and minimise risks.
Integrity – Under the ACCA Code of Ethics and Conduct, integrity requires that “in all
professional, business, personal and financial relationships, members should be
straightforward and honest. This implies honesty, fair dealing and truthfulness. Members
should not be associated with (e.g. sign off) reports, returns, communications or other
information where they believe that the information:



contains materially false or misleading statements;
contains statements or information furnished recklessly; or
omits or obscures information required to be included where such omission or obscurity
would be misleading.”
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1003
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
This understanding of the concept of integrity is fundamental for strong corporate
governance. The perceived integrity of the entity (e.g. as a corporate body), the integrity of
the actions taken by the management and employees of the entity, the integrity of its external
and internal reports and information cannot be greater than the integrity of those involved.
Individual integrity describes a person of high moral value – an individual who observes a
steadfast adherence to a strict moral code or ethical code notwithstanding other pressures on
them to act otherwise. The virtue of the individual rather than the ethics of the action is
emphasised – integrity provides the necessary ethical framework.
As in many situations in life, in corporate governance trust is vital. Integrity underpins this.
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Reputation – Although reputation has a personal and entity aspect, an entity’s reputation
depends heavily on the reputation of its managers and employees – an entity’s reputation is
effectively the cumulative result of all of the other underpinning concepts of good corporate
governance.
Reputation risk is a business risk that many entities now consider to be the greatest risk to
their market standing. Evidence suggests that reputation carries an appropriate market
capitalisation premium (good reputation) or discount (bad or declining reputation) for listed
Answer 2 PUBLIC SERVICE
(a)
Corporate comparison
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Public service entities (e.g. health services, transport, libraries, schools) are owned by national
or local governments and councils. They do not have shareholders.
Depending on their structure and constitution, they may be governed by a board of appointed
directors, trustees or governors (e.g. health service, schools), publically elected officials (e.g.
local city hall mayor) or directly by a government minister.
Ultimately all public services are accountable to the public, directly or indirectly. Ultimately,
national and local government are accountable to the general public, who may pass judgement
through their vote.
As with companies, public service entities require an executive that shows appropriate
leadership and management to be recruited – not only representative of the service they
provide, but also from diverse backgrounds to broaden the “gene pool” and represent the
community. They also need to balance the need for stability against the need to keep fresh
and up to date
Although it is not common for public services to publish general public financial statements,
those that have a direct link to the public (e.g. local councils) often do produce independently
audit statements of income and expenditure, but not in the detail as required of listed
companies.
Many of the larger public services (e.g. local councils) have internal audit departments
carrying out similar roles to listed company internal auditors. They do not, however, report to
an audit committee as it is not common for corporate governance style committees to exist in
public services.
1004
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
In the UK (and other countries) government expenditure is very closely scrutinised through
various committees of Members of Parliament and a full time “internal audit” department, the
Audit Commission. Ministers may be called upon to explain to Parliament certain elements
of the expenditure of their departments. A similar system operates at the local administration
level.
In addition many public services have established independent procedures whereby
employees and members of the public may make official complaints concerning the service’s
activities and procedures (similar to the whistle blowing procedures in various UK corporate
governance codes).
(b)
Public service governance
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Because of the significant range and objectives of public services, taking one set of basic rules
and applying them to all situations is neither practical nor possible.
Several organisations publish guidelines and principles to be applied by public service
entities, examples include the Committee on Standards in Public Life (Nolan Principles) and
the Independent Commission for Good Governance in Public Services.
Tutorial note: Describing either of these guidelines will be sufficient to obtain the marks
allocated. Both would not be required.
Nolan Principles
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The Nolan Principles consist of seven principles, very similar to those in the UK Corporate
Governance Code:
Selflessness – holders of public office should act solely in terms of the public interest. They
should not do so in order to gain financial or other material benefits for themselves, their
family, or their friends.
Integrity – holders of public office should not place themselves under any financial or other
obligation to outside individuals or organisations that might seek to influence them in the
performance of their official duties.
Objectivity – in carrying out public business, including making public appointments,
awarding contracts, or recommending individuals for rewards and benefits, holders of public
office should make choices on merit.
Accountability – holders of public office are accountable for their decisions and actions to
the public and must submit themselves to whatever scrutiny is appropriate to their office.
Openness – holders of public office should be as open as possible about all the decisions and
actions that they take. They should give reasons for their decisions and restrict information
only when the wider public interest clearly demands.
Honesty – holders of public office have a duty to declare any private interests relating to their
public duties and to take steps to resolve any conflicts arising in a way that protects the public
interest.
Leadership – holders of public office should promote and support these principles by
leadership and example.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1005
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Independent Commission for Good Governance in Public Services
The Independent Commission for Good Governance in Public Services (Office for Public
Management (OPM) and the Chartered Institute of Public Finance and Accountancy
(CIPFA)) identified six principles of good governance in the public service.
Focusing on the organisation’s purpose and on outcomes for citizens and service users:
Being clear about the organisation’s purpose and its intended outcomes for citizens
and service users;

Making sure that users receive a high quality service;

Making sure that taxpayers receive value for money.
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
Performing effectively in clearly defined functions and roles:

Being clear about the functions of the governing body;

Being clear about the responsibilities of NEDs and the executive, and making sure
that those responsibilities are carried out;

Being clear about relationships between governors and the public.
Promoting values for the whole organisation and demonstrating the values of good
governance through behaviour:
Putting organisational values into practice;

Individual governors behaving in ways that uphold and exemplify effective
governance.
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
Taking informed, transparent decisions and managing risk:

Being rigorous and transparent about how decisions are taken;

Having and using good quality information, advice and support;

Making sure that an effective risk management system is in operation.
Developing the capacity and capability of the governing body to be effective:

Making sure that appointed and elected governors have the skills, knowledge and
experience they need to perform well;

Developing the capability of people with governance responsibilities and evaluating
their performance, as individuals and as a group;

Striking a balance, in the membership of the governing body, between continuity
and renewal.
Engaging stakeholders and making accountability real:
1006

Understanding formal and informal accountability relationships;

Taking an active and planned approach to dialogue with and accountability to the
public;

Taking an active and planned approach to responsibility to staff;

Engaging effectively with institutional stakeholders.
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Answer 3 AGENTS AND OBJECTIVES
(a)
Agency theory in management of a business
A company is, in law, a natural person and has a legal being of its own. Although a company
is itself a person, it is an artificial legal person created by law, and can, therefore, of necessity,
act only through the agency of natural persons. It is on account of the peculiar character of a
company that the need for management/directors arises. Directors are not only agents of a
company but also its trustees. (In the legal systems of the UK, the US, and most Western
countries the managers of a business have a fiduciary duty to the owners of that business.)
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The separation of ownership and control in companies leads to the “principal – agent
relationship”. In this role managers (the agents) use the funds at their disposal for purposes
authorised by shareholders (the principals). As shareholders normally invest in shares to
maximise their own returns then managers, as their agents, are obliged to target this end (i.e.
shareholders have a right to expect their property to be used for their own benefit/gain).
Managers have both the ability to commit the organisation to whatever contracts and
transactions they feel appropriate and a responsibility towards the owners of the business.
Agency theory assures that this responsibility takes place.
According to agency theory, the management of an organisation is undertaken on behalf of
the owners of that organisation (i.e. shareholders). Consequently the management of value
created by the organisation is only relevant insofar as that value accrues to the shareholders.
Implicit in this view of the management of the firm is that society at large and all other
stakeholders to the organisation will also benefit as a result.
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In summary, according to Agency Theory, managers merely act as custodians of the
organisation and its operational activities and manage it in the best interest of its owners. All
other stakeholders of the business are largely irrelevant; if they benefit from the business then
this is coincidental to the activities of management in running the business.
(b)
Rewards or incentives

Basic salary: At what level should remuneration be set to satisfy directors not to
pursue their own interests over that of the shareholders? A low salary with no other
incentives, in comparison to peers, may not encourage the directors to maximise the
shareholders wealth but to look for ways of diverting, legally or illegally, that
wealth to their own pockets. It will also not attract the right calibre of director.
A basic salary that is set too high, would be welcomed by the director, but would
not encourage them to pursue and drive the company forward if there was little
personal risk to their position. It would not matter what happened to the company,
so long as they did enough not to lose their position and thus their salary.

Target-related remuneration: If management are rewarded according to the level
of achievement (e.g. turnover, profit, share value, financial position value) they
should strive to achieve the appropriate target levels to ensure the bonus is
rewarded. In doing so, shareholders’ wealth should also increase (e.g. share price,
increased dividends) so too the value of the firm.
However, if the targets are insufficiently challenging, the value added for the
shareholder may not be that great. If the targets are too hard, directors may just
ignore them, not bother to achieve and divert to pursuing their own interests.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1007
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
In addition, in order to achieve a target, the director may undertake questionable
(e.g. aggressive application of accounting practices) unethical or illegal (e.g.
booking sales not made) practices.
Direct intervention by shareholders: Aggressive intuitional investors, as opposed
to passive individual private investors, have direct influence over the performance
of an enterprise and take an active role in checking the performance of the company
and are very quick to lobby other small shareholders when they suspect poor service
or any malpractice by the directors.

Threat of dismissal: Shareholders can take a direct approach by threatening the
managers with dismissal if they put their personal interest above that of maximising
the value of the firm. The increase in institutional investors has improved the
shareholders powers to dismiss directors as they are able to dominate but also lobby
other shareholders in decision making.

Threats of takeover: Managers tend to do everything possible to frustrate
takeovers as they are aware that they are going to lose their job. To promote goal
congruence the shareholders may threaten to accept a takeover bid if their set targets
are not met by managers.
pl
e
(c)

Relevance of agency theory
The simplest model of Agency Theory assumes one principle and one agent. It cannot be
assumed that the addition of more principles and more agents merely makes for a more
complex model without negating any of the assumptions.
Sa
m
The theory depends entirely upon a relationship between the parties and a shared
understanding of the context in which agreements are made. With one principal and one
agent this is not a problem as the two parties know each other. For corporations, the
principals are equated to the shareholders of the company.
However, for most listed companies these shareholders are an amorphous (vague,
unstructured) body unknown to the managers. There is neither requirement nor expectation
that any will remain a shareholder for any length of time. Thus there is no relationship
between shareholders (as principals) and managers (as agents) as the principals are merely
those holding the shares (as property being invested in) at a particular point in time.
Shareholders (especially of listed companies) do not invest in the assets of a company or in
the future of that company (certainly not in the context of a sole trader, partnerships,
owner/managers, family-controlled entities); rather they invest for the capital growth of the
shares of the company and/or a future dividend stream.
In the UK (for example) a significant proportion of transactions in shares are conducted by
fund managers of financial institutions acting on behalf of their investors. These fund
managers are rewarded according to the growth (or otherwise) of the value of the fund.
Shares are traded as commodities rather than as part ownership of a business enterprise –
shareholders cannot lay claim to, buy or sell, any particular asset in the company. Thus, in
reality, there is no principal.
1008
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
The agent party to the contract – the managers of the organisation – is also problematic. The
most senior managers are the board of directors but they may have a role as principal as well
as agent. Obviously, as agents, their role is to manage the organisation and receive rewards
for their ability in this respect, but they may also be principals as owners of shares in the
business. So there is no divide between principals and agents as far as they are concerned.
This situation will almost certainly exist where managerial remuneration schemes are based,
at least in part, on share option schemes.
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A further argument that there is no relationship between the principal and the agent is that
many managers are almost as transient as the shareholders and have no evident loyalty to the
business itself. Today, the principal – agent contract is one of growth in share value for the
shareholder and rewards for the manager – but all expressed in the present and without any
regard for the future of the business. Thus managers cannot be expected to be concerned with
stewardship but rather regard the entity as a “cash cow” to be managed for an immediate
benefit to be shared between the managers and the “owners” with little regard for anyone else.
Answer 4 STAKEHOLDER THEORY
(a)
“Stakeholder”
Stakeholders may be defined as “those groups without whose support the organisation would
cease to exist”. However, the most widely used definition of a stakeholder is “any group or
individual who can affect or be affected by the achievement of an organisation’s objectives”
(Freeman 1984). .
Sa
m
A more precise definition which explains what is meant to “affect” and be “affected by” is
“an individual or group:
(i)
which is harmed by, or benefits from the corporation; or
(ii)
whose rights can be violated, or have to be respected, by the corporation” (Evans
and Freeman, 1993).
This definition applies two principles:
(i)
(ii)
the principle of corporate effect; and
the principle of corporate rights.
Stakeholders include managers, employees, customers, suppliers (of goods, services and
finance), local residents, etc as well as shareholders and owners. Stakeholders may also
include competitors, one or more governments and/or their departments/agencies, industry
regulators, even non-persons like “nature” (e.g. land, natural resources and wildlife).
(b)
“Stakeholder theory”
More of an approach than a theory, stakeholder theory looks at the whole range of groups to
which an organisation is responsible and addresses morals and values in managing an
organisation.
It contests the assertion that business ethics begins and ends with the responsibilities of
management to the owners (shareholders) of a business. Rather, a company should not be
managed only in the interest of its shareholders but for all those stakeholders who have a
legitimate interest in it.
Further, the theory argues that an organisation can enhance the interests of its shareholders
(and owners) without damaging the interests of its wider stakeholders.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1009
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
The body of theory that has been developed includes different forms. For example:

Normative (valid) theory – this reasons that companies ought to take account of the
interests of stakeholder. This stakeholder theory strongly suggests that overlooking
stakeholders is:
(i)
(ii)
unwise or imprudent; and/or
ethically unjustified.
Descriptive (accuracy) theory – this seeks to ascertain whether and how companies
actually do take account of stakeholders’ interests.

Instrumental (power) theory – this seeks to ascertain whether it is beneficial to the
company to take shareholders’ interests into account by examining the links, if any,
between stakeholder management and the achievement of corporate goals.
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
The “broadly managerial” view suggests that the key attribute of stakeholder management
(which is comprised of attitudes, structures and practices) is simultaneous attention to the
legitimate interests of all appropriate stakeholders in establishing organisation structures and
general policies and in decision making.
(c)
Airport
Tutorial note: Heathrow is used as the example. The stakeholders and their demands would
be the same for any large international airport.
Sa
m
Owner – BAA directly own most of the UK airports and is owned by Ferroval, a Spanish
international construction company. As owners, BAA will expect excellent returns on their
investment in Heathrow. In return, many of the stakeholder groups will expect BAA to
provide up to date facilities, services and security at Heathrow.
Airlines – Heathrow is the world’s busiest airport. All airlines expect to be able to land, turn
around aircraft (e.g. unload passengers and baggage, service cabins, refuel, load baggage,
board passengers and take off) within a minimum prescribed time. They expect to be able to
land on time without waiting (delays cost money in burning extra fuel) and take off on time
(delays have a domino effect for the aircraft’s next flight).
Passengers – Passengers expect to be able to deal with the formalities of arriving at the
airport, checking in luggage, going through passport control and security and boarding aircraft
as effortlessly as possible. They do not want to spend most of the time it takes travelling,
waiting in queues. They also expect polite, courteous and helpful airport and check-in staff.
In reverse, leaving the aircraft, going through passport control, picking up luggage and
clearing customs should be as easy as possible. Passengers do not want to have to walk for 20
minutes to clear passport control (nor wait in a long queue to do so) and then wait a further 20
minutes to collect their baggage.
Getting to/from the airport must be easy. For example, metro, train and road access must be
relatively quick and convenient (e.g. drop off points for car travellers (including parking) and
metro stations should be as close as possible to the terminals).
While waiting at the terminal, passengers expect a minimum level of facilities to be available
(e.g. plenty of seats, coffee shops and restaurants, toilets and washrooms, mother/father and
baby areas, separated non-smoking and smoking areas, a range of duty free shopping, banks
and ATMs, facilities for disabled passengers).
1010
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Heathrow is particularly susceptible to competition from other London airports (e.g. Gatwick,
City and Stanstead airports) as well as other city airports in the UK (e.g. Birmingham and
Manchester). It is also challenged by foreign hub airports (e.g. Schiphol, Amsterdam) that
will fly passengers from regional airports in the UK to connecting flights at Schiphol.
Employees – Generally, the expectations of BAA employees at Heathrow would be the same
as employees of any other similar organisation. Employees of the airlines and other
organisations working at Heathrow (e.g. shops and restaurants not controlled by BAA) would
be stakeholders of their employees as well as of Heathrow. They would expect Heathrow to
provide an appropriate environment for them to work in.
pl
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Local community – The local community has similar interests in Heathrow as any local
community with organisations (e.g. employment). However, at Heathrow there are very
specific interests with the local community. For example, noise pollution (e.g. night flights),
fume pollution, traffic congestion, terrorist attack, aircraft failure on landing/take-off.
Lobbyists, interest and pressure groups – Airport expansion and the effect of increased air
traffic (e.g. adding to the greenhouse effect) are currently “hot” topics for interest groups.
The need for a third runway at Heathrow has been discussed for well over thirty years, with
many plans being proposed and considered. The whole idea of a third runway has been
vigorously (and successfully) opposed by many pressure groups including Greenpeace
(environment concerns), local authorities, the London Mayor’s Office and local residents.
The most recent plans were withdrawn following a change in government in 2010.
Sa
m
Other stakeholders would include the many suppliers to the airport, transport systems (metro,
train, taxis), the national government and the city of London itself (e.g. most tourists arrive
through Heathrow so hotels, restaurants, historic sites, etc have an interest in Heathrow).
Answer 5 ALLIYA YONGVANICH
(a)
Roles of the chairman in corporate governance
The chairman is the leader of the board of directors in a private or public company although
other organisations are often run on similar governance lines. In this role, he or she is
responsible for ensuring the board’s effectiveness as a unit, in the service of the shareholders.
This means agreeing and, if necessary, setting the board’s agenda and ensuring that board
meetings take place on a regular basis.
The chairman represents the company to investors and other outside stakeholders/
constituents. He or she is often the “public face” of the organisation, especially if the
organisation must account for itself in a public manner.
Linked to this, the chairman’s roles include communication with shareholders. This occurs in
a statutory sense in the annual report (where, in many jurisdictions, the chairman must write
to shareholders each year in the form of a chairman’s statement) and at annual and
extraordinary general meetings.
Internally, the chairman ensures that directors receive relevant information in advance of
board meetings so that all discussions and decisions are made by directors fully apprised of
the situation under discussion.
Finally, his or her role extends to co-ordinating the contributions of non-executive directors
(NEDs) and facilitating good relationships between executive and non-executive directors.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1011
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
(b)
Separation of the roles of CEO and chairman
Benefits
The separation of roles offers the benefit that it frees up the CEO to fully concentrate on the
management of the organisation without the necessity to report to shareholders or otherwise
become distracted from his or her executive responsibilities.
The arrangement provides a position (that of chairman) that is expected to represent
shareholders’ interests and that is the point of contact in the company for shareholders. Some
codes also require the chairman to represent the interests of other stakeholders such as
employees.
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Having two people rather than one at the head of a large organisation removes the risks of
“unfettered powers” being concentrated in a single individual and this is an important
safeguard for investors concerned with excessive secrecy or lack of transparency and
accountability.
The case of Robert Maxwell (or Conrad Black) is a good illustration of a single dominating
executive chairman operating unchallenged and, in so doing, acting illegally. Having the two
roles separated reduces the risk of a conflict of interest in a single person being responsible
for company performance whilst also reporting on that performance to markets.
Finally, the chairman provides a conduit for the concerns of non-executive directors who, in
turn, provide an important external representation of external concerns on boards of directors.
Sa
m
Tutorial note: Bringing in relevant examples to your answer demonstrates to the examiner
that you have read around the subject. You may also refer to a specific code (e.g. the UK
Corporate Governance Code) which requires separation of the two roles. Note that detailed
(clause number) knowledge of code provisions is not required.
Increase in accountability
In terms of the separation of roles assisting in the accountability to shareholders, four points
can be made.
1012

The chairman scrutinises the CEO’s management performance on behalf of the
shareholders and will be involved in approving the design of the CEO’s reward
package. It is the responsibility of the chairman to hold the CEO to account on
behalf of the shareholders.

Shareholders have an identified person (chairman) to hold accountable for the
performance of their investment. Whilst day-to-day contact will normally be with
the investor relations department (or its equivalent) they can ultimately hold the
chairman to account.

The presence of a separate chairman ensures that a system is in place to ensure
NEDs have a person to report to outside the executive structure. This encourages
the freedom of expression of NEDs to the chairman and this, in turn, enables issues
to be raised and acted upon when necessary.

The chairman is legally accountable and, in most cases, an experienced person.
He/she can be independent and more dispassionate because he or she is not
intimately involved with day-to-day management issues.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
(c)
Corporate governance provisions varying by country
There is a debate about the extent to which corporate governance provisions (in the form of
written codes, laws or general acceptances) should be global or whether they should vary to
account for local differences. In this answer, Vincent Viola’s view is critically evaluated.
pl
e
In general terms, corporate governance provisions vary depending on such factors as local
business culture, businesses’ capital structures, the extent of development of capital funding
of businesses and the openness of stock markets. In Germany, for example, companies have
traditionally drawn much of their funding from banks thereby reducing their dependence on
shareholders’ equity. Stock markets in emerging economies are less open and less liquid than
those in the West where business activity may primarily be concentrated among familyowned enterprises.
Against Vincent’s view
Although business cultures vary around the world, all business financed by private capital
have private shareholders. Any dilution of the robustness of provisions may ignore the needs
of local investors to have their interests adequately represented. This dilution, in turn, may
allow bad practice, when present, to exist and proliferate.
Some countries suffer from a poor reputation in terms of endemic corruption and fraud and
any reduction in the rigour with which corporate governance provisions are implemented fail
to address these shortcomings, notwithstanding the fact that they might be culturally
unexpected or difficult to implement.
Sa
m
In terms of the effects of macroeconomic systems, Vincent’s views ignore the need for sound
governance systems to underpin confidence in economic systems. This is especially
important when inward investment needs are considered as the economic wealth of affected
countries are partly underpinned by the robustness, or not, of their corporate governance
systems.
Supporting Vincent’s view
In favour of Vincent’s view are a number of arguments. Where local economies are driven
more by small family businesses and less by public companies, accountability relationships
are quite different (perhaps the “family reasons” referred to) and require a different type of
accounting and governance.
There is a high compliance and monitoring cost to highly structured governance regimes that
some developing countries may deem unnecessary to incur.
There is, to some extent, a link between the stage of economic development and the adoption
of formal governance codes. It is generally accepted that developing countries need not
necessarily observe the same levels of formality in governance as more mature, developed
economies.
Some countries’ governments may feel that they can use the laxity of their corporate
governance regimes as a source of international comparative advantage. In a “race to the
bottom”, some international companies seeking to minimise the effects of structured
governance regimes on some parts of their operations may seek countries with less tight
structures for some operations.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1013
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Answer 6 TQ COMPANY
(a)
Removing a serving chief executive
(i)
Leaving the service of a board
Resignation with or without notice. Any director is free to withdraw his or her labour at any
time but there is normally a notice period required to facilitate an orderly transition from the
outgoing chief executive officer (CEO) to the incoming one.
pl
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Not offering himself for re-election. Terms of office, which are typically three years, are
renewable if the director offers him or herself for re-election and the shareholders support the
renewal. Retirement usually takes place at the end of a three-year term when the director
decides not to seek re-election.
Death in service when, obviously, the director is unable to either provide notice or seek
retirement.
Failure of the company. When a company fails, all directors’ contracts are cancelled although
this need not signal the end of the directors’ involvement with company affairs as there may
be on-going legal issues to be resolved.
Being removed (e.g. by being dismissed for disciplinary offences). It is relatively easy to
“prove” a disciplinary offence but much more difficult to “prove” incompetence. The nature
of disciplinary offences are usually made clear in the terms and conditions of employment and
company policy.
Sa
m
Prolonged absence. Directors unable to perform their duties owing to protracted absence, for
any reason, may be removed. The length of qualifying absence period varies by jurisdiction.
Being disqualified from being a company director by a court. Directors can be banned from
holding directorships by a court for a number of reasons including personal bankruptcy and
other legal issues.
Failing to be re-elected if, having offered himself for re-election, shareholders elect not to reappoint.
An “agreed departure” (e.g. by providing compensation to a director to leave).
(ii)
Discuss Miss Hoiku’s statement
The way that directors’ contracts and company law are written (in most countries) makes it
difficult to remove a director such as Mr Smith from office during an elected term of office so
in that respect, Miss Hoiku is correct. Unless his contract has highly specific performance
targets built in to it, it is difficult to remove Mr Smith for incompetence in the short-term as it
is sometimes difficult to assess the success of strategies until some time has passed. If the
alleged incompetence is during Mr Smith’s term of office (typically three years) then it will
usually be necessary to wait until the director offers himself for re-election. The shareholders
can then simply not re-elect the incompetent director (in this case, Mr Smith). The most
likely way to achieve the departure of Mr Smith during his term of office will be to
“encourage” him to resign by other directors failing to support him or by shareholders
issuing a vote of no confidence at an AGM or EGM. This would probably involve offering
him a suitable financial package to depart at a time chosen by the other members of the board
or company shareholders.
1014
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
(b)
Importance of the chairman’s statement
The chairman’s statement (or president’s letter in some countries) is an important and usually
voluntary item, typically carried at the very beginning of an annual report. In general terms, it
is intended to convey important messages to shareholders in general, strategic terms. As a
separate section from other narrative reporting sections of an annual report, it offers the
chairman the opportunity to inform shareholders about issues that he or she feels it would be
beneficial for them to be aware of. This independent communication is an important part of
the separation of the roles of CEO and chairman.
(c)
pl
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In TQ Company, the role of the chairman is of particular importance because of the
dominance of Mr Smith. Miss Hoiku had a particular responsibility to use her most recent
statement to inform shareholders about going concern issues notwithstanding the difficulties
that might cause in her relationship with Mr Smith. Miss Hoiku has an ethical as well as an
agency responsibility to express her independence in the chairman’s statement and convey
issues relevant to company value to the company’s shareholders. She can use her chairman’s
statement for this purpose.
Structure of Mr Smith’s reward package
Sa
m
The balance between basic to performance related pay was very poor. Mr Smith, perhaps
being aware that the prospect of gaining much performance related income was low, took the
opportunity to increase the fixed element of his income to compensate. This was not only
unprofessional and unethical on Mr Smith’s part, but it also represented very bad value for
shareholders. Having exercised his share options and sold the resulting shares, there was now
no element of alignment of his package with shareholder interests at all. His award to himself
of an “excessively” expensive company car was also not in the shareholders’ interests. The
fact that he exercised and sold all of his share options means that he will now have no
personal financial motivation to take strategic decisions intended to increase TQ Company’s
share value. This represents a poor degree of alignment between Mr Smith’s package and the
interests of TQ’s shareholders.
(d)
Miss Hoiku’s performance as chairman
The company chairman’s performance is described as particularly poor. It is a key function
of the chairman to represent the shareholders’ interests in the company and Miss Hoiku has
clearly failed in this duty.
A key reason for her poor performance was her reported inability or unwillingness to face up
to Mr Smith who was clearly a domineering personality. A key quality of a company
chairman is his or her ability and willingness to personally challenge the CEO if necessary.
She failed to ensure that a committee structure was in place, allowing as she did, the
remunerations committee to atrophy when two members left the company.
Linked to this, it appears that the two non-executive directors that left were not replaced and
again, it is a part of the chairman’s responsibility to ensure that an adequate number of nonexecutives are in place on the board.
She inexplicably allowed Mr Smith to design his own rewards package and presided over him
reducing the performance related element of his package which was clearly misaligned with
the shareholders’ interests.
When Mr Smith failed to co-ordinate the other directors because of his unspecified business
travel, she failed to hold him to account thereby allowing the company’s strategy to fail.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1015
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
There seems to have been some under-reporting of potential strategic problems in the most
recent annual report. A “future prospects” or “continuing business” statement is often a
required disclosure in an annual report (in many countries) and there is evidence that this
statement may have been missing or misleading in the most recent annual report.
Answer 7 NOMINATION COMMITTEE
(a)
Members
These should comprise a majority of independent non-executive directors (NEDs) with the
size of the committee determined by the Chairman of the Committee.
Duties

Regularly review the structure, size and composition (including the skills,
knowledge and experience) of the board and make appropriate recommendations to
the board.

Ensure appropriate succession planning for directors (in particular the CEO and
CFO) and other senior executives, taking into account the challenges and
opportunities facing the company and the skills and expertise needed in the future.

Identify and nominate for the approval of the board, candidates to fill board
vacancies.
Sa
m
(b)
pl
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The Nomination Committee Chairman should be either the Chairman of the Board or an
independent NED. The Chairman should not chair the committee when it is dealing with their
successor.
1016

Before any appointment is made by the board, evaluate the balance of skills,
knowledge and experience on the board, and, in the light of this evaluation prepare a
description of the role and capabilities required for a particular appointment.

Keep under review the leadership needs of the organisation, both executive and
non-executive, with a view to ensuring the continued ability of the organisation to
compete effectively in the marketplace.

Keep up to date and fully informed about strategic issues and commercial changes
affecting the company and the market in which it operates.

Review annually the time required from non-executive directors. Performance
evaluation should be used to assess whether the non-executive directors are
spending enough time to fulfil their duties.

Ensure that on appointment to the board, non-executive directors receive a formal
letter of appointment setting out clearly what is expected of them in terms of time
commitment, committee service and involvement outside board meetings.

Ensure that on appointment to the board all directors receive appropriate induction
and thereafter appropriate continuing professional development.

Make a statement in the annual report about its activities, the process used to make
appointments and explain if external advice or open advertising has not been used.
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)

formulating plans for succession for both executive and non-executive directors
and in particular for the key roles of chairman and CEO;

suitable candidates for the role of senior independent director;

membership of the audit and remuneration committees, in consultation with the
chairmen of those committees;

the re-appointment of any non-executive director at the conclusion of their
specified term of office having given due regard to their performance and
ability to continue to contribute to the board in the light of the knowledge,
skills and experience required;

the continuation (or not) in service of any director who has reached the age of
70 or as specific by the articles;

the re-election by shareholders of any director under the ‘retirement by
rotation’ provisions having due regard to their performance and ability to
continue to contribute to the board in the light of the knowledge, skills and
experience required;

any matters relating to the continuation in office of any director at any time
including the suspension or termination of service of an executive director as an
employee of the company subject to the provisions of the law and their service
contract; and

the appointment of any director to executive or other office.
Advantages
Sa
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(c)
Lastly, a further duty may include making recommendations to the board
concerning, for example:
pl
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






(d)
Independent selection procedure.
Greater opportunities to identify a wider range of capable individuals.
Can avoid board cloning and “stale blood”.
Senior executives can concentrate on running the business.
Selection process is not captured by an individual director (e.g. CEO).
Forward thinking on succession matters.
Risk of any conflict of interest
To minimise any risk arising between members of the Nomination Committee it is good
practice to rotate the chairman and the members on a regular basis (e.g. every three years).
It is also good practice for members of the Nomination Committee not to sit in, or be part of,
any other committees (e.g. the Audit Committee or the Remuneration Committee).
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1017
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Answer 8 TOMATO BANK
(a)
Criticisms of remuneration committee in agreeing Mr Woof’s reward package
There is evidence of a lack of independence in the roles of the non-executive directors
(NEDs) who comprise the committee. One of the main purposes of NEDs is to bring
independent perspectives within the committee structure and shareholders have the right to
expect NEDs to not be influenced by executive pressure in decision-making (such as from the
finance directors). Two of the NEDs on the remuneration committee were former colleagues
of Mr Woof, creating a further conflict. The effect of this lack of independence was a factor
in the creation of Mr Woof’s unbalanced package. That, in turn, increased agency costs and
made the agency problem worse.
pl
e
There was a clear breach of good practice with the remuneration committee receiving and
acting on the letter from Mr Woof and agreeing to the design of the remuneration package in
such a hasty manner. Remuneration committees should not receive input from the executive
structure and certainly not from directors or prospective directors lobbying for their own
rewards. Mr Woof was presumptuous and arrogant in sending the letter but the committee
was naive and irresponsible in receiving and acting upon it.
There is evidence that the remuneration was influenced by the hype surrounding the supposed
favourable appointment in gaining the services of Mr Woof. In this regard it lacked
objectivity. Whilst it was the remuneration committee’s role to agree an attractive package
that reflected Mr Woof’s market value, the committee was seemingly coerced by the finance
director and others and this is an abdication of their non-executive responsibility.
Sa
m
The committee failed to build in adequate performance related components into Mr Woof’s
package. Such was the euphoria in appointing Mr Woof that they were influenced by a
clearly excitable finance director who was so keen to get Mr Woof’s signature that he
counselled against exercising proper judgement in this balance of benefits. Not only should
the remuneration committee have not allowed representations from the FD, it should also
have given a great deal more thought to the balance of benefits so that bonuses were better
aligned to shareholder interests.
The committee failed to make adequate pension and resignation arrangements that
represented value for the shareholders of Tomato Bank as well as for Mr Woof. Whilst
pension arrangements are within the remit of the remuneration committee and a matter for
consideration when a new chief executive officer (CEO) is appointed, shareholder value
would be better served if it was linked to the time served in the company and also if the
overall contribution could be reconsidered were the CEO to be removed by shareholders for
failure such as was the case at Tomato Bank.
Tutorial note: These and similar points could be expressed in several ways.
(b)
Components of a rewards package
The components of a typical executive reward package include basic salary, which is paid
regardless of performance; short and long-term bonuses and incentive plans which are
payable based on pre-agreed performance targets being met; share schemes, which may be
linked to other bonus schemes and provide options to the executive to purchase predetermined
numbers of shares at a given favourable price; pension and termination benefits including a
pre-agreed pension value after an agreed number of years’ service and any “golden
parachute” benefits when leaving; plus any number of other benefits in kind (e.g. cars, health
insurance, use of company property, etc).
1018
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Reasons why a more balanced package should have been used
The overall purpose of a well-designed rewards package is to achieve a reduction
(minimisation) of agency costs. These are the costs the principals incur in monitoring the
actions of agents acting on their behalf. The main way of doing this is to ensure that
executive reward packages are aligned with the interests of principals (shareholders) so that
directors are rewarded for meeting targets that further the interests of shareholders. A reward
package that only rewards accomplishments in line with shareholder value substantially
decreases agency costs and when a shareholder might own shares in many companies, such a
“self-policing” agency mechanism is clearly of benefit. Typically, such reward packages
involve a bonus element based on specific financial targets in line with enhanced company
(and hence shareholder) value.
Ethical case for voluntary reduction in pension
Sa
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(c)
pl
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Although Mr Woof came to Tomato Bank with a very good track record, past performance is
no guarantee of future success. Accordingly, Mr Woof’s reward package should have been
subject to the same detailed design as with any other executive package. In hindsight, a
pension value linked to performance and sensitive to the manner of leaving would have been
a worthwhile matter for discussion and also the split between basic and incentive components.
Although ambitious to design, it would have been helpful if the reward package could have
been made reviewable by the remuneration committee so that a discount for risk could be
introduced if, for example, the internal audit function were to signal a high level of exposure
to an unreliable source of funding. As it stands, the worst that can happen to him is that he
survives just two years in office, during which time he need not worry about the effects of
excessive risk on the future of the company, as he has a generous pension to receive
thereafter.
Mr Woof was the beneficiary of a poor appointments process and his benefits package was
designed in haste and with some incompetence. He traded freely on his reputation as a good
banker and probably inflated his market value as a result. He then clearly failed in his role as
a responsible steward of shareholders’ investments and in his fiduciary duty to investors. In
exposing the bank to financing risks that ultimately created issues with the bank’s economic
stability, it was his strategies that were to blame for the crisis created. The fact that he is
receiving such a generous pension is because of his own lobbying and his own assurance of
good performance places an obligation on him to accept responsibility for the approach he
made to the remuneration committee five years earlier.
The debate is partly about legal entitlement and ethical responsibility. Although he is legally
entitled to the full value of the pension, it is the perception of what is fair and reasonable that
is at stake. It is evident that Mr Woof is being self-serving in his dealings and in this regard is
operating at a low level of Kohlberg’s moral development (probably level 1 in seeking
maximum rewards and in considering only the statutory entitlement to these in his
deliberations). A more developed sense of moral reasoning would enable him to see the
wider range of issues and to act in conformity with a higher sense of fairness and justice,
more akin to behaviour at Kohlberg’s level 3.
Tutorial note: This could be expressed in a range of ways.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Answer 9 CORPORATE GOVERNANCE STANDARDS
Tutorial note: This question has been taken from the old ACCA Paper 3.1 Advanced Auditing and
Assurance. Whilst the detail of the introduction would not be expected, the rest of the answer does
provide useful parallels between the development of IFRS, ISA and UK Corporate Governance codes.
It also demonstrates the typical structure expected when answering this type of discussion-based
question.
Introduction





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The OECD (Organisation for Economic Cooperation and Development) and World Bank are actively
involved in initiatives to promote corporate governance (e.g. holding an annual forum on the subject).
In 1999 (updated 2004) the OECD issued a set of corporate governance principles which, although nonbinding, reflect the concepts of:
the rights of shareholders;
the equitable treatment of stakeholders;
the role of stakeholders;
disclosure and transparency; and
board responsibilities.
These Principles are now being promoted as a framework for dialogue and consultation with emerging
and transition economies with the aim of improving corporate governance practices.
Further, in June 2000 (updated 2004), OECD issued governance guidelines for multinationals that
provide “voluntary principles and standards for responsible business consistent with applicable laws”.
Sa
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The International Forum on Accountancy Development (IFAD) is an initiative of IFAC and the World
Bank. Its vision is “to achieve a rational framework of reporting on the performance of economic
entities, which serves the objectives of issuers and users across the world”. This Vision calls for, inter
alia, improving corporate governance practices using the OECD Principles of Corporate Governance as
a point of reference.
Need for IFRS
The need for a uniform set of international financial reporting standards to provide for the transparency
and consistency of financial reporting is evident in that IOSCO (the International Organisation of
Securities Commissions) originally endorsed 30 International Accounting Standards for cross-border
listings.
In 2005 the European Union, along with several other countries adopted IFRS. Since then many other
countries have formally adopted IFRS, most notably Canada in 2011. It is expected that the
consolidated accounts of Indian companies will be required to comply with Indian accounting
standards, which themselves will have been largely converged to IFRS, by 2016. Japanese companies
are permitted to use IFRS as long as certain criteria are met. The IFRS foundation has complete profiles
of IFRS adoption for 130 nations, as of April 2014 123 of those nations permit or require adoption of
IFRS.
This was followed by the SEC accepting in 2007 that foreign companies listed on the New York Stock
Exchange could file financial statements prepared under IFRS without any need for a reconciling
statement to US GAAP.
1020
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
The IASB and FASB have been working together on a convergence project for many years with the
intention that IFRS and US GAAP should be fully converged by 2014. Although many high-priority
projects have now been completed (e.g. revenue recognition in May 2014) work on a number of
projects has not been added to the joint agenda (e.g. intangible assets) and many projects have been
discontinued (e.g. financial statement presentation and liabilities and equity). Although FASB will
continue to work with IASB to make accounting standards as comparable as possible it now envisages
that standard setters will co-exist to improve standards that address specific needs in the capital markets
(i.e. “one size does not fit all”).
Need for ISAs
pl
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The auditing profession plays a key role in both national and international regulation and the
development of transparent international standards on auditing (ISAs) provides a high level of
assurance on the reliability of financial reporting.
ISAs and International Audit Practice Statements (IAPSs) have been formulated by IFAC through its
International Auditing Practices Committee (IAPC). A significant number of IFAC members use the
ISA as a basis for developing their own national standards. In 2003 IFAC started working with IOSCO
for IOSCO’s endorsement of ISAs. By 2007, progress had been made and the project continued. This
project was completed in 2009 with the endorsement by IOSCO of the clarified ISAs.
Need for corporate governance standards
Corporate governance may be defined as “the ethical corporate behaviour by directors or others charged
with governance in the creation of wealth for all stakeholders”. It is about how these persons:
provide stewardship over the business of an entity to achieve corporate objectives;
balance the corporate objectives with the expectations of society; and
provide accountability to stakeholders.
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


The need for governance has increased as primary stakeholders have become more removed from
management and the control of the entities they own. The use of outside directors in governance roles
has been shown to provide protection to entity stakeholders.
The growth of global capital markets and the significant frauds which are being perpetrated in these
markets has put this need on a global scale. Corporate governance can counter financial statement
fraud, corruption and money laundering.
If investors are to invest, stamping out corruption (for example) is important. An infrastructure is
therefore needed for regulation, corporate governance, disclosure and transparency.
The importance of the role of corporate governance is reflected in the IAASB’s ISA 260. Auditors are
required to communicate audit matters of governance interest to those charged with corporate
governance on a timely basis. That the ISA requires the auditor to identify those responsible for
governance, when the entity has not, emphasises the need for governance systems to be established.
It has widely been reported that had corporate governance and public governance existed in Southeast
Asia, then the economic crisis that occurred in 1997 may have been avoided (because the speculators
would not have such a free hand as they did).
Arguments for global corporate governance standards
Corporate governance on a national basis is appropriate when investing and financing by companies is
on a national basis.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
However, a set of global rules should be applicable, as a minimum, to entities listing shares or obtaining
financing in the public capital markets outside of their national boundaries.
Requiring companies who participate in global capital markets to follow global rules will provide
greater protection to global investors. Corporate governance will still be required at a national level.
The use of Global Shares by global business enterprises increases the need for corporate governance
rules to be global. Global shares (i.e. the same form of shares for listing in a home country and a nonhome country) enable virtually seamless cross-border trading. As their use becomes more widespread,
global stakeholders will need higher quality global accounting, auditing and corporate governance
standards.
pl
e
Regulators are national, not international, and so international consistency is needed to avoid regulation
arbitrage. Global standards are necessary because national and international standards will not
converge of their own volition. Local subsidiaries of international groups tend to be content (e.g. on
cost grounds) to comply with lower local standards (e.g. accounting and auditing) and not adopt the
higher standards of their parent’s location.
Companies in some countries (e.g. in India) have been advised not to globalise until there is a
framework for good corporate governance. It is therefore asserted that global standards are key to
developing countries’ prospects for sustainably mobilising capital for economic growth. Developing
countries can further benefit by imitating the models and systems of another – rather than incurring the
costs of developing their own models.
Sa
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There does not have to be a “one size fits all” approach to global standards because there are
universally recognised standards that can provide benchmarks (e.g. responsibility, accountability,
fairness and transparency). If universal principles of transparency and objectivity (for example) can
support international accounting and auditing frameworks, then a global corporate governance model
can cater for different legal structures and cultural identities.
OECD’s voluntary code provides a point of reference for multinationals which are encouraged to:

Contribute to economic, social and environmental progress;

Respect the human rights of those affected by their activities;

Encourage local capacity building;

Encourage human capital formation (e.g. by creating employment opportunities and through
training programs);

Refrain from seeking/accepting exemption from environmental, health and safety, equal
opportunities and labour legislation, etc;

Support and uphold good corporate governance (principles and practices);

Abstain from improper involvement in local political activities.
Arguments against global corporate governance standards
Development of corporate governance and its implementation needs to be at a national level because
regulators are national and it is not appropriate, given the need to respect diverse cultures and legal
structures, to prescribe a global standard. For example:



1022
concern in the US is for increasing shareholders’ value;
continental Europe’s economic philosophy is creating employment;
in Japan companies work with the government towards the national strategy.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Many people fear that global corporate governance standards may attempt to impose an AngloAmerican business model on developing countries. Corporate governance and the composition of
boards should suit the local business environment to encourage economic success.
IAPC has established as a principle that auditors determine the relevant persons who are charged with
governance responsibilities. However, that there may be no such persons suggests that the needed for
governance is not yet proven at a national level.
Global standards are unnecessary because they emerge eventually by a natural process of convergence.
For example, International Financial Reporting Standards (IFRSs) have been issued by the International
Accounting Standards Board in place of separate International Accounting Standards (IASs) and UK
Financial Reporting Standards (FRSs) since the end of 2001.
Conclusion
pl
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International standards are not global standards. If accounting and auditing standards have only
reached an international level, then the need for corporate governance standards at the present time is
only international – not global.
A global corporate governance framework is essential for high-quality financial reporting and auditing
standards to be interpreted, used and enforced consistently throughout the world.
Accounting standards have been implemented on a nation by nation basis before the international
acceptance by IOSCO of IFRS. Auditing standards are following suit. The OECD Principles are very
general and, as the need for global corporate governance standards is apparent, the initiatives to create
them will continue to emerge.
Sa
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Answer 10 OBJECTIVES OF COMPANIES
Non-financial, ethical and environmental issues in many cases overlap, and have become of increasing
significance to the achievement of primary financial objectives such as the maximisation of shareholder
wealth. Most companies have a series of secondary objectives that encompass many of these issues.
Traditional non-financial issues affecting companies include:

Measures that increase the welfare of employees such as the provision of housing, good and
safe working conditions, social and recreational facilities. These might also relate to
managers and encompass generous perquisites (“perks”).

Welfare of the local community and society as a whole. This has become of increasing
significance, with companies accepting that they have some responsibility beyond their
normal stakeholders in that their actions may affect the environment and the quality of life of
third parties.

Provision of, or fulfilment of, a service. Many organisations, both in the public sector and
private sector provide a service (e.g. to remote communities) which would not be provided on
purely economic grounds.

Growth of an organisation, which might bring more power, prestige, and a larger market
share, but might adversely affect shareholder wealth.

Quality. Many engineering companies have been accused of focusing upon quality rather
than cost effective solutions.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1023
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK

Survival. Although to some extent linked to financial objectives, managers might place
corporate survival (and hence retaining their jobs) ahead of wealth maximisation. An obvious
effect might be to avoid undertaking risky investments.
Ethical issues faced and taken by companies have been brought increasingly into focus by the actions
of, for example, Enron and the banking crisis. Whilst there has always be a trade-off between applying
a high standard of ethics and increasing cash flow or maximisation of shareholder wealth, the concept
of corporate social responsibility places a greater emphasis on the need for ethical behaviour to
encourage maximisation of shareholder wealth.
Typical ethical dilemmas and questions include:
Rewarding directors “for failure” (e.g. payment of bonuses when growth, profits and
dividends have been in decline); “golden parachutes” when directors are forced to resign or
are sacked; activation of share options or generous pension schemes despite failure.

Should bribes be paid to facilitate the company’s long-term aims?

Are wages being paid in some countries below subsistence levels? Should they be?

Are working conditions of an acceptable standard?

Do the company’s activities involve experiments on animals, genetic modifications, etc?

Should the company deal with or operate in countries that have a poor record of human
rights?

What is the impact of the company’s actions on pollution or other aspects of the local
environment (because it is cheaper to pay fines than follow the law)?
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
Environmental issues have very direct effects on most companies. For example:

If natural resources become depleted the company may not be able to sustain its activities;

Weather and climatic factors can influence the achievement of corporate objectives (e.g.
climate change, sustainability of water supplies, etc).

Extreme environmental disasters (e.g. typhoons, floods, earthquakes, and volcanic eruptions)
will also affect a companies’ cash flow, as will obvious environmental considerations (e.g. the
location of mountains, deserts, or communications facilities).

Should companies develop new technologies that will improve the environment, such as
cleaner petrol or alternative fuels? Such developments might not be the cheapest alternative.
Environmental legislation is a major influence in many countries. This includes limitations on where
operations may be located and in what form, and regulations regarding waste products, noise and
physical pollutants.
All of these issues have received considerable publicity and attention in recent years. Environmental
pressure groups are prominent in many countries; companies are now producing social and
environmental accounting reports, and/or corporate social responsibility reports as well as recognising
the valid contribution and expertise such groups can make as stakeholders.
Companies increasingly have multiple objectives that address some or all of these three issues. In the
short term non-financial, ethical and environmental issues might result in a reduction in shareholder
wealth; in the longer term it is argued that only companies that address these issues will succeed.
1024
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Answer 11 PRINCIPLES OF CSR
Reasons why CSR became important
Corporations exist for a business purpose (i.e. to make profits). To sustain the
profitability of its business, a company may need to consider its social and
environmental responsibilities.

Many stakeholders including global bodies, NGOs and governments argue that
enterprises should make a contribution towards the sustainable development of the
planet.

A socially responsible company may be preferred by customers and employees (e.g.
customers may prefer to buy products from an environmentally-friendly, nonpolluting company and employees prefer to be a part of a company that takes up
social causes such as providing better schools in the locality where it is situated).

Contribution to social causes such as education, healthcare and safety measures
will, in turn, help to create a safe and stable external environment for the
organisation and reduce the external risks it faces (e.g. provision of free
vaccinations to residents of the area in which the company’s factory is located will
help the company to avoid the risk of the lack of required manpower, which it
obtains from the local area).

CSR also includes acting within the legal parameters set by the state authorities and
hence when a corporation contributes to social causes that are the province of the
state, this may enable the corporation to gain certain favours from the government
that will benefit the business in the long term; a classic example that “ethics pays”
and an approach that may, by voluntary responsibility, avoid statutory regulation,
interference and costs.
pl
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
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(a)
(b)
Main principles

A company needs to conduct its business ethically. The manner in which the
company conducts its business is a reflection of what the company is and of the
people who actually run the company. Accordingly every company should have
guidelines on the ethical behaviour that each employee, director, manager and any
person working with the company should follow.

Employees should be treated fairly and should be provided with a good work
atmosphere so that they feel taken care of. Providing education and training to
employees so that they are given the opportunity to develop their skills is also a part
of CSR. This is important since employees today prefer to work with companies
that actively follow CSR policies since they feel motivated if they contribute to
local and international activities through their company.

The company needs to respect human rights and hence should ensure that it does not
follow any practices in the company that are against the rights of any particular
section of society. For example, it should not make its workers work in hazardous
conditions that may lead to health problems. Safe working conditions should be
provided, especially if the company deals in harmful chemicals, explosives, etc.

A company is an artificial person recognised by law and hence it should act in a
responsible manner as a citizen of the community. This requires it to contribute
effectively towards the community by supporting social causes such as education,
health, the environment, etc.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
The company should contribute generously to promoting the welfare of the
environment. This is essential since if it does not protect the environment it works
in, this will have an adverse effect on the working of the company itself. Examples
of measures it can take include:

installing waste disposal and recycling plants to safely dispose of the
waste emitted by the company;

using renewable energy resources, such as wind and water, instead of
exhaustible, non-renewable energy resources such as coal and oil;

ensuring that the resources used by the company are replaced (e.g. if the
company has felled trees in an area then it should plant equal number of
trees in the surrounding area so that the ecosystem is not disturbed);

taking measures to reduce the overall air, water and noise pollution so that
it may operate in a safe environment that enables the business to continue
for a longer period.
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
Answer 12 BATELEUR ZOO GARDENS
(a)
Internal controls
Tutorial note: A typical question where there are many more marks available than required.
Remember that not all controls are preventive. Some should detect (so as to correct) things
that have “gone wrong”.
Lack of investment

Monthly review and monitoring of:
Sa
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(i)


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
1026
admission fees;
number of day visitors;
annual memberships taken out (analysed between new and renewed);
lapsed membership;
sponsorship waiting lists (animals without sponsors and sponsors waiting
for suitable animals).

Approval of annual budgets which plan for adequate investment to attract visitors.

Monthly comparison of actual expenditure on new exhibits and breeding programs
against budget – to see the extent to which the expected level of investment in
development is being made.
(ii)
Incomplete data transfer

Monthly reconciliations of actual (invoiced) sponsorship income to that expected
(based on number of sponsorships, by type, per sponsor department records) and
investigation of shortfalls.

Monitoring of instances of incomplete/inaccurate data transfer – how identified,
reason for occurrence, amounts involved, how rectified.
(iii)
Non-charges

Monitoring of sponsorship income generated (i.e. actual) to that available (e.g.
projected), by class of animal, and investigation of shortfalls.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Comparison of BZG’s advertising expenditure against budget (to identify potential
for unrecorded costs).
(iv)
Misappropriated cash

Two people could “man” each ticket kiosk at all times. A duty log should be kept
(date, time, staff member).

The kiosks must not be left unattended while cash is held there.

All cash received from visitors should be counted and recorded and a receipt given.

Cash and a copy of the receipts should be transferred, securely, to cashiers.

The existence of CCTV at the kiosks should be made evident, to act as a deterrent.

Daily reconciliation of cash takings to “gate” (i.e. number of day visitors) and
investigation of any apparent shortfall.

A separate admission gate after the kiosk checks that entrants have been issued a
ticket.

An auditable cash register system to control cash drawers at ticket booths.
Transactions must be traceable in multiple forms of tender (cash, credit card).

Multiple cash drawer inserts enabling quick and easy shift changes. An automated
audit trail of all movements in and out of each drawer.
(v)
Systems not available

Back up/recovery/contingency plans must be in place to ensure that BZG can take
bookings and issue tickets even when the electronic system is not available.
Sa
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
(b)

In particular, the back-up system should be tested periodically to ensure that credit
card bookings can be taken and correct discounts processed for concessionary
tickets and group bookings.

Preventive arrangements to ensure that any “down time” is kept to a minimum (e.g.
acquiring highly reliable systems components and frequent
housekeeping/maintenance).
(vi)
Unrecorded donations

Periodic inspection of animals and comparison with book records (e.g. fixed asset
register for larger species and inventory records for smaller species).

Comparing new animals identified by veterinary records to additions to inventory
records (or asset register).
Assessment
Whilst there are several governance codes aimed specifically at the not-for-profit sector (e.g.
Panel on the Not-for-profit Sector) many are based on UK corporate governance codes (e.g.
the UK Corporate Governance Code, OECD Code) tailored to suit the specific requirements
of the sector.
Looking towards supporting publications on corporate governance, both Turnbull and COSO
contain extensive detail on how the effectiveness of a control system can be questioned.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Overall three basic questions must be answered:

Have the entity’s objectives been achieved with regard to reliability of managerial
and financial reporting?

Have the entity’s operations been carried out effectively and efficiently?

Has the entity fully complied with applicable laws and regulations?
Based on the Turnbull Report, the following questions could be asked by the trustees (of the
board) on the following areas:
risk assessment;
control environment and activities;
management information and communication; and
monitoring
Risk assessment
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


Does the charity have clear objectives and have they been communicated to provide
effective direction to employees on risk assessment and control issues?

Are the significant internal and external operational, financial, compliance and other
risks identified and assessed on an on-going basis?

Is there a clear understanding by management and others in the charity of which
risks are acceptable to the board?
Sa
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
Control environment and control activities
1028

Does the board have clear strategies for dealing with significant risks that have been
identified? Is there a policy on how to manage those risks?

Do, for example, the charity’s culture, code of conduct and human resource policies
support the objectives, risk management and internal control system?

Does senior management demonstrate, through its actions as well as it policies, the
necessary commitment to competence, integrity and fostering a climate of trust in
the charity?

Are authority, responsibility and accountability defined clearly such that decisions
are made and actions taken by the appropriate people? Are the decisions and actions
of different parts of the charity appropriately co-ordinated?

Does the charity communicate to its employees what is expected of them and the
scope of their freedom to act?

Do people in the charity (and in its providers of outsourced services) have the
knowledge, skills and tools to support the achievement of the charity’s objectives
and to manage effectively risks to their achievement?

How are processes/controls adjusted to reflect new or changing risks, or operational
deficiencies?
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Management information and communication
Do management and the board receive timely, relevant and reliable reports on
progress against objectives and the related risks that provide them with the
information, from inside and outside the charity, needed for decision-making and
management review?

Are information needs and related information systems reassessed as objectives and
related risks change or as reporting deficiencies are identified?

Are periodic reporting procedures (e.g. monthly) effective in communicating a
balanced and understandable account of the charity’s position and prospects?

Are there established channels of communication for individuals to report suspected
breaches of law or regulations or other improprieties?
Monitoring
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
Are there on-going processes embedded in the charity’s overall operations and
addressed by senior management, which monitor the effective application of the
policies, processes and activities related to internal control and risk management?

Do these processes monitor the charity’s ability to re-evaluate risks and adjust
controls effectively in response to changes in its objectives, its business, and its
external environment?

Are there effective follow-up procedures to ensure that appropriate change or action
occurs in response to changes in risk and control assessments?
Sa
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

Is there appropriate communication to the board (or board committees) on the
effectiveness of the on-going monitoring processes on risk and control matters and
of failures (and action taken) in the systems?

Are there specific arrangements for management monitoring and reporting to the
board on risk and control matters of particular importance?
Answer 13 VCF
(a)
Controls
Tutorial note: This question is about identifying the controls that are described in the
scenario. This includes non-financial and qualitative controls, not just financial controls.
The question asks candidates to identify and evaluate. Most marks are given for evaluation,
for example the strengths and weaknesses of the main controls. It is not necessary to discuss
risks in detail here, although a brief mention of the major risks may help candidates in their
evaluation (i.e. do the controls actually address the key risks or not). In answering the
question, candidates need to recognise the social controls exercised by Viktor. Answers need
to be specific (i.e. clearly related to the case), not general.
Dependence on key personnel
The principal control and also the main weakness of the system is its dependence on Viktor’s
knowledge and experience. If something happens to Viktor, perhaps as a result of the
personal risks he takes, the other directors and the company would be left to cope without
him.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Role of board
The board does not appear to actively supervise VCF’s activities. Viktor’s actions appear to
be unquestioned, and the rest of the board appears to have little involvement in decisionmaking.
Composition of the board
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As Viktor is both chairman and CEO he may have too much power. In addition two of the
three other directors are connected to Viktor - his wife (who has a marketing role) and one of
the non-executive directors who is a long-time family friend. It is probable that both would
support Viktor and follow his requirements without questioning or challenging. Therefore it
is highly likely that the board is not effective and would not be exerting sufficient control over
Viktor and the way the company is run.
Effectiveness of the board
As suggested above, the board appears to be fully controlled by Viktor. The lack of control
over Viktor is further complicated by the fact that there are no formal board agendas (board
meetings are informal affairs led by Viktor’s verbal review of sales activity) and that board
meetings are only held every three months. The board is failing completely in providing any
form of control and governance over Viktor and the company.
Budgets and management accounts
Sa
m
As Viktor sees little value in comparing actual profit against budget it appears that little use is
made of the budgets which are supposedly used for expense control. Actual expenditure
compared to budget with detailed variance analysis and explanations is one of a number of
standard method of control within organisations.
In addition there is a risk that the procedures for producing the budgets and management
accounts may have become “relaxed” as the staff know that he does not take much notice of
them and relies heavily on his spreadsheet cash flow monitoring process.
Sensitivity analysis
The analysis undertaken by Viktor to manage cash flow does not appear to be linked in with
the budget and management accounts being produced. In addition VCF seems very
dependent on this analysis being reasonable, particularly as costs are tight.
Control weaknesses within this approach include a lack of focus on sales and expenditure, the
integrity of the input data is not controlled as it is outside of the budgetary systems of VCF
and there appears to be no reconciliation of the output of the mosel to provide assurance on its
accuracy.
Costs
Product costing is not considered to be valuable, but is a major way of controlling such costs
and of setting prices.
The system for analysing costs appears to be based on the ideas that costs are driven by sales
(costs expressed as % of sales). Many of the costs such as staff costs have other drivers, and
are also incurred a long time in advance of sales being made (e.g. R&D and export marketing)
so that the link with sales may be fairly tenuous. There appears to be few ways that Viktor is
controlling and monitoring these costs for R&D and exporting as they are not set against
external benchmarks.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Cost of sales is determined as being what is paid through outsourcing production (i.e. 20%).
No attempt appears to be made to monitor the costs of outsourcing to see that they are
reasonable.
Growth and expenses
The company has experienced rapid growth over the last ten years. Despite being very
profitable, cash flow is often tight. This implies a lack of “backroom” control over expenses
and the working capital cycle. Viktor has identified the failure to control costs as a major risk
– implying that he recognises that poor controls over costs are currently in place.
General monitoring
Economic conditions
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Viktor monitors primarily through using non-financial performance indicators (e.g. sales
levels, market share, continual innovation and high levels of customer satisfaction). There
needs to be a balance between monitoring and controlling financial as well as non-financial
indicators. Non-financial indicators can often be vague, difficult to assess and often
subjective, thus undermining effective control especially if Viktor finds what he wants to see
and is told by his staff what he wants to hear.
Sa
m
Whilst he keeps close contact and understands customer needs very well, the structure of the
board and his management style appears to exclude strategic controls to identify political,
social and economic threats. Economic cycles tend to be based on ten year cycles – a
recession will usually occur every 10 to 15 years. The firm has experienced rapid growth
over a ten year period, thus indicating that a potential downturn in the economy and his
markets is due.
Viktor has identified economic recession as being a major risk, but does not appear to be
putting into place appropriate controls to be able to manage his business when it arises.
Sales pricing
There appears to be no formal controls over the pricing system – it just seems to be based on
customers’ willingness to accept high prices. If there is a risk of economic recession,
customers may not be prepared to pay these prices and VCF will be forced to adopt more
sophisticated pricing methods.
In addition, the risk of competitors finally being able to improve their products to match or
exceed those of VCF, or a failure within VCF’s innovation will also lead to lower sales
prices. Without the appropriate pricing controls, such changes may not be easily managed.
Exchange control
Adverse movements in the exchange rate are treated as an acceptable risk in that gains and
losses have tended to equate. However, by implementing basic control through hedging
against adverse rate movements, Viktor should be able to make a net gain – or at least
minimise losses. This control can be particularly effective as payment is often made over
several months during which exchange rates could materially fluctuate.
Staff management
Viktor’s HR policy appears to be controlled through achievement of sales growth – high
salaries, targets.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Manager assessment appears to depend on Viktor’s personal involvement; there seems to be
no formal system of appraising managers. This is more of a problem as the achievement of
many of the responsibilities of management cannot be measured in monetary terms; other
than Viktor’s knowledge of competitors, it is difficult to see how standards of after-sales
service and customer satisfaction are being measured to benchmark managers’ performance.
In addition cost control does not appear to be a major element in the assessment of managers’
performance.
In addition, management moral may not be controlled effectively. Viktor will often bypass
area managers to take personal control of customers.
pl
e
His approach of dismissing staff who do not agree with his way of doing things undermines
any controls there may be to ensure that the firm follows appropriate legal and regulatory
requirements when dealing with staff discipline and dismissal. There is a risk that VCF may
be sued for unfair dismissal and that Viktor’s reputation deters talented individuals of
applying for employment with the firm.
Research and development
The fact that research and development is expensed suggests that it is not linked into any
product thus specific product development lacks clarity and the benefits of R&D activity are
uncertain. Some uncertainties are inevitable given the nature of the industry; however there
seems to be risks that activity is wasted on projects that provide no benefits, that projects fail
to deliver the planned benefits and costs are not adequately controlled.
Sa
m
In addition, under IFRS development expenditure must be capitalised if it meets the stated
criteria. It is probably that some of the expenditure related to specific products should be
capitalised. This may be an isolated case, but it could indicate weak controls over selection
and application of accounting policies.
Patent protection
The main control is the institution of legal proceedings but this may be a more effective
control for limiting losses than avoiding the risks of competitors using VCF’s technology in
the first place. There do not appear to be any restrictions placed on staff moving to
competitors and taking knowledge with them that competitors can use; the chances of this
happening may be enhanced by Viktor’s dismissal of unhappy staff.
(b)
Report
Tutorial note: This question requires candidates to give similar emphasis to each of
corporate governance (especially the role and function of the Board); risk management
strategy; and internal controls. A good report is likely to utilise the evaluation in the answer
to part (a) but needs to make specific recommendations for improvement. It is insufficient to
identify weaknesses in existing governance, risk management strategy and internal controls.
Recommendations need to be specific (e.g. “establish a risk register and assess risks by
considering their likelihood and impact”), rather than general (such as “improve risk
management procedures”). Professional marks are allocated for a report format.
To: The Board
From: Management consultant
Subject: Improvements in governance, risk management and internal controls
Date: 07 April 200X
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Introduction
In accordance with your terms of reference issued on the 25th February 200X, I have reviewed
the company’s corporate governance, risk management strategy and internal controls.
My report, as follows, considers where the firm’s current practice in these three areas, as
benchmarked against good practice, may be considered as being below such good practice.
Recommendations have been made, that if implemented, would bring the firm’s practice into
line with good practice. with recommendations.
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e
As Pacific Country currently has no specific corporate governance code in operation, I have
used the UK’s Corporate Governance Code as an appropriate benchmark as being the leading
principles based code, often used as the basis for many other countries codes. For both risk
management and internal controls, the Committee of Sponsoring Organisations of the
Treadway Commission (COSO) guidelines have been used – again these are the most
commonly used guidelines for internal control and risk management.
CORPORATE GOVERNANCE
VCF fails to fulfill several key requirements of good corporate governance practice. Nearly
twenty years’ experience of applying corporate governance principles within the UK have
shown the benefits to listed companies of applying good corporate governance. Initially,
directors were highly skeptical of the need for such codes, but a review three years after the
first code was introduced in the UK, showed that the vast majority of directors were in favour
and said the Code was of benefit not only in the improvements to the way they managed their
companies but also to the way external interests viewed them.
Sa
m
In a principles based approach, the board may decide not to apply specific aspects of the code.
In doing so, they would be required to explain in the annual report their reasons for not doing
so. It is then left to the market to decide the reaction, if any (e.g. share price discount,
increased cost of capital).
The failure to follow best practice may mean that VCF is seen as riskier than it need be, and
hence less appealing to investors, resulting not only in a lower share price but also higher cost
of capital, greater “interest” from regulators and perhaps a reluctance for “high flying”
employees to join the company.
In addition, implementing best practice early would send a good signal to the market of the
intentions of the board to discharge its duties in the best interests of shareholders. This will
be of significant benefit to VCF should it plan to raise additional funding for expansion.
Combined role of CEO and Chairman
A key element of the UK’s approach to running the company is for the roles of the CEO and
Chairman to be separated. This is not only to ensure that unfettered power is not concentrated
in the hands of one individual but also to allow each role to be effectively carried out.
Currently the board’s operation and that of VCF is completely dependent on Jack Viktor. In
reality the board does not seem to be operating as a board, rather more as a forum to enable
the CEO to brief the other directors.
Given that VCF has rapidly grown over the last ten years, more of Jack Viktor’s time will
have been devoted to running the business and far less to ensuring that the board was
effective.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
An independent Chairman, with appropriate experience of being a chairman and of the
industry that VCF operates within should be appointed as part of the restructuring of the
board.
Non-executive directors
Although two of the four directors are non-executives, the connections both have with the
company means that they cannot be classified as independent. Being independent means that
the only connection they have with the company is their salary – no bonuses, past
employment, trade connections, family connections etc.
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Governance guidelines state that at least 50% of the board should comprise independent nonexecutive directors and will thus be able to contribute an objective view of the company.
In addition there is no indication that either of the non-executive directors has significant
financial expertise; at least one non-executive director ought to have an accounting
qualification to be able to analyse the accounting information with appropriate knowledge.
Board meetings
The board does not appear to be meeting often enough (currently only once every three
months) to be exercising effective supervision over the company. Best practice indicates that
boards would meet at least once every month, with regular meetings as necessary of board
committees.
Sa
m
The board meetings should be controlled by the Chairman with an agenda and meeting papers
issued in good time to allow directors to prepare. All directors should have unrestricted
access to whatever information they require for the board meetings. It should be clear what
decisions should be made by the board and which can be made by the CEO prior to reporting
to the board.
Board Committees
VCF does not operate the committee structure recommended by corporate governance
guidance (i.e. a nominations committee, remuneration committee and audit committee).
Nomination committee
A nomination committee, made up of a mix of executive and non-executive directors (no one
group or individual should dominate) would lead the process for board appointments. The
committee needs to consider carefully the best structure of the board including the balance
between executives and non-executives, the range of skills possessed by the board, the need
for continuity and the appropriate size of the board.
Audit committee
An audit committee would be made up of independent non-executive directors. This
committee would be responsible for certain control tasks including reviewing financial
information, the integrity of the financial statements and VCF’s system of risk management,
and liaising with, and reviewing, the work of external audit. They would also consider the
need for an internal audit function.
At least one member of this committee should have relevant and recent financial experience.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Remuneration committee
A remuneration committee again consists of independent non-executive directors. Their role
will be to ensure that the structure and levels of remuneration paid to directors are sufficient
to attract, retain and motivate directors of the quality to run the company successfully. They
would also consider the level of remuneration of managers just below the board (e.g. the area
managers).
Though salaries paid to directors and managers could well be justified, the increased
transparency through the use of a remuneration committee can mean market acceptance and
justification.
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Views of shareholders
There appears to be no mechanism for seeking the views of shareholders other than the CEO,
who is the majority shareholder. It is important under corporate governance to ensure that the
rights of the minority shareholders are protected and that they are kept informed of events.
Where an individual shareholder is considered to be significant (e.g. holding at least 1% of
the shares) regular meetings (e.g. quarterly) should be arranged to seek the views of such
shareholders. It is usually the responsibility of the Chairman to ensure the two way dialogue
between the board and shareholders.
RISK MANAGEMENT STRATEGY
Sa
m
Overall VCF does not appear to have a clear risk management framework – this is a specific
failing of the board as an effective board is critical to risk management. Within most
corporate governance codes, risk management is core to the process of internal control.
A typical risk management approach would be:

The board should formalise the strategic, tactical and operational objectives of VCF.

Events should be identified that may have a positive or negative impact on VCF
achieving its objectives.

The impact and probability of each event should then be assessed. This will include
the impact on each stakeholder group.

Once assessed, the action to be taken concerning each risk identified can be
considered (risk response).

Risks should be managed through the use of a risk register.

Risk awareness should be embedded throughout the organisation.
Whilst some of these elements appear to be used within VCF, they are somewhat limited in
their scope and centred around the CEO rather than the board. For example:

A high level of risk appears to be tolerated, but based on the CEOs risk appetite
(who admits to taking both high personal and business risks) with no clear idea of
whether the returns the company is achieving justify the level of risks being taken.

The board does not appear to have considered whether the benefits of countering
certain risks outweigh the costs, for example are the costs and resources required to
pursue legal action for infringement of patents worth the benefits?
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
A key aspect of risk identification is the CEO’s analysis of likely threats to cash
flow. Whilst this is a good starting point, it does not cover all risks that could
impact the business. There appears to be no input from the board or any other
source.

Reacting to a risk that has already hit, without any expectation, is most of the time a
recipe for disaster. VCF operates in many different geographical areas, each would
have separate risk profiles which must be managed and predicted. Contingency
plans should be in place and regularly updated to take into account scenarios of
different expectations.

The decisions made on whether to accept exchange risk have been determined by
historical balancing out of gains and losses, whereas VCF should also be
considering the likely future movements of exchange rates given the length of many
of the contracts.

Outsourcing and personal contact whilst useful, are limited methods for addressing
many of the main risks the company faces.
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
INTERNAL CONTROLS
In summary, the control system needs to depend less on the CEO’s involvement and have
more formal procedures in place.
Role of board
Sa
m
Expanded board membership, as recommended above, should enable the whole board to
exercise more effective supervision over the company. This includes carrying out a formal
process of risk identification, and monitoring and considering the effectiveness of internal
control, including formal monthly reports from the area managers plus an annual review of
internal control.
Internal audit
A small internal audit department could be established. Not only would it fulfil the
requirements of corporate governance guidelines, but it could be used to review the value for
money of a number of aspects of the operations, including supplier procurement, marketing
and research and development - thus potentially saving the business considerable costs.
Accounting system controls
The budgeting and management accounts system needs to be reviewed to assess whether all
the information produced is necessary.
Comparisons need to be made of actual costs with budgeted costs and variances investigated.
A more formal system of responsibility accounting needs to be introduced with costs
allocated to cost centres and ultimately to individuals for control purposes.
Costing system
The accounting system will also be more effective if it is more clearly linked with cost
drivers, the factors influencing costs.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
More attempts need to be made to link costs into products or groups of products, for example
allocating marketing costs across the products promoted and assessing how far research and
development costs can be linked into products.
This will provide a better idea of product profitability and enable more informed pricing
decisions to be taken. The CEO’s knowledge of competitors and other available industry
information may enable benchmarking against competitor best practice.
Area managers
The responsibilities of area managers need to be clarified with control procedures introduced
to ensure they perform their duties as intended.
Staff controls
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The system for appraising managers needs to be formalised, and the scope of assessment
widened, covering control over costs as well as the aspects currently appraised.
All staff should be formally appraised and feedback obtained to ascertain whether staff are
happy, since departure of dissatisfied staff to competitors may jeopardise VCF’s competitive
position.
VCF should ensure that staff contracts are drafted as tightly as possible as regards use
elsewhere of knowledge of VCF’s operations, and joining competitors, although local
employment law may limit how effective these restrictions can be.
Sa
m
Answer 14 INTERNAL AUDIT EFFECTIVENESS
Tutorial note: There are significant differences in quality among providers of internal audit that can
prevent them reaching their full potential. The mere presence of an internal audit function says nothing
about its capabilities.
An internal audit function can achieve heightened levels of effectiveness if it:
(1)
(2)
(3)
(4)
is strongly aligned with stakeholder needs;
achieves best-in-class capabilities;
complies with applicable professional standards; and
measures results.
The four action areas, which are described below, give management, audit committees and internal
auditors a high-level framework to assess internal audit effectiveness. Unless an organisation adopts
each measure comprehensively, it runs the risk of having an internal audit function that may fail to meet
the new, higher expectations for the key governance activity.
Stakeholder needs
In identifying and communicating with their stakeholders, internal audit is responsible for aggregating
and analysing risk assessments and audit results, compiling and presenting to the managing board (and
audit committee), enhancing and managing the global risk assessment process and maintaining a liaison
with the independent accountants.
Internal audit needs to understand the expectations of its primary stakeholders (senior management and
the audit committee) and align its activities accordingly. This alignment ensures that internal audit
functions and key stakeholders share the same priorities when it comes to applying internal audit
resources to risk management and control.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
For example, do the key sponsors, management and internal audit have the same view of the role of
internal audit? Once internal audit aligns itself with the priorities of its key stakeholders, the function
needs to establish solid lines of communication with senior management and/or the audit committee if
one is established.
By maintaining good communication, internal audit can also ensure that its priorities continue to match
those of its key stakeholders as they evolve.
Best-in-class capabilities
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Highly effective internal audit groups view best-in-class auditing practices as key to their success as
well as the success of their companies. To keep pace with organisational changes, and to meet the
heightened expectations of key stakeholders, an internal audit function needs to achieve proficiency in
its operations, processes and skill sets. Typically, top-performing internal audit groups exhibit a strong
commitment to the following areas:
Resources: Best-in-class internal audit departments identify the skills and resources they need
to achieve organisational objectives. They expand their risk management, compliance,
business and product capabilities to build on their core internal audit and control
competencies. They use flexible co-sourcing arrangements to acquire specialised skills from
third-parties.

People development: Investing in building career management practices for internal auditors
and designing learning and development curricula. An effective internal audit function
continuously measures levels of staff proficiency as well as career development progress.

Knowledge management: Top internal audit functions capture, manage and share their
internal knowledge, recognising its importance to the long-term success of the organisation.
Sa
m


Risk mitigation: To strengthen corporate antifraud and risk mitigation efforts, an internal audit
function must be aware of potential schemes and scenarios affecting the industries and
markets served by the organisation. It must understand measures intended to detect fraud and
be able to evaluate and test antifraud controls.

Risk assessment: A highly effective internal audit function has assessed the risks facing the
organisation and built an audit plan to address them. There is transparency to the process so
that key stakeholders can see the risk profile and understand the risks and their coverage.
Without a process to identify and communicate the underlying risks, stakeholders cannot
satisfy themselves that the audit plan is adequate. The process must also be dynamic and link
changes in the company’s risk profile to changes in the audit plan.

Tools and technology: Pervasive use of technology is a hallmark of highly effective internal
auditing functions, which use it to improve processes ranging from data retrieval to risk
monitoring. Continuous auditing techniques, data mining and predictive modelling can all be
employed to enhance the quality of the audit process.

Professional practices: Maintaining and upgrading audit methodology and identifying and
implementing best-in-class audit practices.
Applicable professional standards
An effective internal audit function will also operate in compliance with professional standards,
principally those of the Institute of Internal Auditors. In January 2004, the IIA revised its International
Standards for the Professional Practice of Internal Auditing to more directly address internal audit
responsibilities in the area of corporate governance.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
The revised Standards acknowledge the close link between corporate governance and the practice of
internal auditing, suggesting that work related to corporate governance is fundamental to the basic
performance of the internal auditing function.
In particular performance standard 2110 Governance requires that the internal audit activity assesses
and makes appropriate recommendations for improving the governance process in its accomplishment
of the following objectives:
Promoting appropriate ethics and values in the organisation;
Ensuring effective organisational performance management and accountability;
Communicating risk and control information to appropriate areas of the organisation; and
Coordinating the activities of and communicating information among the board, external and
internal auditors, and management.
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



The IIA revised standards also require both internal and external reviews of internal audit quality. To
address these requirements, a company needs to determine if its internal audit structure meets
organisational needs and complies with the IIA Standards. External assessments must be conducted at
least once every five years by a qualified, independent reviewer or review team from outside the
organisation.
Measuring results
On a routine basis, companies measure and quantify the performance effectiveness of their business
activities. In the same manner, internal audit needs to demonstrate its own effectiveness using a
performance measurement system tied to the expectations of its key stakeholders.
Sa
m
Only by referring back to the needs of its key stakeholders and regularly tracking its performance
against the expectations of the board, senior management and operating management, can an internal
audit function satisfy their increased scrutiny and more demanding expectations. To achieve this, the
balanced scorecard may be used, which goes well beyond numbers to examine important, broad-based
activities. The balanced scorecard concept, based on the simple premise that “measurement motivates”,
is used by thousands of corporations, organisations and government agencies worldwide.
Answer 15 FLIGHT INVESTMENT
Tutorial note: You should be able to derive a significant % of this answer from your F8 studies.
(a)
Purposes of an audit committee
The basis for establishing an audit committee primarily concerns corporate governance (i.e.
the ethical corporate behaviour of directors or others charged with governance in the creation
of wealth for all stakeholders). Such committees have been mandatory for domestic
companies listed on the New York Stock Exchange for many years and are also a requirement
of the London Stock Exchange for UK listed companies.
An audit committee is a sub-committee of the board, established by the board, which provides
an independent oversight of the organisation’s systems of internal control and financial
reporting process. This separate committee:

enables the board to delegate a thorough and detailed review of financial matters,
control systems and audit;

enables non-executive directors to contribute an independent judgement and play a
positive role in an area for which they are particularly fitted;

offers the internal and external auditors a direct link with non executive directors.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1039
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Taking, for example, the UK Corporate Governance Code, the main role and responsibilities
of the committee members must be set out in written terms of reference and include:
monitoring the integrity of the financial statements of the group, reviewing
significant financial reporting judgements contained in them;

reviewing the group’s internal financial controls and, unless expressly addressed by
a separate board risk committee composed of independent directors, or by the board
itself, to review the company’s internal control and risk management systems;

monitoring and reviewing the effectiveness of the group’s internal audit function;

making recommendations to the board to put before the shareholders for approval in
general meeting relating to the auditor’s appointment, re-appointment and removal
and approving the auditor’s remuneration and terms of engagement;

reviewing and monitoring the external auditor’s independence and objectivity and
the effectiveness of the audit process in the light of relevant professional and
regulatory requirements;

developing and implementing policy on the engagement of the external auditors to
supply non-audit services (having regard for relevant ethical guidance on the
provision of non-audit services by the external audit firm);

reporting to the board; identifying any matters on which action or improvement is
needed and making recommendations for the steps to be taken;

reviewing arrangements by which staff of the company may, in confidence, raise
concerns about possible improprieties in matters of financial reporting or other
matters and to ensure that arrangements are in place for the proportionate and
independent investigation of such matters and for appropriate follow-up action
Sa
m
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
(b)
Composition of the committee
Because of the nature of the work of an audit committee, its members should be independent
of the company and its executives. Thus its composition should be drawn from the nonexecutive directors of the board.
In a large company there should be a minimum of three members. Smaller companies may
have a minimum of two members for the audit committee. All must be independent, nonexecutive directors.
Guidance given in the UK Corporate Governance Code suggests that to be independent, each
non-executive director must:
1040

not have been an employee of the company within the last five years;

not have had material business relationships with the company in the past three years;

have no remuneration paid (apart from the director’s fee) by the company;

not participate in the company’s share option or performance-related pay schemes,
or be a member of the company’s pension scheme;

not have close ties with the company’s advisors, directors or senior employees;

not have been a member of the board (as a non-executive director) for more than
nine years;

be, or represent, a major shareholder;

not hold too many non-executive directorships in various companies; and

must therefore be able to devote enough time to the tasks in hand.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
At the present time Flight Investments has only one non-executive director, Mr Ackroyd. As
he has a close relationship with the CEO (he is his brother-in-law) he will not be perceived to
be independent.
In addition, good governance practice requires that at least 50% of the board should be
independent non-executive directors. As there are currently four executive directors plus Mr
Ackroyd, at least five non-executive directors should be appointed.
Should Mr Ackroyd resign (he hardly ever attends board meetings) then at least four nonexecutive directors will be required. Such numbers will be sufficient for an audit committee.
(c)
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At least one of the NEDs who will make up the audit committee must be experienced in
financial accounting (e.g. IFRS) and the others should have sufficient business experience to
be of appropriate assistance to the firm.
Specific responsibilities with internal audit and external auditors
Internal audit
Approve the appointment or termination of the head of internal audit.

Ensure that the internal auditor has direct access to the Audit Committee and is
accountable to the Audit Committee.

Review and assess the annual internal audit work plan, ensuring that it covers all
group companies.

Receive a report on the results of the internal auditors’ work on a periodic basis
including reports all group companies and locations visited.

Review and monitor group and local management’s responsiveness to the internal
auditor’s findings and recommendations.

Meet with the head of internal audit at least once a year without the presence of
management.

Monitor and assess the role and effectiveness of the internal audit function in the
overall context of the group’s and individual companies’ risk management systems.
Sa
m

External audit

Approve the terms of engagement and the remuneration to be paid in respect of
audit services provided for all of the auditors of the group;

Ensure that all the external auditors are independent of the group and group
companies. For example:




discussion with the auditors;
review of their policies and processes to maintain independence; and
compliance with appropriate ethical guidelines.
At the start of each annual audit cycle, ensure that appropriate plans are in place for
the group audit (e.g. the overall strategy, risk assessment, materiality, resources,
work plans and group accounting instructions).
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1041
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK

Review, with the group auditors, the findings of their work. For example:

discussing the outcome of the audit of each subsidiary;

discussing major issues that arose during the audit (both resolved and
unresolved);

key accounting and audit judgements;

levels of error identified during the audit; and

discussing with management and auditors why certain errors remain
unchanged.
Review with the group auditor’s the draft financial statements of each subsidiary
company, with particular attention to significant elements. For example:








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
compliance with legislation;
compliance with the applicable financial reporting framework (e.g. IFRS);
disclosure of all items and accounting policies;
large or unusual items;
foreign currency translation;
valuations of properties and investments;
consistency of treatment of like items in the group; and
all other financial information included in the annual report.
Review the audit representation letters (before signing by management);

Review the management letters and monitor management’s actions taken on its
recommendations.
Sa
m


Consider any modifications made by the group and subsidiary auditors in their
reports and in particular the impact of any subsidiary qualification on the group
auditor’s report.

Consider the planning of subsequent audits, with particular reference to:




1042
timing;
use of internal auditors;
use of computer-assisted auditing techniques; and
location visits.

Make recommendations to the main board on the appointment and remuneration of
the auditors.

Assess the effectiveness of the audit process for the group and for the subsidiary.
For example:

was the agreed audit plan met and where changes were made, understand
the reasons for such changes, including changes in perceived audit risks
and the work undertaken address those risks;

consider the robustness and perceptiveness of the group auditors in their
handling of the key accounting and audit judgements identified and in
responding to questions from the audit committees, and in their
commentary, where appropriate, on the systems of internal control;

obtain feedback about the conduct of the audit from key people involved
(e.g. finance directors and the head of internal audit).
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
The audit committee should develop and recommend to the board the company’s
policy in relation to the provision of non-audit services by the auditor. The audit
committee’s objective should be to ensure that the provision of such services does
not impair the external auditor’s independence or objectivity. In this context, the
audit committee should consider:

whether the skills and experience of the audit firm make it a suitable
supplier of the non-audit service;

whether there are safeguards in place to ensure that there is no threat to
objectivity and independence in the conduct of the audit resulting from the
provision of such services by the external auditor;

the nature of non-audit services, the related fee levels and the fee levels
individually and in aggregate relative to the audit fee; and the criteria
which govern the compensation of the individuals performing the audit.
pl
e

Answer 16 REPORTING ON INTERNAL CONTROL SYSTEMS
Tutorial note: As the question gave the UK CC and SOX as examples, it is a good idea to base your
answer on them. None the less, provided you are able to compare a “comply or explain” approach to a
rules-based approach, you should get the marks to pass.
UK Corporate Governance Code
Sa
m
The UK Corporate Governance Code requires that “The board should, at least annually, conduct a
review of the effectiveness of the group’s system of internal controls and should report to shareholders
that they have done so. The review should cover all material controls, including financial, operational
and compliance controls and risk management systems.”
Also, the Financial Services Authority (FSA) through the requirements of the London Stock Exchange,
requires a description of the main features of the internal control and risk management systems in
relation to the financial reporting process to be included in the corporate governance statement.
Between the FSA and the Turnbull Guidance (on applying the requirements of the UK Corporate
Governance Code) the board’s statements on internal control and risk management must refer to:

an on-going process, that it is regularly reviewed by the board, for identifying, evaluating and
managing the significant risks faced by the company (the process should be detailed);

an acknowledgement by the board of its responsibility for the system of internal control and
for reviewing its effectiveness;

an explanation that control systems are designed to manage rather than eliminate the risk of
failure to achieve business objectives and can only provide reasonable and not absolute
assurance against material misstatement or loss;

a detailed summary of the board’s processes applied in reviewing the effectiveness of internal
control; and

the process applied to deal with material internal control aspects of any significant problems
disclosed in the financial statements.
There is no requirement in the UK, under the FSA or UK Corporate Governance Code, for the auditors
to specifically test and report to the shareholders on the internal controls and risk management process.
They are, however, required by the FSA to review the directors’ statement of compliance with the UK
Corporate Governance Code’s requirements that include the above detail on internal control.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1043
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
Such a review would normally be made through:

enquiries with directors and other relevant parties (e.g. the audit committee) to understand the
process used by the directors and relate it to their understanding of internal control and
business risk systems through their audit work;

a review of board minutes and other relevant documentation (e.g. reports to the board from
internal audit) to assess whether or not they the directors’ statement is adequately supported;

attendance at any relevant board or committee meetings; and

obtaining written representations if considered necessary.
The review would also cover any “comply or explain” disclosure relating to the compliance statement.
pl
e
If the auditors are satisfied that the directors’ statement is relevant and as required, they do not refer to
it in their report. However, if they consider that the explanations for non-compliance (under “comply
or explain”) are insufficient or misleading, they will bring this to the attention of the users of the
financial statements in their audit report, without qualifying their opinion.
Whilst company auditors are not required to report to shareholders directly on internal controls, they
must, under auditing standards, understand the business environment, including internal control, of the
company. Any weakness in the controls must be reported to those charged with governance. In
addition they must review all other information published along with the financial statements to ensure
that there are no inconsistencies between the financial statements and the other information. This will
include all of the corporate governance, CSR and other such information.
Sarbanes-Oxley
Sa
m
Section 404 of Sarbanes-Oxley requires management to document and evaluate the design and
operation, and report on the effectiveness, of its internal control over financial reporting.
The internal control report must be included in the annual report and include the following components:

Management’s recognition of its responsibility for establishing and maintaining adequate
internal controls and procedures for financial reporting.

The framework used by management in its evaluation (e.g. COSO).

Management’s assessment of the effectiveness of the company’s internal control over
financial reporting and a statement of the effectiveness of the internal control.

A statement that the issuer’s external auditors have issued an attestation report on
management’s assessment of effectiveness of internal control over financial reporting and that
it is included in the annual report.
The report will also include:

the nature and extent of involvement by the chairman and CEO, but may also specify the
other members of the board involved in the internal controls over financial reporting. The
purpose is for shareholders to be clear about who is accountable for the controls.

disclosure of any “material weaknesses” in the company’s internal control over financial
reporting identified by management;

for frameworks developed internally, a description of the key metrics, measurement methods
(e.g. rates of compliance, fair value measures, etc) and tolerances allowed;
1044
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)

rates of compliance, failures, costs, resources committed and outputs (if measurable) achieved
as necessary; and

any qualification to the auditor’s attestation.
Under SOX, auditors have strict and extensive responsibilities to audit and report on the internal control
over financial reporting. They must:

give an opinion on the management’s assessment of the effectiveness of internal control over
financial reporting; and

an assessment of the effectiveness of the company’s internal control over financial reporting.
pl
e
The approach auditors must take is effectively the same as they would take for the full audit of the
financial statements.
The reporting requirement of the directors’ and the auditors is therefore a significant difference to the
requirements of the FSA and the UK Corporate Governance Code.
Answer 17 FERRY
(a)
Business risks
(b)
Processes for managing
Tutorial note: A lot of the answer needs to come from your ability to apply common sense and
commercial awareness. Also part (b) is clearly related to the requirement of part (a), it is appropriate
to adopt a “tabular” approach.
Sa
m
Rights to operate

The rights to operate, which provide assurance
that Ferry is a going concern for the time-being,
are for a limited period (only 5½ years of the 9
years remain). This casts doubts over the longterm future prospects of Ferry.

Accept at the present level (as one that
has to be borne) but bear in mind (e.g.
when making strategic decisions) the
impact that management’s actions could
have on any renewal of the rights.

Terms and conditions attached to the rights may
threaten Ferry’s operational existence if, for
example, there are any circumstances under
which the rights could be withdrawn.

Relevant terms and conditions should be
communicated to all staff so they are
clear about the importance of their areas
of responsibility.
Competition

Although at the moment there is none, any
competition in the future (e.g. from a bridge
crossing or if the right were to become nonexclusive) could reduce profitability.

Monitor the progress of plans for bridge
building or relevant road expansion projects.

Reduce the risk by increasing the reliability
and reputation of Ferry’s service, improving
comfort, etc (e.g. in air-conditioned lounges).

Although a major refurbishment has only
relatively recently been undertaken, Ferry
should manage its cash flows and borrowing
capability (e.g. bank loan facility) to carry
out repairs as and when needed.
Age of Ro-Ros

The age of the Ro-Ros (20 years) will have a
bearing on fuel consumption and other costs
(e.g. repairs and maintenance).
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1045
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
(a)
Business risks
(b)
Processes for managing
Environmental Protection Regulations
Ferry will have to comply with emissions
standards within 18 months. Costs must
necessarily be incurred to meet
Environmental Protection Regulations.

Quite apart from the emissions standards,
fuel leaks or other waste spills (e.g. of
sewage) may result in substantial fines.
Fuel prices
To reduce the risk of disruption to scheduled
crossings and to ensure that the Ro-Ros are
not withdrawn from use (for noncompliance), Ferry should:

ensure funds are available for the
investment in overhauling the engines;

plan the timing of the overhauls when
business is relatively low – taking only
one Ro-Ro out of use at a time;
Increases in fuel prices will reduce
profitability.

notify customers in advance of any
necessary changes in schedule (and
apologise for any inconvenience);

monitor and record the amount and
frequency of spills, etc (e.g. arising on
refuelling).

Incorporation of surcharges in the price
structure so that significant increases can be
passed on to the customers.

Hedging against the effect of energy price
(and exchange rate) risks through forward
contracts.

Manage the impact of the risk/modify the
business activity. For example, driving
conditions may be hazardous if weather
conditions are so bad as to disrupt the
crossing, therefore offer facilities in
comfortable surroundings in which travellers
can break their journey.

Keep tariffs (i.e. prices) under review and
respond to changes in the economy and
demand patterns. For example:
Sa
m


pl
e

Weather

Weather conditions may delay or cancel
crossings. Actual and potential customers
may prefer to drive if they face disruptions
and uncertain journey times.
Economy

Currently 70,000 vehicles a year is c. 40%
capacity (W). Although capacity has almost
doubled over two years, the demand for
travel is likely to be reduced if there is an
economic downturn (especially if journeying
is for holiday/leisure).
1046



charge premiums at peak and busy
periods;
offer discounts for advance bookings;
introduce a loyalty scheme for frequent
users.
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
(a)
Business risks
(b)
Processes for managing
Service levels

Ferry’s service is described as “efficient and 
timely”. Deterioration in service levels is
likely to result in loss of customers, revenue
and goodwill.
Ferry should benchmark how frequently it
operates, and if crossings are on time, against
a comparable Ro-Ro ferry service operating
in similar weather conditions.

Ferry’s reputation may suffer if there are 
complaints about the facilities provided
through franchise arrangements.
Ferry’s contractual arrangements
franchisees should ensure that:

WORKING
the franchisees bear the risks of nonperformance (e.g. through penalty
payments); and
pl
e

with
Ferry can terminate contracts
expeditiously and seek alternative
providers.
2 boats × 40 vehicles × 6 crossings per day × 365 days = c. 175,000 vehicles.
Therefore 70,000 represents 40% capacity.
Loss of subsidy
Ferry may be financially dependent on the 
subsidy which it receives. If information in
the quarterly returns is not submitted on a
timely basis, cash flows will deteriorate as
the local transport authority’s payments of

the subsidy will be delayed.
Ferry’s information system must have
internal controls necessary to provide
accurate and timely information on the
number of vehicles carried.
Sa
m


Inaccuracies in the returns (e.g. through
error) may result in payments being withheld
altogether.

Numbers returned could be fraudulently
overstated to inflate the amount of subsidy
received.
An internal audit function could assist in
providing assurance to management about
the reliability of the information being
submitted to the authority.
Passenger safety

Although passenger safety is of paramount 
importance, associated costs are likely to be
onerous.
Costs of providing a safe service should be
reflected in the prices charged (e.g. including
an insurance premium).

Passengers may prosecute Ferry for personal 
injury or damage to or loss of property.

A fatal accident could irreparably damage
Ferry’s image and result in a huge financial 
liability.
Ferry should disclaim liability where
appropriate (e.g. for valuables left in
unattended vehicles).
©2014 DeVry/Becker Educational Development Corp. All rights reserved. Staff training should be on-going with
regular safety drill procedures (e.g. in
manning the use of lifeboats).
1047
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
(a)
Business risks
(b)
Processes for managing
Crew safety

Ferry will have difficulty recruiting and 
maintaining the services of appropriately
qualified crew members if it does not have
sufficient regard for their health and safety.
Work rosters should ensure, for example,
that:

crew members take breaks between
journeys;

there is adequate “cover” when crew are
sick or taking leave.
Disaster
A serious accident (e.g. fire), collision or 
breakdown may threaten operations in both
the short and longer-term.
Safety management
The application for a safety management
certificate will be turned down if there is
insufficient information to support Ferry’s
conformity to documented procedures.

Recommendations for risk management
could include the deployment of on-board
equipment or rapid response from an external
emergency unit.

Ferry must have documented procedures.
Adherence to them must be monitored (e.g.
through captain’s logs) and their
effectiveness reported to management.
Sa
m

External consultants could be engaged to
develop a model to simulate unwanted
outcomes (e.g. collisions) and their potential
impacts (e.g. loss of life).
pl
e

An internal audit function could monitor and
review the safety management system and
make recommendations for improvements.

Answer 18 SOUTHERN CONTINENTS COMPANY
(a)
Risks management strategies
There are four strategies for managing risk and these can be undertaken in sequence. In the
first instance, the organisation should ask whether the risk, once recognised, can be
transferred or avoided.
Transference means passing the risk on to another party which, in practice means an insurer
or a business partner in another part of the supply chain (e.g. a supplier or a customer).
Avoidance means asking whether or not the organisation needs to engage in the activity or
area in which the risk is incurred.
If it is decided that the risk cannot be transferred nor avoided, it might be asked whether or
not something can be done to reduce or mitigate the risk. This might mean, for example,
reducing the expected return by diversify the risk or re-engineer a process to bring about the
reduction.
Risk sharing involves finding a party that is willing to enter into a partnership so that the risks
of a venture might be spread between the two parties. For example an investor might be
found to provide partial funding for an overseas investment in exchange for a share of the
returns.
1048
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Finally, an organisation might accept or retain the risk, believing there to be no other feasible
option. Such retention should be accepted when the risk characteristics are clearly known
(the possible hazard, the probability of the risk materialising and the return expected as a
consequence of bearing the risk).
Application to risks
Three risks to the Southland factory are described.
Risk to the security of the factory in Southland. This risk could be transferred. The
transference of this risk would be through insurance where an insurance company will assume
the potential liability on payment, by SCC, of an appropriate insurance premium.
pl
e
Risk to the supply of one of the key raw materials that experienced fluctuations in world
supply. This risk will probably have to be accepted although it may be possible, with
redesigning processes, to reduce the risk.
If the raw material is strategically important (i.e. its use cannot be substituted or reduced), risk
acceptance will be the only possible strategy. If products or process can be redesigned to
substitute or replace its use in the factory, the supply risk can be reduced.
The environmental risk that concerned a possibility of a poisonous emission can be reduced
by appropriate environmental controls in the factory. This may require some process changes
(e.g. inventory storage) or amendments to internal systems to ensure that the sources of
emissions can be carefully monitored.
Sa
m
Tutorial note: The strategies for the individual risks identified in the case are not the only
appropriate responses and other strategies are equally valid providing they are supported
with adequate explanation.
(b)
Embedded risk
Risk awareness is the knowledge of the nature, hazards and probabilities of risk in given
situations. Whilst management will typically be more aware than others in the organisation of
many risks, it is important to embed awareness at all levels so as to reduce the costs of risk to
an organisation and its members (which might be measured in financial or non-financial
terms).
In practical terms, embedding means introducing a taken-for-granted risk awareness into the
culture of an organisation and its internal systems. Culture, defined in Handy’s terms as “the
way we do things round here” underpins all risk management activity as it defines attitudes,
actions and beliefs.
The embedding of risk awareness into culture and systems involves introducing risk controls
to the process of work and the environment in which it takes place. Risk awareness and risk
mitigation become as much a part of a process as the process itself so that people assume such
measures to be non-negotiable components of their work experience. In such organisational
cultures, risk management is unquestioned, taken for granted, built into the corporate mission
and culture and may be used as part of the reward system.
Tutorial note: Other meaningful definitions of culture in an organisational context are
equally acceptable.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1049
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
(c)
Performance-related pay
Benefits
In general terms, performance-related pay serves to align directors’ and shareholders’
interests in that the performance-related element can be made to reflect those things held to be
important to shareholders (e.g. financial targets). This, in turn, serves to motivate directors,
especially if they are directly responsible for a cost or revenue/profit budget or centre.
pl
e
The possibility of additional income serves to motivate directors towards higher performance
and this, in turn, can assist in recruitment and retention. Finally, performance-related pay can
increase the board’s control over strategic planning and implementation by aligning rewards
against strategic objectives.
Implications of package offered to Choo Wang
Choo Wang’s package appears to have a number of advantages and shortcomings. It was
strategically correct to include some element of pay linked specifically to Southland success.
This will increase Choo’s motivation to make it successful and indeed, he has said as much –
he appears to be highly motivated and aware that additional income rests upon its success.
Against these advantages, it appears that the performance-related component does not take
account of, or discount in any way for, the risk of the Southland investment. The bonus does
not become payable on a sliding scale but only on a single payout basis when the factory
reaches an “ambitious” level of output.
Sa
m
Accordingly, Choo has more incentive to be accepting of risk with decisions on the Southland
investment than risk averse. This may be what was planned, but such a bias should be
pointed out.
Clearly, the company should accept some risk but recklessness should be discouraged. In
conclusion, Choo’s PRP package could have been better designed, especially if the Southland
investment is seen as strategically risky.
Answer 19 H&Z COMPANY
(a)
Risk management
(i)
Roles of a risk manager
Providing overall leadership, vision and direction, involving the establishment of risk
management (RM) policies, establishing RM systems, etc. Seeking opportunities for
improvement or tightening of systems.
Developing and promoting RM competences, systems, culture, procedures, protocols and
patterns of behaviour. It is important to understand that risk management is as much about
instituting and embedding risk systems as much as issuing written procedure. The systems
must be capable of accurate risk assessment which seems not to be the case at H&Z as he did
not account for variables other than impact/hazard.
Reporting on the above to management and risk committee as appropriate. Reporting
information should be in a form able to be used for the generation of external reporting as
necessary. John’s issuing of “advice” will usually be less useful than full reporting
information containing all of the information necessary for management to decide on risk
policy.
1050
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
Ensuring compliance with relevant codes, regulations, statutes, etc. This may be at national
level (e.g. Sarbanes Oxley) or it may be industry specific. Banks, oil, mining and some parts
of the tourism industry, for example, all have internal risk rules that risk managers are
required to comply with.
Tutorial note: The examiner directed the markers “do not reward bullet lists” because the
question says “describe”.
(ii)
John Pentanol’s understanding of his role
John appears to misunderstand the role of a risk manager in four ways.
pl
e
Whereas the establishment of RM policies is usually the most important first step in risk
management, John launched straight into detailed risk assessments (as he saw it). It is much
more important, initially, to gain an understanding of the business, its strategies, controls and
risk exposures. The assessment comes once the policy has been put in place.
It is important for the risk manager to report fully on the risks in the organisation and John’s
issuing of “advice” will usually be less useful than full reporting information. Full reporting
would contain all of the information necessary for management to decide on risk policy.
He told Jane Xylene that his role as risk manager involved eliminating “all of the highest
risks at H&Z Company” which is an incorrect view. Jane Xylene was correct to say that
entrepreneurial risk was important, for example.
Sa
m
The risk manager is an operational role in a company such as H&Z Company and it will
usually be up to senior management to decide on important matters such as withdrawal from
risky activities. John was being presumptuous and overstepping his role in issuing advice on
withdrawal from Risk 3. It is his job to report on risks to senior management and for them to
make such decisions based on the information he provides.
(b)
John’s advice
The advice is based on an incomplete and flawed risk assessment. Most simple risk
assessment frameworks comprise at least two variables of which impact or hazard is only one.
The other key variable is probability. Risk impact has to be weighed against probability and
the fact that a risk has a high potential impact does not mean the risk should be avoided as
long as the probability is within acceptable limits. It is the weighted combination of
hazard/impact and probability that forms the basis for meaningful risk assessment.
John appears to be very certain of his impact assessments but the case does not specify on
what information the assessment is made. It is important to recognise that “hard” data is
very difficult to obtain on both impact and probability. Both measures are often made with a
degree of assumption and absolute measures such as John’s ranking of Risks 1, 2 and 3 are
not as straightforward as he suggests.
John also overlooks a key strategic reason for H&Z bearing the risks in the first place, which
is the return achievable by the bearing of risk. Every investment and business strategy carries
a degree of risk and this must be weighed against the financial return that can be expected by
the bearing of the risk.
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1051
GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
(c)
Value of risk management
(i)
Definition of “entrepreneurial risk”
Entrepreneurial risk is the necessary risk associated with any new business venture or
opportunity. It is most clearly seen in entrepreneurial business activity, hence its name. In
“Ansoff” terms, entrepreneurial risk is expressed in terms of the unknowns of the
market/customer reception of a new venture or of product uncertainties (e.g. product design,
construction, etc). There is also entrepreneurial risk in uncertainties concerning the
competences and skills of the entrepreneurs themselves.
(ii)
pl
e
Entrepreneurial risk is necessary, as Jane Xylene suggested, because it is from taking these
risks that business opportunities arise. The fact that the opportunity may not be as hoped does
not mean it should not be pursued. Any new product, new market development or new
activity is a potential source of entrepreneurial risk but these are also the sources of future
revenue streams and hence growth in company value.
Jane Xylene’s view of risk management
There are a number of arguments against risk management in general. These arguments apply
against the totality of risk management and also of the employment of inappropriate risk
measures.
There is a cost associated with all elements of risk management which must obviously be
borne by the company.
Sa
m
Disruption to normal organisational practices and procedures as risk systems are complied
with.
Slowing (introducing friction to) the seizing of new business opportunities or the development
of internal systems as they are scrutinised for risk.
“STOP” errors can occur as a result of risk management systems where a practice or
opportunity has been stopped on the grounds of its risk when it should have been allowed to
proceed. This may be the case with Risk 3 in the case. (Contrast with “GO” errors which are
the opposite of STOP errors.)
There are also arguments for risk management people and systems in H&Z. The most
obvious benefit is that an effective risk system identifies those risks that could detract from
the achievements of the company’s strategic objectives. In this respect, it can prevent costly
mistakes by advising against those actions that may lose the company value. It also has the
effect of reassuring investors and capital markets that the company is aware of and is in the
process of managing its risks. Where relevant, risk management is necessary for compliance
with codes, listing rules or statutory instruments.
Answer 20 ETHICAL THEORIES
(a)
Ethical dilemma
Ethical dilemmas may arise when different values compete. These could include:
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client and corporate;
individual and collective;
means and ends.
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STUDY QUESTION BANK – GOVERNANCE, RISK AND ETHICS (P1)
The case highlights a typical dilemma in the workplace. Clearly there is no conflict between
what Boris should do as an accounting professional and the requirements of the organisation.
The conflict arises if he bows to the pressure he is being subjected to and turns a blind eye.
Considering this case from the viewpoint of an outsider, it is easy to take the moral high
ground. Boris must obviously “do the right thing” and refuse to condone Chris’s proposal.
But it is not as easy as that for Boris. He has spent many years building up an effective
partnership with Chris, and respects his abilities and judgement. If he reports him, and Chris
is reprimanded, it will sour the relationship.
(b)
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Boris is therefore under pressure, both because of Chris’s seniority and because the two
managers like and respect each other. Under pressure, it is human nature to be tempted to
take the easy option.
Theories and approaches
Deontological theories
Deontological theories maintain that the right action to pursue is independent of the
consequences of that action. The ends are less important than the means. The right action is
to keep promises, repay debts and abide by contracts irrespective of what the consequences
are.
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This view is most commonly associated with the work of the German philosopher Immanuel
Kant whose famous categorical imperative argued that “I ought never to act in such a way
except that I can also will that my maxim should become a universal law”. In other words, do
unto others as you would have them do to you. It is about treating people fairly and with
respect.
There are many relationships in the public services that are of this kind. The doctor has a
duty of care towards the patient, the teacher towards the student. This is a characteristic of
professional roles in the public services.
Teleological theories
Teleological theories provide the second major guide to moral decisions, where actions are
evaluated in terms of their consequences. Public policy goals, in terms of a better educated or
healthier citizenry, might be examples of such consequences.
Utilitarianism is the best known teleological theory. Utilitarianism holds that an action is
morally justifiable if it leads to the greatest happiness of the greatest number. It is concerned
with the maximisation of good and the minimisation of harm. The concept of measurement is
a key feature of utilitarianism and a variation of utilitarianism can be found in cost-benefit
analysis.
For example, in the planning of a new airport, the costs and benefits of noise pollution, road
congestion, threats to life and wildlife, threats to the quality of life and the benefits of
different forms of transport, would be calculated in as comprehensive a manner as possible.
Virtues approach
A virtues approach looks to the qualities of individuals which allow them to be moral. This
approach has a long history going back to Confucius and Aristotle and its modern equivalent
can be found in those virtues that are said to characterise those who hold public office.
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GOVERNANCE, RISK AND ETHICS (P1) – STUDY QUESTION BANK
It is therefore argued that public policies will be ethical because those managers involved in
the formulation and implementation of policy possess integrity and probity, are impartial and
honest.
This view is one that is shared by professionals in the public services, who see their
professional ethos as virtuous.
Justice approach
Justice is concerned with issues of fairness, entitlement and dessert. The formal principle of
justice can be stated in terms of treating like cases alike and unlike cases differently. Justice
can take two forms:
distributive justice (how goods and services are distributed in society); and
procedural justice.
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It is often argued that the market is unjust since it discriminates against those who are poor
and unemployed. (But consider for example, in the UK, prescriptions are free at the point of
delivery to many who fall into these categories, whilst the tax-payers are obliged to pay for
the same medications). In organisations, criteria for distributive justice might be applied (e.g.
when paying bonuses).
Rights-based approach
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Individuals have rights including legal, political, employee and human rights. Rights are
often seen as a corollary of duties. That is, employees may have certain rights such as the
right to a healthy and safe working environment but at the same time they may have a duty to
give “a fair day’s work for a fair day’s pay”.
In the UK, the Patient’s Charter (for the national health service) takes account of the fact that
patients do have rights but also have duties, such as keeping appointment times and not
abusing staff. Schools and colleges similarly have charters which, for example, in return for
the right to education in a safe environment expect students to be punctual, participate in
classes and meet assignment deadlines.
Answer 21 ETHICAL MANAGEMENT
(a)
“Ethical management” in the public services
The notion of “the manager” in public services is not always clear-cut (as in the private
sector) and can be taken to include different categories of public service employees. For
example, teachers, nurses, doctors and a whole host of professionals in the public services
carry out managerial responsibilities, particularly in terms of managing people or budgets.
Ethical management therefore concerns:
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the impact on managers of managing in an increasingly complex and ambiguous
environment where the management task is no longer straight forward with an
expected outcome

managing across organisational and cultural boundaries;

the increasing demands for managers to take more responsibility but without
necessarily having the appropriate authority;

reconciling individual values with organisational values;

the nature of the public service ethos;
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