(d) Explain to the management of Bailey’s why consideration should be given to resolving the problems through:
(i) job rotation; (5 marks)
(d) Explain to the management of Bailey’s why consideration should be given to resolving the problems through:
(i) job rotation; (5 marks)
(b) Paying a dividend of 10c per share (1 mark)
(d) Combining all reserves into a single figure. (2 marks)
1 The board of Worldwide Minerals (WM) was meeting for the last monthly meeting before the publication of the yearend
results. There were two points of discussion on the agenda. First was the discussion of the year-end results;
second was the crucial latest minerals reserves report.
WM is a large listed multinational company that deals with natural minerals that are extracted from the ground,
processed and sold to a wide range of industrial and construction companies. In order to maintain a consistent supply
of minerals into its principal markets, an essential part of WM’s business strategy is the seeking out of new sources
and the measurement of known reserves. Investment analysts have often pointed out that WM’s value rests principally
upon the accuracy of its reserve reports as these are the best indicators of future cash flows and earnings. In order to
support this key part of its strategy, WM has a large and well-funded geological survey department which, according
to the company website, contains ‘some of the world’s best geologists and minerals scientists’. In its investor relations
literature, the company claims that:
‘our experts search the earth for mineral reserves and once located, they are carefully measured so that the company
can always report on known reserves. This knowledge underpins market confidence and keeps our customers
supplied with the inventory they need. You can trust our reserve reports – our reputation depends on it!’
At the board meeting, the head of the geological survey department, Ranjana Tyler, reported that there was a problem
with the latest report because one of the major reserve figures had recently been found to be wrong. The mineral in
question, mallerite, was WM’s largest mineral in volume terms and Ranjana explained that the mallerite reserves in
a deep mine in a certain part of the world had been significantly overestimated. She explained that, based on the
interim minerals report, the stock market analysts were expecting WM to announce known mallerite reserves of
4·8 billion tonnes. The actual figure was closer to 2·4 billion tonnes. It was agreed that this difference was sufficient
to affect WM’s market value, despite the otherwise good results for the past year. Vanda Monroe, the finance director,
said that the share price reflects market confidence in future earnings. She said that an announcement of an incorrect
estimation like that for mallerite would cause a reduction in share value. More importantly for WM itself, however, it
could undermine confidence in the geological survey department. All agreed that as this was strategically important
for the company, it was a top priority to deal with this problem.
Ranjana explained how the situation had arisen. The major mallerite mine was in a country new to WM’s operations.
The WM engineer at the mine said it was difficult to deal with some local people because, according to the engineer,
‘they didn’t like to give us bad news’. The engineer explained that when the mine was found to be smaller than
originally thought, he was not told until it was too late to reduce the price paid for the mine. This was embarrassing
and it was agreed that it would affect market confidence in WM if it was made public.
The board discussed the options open to it. The chairman, who was also a qualified accountant, was Tim Blake. He
began by expressing serious concern about the overestimation and then invited the board to express views freely. Gary
Howells, the operations director, said that because disclosing the error to the market would be so damaging, it might
be best to keep it a secret and hope that new reserves can be found in the near future that will make up for the
shortfall. He said that it was unlikely that this concealment would be found out as shareholders trusted WM and they
had many years of good investor relations to draw on. Vanda Monroe, the finance director, reminded the board that
the company was bound to certain standards of truthfulness and transparency by its stock market listing. She pointed
out that they were constrained by codes of governance and ethics by the stock market and that colleagues should be
aware that WM would be in technical breach of these if the incorrect estimation was concealed from investors. Finally,
Martin Chan, the human resources director, said that the error should be disclosed to the investors because he would
not want to be deceived if he were an outside investor in the company. He argued that whatever the governance codes
said and whatever the cost in terms of reputation and market value, WM should admit its error and cope with
whatever consequences arose. The WM board contains three non-executive directors and their views were also
invited.
At the preliminary results presentation some time later, one analyst, Christina Gonzales, who had become aware of
the mallerite problem, asked about internal audit and control systems, and whether they were adequate in such a
reserve-sensitive industry. WM’s chairman, Tim Blake, said that he intended to write a letter to all investors and
analysts in the light of the mallerite problem which he hoped would address some of the issues that Miss Gonzales
had raised.
Required:
(a) Define ‘transparency’ and evaluate its importance as an underlying principle in corporate governance and in
relevant and reliable financial reporting. Your answer should refer to the case as appropriate. (10 marks)
(b) Explain Kohlberg’s three levels of moral development and identify the levels of moral development
demonstrated by the contributions of Gary Howells, Vanda Monroe and Martin Chan. (12 marks)
(c) Critically discuss FOUR principal roles of non-executive directors and explain the potential tensions between
these roles that WM’s non-executive directors may experience in advising on the disclosure of the
overestimation of the mallerite reserve. (12 marks)
(d) Draft a letter for Tim Blake to send to WM’s investors to include the following:
(i) why you believe robust internal controls to be important; and
(ii) proposals on how internal systems might be improved in the light of the overestimation of mallerite at
WM.
Note: four professional marks are available within the marks allocated to requirement (d) for the structure,
content, style. and layout of the letter.
(16 marks)
(c) Define ‘market risk’ for Mr Allejandra and explain why Gluck and Goodman’s market risk exposure is
increased by failing to have an effective audit committee. (5 marks)
(c) Mr Cobar, the chief executive of SHC, has decided to draft two alternative statements to explain both possible
outcomes of the secrecy/licensing decision to shareholders. Once the board has decided which one to pursue,
the relevant draft will be included in a voluntary section of the next corporate annual report.
Required:
(i) Draft a statement in the event that the board chooses the secrecy option. It should make a convincing
business case and put forward ethical arguments for the secrecy option. The ethical arguments should
be made from the stockholder (or pristine capitalist) perspective. (8 marks)
(ii) Draft a statement in the event that the board chooses the licensing option. It should make a convincing
business case and put forward ethical arguments for the licensing option. The ethical arguments should
be made from the wider stakeholder perspective. (8 marks)
(iii) Professional marks for the persuasiveness and logical flow of arguments: two marks per statement.
(4 marks)
2 The risk committee at Southern Continents Company (SCC) met to discuss a report by its risk manager, Stephanie
Field. The report focused on a number of risks that applied to a chemicals factory recently acquired by SCC in another
country, Southland. She explained that the new risks related to the security of the factory in Southland in respect of
burglary, to the supply of one of the key raw materials that experienced fluctuations in world supply and also an
environmental risk. The environmental risk, Stephanie explained, was to do with the possibility of poisonous
emissions from the Southland factory.
The SCC chief executive, Choo Wang, who chaired the risk committee, said that the Southland factory was important
to him for two reasons. First, he said it was strategically important to the company. Second, it was important because
his own bonuses depended upon it. He said that because he had personally negotiated the purchase of the Southland
factory, the remunerations committee had included a performance bonus on his salary based on the success of the
Southland investment. He told Stephanie that a performance-related bonus was payable when and if the factory
achieved a certain level of output that Choo considered to be ambitious. ‘I don’t get any bonus at all until we reach
a high level of output from the factory,’ he said. ‘So I don’t care what the risks are, we will have to manage them.’
Stephanie explained that one of her main concerns arose because the employees at the factory in Southland were not
aware of the importance of risk management to SCC. She said that the former owner of the factory paid less attention
to risk issues and so the staff were not as aware of risk as Stephanie would like them to be. ‘I would like to get risk
awareness embedded in the culture at the Southland factory,’ she said.
Choo Wang said that he knew from Stephanie’s report what the risks were, but that he wanted somebody to explain
to him what strategies SCC could use to manage the risks.
Required:
(a) 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)
(d) Corporate annual reports contain both mandatory and voluntary disclosures.
Required:
(i) Distinguish, using examples, between mandatory and voluntary disclosures in the annual reports of
public listed companies. (6 marks)