ACCA P1 Revision Mock - Ans J11%28with marks%29

ACCA

Paper P1

Governance, Risk and Ethics

June 2011

Revision Mock – Answers

To gain maximum benefit, do not refer to these answers until you have completed the revision mock questions and submitted them for marking.

PAPER P1 : GOVERNANCE, RISKS AND ETHICS

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© Kaplan Financial Limited, 2011

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REVIS ION MOCK : ANSWERS

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ANSWER 1

(a) Concepts of Risk and Risk Management

Risk is the ‘chance of exposure to the adverse consequences of uncertain future events’. If and when those risks actually occur, they can have an adverse impact on the organisation’s objectives.

Risk management is therefore the process of reducing the possibility of adverse consequences either by reducing the likelihood of an event or its impact. Reducing the likelihood involves putting into place procedures to try and stop the risk actually occurring. For example, the risk of key staff leaving an organisation can be reduced by ensuring staff are being paid at or above the industry average wage. Reducing the impact involves risk mitigation procedures such as taking out insurance or an organisation withdrawing from a risky area of business.

Historically, the focus of risk management has been on preventing loss. However, recently, organisations have begun to view risk management in a different way, so that risks are also seen as opportunities to be seized. Organisations are accepting some uncertainty in order to benefit from higher rewards associated with higher risk. Risk management is being seen as a way to identify risks associated with new opportunities and to increase the probability of positive outcomes and maximise returns. Effective risk management is then seen as a way of enhancing shareholder value by improving performance.

Management are responsible for establishing a risk management system in an organisation. There are four elements to that system:

(1) Risk identification

Risks are identified by key stakeholders. Risks must obviously be identified before they can be managed. Key stakeholders normally include directors, managers and employees within a company and may also include other external stakeholders (Mendelow’s matrix is useful in determining the power and interests of external stakeholders and therefore their involvement in risk identification).

(2) Risk analysis

Risks are evaluated according to the likelihood of occurrence and impact on the organisation. This analysis provides a prioritised risk list identifying those risks that need the most urgent attention.

(3) Risk planning

Planning involves establishing appropriate risk avoidance policies. Policies include ceasing risky activities through to obtaining insurance against unfavourable events. Contingency planning involves establishing procedures to recover from adverse events, should they occur.

(4) Risk monitoring

Risks are monitored on an ongoing basis. Where risks change or new risks are identified then those risks are added to the risk analysis for appropriate categorisation and action.


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(b) The dynamic nature of risk assessment

The risks faced by organisations are not static; they change over time and between situations. One of the key features of any business environment is that the things that affect an organisation, either internal or external factors, are very changeable. In some situations, environmental factors change relatively little, but in other environments, risk factors can change a great deal.

BMB operates in a fairly dynamic environment since it exposed to frequent changes in internal and external risks.

• The government may alter the environmental emissions targets for example,

• the lease terms depending on passengers numbers

• In addition, the RSSB may insist on new safety criteria being met.

• Also, BMB is finding that their bio-diesel project, which seemed so worthwhile in terms of generating positive interest and reducing carbon emissions, may actually be incredibly risky since the production of bio-fuel itself may not be economically viable.

The risks that BMB faces can change with changes in the company’s internal activities as well as with external environmental changes, for possibility that BMB will need to refinance brings with it risks which need to be assessed.

The environmental change and turbulence faced by BMB means that the assessment of any given risk can change and therefore the strategy for managing that risk also needs to change, hence risk assessment itself must be dynamic as a direct result of risks being dynamic.

(c) Business Risks affecting BMB

Product/market risk

This is the risk that customers will not buy new products (or services) provided by the organisation, or that the sales demand for current products and services will decline unexpectedly.

For BMB there is the risk that lack of investment in railways will mean that customers turn to other modes of transport; BMB’s forecast income may therefore be overstated.

This risk is made worse by government policies focusing on road building at the expense of investment in the rail network. At worse, BMB may not be able to pay the lease amount to the government, jeopardising the going concern status of the company.

Commodity price risk

Businesses might be exposed to risks from unexpected increases (or falls) in the price of a key commodity.

The new trains that BMB want to run assume that sufficient quantities of bio-diesel will be available to power the trains. It will be extremely difficult to backward engineer these trains to run on ‘ordinary’ diesel; lack of supply of bio-diesel will increase the price of this resource forcing BMB to increase train ticket prices.

Too large an increase in prices will have the effect of forcing more customers back onto the roads. It seems, from the environmental group comments, that this is a real threat to the new project.


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Product reputation risk

Some companies rely heavily on brand image and product reputation, and an adverse event could put its reputation (and so future sales) at risk.

The reputation of BMB is based on the company’s ability to use innovative and new products as well as being able to advertise those products effectively.

The use of the bio-diesel train is a case in point here. However, the bio-diesel has not been fully tested and it could therefore still fail or have unforeseen side-effects (e.g. increase in pollution).

Currency risk

Currency risk, or foreign exchange risk, arises from the possibility of movements in foreign exchange rates, and the value of one currency in relation to another.

BMB is exposed to currency risk with respect to the sourcing of new trains. The trains are being manufactured in a country with a volatile exchange rate, with the sale being denominated in the second country’s currency.

Adverse movements will affect BMB as the amount payable will increase. Obtaining some form of hedging against this risk would be appropriate.

Tutorial note

Only three risks were required, however this is not an exclusive list

(d) Explain the ALARP principle in risk assessment

ALARP stands for ‘as low as reasonably practicable’. The ALARP principle is that the residual risk shall be as low as reasonably practicable.

Organisations cannot carry out their work without taking risks, for example if they are involved in hazardous activities or, like BMB, are responsible for the safety of many customers on a daily basis. In addition, many businesses choose to increase the risks they take, since higher risks often result in greater returns for shareholders. The directors have a duty to minimise the adverse impact of risks but the objective of risk management is not to avoid all risks entirely.

For a risk to be ALARP it must be possible to demonstrate that the cost involved in reducing the risk further would be disproportionate to the benefit gained. The ALARP principle arises from the fact that infinite time, effort and money could be spent on the attempt of reducing a risk to zero. It should not be understood as simply a quantitative measure of benefit against detriment. It is more a best common practice of judgment of the balance of risk and societal benefit.

For example, BMB may be able to eliminate the risk of trains being unable to run due to a lack of bio-fuel by installing engines which can run on either diesel or bio-fuel. However, these engines are likely to be prohibitively expensive and would significantly increase the cost of rail travel to all passengers.

Instead, BMB may manage the risk by developing supplier relationships and keeping up to date with commodity prices. This is a compromise solution that maintains the risk as low as reasonably practicable.


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(e) Press Release on behalf of the board of BMB

Climate change is possibly the greatest global issue we face. As with all companies, we at BMB have a role to play in managing this issue. We want to make that role as big as we can and to this ends, BMB has been working hard for some time to minimise the environmental impacts of diesel, both in climate and air pollution terms. BMB is therefore extremely excited to be able to announce the imminent arrival of our Bio-fuel 25 (‘BF25’) train services which will operate across the country.

We believe that bio-fuels can be used to power trains without compromising on passenger safety or train performance. It is our view that BMB’s position at the forefront of cleaner, more sustainable rail travel means we have a responsibility to pursue the use of bio-fuel and minimise any risks posed by its use.

(i) Investment in Risk Management Strategies

Any development into new, previously untested areas, brings with it risks. At BMB, we do not believe that potential risk should prevent the pursuit of ground breaking strategies which could benefit society. Instead, we believe with expert management, the adverse effects of risk can be brought to an acceptable level.

It is therefore important to have effective risk management strategies in place in order to be prepared for any possible adverse effects of our operations. We need to devise strategies to ensure the safety of our passengers at all times, and since innovation in our services can lead to changing risks, we must be able to constantly update our risk profile and develop responses to it. If trains begin to travel faster for example, we must update our safety regulations. Similarly, if there are increased risks from the use of bio-fuel, we must ensure it is stored and used in the correct manner.

The investment of management time and expertise in risk management strategies is therefore essential in order to face our businesses’ changing risks and minimise negative effects on all of our stakeholders.

(ii) The advantages of the investment in BMB BF25 Biodiesel trains

The BF25 Biodiesel trains will revolutionise rail travel. We believe that the advantages of this investment go far beyond the increased profits we expect our shareholders to enjoy.

Passengers will be able to travel safely and quickly on the new trains, secure in the knowledge that any negative environmental effect of their travel is minimised. We hope to achieve higher passenger numbers as a result of this ‘greener’ travel.

The operation of the BF25 trains will also help the government achieve emissions targets and begin to legislate for reduced carbon emissions from rail travel. Where BMB goes today, other rail networks will follow, bringing greater environmental benefits to society.

Through the launch of BF25 trains, which we hope will be operational by the end of the year, BMB will show that it is possible to use Bio-fuel in a safe effective way in rail travel. Our shareholders, passengers, local communities and also our competitors will all gain benefit from the investment we have made.


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ACCA marking scheme Marks

(a) Up to 2 marks for explanation of concept of risk 2

Up to 2 marks for explanation of concept of risk management 2

Up to 2 marks for each well explained stage in the process of managing risk in an organisation (looking for identification, analysis, planning and monitoring)

Max 6

––––

Maximum 10

––––

(b) Up to 2 marks for clear explanation of the dynamic nature of risk assessment

2

Up to 2 marks for each relevant example from the scenario Up to 4

––––

Maximum 6

––––

(c) For each of the three risks presented give a maximum of 4 marks. 1 mark for describing a relevant business risk, three marks for good discussion of it i.e. its impact on BMB – must be applied to BMB to gain merit

Up to 12

––––

Maximum 12

––––

(d) For each relevant point in explaining the ALARP principal, award up to 2 marks per point

Up to 6

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Maximum 6

(e) (i) For each reason why investment in risk management strategies is important up to 2 marks

6

(ii) For each explanation of why the investment will benefit particular stakeholders (passengers, shareholders, communities, government etc) award up to 2 marks

6

Professional marks: 1 each to be awarded for clarity, logical flow, persuasiveness and structure of the press release

4

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Maximum 16

Total 50

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ANSWER 2

(a) Content of code of ethics

There is no standard applicable in defining the content of a code of ethics although the OECD in line with other organisations does provide some useful advice as to what it should include.

Codes of ethics, above all other considerations, must be relevant to the organisation. This means dispensing with bland meaningless statements and embracing ideas and concepts that staff can readily relate to, believe in and use. Different industries will consider different issues as being important. This company, in line with others, will commit to ensuring human dignity is given the highest priority in all undertakings.


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This primary goal can them be extended into consideration of a variety of other areas such as the need to ensure client confidentiality as necessary or rules and regulations for dealing with partners/other NGOs or suppliers. The scope of issues covered is naturally a result of governor deliberation assisted through expert advice and benchmarking.

The code should have certain structural features being short and digestible for the user yet at the same time attempting to be comprehensive in nature. The balance is a difficult one to achieve in practice and in part relates to the extent to which general guidelines are offered or statements of principles made through which the individual should attempt to deploy their own ethical frame of reference.

The language used in codes of ethics should, as far as possible, be unambiguous or plain speaking so as to have the greatest impact on the reader and to be clear as to intent and application. Aggressive stances are often avoided except where it provides additional clarity such as in the case of ethical action regarding bribes and personal favours.

Codes may usefully draw upon the underlying principles of good governance or existing codes such as the IFAC code for accountants. Blending the most appropriate elements from a variety of sources is a difficult skill to apply in practice but necessary for the creation of a worthy document.

Implementation

Most of the criticism attached to codes of ethics is not with regard to their content but to a lack of sustained commitment in terms of their implementation. The most important requirement is for the board of governors to fully endorse and support the code into the future. This can be achieved through a formal launch and constant reference to the code by those in authority.

Implementation will require discussion with and training of staff in the nature and application of the code. Workshops can be used as part of a comprehensive roll out programme that ensures all staff are aware of and actively supporting its use. It is important that backroom as well as frontline staff are involved in the process and fully aware of their obligations regarding code use.

Rigorous enforcement and sanction for misuse will also be part of the implementation process with swift action against for those that do not adhere to its requirements. This form of action may seem hostile to the NGO but is important to ensure continued buy in to the process and reinforce the commitment and belief placed in the code by senior management.

Just as any other form of internal control needs to be audited the code of ethics and its use should become part of the remit of an internal audit function. Independent investigations should be carried out to ensure the code has been successfully adsorbed into the cultural fabric of the agency and reporting lines should be direct to the audit committee. This channel should be supported by appropriate whistleblower facilities for those in the organisation that feel the codes requirements are not being met. The need to provide all staff with a voice regarding code issues is very important to successful implementation.

Finally, there is a need to continually support and adapt the code over time. A code forgotten is not worth having. The code should be adapted as new challenges emerge in order to support its continued relevance to the organisation over time.


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(b) Good corporate governance is important for any organisation. The benefits that derive for private sector structures easily transpose to those in the NGO sector.

In as much as good governance leads to increased returns of profits for private organisations, the existence of controls, risk management and appropriate supervision ensure financial stability within the NGO. This finance related goal can be considered through the ability to continue to provide value for money, achieving entity goals and ensuring economic and efficient operations so as to meet needs both today and into the future.

Risk reduction through governance regulation has a particular resonance when considering the risks inherent in operating in poorer regions around the world. These risks may be political or physical and may manifest themselves in negative publicity or unexpected costs.

Good governance assists private organisations in attracting investment. This is equally true for NGOs. Those that wish to support such worthy causes such as governments or private individuals will feel more assured that their money is being put to good use if the organisation is well governed through appropriate structures for board operations and internal control.

The scenario identifies the increased commercialisation of the venture. This would include the use of professional management teams who understand and support governance apparatus used in the private sector. This alignment to their management style provides a positive working environment for management, a known structure within which to operate effectively. It is also true that the use of such management will make the implementation or imposition of such a regime easier to deal with for an NGO going through such a transition.

The existence of governance regimes includes the inherent need to adhere to the underlying governance concepts of integrity, justice, even handedness and probity amongst others. Since these will be fundamental ethical belief with the NGO, the implementation of additional levels of governance regulation is smoothed or made easier.

Overall, the benefits of good governance are within the word itself. To govern is to command and implicit in this is the ability to command in a beneficial way. The requirement is to attempt to balance the level to which commercial governance regulation is necessary or sought. It is of benefit to the extent to which it does not compromise the ability to offer the service in the most effective way. Clearly to embrace the concept without regard to this qualification would be inappropriate.

(c) Sustainability

Sustainability means operating in such a way today so as not to jeopardise the ability of the organisation to operate in the future. This can be extended to state that it relates to the need for the organisation to operate in a way that does not negatively impact on future generations' ability to enjoy the same opportunities and resources as those that are available to the current generation.

In the context of the charity, the former view relates to the context of the remark. The NGO must ensure that it holds in reserve some financial resources so that it can sustain itself and so its ability to continue into the future. This is important because of the almost endless need for such services in the world. The NGO could simply expend all of its resources on meeting current demand and find it difficult to continue to grow and retain staff beyond this level and into the future.


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Since the environmentalist issue of clean water supply is also mentioned the concept of sustainability could extend to the need to create sustainable sources of drinking water to serve communities over successive generations. This might involve the need for deep bore wells to tap into the water table far below the ground that can adequately be replenished by seasonal rains.

The issue of sustainability in all its forms is a global and immediate issue for NGOs but more importantly for commercial organisations that recognise the finite nature of global resources and seek to operate in ways that do not compromise the ability of future generations to enjoy the natural world in the same way as individuals do today.

ACCA marking scheme Marks

(a) 1 mark for each content issue to a maximum of 6 marks 6

1 mark for each implementation issue to a maximum of 6 marks 6

–––

Maximum 12

(b) 1 mark for each relevant point made to a maximum of 8 marks 8

(c) Up to 2 marks for a definition of sustainability 2

1 mark for each relevant contextual point to a maximum of 3 marks 3

–––

5

–––

Total 25

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ANSWER 3

(a) Agency cost

An agency cost is a cost incurred by the shareholder (the principal) in monitoring the activities of company agents (i.e. directors). Agency costs are normally considered as ‘over and above’ existing analysis costs (such as those involved in making an initial investment decision) and are the costs that arise because of compromised trust in agents (directors). They can be classified under two headings; costs associated with monitoring the agent, and those termed residual loss.

Monitoring costs

This type of agency cost includes costs associated with attempts to control or monitor the organisation. The most important of these will be the provision of information to shareholders, such as financial statements and annual reports detailing company operations. Any publicly owned company will have to provide an annual report to its shareholders, and it appears that Anna Killian has been recently reviewing the Roman Homes report.

The quality of information within the report may vary. Her review of the report has led Anna to have a number of questions for the board of Roman Homes. To produce better reports and to provide more information to shareholders will take time and hence incur agency costs for the business.


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Large organisations are required, usually as part of listing rules, to communicate effectively with major shareholders. Meetings attended by the key board members including the chief executive can be arranged and institutional shareholders invited, although these will take time and money both to organise and deliver.

The AGM is a regular meeting that can be utilised by shareholders to ask questions of the company, as Anna did at last week’s meeting. For an AGM to be effective in addressing investor concerns it would need to be held at a venue accessible to all, and to be attended by the majority of the board. The latter does not appear to have been the case at the Roman Homes’ AGM with attendance from board members being very low, and key strategic decisions makers being absent.

Many companies utilise performance-related incentive schemes to encourage directors to make decisions that are in the best interest of the shareholders. The most effective of such schemes is that of offering directors share options, usually with a specified period of time (several years) in which the shares cannot be sold. This provides the incentive for their decision making to reflect the requirements of shareholders for long-term share price growth.

A hidden cost associated with the agency relationship, and one of significance in the case of Roman Homes, relates to the increased risk taken on by shareholders due to relying on someone else to manage their investment. In the case of Roman Homes it appears that the board (primarily the chief executive, Dean Robertson) has taken some risky decisions in the past, and been successful so far, but this level of risk may not be aligned with that of the shareholders.

Residual loss

Residual loss costs are a part of agency costs. These are costs that attach to the employment of high calibre directors (generally outside of salary) and the trappings associated with the running of a successful company. The packages of the board members of Roman Homes may include benefits in kind such as company cars, medical insurance and school fee payments and would be considered a residual loss to shareholders.

(b) Methods of shareholder resolution of agency problems

If the shareholders are unhappy with decisions taken by the directors and the resultant way that a company is being run they have a number of options open to them to resolve this problem.

Firstly it would be advisable for major shareholders to hold meetings with the chairman, and possibly other board members, to allow all concerns to be communicated directly.

Interested parties may propose resolutions to be put to the vote at the next AGM, or may vote against proposals put forward by the board or a subcommittee. These might include a reluctance to reappoint directors who may have a conflict of interest in supporting the management or the owners of the company.

It might be possible for shareholders to persuade another company to bid to take over the organisation should the situation become desperate, since this will often result in a change of management at board level.

The market provides a simple mechanism for dealing with unresolved conflict, that of being able to divest shareholding back into the market place. This option is always available to shareholders if they consider the risks involved too great for the return they are receiving.



(c) Factors that would prompt an institutional investor to intervene

Intervention by an institutional investor in a company whose stock it holds is usually considered to be radical step. It is an important ‘last resort’ for institutional investors to have available to them as they seek to adequately represent the interests of their own investors.

There are a number of conditions under which it would be appropriate for institutional investors to intervene in a company whose shares it is holding, including: Concerns about strategy in terms of products sold, markets serviced, expansions pursued or any other aspect of the company’s overall strategic positioning.

This may be the situation for Faretime with concerns over Roman Homes proposed new development at a time of apparent downturn in the housing market. It appears that this risky approach has been successful in the past, but if Faretime, and in particular Anna Killian, do not believe it is appropriate now they may see reason to intervene.

Its operational performance may give rise to a need for action, especially if there are one or more segments that have consistently underperformed without adequate explanation.

This does not appear to be the case at Roman Homes with successful results reported in the past.

When non-executive directors do not hold executive management to account. There may, for example, be evidence of unaccountable ‘kitchen cabinets’ or curious executive decisions that are not adequately challenged by non-executive directors.

This appears to be happening within Roman Homes with many decisions seemingly being taken by Dean Robertson, chief executive, with minimal involvement from the non-executive chairman. This indicates a lack of influence of non-executive directors on the actions of the board.

Consistent or serious failure in internal controls would justify intervention, although this, in turn, may become evident through operational underperformance. Ongoing or unaddressed failures in, for example, quality assurance, health and safety, environmental emissions, budgetary control or information systems might justify intervention.

Failing to comply with the relevant code, laws or stock market rules is the next situation. If the company is listed in a rules-based jurisdiction, it is a matter of law but in a principles-based country, compliance is only ‘optional’ under the stock market’s ‘comply or explain’ rules. Consistent or unexplained non-compliance is like to be penalised by the market.

In the case of Roman Homes there is some indication that corporate governance best practice has not been followed in relation to the area of audit. Firstly, the audit committee is headed up by an executive director, which is against the view that it should be comprised solely of non-executive directors. Secondly, there has been no internal audit function within the business, though this is now to be rectified as announced at the AGM.

Inappropriate remuneration policies, if extreme or obviously self-serving, might attract intervention. Such a situation would normally also signify a failure of the remunerations committee which would make it a double cause for concern.

A poor approach to social responsibility is a condition for possible intervention, especially if there is publicly-available evidence that might adversely affect the reputation of the company.



(d) Internal audit department reports directly to the Audit Committee

These proposals are evaluated on the presumption that the audit committee membership is solely non-executive directors, at least one of whom has relevant financial experience. This is not the current situation at Roman Homes where the audit committee is headed up by an executive director.

The independence of the audit committee means that the recipients of internal audit reports, and those planning the internal audit workload and schedule, will not be directly involved in the areas investigated, but are of senior status.

Non-executive directors on the audit committee are likely to be expert in matters regarding the management of a large company and thus can add value to the functioning of the internal audit department.

This structure sets up the internal audit function as being almost wholly independent from the executive management of the company, but ensures that the internal auditors work within Roman Homes and hence have experience of the business and its activities.

Internal audit function is outsourced to a firm of auditors

The benefits mentioned above regarding the experience and use of the audit committee will be maintained in this situation, in addition to the fact that utilisation of the external audit firm may bring some benefits with regards to potential cost savings, flexibility and skill levels.

Given that the firm already carry out external audit work for Roman homes there should be some existing awareness of the business and its activities, though it is likely to be different individuals carrying out the internal audit work.

One issue to consider carefully with this arrangement would be to ensure that the independence of the external audit is not compromised in any way if the internal audit services are provided by the same firm. The responsibility for ensuring this independence lies both with the audit firm and the board.

ACCA marking scheme (a) Definition of agency costs – up to two marks

Examples of agency costs – one mark for example, and further one mark for relating to Roman Homes situation:

– information / reports

– meetings, inc AGM

– incentive schemes

– higher risks

– residual loss e.g. company car

Max 2

Max 8

Max 9 in total

(b) Methods of shareholder intervention – one mark each:

– meetings

– voting at AGM

– resolutions at AGM

– accepting takeovers

– divest shares

– any other relevant point

Max 4

(c) Factors prompting intervention – one mark per factor and further one mark for application to Faretime

Max 8

(d) Up to three marks for evaluating each proposal, one mark per relevant point made.

(require at least one point for and one against the structure to create a balanced evaluation)

Max 4



ANSWER 4

(a) Roles of a company secretary

Most countries require a limited liability company to appoint a company secretary. A company secretary, along with the directors, is charged with the governance of the company, but their role is more advisory and procedural. A company secretary’s loyalty is primarily to the company, and they must fulfil this duty especially when conflict arises between directors or within the board itself.

A company secretary is usually seen as the chief administrative officer of the company which leaves the directors free to concentrate on the effective running of the business. Typically they do not have the same legal responsibilities as a director.

They have several compliance roles including the timely filing of company accounts and other legal and regulatory returns and documents. They will also maintain any statutory registers, such as the share register, and documents required by the authorities.

Procedurally the company secretary role will include the arranging of the board meetings, drafting and circulating board meeting minutes and ensuring that board decisions are effectively communicated to the business.

In addition to board meetings, the company secretary will organise and provide proper notice to members of the annual and any extraordinary general meetings. They will organise the agenda and the resolutions to be discussed and voted on at the meetings. The minutes of the meetings will be taken and made available for inspection by shareholders.

A company secretary is often responsible for the induction package of a new director, and should make themselves available to all directors to provide advice to assist in the fulfilment of their duties.

(b) Governance structure

The governance structure within National Airways (NA) is an insider structure, on occasion verging on a family structure. The insider structure relates to the existence of major shareholders who also operate in an executive capacity running the company.

This structure still exists within the floated company as the directors hold the power and do not consider external shareholders as important as their own more immediate perceptions of corporate governance and direction.

Evaluation of the benefits of this structure

The insider structure offers a key benefit of tight control. The directors, being shareholders, run the company in such a way as to have an immediate impact on the nature of risk and safeguards, and through their expertise should ensure the company is run in an effective way.

This benefit seems to have been sacrificed by the lack of directorial interest in the structure and the dominance of the executive chairman as sole decision maker.

The insider structure leads to reduced agency costs since the shareholders are fully informed of the status of the enterprise and require less disclosure due to their continual presence at board meetings.

This benefit is, however, lost due to the irregular meetings of the board and their lack of interest in proceedings.

Access to capital is another feature as the shareholders are more willing to provide additional capital since they control operations. In addition such shareholders tend to be wealthy corporate bodies or individuals with adequate reserves to fund the company.



This does not occur here since the individuals did not seem to be able to provide internal funding, hence they needed to float the organisation.

Long-term attitudes and a lack of short-term decision-making are another feature. This seems to be the case in NA since directors see the company as an ongoing source of wealth and interest to their descendents.

This benefit is however lost when the long term decisions clash with the short term needs of the minority shareholders who operate as outsiders. Their existence as a majority in this scenario heightens the long term short term debate.

Case evidence of the lack of benefits of the current structure

Additional case evidence of the lack of benefits of the insider structure in this scenario can be seen in the existence of outsiders as the majority owners of the business. In order to act in shareholders’ best interests the presumption is firstly that the company should meet the majority need. This being the case the governance structure will need to move away from directors’ aspirations and improve on dialogue and disclosure to meet outsider’s needs.

The dominance of the executive chairman and the general lack of interest of the board also suggest that of an insider structure. Change appears to be inevitable and required to meet the challenging commercial environment that NA is now operating in.

(c) Comments made by Raymond Kennedy

The relationship between trade unions and those charged with governance is often assumed to be adversarial. However, many examples exist of trade unions and management working together for the mutual success of the organisation and achievement of objectives.

Raymond Kennedy’s comments at the meeting appear to demonstrate a lack of understanding of the benefits that a good relationship with the AWU could bring, and also demonstrate poor application of core corporate governance fundamentals.

Prior to the meeting Raymond Kennedy publicly disputes the AWU membership claims. The AWU is a stakeholder in National Airways and represents employee to the board and management. The level of power (or influence) of the union can often be determined by the level of membership of the union. There appears to be some uncertainty as to whether the union membership is 70% or 90%, hence its power is unclear.

Taking each of his comments during the board meeting in turn:

• During the meeting Raymond speculates about the reaction of the AWU to the three proposed strategies. He remarks that the company cannot ‘survive without major changes to the way we work’, which suggests that the union lacks an understanding of the overall business objectives.

Whilst strategic change is necessary in any business to ensure that it adapts and responds to evolving risks, stakeholder participation and reaction must be properly considered before any changes are made.

This is of particular importance for National Airways who have just announced a significant operating loss in the last financial year.

• Raymond also believes that the employees should support the company rather than threatening strike action when they are unhappy with management decisions. Given that employees are paid to assist a company achieving its goals it is reasonable to expect the employees to support management in this aim. Any strike action taken by a union with such a high operational employee membership is likely to severely disrupt company business and threaten those objectives.



Strike action is not, however, a decision that is taken lightly by the unions. For example, workers on strike are not paid for the strike days, and it is often seen as last resort to raise awareness on an issue that management have not listened to or responded to. In particular, Raymond has not anticipated that the new strategies may be perceived as unfair. He desires that the employees support the company, which suggests an element of ‘team spirit’, and yet the pay freezes, job losses and pension fund closure will not apply to senior management.

• His final remarks are that the changes will be imposed regardless of any strike action that may be threatened. Raymond is adopting an adversarial attitude by suggesting a stern response to the unions before any communication of plans has even started.

Engagement with a trade union by senior management can unite the workforce behind an organisation’s strategic objectives and aid in the development of changes to core policies and working practices. Communication, discussion and consensus, rather than imposition of major employee related policy changes, is far more likely to result in a smooth policy changeover and also buy-in from the employees as to the need for change.

Raymond does not appear to appreciate the benefits a trade union can bring to the effective corporate governance of an organisation. A trade union can provide effective checks and balances to monitor and respond to management abuses. Therefore, the trade union can be seen by shareholders to be providing an effective board monitoring function.

Good corporate governance would suggest engagement with the unions in advance of any formal public announcement of plans that will have a significant effect on all current and future employees within the business.

ACCA marking scheme

Marks

(a) ½ mark for bullet / short sentence

1 mark for full detail in describing a role of the company secretary Up to 5

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Maximum 5

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(b) Identification of the insider structure 1

Any further explanation of insider structure, or reference to family structure

(Note: answer must discuss insider structure as the identified structure)

1

1 mark for any relevant benefit discussed, with further 1 mark for any criticism / drawback highlighted

Up to 8

1 mark for any specific point made in reference to NA Up to 4

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Maximum 12

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(c) 1 mark per relevant point made in analysis of comments:

up to 3 marks for discussion of any one comment area

Up to 8

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Maximum 8

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Total 25

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Documents

ACCA P1 Revision Mock - Ans J11%28with marks%29