P1 Answers

7/17/2019 P1 Answers

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December 2007 Q1

Tutorial note. The specifc reerences to academic and literature sources in answers is or

illustrative purposes only and do not mean that candidate answers need to reer to those

sources in order to achieve good marks.

1(a) Transparency and its importance at WMDefne transparency Transparency is one o the underlying principles o corporate

governance. As such, it is one o the ‘building blocks’ that underpin a sound system o

governance. In particular, transparency is reuired in the agency relationship. In terms o

defnition, transparency means openness !say, o discussions", clarity, lack o withholding o

relevant inormation unless necessary and a deault position o inormation provision rather

than concealment. This is particularly important in fnancial reporting, as this is the primary

source o inormation that investors have or making e#ective investment decisions.

Evaluation o importance o transparency There are a number o benefts o

transparency. $or instance, it is part o gaining trust with investors and state authorities !e.g.

ta% people". Transparency provides access or investors and other stakeholders to company

inormation thereby dispelling suspicion and underpinning market confdence in thecompany through truthul and air reporting. It also helps to manage stakeholder claims and

reduces the stresses caused by stakeholders !e.g. trade unions" or whom inormation

provision is important. &easons or secrecy'confdentiality include the act that it may be

necessary to keep strategy discussions secret rom competitors. Internal issues may be

private to individuals, thus (ustiying confdentiality. $inally, ree !secret or confdential"

discussion oten has to take place beore an agreed position is announced !cabinet

government approach".

!eerence to case At )orldwide *inerals, transparency as a principle is needed to deal

with the discussion o concealment. +hould a discussion o possible concealment even be

taking place Truthul, accurate and timely reporting underpins investor confdence in all

capital-unded companies including )*. The issue o the overestimation o the mallerite

reserve is clearly a matter o concerto shareholders and so is an e%ample o where a deault

assumption o transparency would be appropriate.

(b) "o#lber$%s levels o moral development

Description o levels ohlberg described human moral development in terms o three

consecutive levels.

/reconvention moral responses view morality in terms o rewards, punishments and whether

or not the act will be penali0ed, ound out or rewarded.

1onventional moral responses view morality in terms o compliance with the agreed legal

and regulatory rameworks relevant at the time and place in which the decision is taking

place.

/ost conventional responses go beyond the other two and rame morality in terms o the

e#ects o the action on onesel and others, on how it will a#ect one’s own moral approach

and how it will accord with wider systems o ethics and social norms.

T#ree people in t#e case



The three people mentioned in the case e%hibit di#erent levels o moral development. 2ary

3owells is demonstrating the preconvention in that he sees the decision to disclose or not in

terms o whether )*can get away with it. 3e was inclined to conceal the inormation

because o the potential impact on the company’s share price on the stock market. 3is

suggestion was underpinned by his belie that the concealment o the incorrect valuation

would not be ‘ound out’.

4anda *onroe demonstrates conventional behavior, reminding the )* board o its legal and

regulatory obligations under the rules o its stock market listing. In particular, she reminded

the board about the importance o the company’s compliance with corporate governance

and ethics codes by the stock market. To ail to disclose would, in 4anda’s view, be a breach

o those stock market e%pectations. &ather than rewards and punishments, 4anda was more

concerned with compliance with rules and regulations.

*artin 1han is demonstrating post conventional morality by reerring to consistency o

treatment and the notion o ‘do as you would be done by’. 3e said that he wouldn’t want to

be deceived i he were an outside investor in the company. 3is response was underpinned

neither by rewards or punishments, nor by compliance with regulations, but rather than a

persuasion that moral behavior is about doing what one believes to be right, regardless o

any other actors.

(c) &on'eecutive directors

!oles o &EDs

5on-e%ecutive directors have our principal roles.

The strategy role recogni0es that 567s are ull members o the board and thus have the

right and responsibility to contribute to the strategic success o the organi0ation or the

beneft o shareholders. The enterprise must have a clear strategic direction and 567s

should be able to bring considerable e%perience rom their lives and business e%perience to

bear on ensuring that chosen strategies are sound. In this role they may challenge any

aspect o strategy they see ft and o#er advice or input to help to develop successulstrategy.

In the scrutini0ing or perormance role, 567s are reuired to hold e%ecutive colleagues to

account or decisions taken and company perormance. In this respect they are reuired to

represent the shareholders’ interests against the possibility that agency issues arise to

reduce shareholder value.

The risk role involves 567s ensuring the company has an adeuate system o internal

controls and systems o risk management in place. This is oten inormed by prescribed

codes !such as Turnbull in the 8" but some industries, such as chemicals, have other

systems in place, some o which all under I+9 standards. In this role, 567s should satisy

themselves on the integrity o fnancial inormation and that fnancial controls and systems

o risk management are robust and deensible.

$inally, the ‘people’ role involves 567s overseeing a range o responsibilities with regard to

the management o the e%ecutive members o the board. This typically involves issues on

appointments and remuneration, but might also involve contractual or disciplinary issues

and succession planning.



Tutorial note: these our roles are as described in the 8 3iggs &eport and are also contained in the 1ombined 1ode

;<<=.

Tensions in &ED roles in t#e case

This reers to a potential tension in the loyalties o the 567s. Although the 567 is

accountable, through the chairman to the shareholders and thus must always act in the

economic best interests o the shareholders, he or she is also a part o the board o thecompany and they may, in some situations, advice discretion. )ithholding inormation might

be (udged correct because o strategic considerations or longer-term shareholder interests.

In most situations, 567s will argue or greater transparency, less concealment and more

clarity o how and why a given action will be in the interests o shareholders.

The case o mallerite overestimation places the )* 567s in a position o some tension. Any

instinct to conceal the ull e%tent o the overestimate o the reserve or the possible

protection o the company’s short-term value must be balanced against the duty to serve

longer-term strategic interests and the public interest. )hilst concealment would protect the

company’s reputation and share price in the short term, it would be a duty o the 567s to

point out that )* should observe transparency as ar as possible in its dealing with the

shareholders and other capital market participants.

!d" etter or Tim *la+e to send to WM%s investors World,ide Minerals plc

Date

Dear -#are#olders. Estimation o mallerite reserves

>ou will be aware o the importance o accurate resource valuation to )orldwide *inerals

!)*". 8nortunately, I have to inorm you that the reserve o mallerite, one o our key

minerals in a new area o e%ploration, was ound to have been overestimated ater the

purchase o a mine. It has been suggested that this inormation may have an e#ect on

shareholder value and so I thought it appropriate to write to inorm you o how the board

intends to respond to the situation.

In particular, I would like to address two issues. It has been suggested that the

overestimation arose because o issues with the internal control systems at )*. I would

frstly like to reassure you o the importance that your board places on sound internal control

systems and then I would like to highlight improvements to internal controls that we shall be

implementing to ensure that the problem should not recur.

(i) /mportance o internal control

Internal control systems are essential in all public companies and )orldwide *inerals !)*"

is no e%ception. I anything, )*’s strategic position makes internal control even more

important, operating as it does in many international situations and dealing with mineralsthat must be guaranteed in terms o volume, grade and uality. Accordingly, your board

recognises that internal control underpins investor confdence. Investors have traditionally

trusted )*’s management because they have assumed it capable o managing its internal

operations. This has, specifcally, meant becoming aware o and controlling known risks.

&isks would not be known about and managed without adeuate internal control systems.

Internal control, urthermore, helps to manage uality throughout the organi0ation and it

provides management with inormation on internal operations and compliance. These



eatures are important in ensuring uality at all stages in the )* value chain rom the

e%traction o minerals to the delivery o product to our customers. ?inked to this is the

importance o internal control in helping to e%pos@ and improve underperorming internal

operations. $inally, internal control systems are essential in providing inormation or internal

and e%ternal reporting upon which, intern, investor confdence rests.

(ii) roposals to improve internal systems at WM

As you may be aware, mineral estimation and measurement can be problematic, particularly

in some regions. Indeed, there are several actors that can lead to under or overestimation

o reserves valuations as a result o geological survey techniues and regional cultural'social

actors. In the case o mallerite, however, the issues that have been brought to the board’s

attention are matters o internal control and it is to these that I would now like to turn.

In frst instance, it is clear rom the act that the overestimate was made that we will need to

audit geological reports attain appropriate !and probably lower" level in the organi0ation in

uture. 9nce a claim has been made about a given mineral resource level, especially one

upon which investor returns might depend, appropriate systems will be instituted to ask or

and obtain evidence that such reserves have been correctly and accurately uantifed. )ewill recogni0e that single and verbal source reports o reserve uantities may not necessarily

be accurate. This was one o the apparent causes o the overestimation o mallerite. A

system o auditing actual reserves rather than relying on verbal evidence will rectiy this.

The purchase o any going concern business, such as the mallerite mine, is sub(ect to due

diligence. )* will be e%amining its procedures in this area to ensure that they are ft or

purpose in the way that they may not have been in respect o the purchase o the mallerite

mine. I will be taking all appropriate steps to ensure that all o these internal control issues

can be addressed in uture. Thank you or your continued support o )orldwide *inerals and

I hope the oregoing goes some way to reassure you that the company places the highest

value on its investors and their loyalty.

ours ait#ully. Tim *la+e #airman

!a" 8p to ; marks or defnition o transparency. mark per relevant point on advantages o

transparency up to a ma% o = marks. mark per relevant point on reasons or confdentiality

or concealment up to a ma% o = marks. 8p to ; marks or relevance to case. !< marks"

!b"8p to ; marks or each ohlberg level identifed and described up to a ma%imum o B

marks. 8p to ; marks or each person’s position identifed with reasons'evidence rom the

case. marks or identifcation only. !; marks"

!c" ; marks or each 567 role identifed and brieCy e%plained up to a ma%imum o D marks.E

marks or discussion o tension in advising on reserve overestimate. !; marks"

!d"!i" mark or each relevant point made on importance o internal control up to a

ma%imum o B marks.

!ii"8p to ; marks or each relevant point identifed and e%amined up to a ma%imum o B

marks. 8p to E proessional marks or structure, content, style and layout o letter. !8p to a

ma%imum o B marks"

!Total F< marks"



3une 2004 Q5

5(a) (i) Describe rules'based In a rules-based (urisdiction, corporate governance

provisions are legally binding and enorceable in law. on-compliance is punishable by fnes or

ultimately !in e%tremis" by delisting and director prosecutions. There is limited latitude or

interpretation o the provisions to match individual circumstances !‘one si0e fts all’". +ome

have described this as a ‘bo% ticking’ e%ercise as companies seek to comply despite someprovisions applying to their individual circumstances more than others. Investor confdence

is underpinned by the uality o the legislation rather than the degree o compliance !which

will be total or the most part".

(ii)rinciples'based approac# 6dvanta$es o a principles'based approac# The rigor

with which governance systems are applied can be varied according to si0e, situation, stage

o development o business, etc. 9rgani0ations !in legal terms" have a choice to the e%tent

to which they wish to comply, although they will usually have to ‘comply or e%plain’.

6%planations are more accepted by shareholders and stock markets or smaller companies.

9beying the spirit o the law is better than ‘bo% ticking’ !‘sort o business you are’ rather

than ‘obeying rules’". Geing aware o overall responsibilities is more important than going

through a compliance e%ercise merely to demonstrate conormance. Avoids the ‘regulation

overload’ o rules based !and associated increased business costs". The costs o compliance

have been a cause o considerable concern in the 8nited +tates. +el-regulation !e.g. by

$inancial +ervices Authority in the 8" rather than legal control has proven itsel to underpin

investor confdence in several (urisdictions and the mechanisms are sel-tightening !uicker

and cheaper than legislation" i initial public o#ering !I/9" volumes all or capital Cows

elsewhere.

ontet o developin$ countries 7eveloping countries’ economies tend to be dominated

by small and medium si0ed organi0ations !+*6s". It would beery costly and probably utile,

to attempt to burden small businesses with regulatory reuirements comparable to larger

concerns. 3aving the Ce%ibility to ‘comply or e%plain’ allows or those seeking oreign euityto increase compliance whilst those with di#erent priorities can delay ull compliance. In low-

liuidity stock markets !such as those in some developing countries" where share prices are

not seen as strategically important or businesses, adopting a more Ce%ible approach might

be a better use o management talent rather than ‘(umping through hoops’ to comply with

legally-binding constraints. The state needs to have an enorcement mechanism in place to

deal with non-compliance and this itsel represents accost to ta%payers and the corporate

sector. 7eveloping countries may not have the ull inrastructure in place to enable

compliance !auditors, pool o 567s, proessional accountants, internal auditors, etc" and a

principles-based approach goes some way to recogni0e this.

(b) /nternal control statement The 8nited +tates +ecurities and 6%change 1ommission

!+61" guidelines are to disclose in the annual report as ollows: A statement omanagement’s responsibility or establishing and maintaining adeuate internal control over

fnancial reporting or the company. This will always include the nature and e%tent o

involvement by the chairman and chie e%ecutive, but may also speciy the other members

o the board involved in the internal controls over fnancial reporting. The purpose is or

shareholders to be clear about who is accountable or the controls. A statement identiying

the ramework used by management to evaluate the e#ectiveness o this internal control.

This will usually involve a description o the key metrics, measurement methods !e.g. rates



o compliance, air value measures, etc" and tolerances allowed within these. )ithin a rules-

based environment, these are likely to be underpinned by law. *anagement’s assessment o

the e#ectiveness o this internal control as at the end o the company’s most recent fscal

year. This may involve reporting on rates o compliance, ailures, costs, resources committed

and outputs !i measurable" achieved. A statement that its auditor has issued an attestation

report on management’s assessment. Any ualifcation to the attestation should be reported

in this statement. Tutorial note: guidance rom other corporate governance codes is also

acceptable.

(c) The e%ternal reporting reuirements !rom the +arbanes-9%ley section E<E" being ‘too

ambitious’ or small and medium companies There are several arguments to support

/roessor ?eroy’s remark. $ewer spare resources to carry out internal control. +*6s tend to

operate with lower levels o spare resource than larger businesses and conducting internal

reviews would be more o a challenge or them. The e%tra attestation ee !over and above

normal audit ee" or the attestation o the internal control report could be a constraint or

many +*6s. ?ack o e%pertise rom within e%isting employees !to internally audit'police as

well as carry out internal activities" would be a likely constraint. +*6s will have ewer

activities and less comple%ity, hence less need or shareholders to reuire the inormation!less to go wrong".

5 (a)(i) mark or each essential eature brieCy described Total mar+s

(ii) mark or each relevant point made on the advantages o principles-based up to a

ma%imum o E marks; marks or each relevant point on developing countries up to a

ma%imum o B marks Total 10

(b); marks or each relevant area o content identifed and brieCy described Total 4 mar+s

(c) mark or each relevant valid argument put orward Total 5 mar+s Total 28

mar+s

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