corporate governance - icsa · she is aware that breakthrough has been suffering from a decline in...

© ICSA, 2014 Page 1 of 27

Corporate Governance November 2013

Suggested answers and examiner’s comments Important notice When reading these answers, please note that they are not intended to be viewed as a definitive ‘model’ answer, as in many instances there are several possible answers/approaches to a question. These answers indicate a range of appropriate content that could have been provided in answer to the questions. They may be a different length or format to the answers expected from candidates in the examination. Examiner’s general comments The pass rate has increased for this examination session but the quality of examination scripts overall remains a problem. As I have commented in the past, Corporate Governance is not any easy topic for many candidates because it deals with the board of directors and shareholders; and these are aspects of corporate affairs with which many candidates have not yet had first-hand experience in their working life. Even so, candidates should be expected to give some thought to what boards of directors do and far too many candidates show in their answers an unrealistic view of ‘life at the top’. Examination questions require some analysis and an ability to think about practical situations described in scenarios in the questions: candidates may have learned principles of good corporate governance, and may be able to repeat guidance in a corporate governance code, but they struggle to apply theory to practice. There were some general problems that applied across answers to several examination questions: (i) There are still problems with allocation of time between questions and far too many candidates

appear to have run short of time, with the result that they produced a hasty answer to their fourth question, which often lacked clarity and a clear presentation. Some candidates also did not manage to complete their fourth answer. The result is that the mark for the fourth question in these cases is lower, dragging down the overall mark for the paper.

As has been stated in past suggested answers and examiners comments, candidates also need

to allocate time sensibly to each part of each question. If a part of a question is worth 10 marks, spend no more than 18 minutes answering it, including the time to put an answer plan together. Too many scripts include long answers to a 6 mark question and very short answers to questions worth up to 10 or 12 marks. The temptation may be to write at length on topics you know more about, but it is not necessarily a good tactic in the examination.

(ii) There are not many questions that require specific detailed knowledge of the UK Corporate

Governance Code (‘UK Code’), but candidates should familiarise themselves with the UK Code before they take the examination. References to provisions in the UK Code, or to the Code in


another country, are often given due credit in the marking process. Too many candidates showed there were unaware of any governance code, but it is quite common for candidates to mention the UK Code and make incorrect assertions about its provisions.

There are two weaknesses in examination technique that seem to feature in many examination scripts in every session. These have been explained for past sessions, but the same problems seem to occur every time: (i) An almost universal problem in examination technique is candidates not considering the

question when writing an answer. Points are awarded for making relevant comments. Far too often, candidates write around a subject without answering the question, or make a brief point which could be relevant but which is not properly discussed in the context of the question. Setting out a brief answer plan would help, before starting to write an answer, because it provides mental discipline. Candidates should be asking themselves: What can I write in answer to this question? How many points can I think of that answer the actual question?

This point has been made several times in the past. Failing to restrict answers to relevant points

and focus on the actual question is an almost universal problem, affecting to a greater or lesser extent most candidates taking the examination. Irrelevant discussion wastes time and earns no marks.

(ii) The following comment was made on the June 2013 examination: it applied again in November

2013: “Candidates have also been advised in the past against using very brief bullet points in answering a question, possibly because they are short of time. Brief bullet points rarely convey an idea sufficiently to justify any mark, because they leave it to the marker to assume what the point is meant to be. Marks are earned for comprehensible explanations of points and ideas.”

In this examination, candidates may have taken heed of my warning, because there were fewer

black dots marked as bullet points in scripts. However, the underlying problem remained. Too many candidates made short/brief comments which did not convey a point adequately. This leaves it to the marker to interpret what was intended, and make a judgement about how much the candidate actually understands the issue. If a candidate does not make a point with sufficient clarity, he or she does not demonstrate that they really understand the point enough to earn marks for it.


1. Several months ago, Samantha Beck (‘Sam’) became a trustee of Breakthrough, a UK charity that supports educational and cultural initiatives for under-privileged children. Sam was invited to join the board of trustees by the board chairman, a long-time friend. In the time since her appointment, Sam has begun to learn about the activities of the charity; however, there are still aspects of operations and funding about which she is not altogether clear. There is some disagreement between trustees about whether the main area of activity for the charity should be educational or whether it should focus more on cultural activities. The board of trustees has met only twice since her appointment, and Sam now understands that many of the policy decisions are made by the chief executive of the organisation and his small management team. Since her appointment, Sam feels that she has done very little as a trustee. She is also annoyed that she has twice been asked to find individuals or companies to support fund-raising days, which she does not consider to be within her area of responsibility. She is aware that Breakthrough has been suffering from a decline in funding in the past year as well as rising administrative costs. She also believes that not enough members of the public are aware of Breakthrough or its activities and that falling revenues may be caused by lack of publicity. Revenues and costs are areas where she believes that trustees should be more involved with the work of the charity. You are the newly-appointed trustee secretary for Breakthrough, and Sam has expressed her concerns to you. You advise her that there is a Good Governance Code for the voluntary and community sector, and that it would be appropriate to raise her concerns about compliance or non-compliance with this Code with the chairman and chief executive. Required (a) Describe the main principles of governance for a charity organisation, such as

those set out in ‘Good Governance: a Code for the Voluntary and Community Sector’.

(8 marks) Tutorial note: The question asked for a description of principles of governance that should apply to a charity organisation, but did not require answers to be based on the ‘Good Governance’ Code. However, the answer below is based on this Code. Other codes of governance or conduct for not-for-profit organisations were acceptable, but the essential requirement was for candidates to identify and specify key general principles of governance for a charity. The points in the answer to part (a) are numbered, so that they are more easily referenced in the answer to part (b). Suggested answer The main principles of a good governance code for charitable organisations should set out the ways in which the board of directors or trustees provide leadership to the organisation. (i) Members of the board should understand their role and responsibilities, both collectively

and individually. They must understand their legal duties and their responsibilities with regard to the governing document of the charity. As trustees, they have a duty to act in the best interests of the beneficiaries of the trust, and all the trustees must have a clear idea of who are the intended beneficiaries of the charity.

(ii) The trustees of a charity should ensure that the organisation delivers its purpose or aim.

To do this, they must ensure that the purpose remains valid and that this is delivered by means of a long-term strategy, an agreed operational budget and monitoring of outcomes and performance.


(iii) The board of trustees should work effectively both as individuals and as a team. There should be arrangements for identifying and recruiting new trustees.

(iv) Once appointed, trustees should be given induction so that they understand what the

charity does, how it operates and how it is funded. Where necessary, trustees should also be given ongoing training in relevant issues. A good governance code for charities should also require that directors or trustees are subject to regular performance reviews into their effectiveness.

(v) The trustees should exercise effective control over the charity, and ensure that it complies

with all legal and regulatory requirements, has good financial and management controls, identifies the major risks facing the charity and has a good risk management system in place to deal with them. The trustees should also ensure that authority is delegated to management, committees or volunteers and that the charity is operating effectively.

(vi) The board of a charity should behave with integrity and promote the integrity of the charity.

A charity should also be open and accountable, both internally and externally. This requirement includes open communications, informing people about the charity and its work.

Examiner’s comments Answers to this part of the question varied in quality. Anything sensible about principles of governance for a not-for-profit (NFP) organisation would have earned reasonable marks, and many principles that apply to NFP organisations are similar to those for companies. Even so, many candidates did not provide sensible ideas. A number of candidates discussed charity organisations as if they were commercial companies, accountable to their shareholders. (b) Discuss the ways in which Breakthrough may be failing to apply these principles to

its governance. (8 marks) Suggested answer The numbered paragraphs refer to the corresponding numbered paragraphs in the answer to part (a). (i) It would seem that the trustees of Breakthrough do not have a common view on the main

purpose of the charity. Some trustees think that educational activities are more important, whereas others believe that cultural activities are more important. The governing document of the charity should make the purpose of the charity clear, and it is surprising that there should be differences of view between the trustees.

(ii) Although the trustees should ensure that the charity is delivering its purpose or aim, this

does not appear to be happening at Breakthrough. As stated previously, the trustees do not seem to be agreed about what the main purpose of the charity is. Although Sam believes that a responsibility of the trustees is to ensure that the charity obtains revenue and controls its costs, it would appear that the trustees as a group do not seem to regard this as their area of concern.

Sam believes, correctly, that the responsibilities of trustees do not include helping with

fund-raising. As individuals, trustees may wish to become involved in fund-raising activities, but this is not their function as trustees, but rather as supporters of the charity.

(iii) The selection of Sam, perhaps on the basis that she was a long-time friend of the

chairman, was inappropriate.


(iv) Sam has possibly been with the charity for too short a time for her performance to be reviewed, but she has done very little as a trustee and she does not appear to have been given any induction to her role and to the charity. It would therefore appear that she has not yet provided any effective input to the charity as trustee, and there is also little sense of the trustees working collectively as a team in its best interests.

(v) The trustees should exercise effective control over the charity, but this requirement may

also be missing in Breakthrough. The chief executive and a small management team appear to make the policy decisions, without input from the trustees. Sam is aware that Breakthrough has experienced a fall in revenue and a rise in administrative costs. She also believes that there is insufficient public awareness of the activities of the charity. These may be significant threats, but the trustees and management do not appear to have addressed these risks and taken action to deal with them.

(vi) Even in the matter of communications, the trustees of Breakthrough do not appear to be

fulfilling their responsibilities adequately. Sam believes that not enough members of the public are aware of the charity or its activities. Without this public awareness, the loss of revenue may well continue in the future.

In summary, the trustees of Breakthrough do not seem to be providing the leadership that the charity requires. This failure in governance threatens the ability of Breakthrough to fulfil its purpose. Examiner’s comments In general, candidates did not appear to identify that part (b) followed on from part (a). Part (a) asked what principles of governance apply to a charity, and part (b) asked how the charity in the question scenario was failing to apply them. A structured answer linking parts (a) and (b) would have earned very good marks, however, very few candidates saw the connection. (c) Advise Sam on measures that she and the other trustees might take to fulfil their

role as trustees of Breakthrough more effectively. (9 marks) Suggested answer All of the trustees of Breakthrough have a responsibility to act with care and skill in the best interests of the organisation. If they are unable to do this, they should not remain as trustees, but should resign from their position. It is not clear how much time the trustees may be required to spend on the affairs of the charity, but Sam needs to understand that she must be prepared to commit a sufficient amount of time. She also needs to understand more about the operations and funding of the organisation, and should insist on receiving suitable induction – later than it should have been provided – so that she can learn enough to contribute effectively in her role as trustee. The effectiveness of the board of trustees depends on the quality of leadership provided by the chairman. The board of trustees does not seem to be effective at the moment, and the chairman must be largely responsible for this. As friend of the chairman, Sam is perhaps in a good position to express her concerns. It may be appropriate for her to discuss her concerns with other trustees first, and find out whether any other trustees share her views and would be willing to support her in a meeting with the chairman. A major problem of the charity at the moment is lack of clarity about its objectives. The chairman should lead the trustees in clarifying these objectives and approving strategies for achieving them. The board must work constructively with the chief executive: the management


team may propose strategies for Breakthrough, but the trustees are responsible for discussing them and approving them. The board of trustees should be responsible for approval of the budget and for monitoring the performance of the charity. The board of trustees should meet regularly and meetings should include a review of financial performance. It has responsibility for revenues (which are currently falling) and costs (which are currently increasing) but does not appear at the moment to be showing sufficient concern for these financial problems and potential risks. The chairman should also be informed that, in Sam’s opinion, the board does not provide sufficient external communication about the charity and its work, and that this failure could be affecting income. Sam cannot change the effectiveness of the board of trustees herself, as an individual. The board should work as a team, and needs leadership from the chairman. Unless the chairman is prepared to provide more effective leadership, and unless Sam is prepared to put in the time and effort required to support the chairman in this aim, she will not be fulfilling her responsibilities as trustee, and she should consider resigning from the board. Examiner’s comments This part of the question was a test of candidates’ ability to apply principles of governance to a question scenario, following on from part (b). Answers varied in quality. Marks would have been earned for common sense suggestions, hinted at in the question, such as to speak with the board chairman, try to meet more often, try to sort out the objective of the organisation and the roles of its trustees, and so on. Many candidates did not make any such suggestions. Examinations put candidates under stress, but it can be important to try to think logically and sensibly before starting to write an answer.


2. Charles Tanner (‘Charles’) is the chairman of Weld plc (‘Weld’), a listed UK construction company that undertakes major building projects worldwide. He is concerned by recent reports in the media about companies in the industry. There has been a television programme by investigative journalists into poor health and safety precautions on a number of major construction projects. This programme alleged that poor safety measures at a Weld construction site in Asia contributed to a large number of casualties in an earthquake. In relation to another incident, widespread publicity was given recently to the conviction of two senior sales executives in a rival construction company for using bribery to win contracts from foreign governments. Charles admits that he does not know about health and safety standards in all the construction projects operated by Weld, and he cannot be certain that Weld’s own sales staff do not use bribery to win business. He is aware, however, of some unreported problems in Weld. Recently, a large prepayment was made to a supply company, and it was subsequently discovered that Weld had been the victim of fraud as the payment was made to a non-existent agent of the supplier. Charles has also expressed his anger to the chief executive officer about the failure by the management team to report to the board about significant overspending on an overseas construction project. Charles discusses his concerns with you, the company secretary, and you suggest that the board should carry out a rigorous review of the company’s internal control system. Required (a) Explain the nature of internal control, the main elements in an internal control

system for a company, and the responsibility of the board for internal control. (9 marks) Suggested answer An internal control system is the system within an organisation for identifying risks that may be subject to management influence or control, applying controls to mitigate these risks and taking corrective action to deal with problems when adverse ‘risk events’ occur. COSO (the Committee of Sponsoring Organizations) has identified five elements to an internal control system. There must be a culture of risk awareness and employees in the organisation must understand the need to monitor risks and keep them within tolerance limits that are consistent with the risk appetite of the board. A suitable attitude to risks and risk awareness should be supported by an organisational culture based on integrity and ethical behaviour. These should be arrangements and procedures for the identification and assessment of risks. Internal control risks can be grouped into three broad categories: operational risks, financial risks and compliance risks. Operational risks are risks of losses arising from inadequate or failed internal processes, people and systems, as well as risks from catastrophic external events that threaten to disrupt business continuity. Financial risks are risks of losses from errors or fraud in accounting and financial reporting systems, including the risks of theft and financial misreporting. Compliance risks are risks of losses from failure to comply with laws and regulations. There should be suitable internal controls for reducing the significant risks (or possibly controls to avoid the risks). A key feature of an internal control system is that management should have some ability to mitigate the risks through control action and the design and implementation of internal controls. There must be communication of information about risks and controls, sufficient to enable individuals at all levels throughout the organisation to perform their functions effectively, including the management of the risks.


There should also be regular monitoring of the effectiveness of the internal control system, to check whether it continues to fulfil its intended purpose. The UK Corporate Governance Code states that the board of directors has a responsibility to ensure a sound system of internal control. The board is responsible for the internal control system and should set policies on internal control and also to seek regular assurance that will enable it to satisfy itself that the system is functioning effectively. At least annually, the board should conduct a review of the effectiveness of the system of internal control and inform the shareholders that it has done so. The review should cover all material operational, financial and compliance controls. Examiner’s comments This was the most popular question in the exam paper. The quality of answers varied enormously. Some candidates showed they understood the essential features of internal control and internal control systems, and provided an excellent answer. At the other end of the spectrum, some candidates did not demonstrate understanding of what internal control is. The question asked about internal control and internal control systems, but many candidates limited their discussion to categories of internal controls: operational, financial and compliance controls. The elements of an internal control system include controls, but also include a control environment, procedures for identifying and assessing/measuring risk, arrangements for communicating information about risks and control issues, and arrangements for monitoring the effectiveness of the internal control system. By not recognising the broader issues in an internal control system – such as the need for an appropriate risk awareness culture – candidates were restricting their answers to part (b) as well. Most candidates showed that they were suitably aware of the responsibilities of the board for the internal control system and monitoring its effectiveness. (b) Suggest how each of the problems identified by Charles may have been caused by

weaknesses in Weld’s internal control system, and describe the impact this could have on Weld’s reputation.

(10 marks) Suggested answer Charles appears to be concerned about several aspects of internal control within the company. He has some doubts about the ethics of sales staff, as he cannot be certain that they do not pay bribes to win contracts. This suggests that he does not have full confidence in the risk awareness culture within the organisation, and that some staff may be willing to take risks (break the law) to win business. Charles therefore does not have confidence in controls to ensure compliance with the Bribery Act 2010, which makes it a criminal offence for a business to give bribes for commercial benefit. Charles also has concerns about either weaknesses in identification of risks or weaknesses in internal controls. This is evident in several of the reported incidents. He is not sure whether the company has adequate health and safety standards: inadequate standards create both operational risks (the risks from injury to employees) as well as compliance risks (failure to comply with health and safety legislation). The television programme appears to have accused Weld of failing to plan adequately for the catastrophe at the construction site in Asia. The prepayment to a non-existent supplier was a fraud that may have been caused by failure in control procedures to check and verify the identity of the supplier. The manager who authorised


the payment also presumably failed to satisfy himself that the necessary identification checks and supplier verification procedures had been undertaken. There was also a failure in information and communication to the board, when the management team failed to report the significant overspending on the overseas project. The large number of concerns may also suggest that the board of directors has failed to conduct a rigorous review of the effectiveness of the system of internal control. However, Charles is the chairman of the board, and must accept responsibility for failure by the board to address the problem of the weaknesses in the internal control system. Weaknesses in internal control can have an adverse effect on the company’s reputation. Poor internal controls could create a situation where health and safety measures at construction sites are inadequate, with the result that an accident on site may cause fatalities or serious injuries that would be reported in the media. If Weld was to be prosecuted under the Bribery Act, this would also affect the company’s reputation. In the construction industry, damage to reputation can create a risk that major customers will decide against awarding contracts to the company, and the company could therefore suffer financially. Examiner’s comments The biggest problem with answers to part (b) was that many candidates did not explain the nature of weaknesses in the internal control system that might be suggested by the matters in the scenario of the question. Problems with health and safety arrangements should have been discussed with reference to inadequate procedures or failure to apply procedures due to operational failures or a lack of a risk awareness culture. Many candidates appear to have assumed that this was obvious and did not warrant an explanation. The question was expecting candidates to comment about the chairman’s lack of awareness of health and safety standards and anti-bribery controls. However, quite a few candidates appeared to have misread the question and assumed that bribery had already occurred in the company, whereas the question stated that the known example was in a different company. Issues relating to the payment to a non-existent agent and failures to report to the board were generally dealt with very briefly, but with reasonable points. There appears to be something about the topics of reputation and reputation risk that inspire candidates into writing long and indignant paragraphs, asserting that every aspect of poor governance will persuade customers to desert the company, shareholders to sell off their shares and individuals to refuse to work for the company. Some candidates appear to think that poor reputation will inevitably lead to insolvency. Of all the examples of potentially weak internal control in this question, only one had been made public knowledge by journalists, and there is no reason why any of the other events should be made known to anyone outside the company. It may be helpful for candidates to consider how many companies they refuse to buy from because of poor governance standards, and tone down their rhetoric accordingly. (c) Recommend the aspects of internal control that the board (or audit committee on

behalf of the board) should investigate in its review of the internal control system in Weld and suggest the questions that it should ask.

(6 marks) Suggested answer The board (or audit committee on behalf of the board) should carry out a review, at least annually, into the effectiveness of the internal control system in Weld, and it should consider each element in the internal control framework.

© ICSA, 2014 Page 10 of 27

The board should investigate whether significant internal and external operational, financial and compliance risks are identified and assessed on an ongoing basis. These risks should include the risks that the board reports on to shareholders in its annual business review. The board must ask questions about the adequacy of the control environment and internal control activities. For example, the board should consider whether it has clear policies for the management of health and safety risks, or disaster recovery policies and procedures. The board should also ask questions about the adequacy of the internal controls. The incidents that Charles is aware of relate to expenditure controls and reporting procedures, but the board should ask questions about the adequacy of controls in all major aspects of operations, finance and compliance with regulations. The questions should concern whether management is aware of their control responsibilities in these areas, whether employees are aware of the procedures and checks they must perform and whether these are carried out as required. In view of the concern that Charles may have about bribery, the board may also wish to ask whether the culture of the company and its performance reward systems may give encouragement to bribery, or whether financial controls are sufficient to ensure that bribes cannot be paid without senior management finding out about them. In view of the failure by management to report the overspending on the construction project, the board must ask questions about the adequacy of reporting systems within the company, in terms of frequency and content of reporting. The board may also wish to consider, in view of possible weaknesses in the internal control system, whether improvements should be made to the process of reviewing the effectiveness of the internal control system. Examiner’s comments Too many answers expected the audit committee to undertake tasks that are the responsibility of management. The audit committee should investigate the adequacy of the existing control system, perhaps with particular emphasis on health and safety controls and anti-bribery controls. The committee might also want to investigate incidents of apparent control system failures, such as the payment to the non-existent agent and failure of management to report to the board. Making these points clearly and sensibly would have been sufficient for a good mark, but many answers did not present these thoughts clearly.

© ICSA, 2014 Page 11 of 27

3. As company secretary for a food manufacturer, you are attending a conference on corporate governance. You meet the company secretary of a bank, and your discussion turns to the problems of corporate governance in your respective organisations. You discuss a number of reported problems involving banks in recent times, which may be attributable partly to poor corporate governance. A rogue trader was convicted of fraud in a recent criminal case, where he is alleged to have lost $5 billion for his bank. Another bank was fined $1 billion for assisting clients with tax evasion and money laundering, although no criminal charges were brought against the bank or its employees. Several banks were fined by the financial regulator for mis-selling insurance products. There have also been reports of prosecutions of individuals employed by financial institutions for alleged money laundering. The company secretary of the bank believes that problems such as these would be lessened if standards of corporate governance could be improved in banks, but he fears that corporate governance in banks is much more complex than in non-bank companies. He wondered whether non-executive directors were up to the task of applying governance discipline in banks. He asks you whether you agree that the challenges of corporate governance are greater in his bank than in your company. Required (a) Discuss how the corporate governance challenges differ for banks compared with

listed companies in other industries. (14 marks) Suggested answer The core elements of corporate governance are the same for all large public companies. This is evident in the fact that in each country a single corporate governance code is applied to all listed companies, both banks and non-banks. However, there are differences of emphasis between different types of company, and some aspects of governance are more significant and some less significant for banks than for non-bank companies. The challenges of corporate governance therefore differ for banks compared with other listed companies. The most significant stakeholders in most public companies are probably the equity shareholders. It is commonly assumed that the main objective of a company is to promote the wealth of its shareholders. Although most banks are public companies and so have responsibilities to their shareholders, the influence of the government and bank customers as stakeholders is much more powerful in banks. The banking payments and money transfer system is fundamental to the operation of an economy. Banks are also major providers of finance for investment, and most of their funding comes from customer deposits. Customers expect banks to protect their money, and confidence in the banking system depends on a presumption of financial stability in banks. Similarly, government has a direct interest in financial stability and a strong banking sector, because of their importance for economic growth and well-being. In the UK (and some other countries) major banks have been ‘bailed out’ with public funds or rescued by means of a takeover. By acquiring majority equity stakes in the Royal Bank of Scotland and Lloyds Bank, the UK government became a major stakeholder in these banks. Banks are therefore subject to strong influence and direction from the government and the banking industry is one of the most heavily-regulated.

© ICSA, 2014 Page 12 of 27

Large banks are also inter-connected through numerous transactions and other relationships, on a global scale. The failure of one major international bank could result in a chain reaction, and the collapse of other banks in other parts of the world. Other banks and other governments are therefore also stakeholders in banks, and this is evident in the international cooperation and coordination of efforts to regulate capital adequacy and liquidity in banks. A challenge for banks is therefore to help ensure not only their own stability, but also the stability of the banking system as a whole. All companies face risks, and a system of corporate governance should provide for effective systems of risk management and internal control. However, financial risks in banking are much greater than in other industries because banks ‘deal’ in money. Potential losses from adverse risk events can be very large, and control systems must be extensive and robust to limit and mitigate the risks. The business of banking can also be very complex, which means that the risks can be both large and difficult to comprehend. As a result, banks may be exposed to large losses from financial risks, and a challenge for corporate governance in banks is to ensure that risk management is sufficiently effective. In addition, the board of directors needs to provide leadership in approving the risk appetite and risk tolerances for the bank, and to ensure that risk exposures remain within acceptable limits. A number of banks have been accused of unethical behaviour, and putting their own interests before the interests of their customers. As a consequence of this perception, and following the global financial crisis in 2008, banks in general have suffered a severe loss of reputation with the general public. A major challenge for banks is to restore their reputation and the reputation of the banking industry as a whole. Greater compliance with regulations is one aspect of the challenge, but an improvement in ethical behaviour is another. It may be argued that the risks from non-compliance with regulations and unethical behaviour driven by greed are mainly problems for investment banking and financial market trading, but this is not the case. In the UK and US, retail banks have been accused of mis-selling financial products to consumers and breaches of the anti-money laundering and anti-terrorist financing regulations. Remuneration of executive directors and senior executives is a corporate governance concern for all major companies, but it has been a particular problem for banks, due to the large incentive payments to employees. It may be suggested that large incentive payments to employees, linked to profitability or the achievement of sales targets, encourages a culture of excessive risk-taking in banks. Inadequate remuneration policies in banks may therefore create a risk to financial stability, because executives put profit and reward before concern for risk and risk management. A challenge for banks is therefore to address the problems of remuneration structures, possibly under political pressure from governments to do so. Banks acknowledge concern for social responsibility and sustainable business, but sustainability concerns are probably much greater for companies in other industries, including the food production industry. The food production industry faces environmental challenges such as producing adequate food to meet total world demand, the quality and healthiness of food, and the effect of food growing and manufacture of food products on the ecological environment. In this respect, the challenges of corporate governance are much greater for some non-bank companies than for banks. Examiner’s comments A fairly regular feature of exam papers in the past has been that at least one question asks candidates about corporate governance in fairly broad terms. For example, questions in the past have asked how governance arrangements may differ between private companies and listed companies. This was another question in much the same vein: how does governance differ between banks and non-bank companies?

© ICSA, 2014 Page 13 of 27

An approach to providing a good answer to questions of this nature is to think about all the topic areas in corporate governance: stakeholders, board structure (including board committees) and effectiveness, financial reporting and other forms of reporting, auditing, risk management, internal control, senior executive remuneration, relations with shareholders, and corporate social responsibility or sustainability. Each of these topics could be taken in turn, and comments made about differences between banks and non-banks – or to comment that there are no significant differences. It would have been helpful to recognise that banks operate with large amounts of money that belongs to its customers (depositors) and their operations are crucial to the workings of an economy. As a result, public concerns and regulator concerns are more significant for banks than for most other types of company. Many candidates attempting this question recognised in their answers that banking is a risky business; therefore risk management and internal control are more significant for banks. However, the quality of explanations varied considerably. Surprisingly, very few answers identified senior executive remuneration as a particular problem for banks and not many more recognised that the behaviour of banks matters to people whose money is deposited with them and people who borrow (or try to borrow) from them. Overall, most candidates did not show an understanding of the nature of the question and, in general, answers were unstructured, containing occasional relevant points, but without demonstrating much understanding of the subject. (b) Suggest how corporate governance in banks may need to improve to meet these

challenges successfully. (6 marks) Suggested answer It would appear that a fundamental change in the governance of banks should be a radical improvement in culture, towards a more ethical culture based on concern for customer needs. Banks may argue that this culture already exists, but popular perceptions are that it does not. Changing the culture of a large organisation such as a bank would be a major challenge, and it may be necessary to begin by changing the leadership at the top of the bank. This occurred, for example, in Barclays Bank in 2012. Changes at the top may have to apply to non-executive directors who have been partly responsible for the inadequate governance of their bank in the past. It may be argued that increasing the number of female directors on the board of banks may help with change in corporate culture. The complexity of banking and risks in banking has implications for the board of directors. Directors are expected to have a good understanding of the business operations of their company, including its risks. There are two related problems. One problem is the lack of emphasis on risk management and control, and the over-emphasis on short-term profitability. The second problem is the lack of understanding of risk, particularly among non-executive directors in banks. A conclusion of the Walker Report in 2009 (following the Global Financial Crisis) was the non-executive directors of banks were not sufficiently familiar with risks in banking and should be given suitable training to improve their knowledge and understanding. The financial skills of bank non-executives may therefore need to be greater than the skills of non-executives in non-bank companies. If the board as a whole, including non-executive directors, acquire a better understanding of risk in their organisation and industry, the prospects for developing a risk awareness culture in the bank and making improvements in risk management should improve.

© ICSA, 2014 Page 14 of 27

Banks must address the problems of remuneration structures, and the non-executive directors, led by the board chairman, should possibly increase pressure within the bank to review basic pay and both short-term bonus arrangements and longer-term incentives. Good corporate governance requires effective communication between banks and their shareholders, but the complexity of the banking business creates difficulties for communication. There is probably a need for banks to be much more open and transparent about their business, so that stakeholders understand what the bank is trying to achieve and its policies and strategies for achieving these objectives. Examiner’s comment Candidates providing a weaker answer to part (a) also struggled with part (b). (c) Explain what non-executive directors should do differently in banks, compared with

non-bank companies, and the particular skills that they need, to contribute effectively to the work of the board of directors.

(5 marks) Suggested answer The responsibilities of non-executive directors (NEDs) are the same in banks as in other companies. As directors of the company they have a duty and responsibility to act with due care and skill in the best interests of the shareholders and other stakeholders. As non-executives, they should contribute constructively to the formulation of the broad strategy for the company. They should monitor the performance of executive management, which is accountable to the board for the company’s performance. As members of the audit committee or risk committee they are responsible for monitoring the external audit, ensuring the independence of the external and internal auditors, and reviewing the effectiveness of the internal control and risk management systems of the bank. As members of the nominations committee, they are involved in succession planning for the board and in recommending appointments to the board of directors. It may be necessary for NEDs to devote more of their time to the affairs of the bank, compared with NEDs in other types of company. Corporate governance in banks is more challenging, and it would therefore seem necessary that NEDs need more time to fulfil their role effectively. NEDs must also be well-informed about the bank and its business. Compared with NEDs in other types of company, they need a greater level of knowledge and understanding of financial matters and the banking industry. NEDs should also continually refresh their knowledge and skills through continual training and development, because the pace of change is more rapid in financial services and banking than in many other industries. If banks are to improve their reputation and bring about a change in culture, there must be ethical leadership. Banks must therefore appoint NEDs who have both strength of character and also high standards of personal integrity and honesty. Banks will continue to be subject to strong political pressures as well as public expectations. NEDs must therefore be aware of political expectations and government pressures, because these could have major implications for the future of the bank. In the UK, for example, political pressure is helping to drive forward proposals to separate retail from investment banking by means of ‘ring fencing’. NEDs need to understand what banks should do in response to political and government pressure, to ensure that the interests of the bank are protected as far as possible.

© ICSA, 2014 Page 15 of 27

Examiner’s comment Answers to this part of the question were generally satisfactory. Most candidates identified the main points: that NEDs in banks should make themselves familiar with the nature of banking and risks in the banking business, and should be prepared to give a suitable amount of time to their role. This question is a good example of how common sense and a good explanation of ideas can earn good marks in this examination.

© ICSA, 2014 Page 16 of 27

4. Rick is the chairman of Tenjee plc (‘Tenjee’), a UK listed company in the technology sector, and is also chairman of the nomination committee. He has asked you, the company secretary, to discuss the feedback he has received from the recent annual performance review of the board, its committees and its individual directors. The board consists of eight directors, comprising the chairman, two executive directors and five other independent non-executives: only one director is a woman. The external consultants used for the performance review indicated problems with some of the non-executive directors (NEDs). A recently-appointed NED has complained to the consultants that she did not receive enough support from the company when she was appointed. She was given copies of the minutes of past board meetings, taken on a tour of several company sites and had two meetings with you, the company secretary, to discuss the company’s affairs. She did not think that this was enough. Another NED was accused by fellow directors of wasting time at board meetings and committee meetings by talking for too long. It was also suggested that he was not preparing adequately by reading the papers for the meeting. A third NED was accused by colleagues of failing to contribute adequately to discussions in board meetings, although as an ex-government minister he had some useful political connections which may benefit the company. A fourth NED, who is currently the chairman of the audit committee, has been a board member for seven years and has just finished the first year of a renewed three-year contract, subject to annual re-election by the shareholders. The chief executive officer (CEO) has also raised, in confidence, another problem. At the moment there are just two executive directors on the board, the CEO and the finance director. The chief operating officer (COO) has informed the CEO that he thinks that the time has come for him to be appointed to the board, in order to further his career. If he does not get the appointment that he is hoping for, he will probably resign and look for boardroom opportunities with another company. The CEO says that he does not want to lose the services of his COO. Required (a) Explain the responsibilities of the board chairman for the annual performance

review of the board, in compliance with the UK Corporate Governance Code. (6 marks) Suggested answer The UK Corporate Governance Code (the UK Code) states that the board should undertake a formal and rigorous annual evaluation of its own performance and the performance of the board committees and individual directors. For FTSE 350 companies, this evaluation should be externally facilitated at least every three years. The UK Code also states that the non-executive directors, led by the senior independent director, should be responsible for the performance evaluation of the chairman. There is no further guidance in the UK Code about how the performance evaluation should be conducted, although there should be a statement in the annual report about how the review has been conducted. As leader of the board, the chairman should be responsible for initiating the annual review, but need not be involved personally in the review process, until the results of the review have been presented. The UK Code states that the chairman should act on the results of the performance review by recognising the current strengths and weaknesses of the board. The performance review of individual directors should include an assessment of the continuing commitment of the individual

© ICSA, 2014 Page 17 of 27

to the work of the board, including time commitment for board and committee meetings and other duties. Where appropriate, the chairman should propose that new members should be appointed to the board or should seek the resignation of existing directors. The board should state in its annual report how performance evaluation of the board, its committees and individual directors has been conducted. Examiner’s comments There were some good answers to this question, which demonstrated these candidates had prepared for the exam. However, it was worth only six marks, and some candidates wrote unnecessarily and at length about how the chairman should act on the results of a performance review. It is important to keep time discipline in this examination. Acting on the results of a performance review is dealt with by part (b), so lengthy explanations in a six-mark part (a) were too much. There were some weaker answers to this question, but this usually appeared to be down to the fact that the candidates had not learned this topic when preparing for the examination, and seemed to guess at what the answer should be. (b) Advise Rick on the measures he may wish to consider in response to the findings of

the recent performance review of the directors of Tenjee, in order to improve board effectiveness.

(13 marks) Suggested answer Rick should consider the performance of each director individually. The recently-appointed NED has complained about lack of support from the company and the insufficient induction that she received when she was appointed. This problem may raise questions about the failure of the chairman, supported by the company secretary, to provide sufficient induction. The UK Code states that the chairman should ensure that new directors receive a full induction on joining the board and should meet with directors regularly to discuss and agree their training and development needs. The chairman appears to have failed in this respect, at least with regard to the new NED. A way forward may well be to discuss the induction and training needs of this director as a matter of urgency, and to provide further induction that is tailored to the individual’s requirements. In addition, the chairman needs to recognise his responsibility for providing induction for all new directors, and for discussing ongoing training needs with all the individual directors. There are problems with the performance of two NEDs. One attends board meetings without having prepared sufficiently by reading the board papers for the meeting, and wastes time at the meetings. The second does not contribute sufficiently to discussions at board meetings. This director may benefit the company from his political connections, but this on its own is an insufficient reason for an individual to be on the board of a listed company. These deficiencies in performance should be discussed with the individuals in private meetings with the chairman, and the chairman should consider whether either or both of them should be asked to resign. The chairman should also consider whether the failure of these two directors to contribute adequately to board meetings is also an indicator of his own poor performance as chairman, whose role is to provide leadership and encourage constructive participation by all board members in meetings. The chairman of the audit committee presents a different problem. This NED has been a board member for seven years, and will remain on the board as an independent director for no more

© ICSA, 2014 Page 18 of 27

than two more years. There do not appear to be any adverse comments about the performance of this director, but Rick – and the nominations committee – need to be aware that a successor must be identified as chairman of the audit committee. If a successor has not already been identified, this problem should be addressed as a matter of some urgency, especially if a new appointment to the board is required. The chairman should also consider the effectiveness of the board as a decision-making and governance body. The annual performance review is an appropriate time for the chairman to consider the broader issue of the composition of the board of directors. If one or two NEDs are to be asked to resign, an opportunity will arise for the board to become more diversified, in particular with regard to gender. Currently there is only one female director, and she is a recent appointment. We do not know the size of Tenjee, but the Davies Report (2011) recommended that all FTSE350 companies should set a target for the minimum proportion of the board who should be women. The chairman should discuss possible weaknesses in his leadership of the board with the NEDs appointed to review his performance, led by the senior independent director. In particular, the chairman should be encouraged to think about effective chairmanship of board meetings and his responsibilities for ensuring that directors are properly prepared in advance for meetings and that they contribute constructively to discussions and deliberations. He should also consider improvements in the induction process for new directors, and perhaps consult the company secretary in the improvements that should be made. Examiner’s comments Most candidates recognised that answers to this question required a comment on each of the directors in the question scenario, but the quality of answers varied. Candidates providing a very basic answer suggested that one NED needed a bit more induction and three other directors should be asked to resign. However, answers were expected to be more perceptive than this. One director complained of insufficient induction: although it was reasonable to suggest that she should be given more induction, the fact that she had to express the need should surely point to some failure on the part of the board chairman and company secretary. Similarly, the director who spoke at too much length at board meetings and the director who did not contribute to discussions needed to be spoken to. But surely the chairman’s job includes responsibility for managing board meetings and getting board members to participate in discussions. Could the chairman be at fault again, for failing to manage board meetings properly? Candidates making the point that board papers were not reaching one of the directors in sufficient time did not really provide a convincing argument: no one else on the board appeared to have the same problem. The chairman of the audit committee who had been a NED for seven years also caused difficulty for some candidates. Some suggested that he should not have been appointed for the final three-year period; others suggested that he should be asked to resign immediately. The sensible points to make were that his independence should be kept under review and plans should be made for his eventual replacement as audit committee chairman within the next year or two. A few candidates identified the issue of representation of women on the board. The issue was quite clearly flagged in the scenario. Many candidates overlooked it completely in all three parts of their answer. It is useful to remember that details in scenarios are often provided to give candidates an opportunity to make a useful point and earn some marks.

© ICSA, 2014 Page 19 of 27

(c) Explain how you would respond to the request of the COO for an appointment to the board.

(6 marks) Suggested answer The concerns and ambition of the COO should be given careful consideration. This matter may be discussed initially in the nomination committee, although it should be brought to the attention of the board as a whole. The COO appears to be a talented individual, and the CEO does not want to lose this individual from the management team. On the other hand, an individual should not be allowed to dictate terms to the board of directors, and the size and composition of the board is a matter for the board, led by the chairman, to decide. The wish to acquire boardroom experience is reasonable for ambitious senior executives in listed companies. The chairman and CEO may agree that it would be appropriate to encourage the COO to apply for a non-executive directorship with one or more other companies, in order to gain experience. Another possibility may be to discuss the COO’s request with the chairman of the remuneration committee, and consider whether there may be scope for improving the remuneration package for the COO. Better remuneration may provide an incentive for the COO to remain with the company, without a board appointment. If the COO insists on a board appointment, however, and the chairman and the rest of the board do not consider it appropriate to add one more executive directorship position to the board, the COO should be told that the company is unable to respond favourably to his requests. The CEO should then consider options for the eventual replacement of the COO in the management team. On the other hand, if the board decides to appoint the COO as director, the balance on the board will change and it will be appropriate to review the board balance and consider further changes if this seems appropriate. Examiner’s comments The quality of answers was again very mixed. Many candidates made lengthy comments about the balance on the board between executive and non-executive directors, without explaining why they considered this significant. One or two candidates even suggested that the UK Corporate Governance Code requires one half of board members to be executive directors. For too many candidates appeared under-prepared to accurately discuss this topic. Some candidates asserted that having another executive director on the board would be a ‘good thing’, without suggesting why. However, a good proportion of answers made sensible points about the board not accepting threats, that there is a due process for making board appointments and that there may be other ways forward to resolve the problem other than agreeing to a new board appointment.

© ICSA, 2014 Page 20 of 27

5. The boards of directors of Horn plc (‘Horn’) and Flute plc (‘Flute’), both UK listed companies, have agreed the terms of a takeover of Flute by Horn, with the consideration to be paid in the form of four new shares in Horn for every three shares in Flute. The proposed takeover must be approved by the shareholders of Horn in a general meeting. The board of Flute includes four executive directors. The terms of the proposed takeover provide for three of these to be appointed to the board of Horn after the takeover, and for each director to be paid a retention fee of several million pounds each. The fourth executive director, the CEO of Flute, would leave the company but would be given a final payment of £10 million. Several institutional shareholders have expressed strong reservations about these payment terms and are threatening to lead a shareholder revolt against the takeover. The shareholders of Horn are also concerned about a suggestion that the executive directors of their company may receive substantial improvements in their remuneration following the takeover, because they will now be members of the board of a much larger company. The chairman of the remuneration committee of Horn has tried to reassure shareholders by stating that executive remuneration would follow the recommendations of the UK Corporate Governance Code on remuneration for senior executives. Required (a) Explain the provisions and guidelines of the UK Corporate Governance Code on

remuneration for executive directors, and suggest how the proposed terms of the takeover of Flute may be inconsistent with these provisions and guidelines.

(9 marks) Suggested answer The UK Corporate Governance Code (the UK Code) states that the level of remuneration should be sufficient to attract, retain and motivate directors of the required quality, but should not be excessive. In addition, a large proportion of the remuneration of executive directors should be structured so as to link rewards to corporate and individual performance. An aim should be to avoid rewarding poor performance. The UK Code refers specifically to the commitments to compensation that may exist in the event of early termination of the appointment of a director. A schedule to the UK Code includes guidelines for the design of performance-related remuneration for executive directors. The performance conditions for any annual bonuses should be stretching and designed to promote the long-term success of the company and there may be a case for part-payment in shares rather than cash. Payouts or grants under an all incentive scheme, long-term as well as short-term, should be subject to challenging performance criteria and the potentially-available rewards should not be excessive. There should also be a formal and transparent procedure for developing policy on executive remuneration and for deciding the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration. The broad principle for remuneration of executive directors is therefore that incentive schemes should be challenging and rewards should be given for performance. The proposals for payments to the executive directors of Flute do not respect the principles and provisions of the UK Code because the proposal is to make payments to three executive directors simply for remaining with the company after the takeover. In effect, this means that

© ICSA, 2014 Page 21 of 27

these directors will be paid a reward for doing nothing other than remaining in the job for which they are already remunerated. There is no apparent justification for the payments, nor the size of the payments, and it is not clear how the proposal to make the payments was raised in the takeover discussions between the two companies. There is a possibility that one or more of the directors of Flute may have been involved in negotiating the payments as a condition of supporting the takeover. There do not appear to be any conditions attached to the proposed payments, such as a minimum period during which the rewarded directors should remain with the company after the takeover. It seems that the directors could accept the payments when the takeover occurs and, should they wish to do so, resign immediately. The proposal to make a payment of ten million pounds to the CEO of Flute who would resign is a form of compensation for loss of office. The CEO has no contractual right to this payment, and may have been involved personally in negotiating it with representatives of Horn. The chairman of the remuneration committee of Horn has informed shareholders that remuneration for executives will follow the guidelines in the UK Code, but he is clearly referring to remuneration arrangements after the ‘golden handcuffs’ payments (retention fee payments) to the three directors and the payment to the departing CEO of Flute have been made. It could be argued that these payments are not relevant to the ongoing remuneration policy of Horn. However, the payments would have the effect of taking wealth away from the shareholders of the enlarged company in order to reward current and former executives. They breach the underlying intention of the remuneration provisions of the UK Code, even if they do not breach specific principles or provisions. Examiner’s comments Part (a) is effectively a question in two parts. The first part asked about provisions and guidelines in the UK Code about remuneration for executive directors, and the second part asked for a comment on the arrangements in the scenario with regard to the UK Code provisions and guidelines. Many candidates specified the guidelines in the UK Code at some length, and were given due credit for this. Far fewer candidates commented on the takeover arrangements. Most candidates suggested that the payments to directors of the target company were excessive, and left it at that. On what basis did they judge the payments to be excessive? Virtually no candidates offered any justification for their view. Comments about directors being involved in setting their own remuneration, or comments about retention payments not being performance-related, would have earned marks. Too few candidates commented in these terms. (b) Explain the measures that Horn’s institutional investors may take to oppose the

remuneration terms of the takeover bid, both before and after the takeover, if it occurs.

(10 marks) Suggested answer Shareholders in both Horn and Flute will be affected by proposals for rewards and remuneration, because they will be joint shareholders in the enlarged company after the takeover. The terms of the takeover bid must be approved by the shareholders of Horn, and the shareholders in Flute have the choice of rejecting the offer. However, there are two problems with action to reject the takeover. The first problem is that the shareholders in Horn who are opposed to the terms of the bid must obtain a majority vote against it and, in practice, this may be difficult. Similarly,

© ICSA, 2014 Page 22 of 27

shareholders in Flute may reject the offer for their shares but, unless there is a sufficient number of them, the takeover may succeed anyway. The second problem is that, apart from the proposals to reward the directors in Horn, the takeover may be in the best interests of the shareholders of both companies, and they may therefore be reluctant to oppose it. Institutional investors with a substantial shareholding in either company may join forces to lobby the board of their respective company to change the terms of the takeover, and either reduce the size of the payments or even abolish them altogether. However, the boards of the two companies may refuse to make any changes to the terms of the takeover. The arguments in favour of paying the three executives to remain with the company may be stronger than the argument in favour of making a payment to the departing CEO. The shareholders may therefore argue for a ‘compromise’ arrangement in which payments are made to the directors who remain, but nothing is paid to the departing CEO of Flute. If the takeover succeeds, the shareholders in the enlarged company may oppose any proposals to increase the remuneration for executive directors. The measures they can take are as follows:

Shareholders can make their views known to the board, in discussions with the chairman, CEO or finance director. If appropriate, shareholders can express their views jointly, in the hope of persuading the board to re-assess its remuneration policy.

If the board does not respond favourably to shareholder pressure, the shareholders can use their votes at the AGM to express their disapproval. Typically, shareholders may vote against the remuneration report of the company (which is only an advisory vote) or they may vote against the re-election of the chairman of the remuneration committee. Even if the shareholders opposed to the company’s remuneration policy are in a minority, a substantial vote against the board’s proposed resolutions at the AGM may persuade the board to reconsider its policy for the future.

A revised remuneration policy will probably include proposals for a new or significantly revised incentive scheme for executives. This will require shareholder approval in general meeting. Shareholders can use the threat of voting against any new incentive scheme as a way of persuading the board to reconsider its remuneration policy.

Examiner’s comments Far too many candidates seem to have had a pre-prepared answer on shareholder activism, and provided an answer that lacked adequate comment or explanation. In rapid succession, many candidates made very brief comments about: speaking to the board chairman; meeting with the SID; joining together to vote against the takeover or remuneration policy, or to vote against the re-election of various directors; speaking to the press; and failing everything else, selling their shares. Adequately explained, these points would have earned good marks – with the exception of selling shares, which is not a measure for opposing remuneration policy. However, too many candidates made these points so briefly that the marker would have to make assumptions about what they were trying to say, because they hadn’t expressed their idea clearly. For example, it is reasonable for concerned institutional investors with a fairly large shareholding to speak with the board chairman; but what should they be speaking about, and for what purpose? Answers did not suggest what the purpose of any such meeting should be. Similarly, many answers suggested that the shareholders should oppose the takeover, or oppose the remuneration policy of the company. But would discontent with remuneration arrangements be sufficient to persuade shareholders to vote against a takeover? And if shareholders oppose the company’s remuneration policy, what should they suggest as an alternative – for example, no retention payments and more short-term or long-term performance-related incentives?

© ICSA, 2014 Page 23 of 27

(c) Assuming the takeover bid is approved by the shareholders, describe the challenges faced by the remuneration committee of the enlarged company.

(6 marks) Suggested answer If the takeover is completed, the enlarged company will have a new board, consisting partly of Horn directors and former Flute directors. Similarly, the executive management team will include senior directors from both companies. It will be the responsibility of the remuneration committee to develop and recommend a common remuneration policy for executive directors and other senior executives in the combined company. The remuneration policies of the two companies formerly may be very different. The remuneration committee may persuade the former senior executives of Flute to accept the remuneration structure that has been established within Horn. The committee cannot force them to accept the remuneration structure of Horn, if this would mean a breach of employment contract. There is also a problem that in a larger company, senior executives may expect larger rewards. There should not necessarily be a link between senior executive remuneration and company size, but in practice executives may well demand more remuneration when the company becomes larger. The remuneration committee may therefore be faced with a problem of ‘upward ratcheting’ in executive salaries. If shareholders have expressed anger about the payments to the Flute directors as a term of the takeover, they may remain very critical of remuneration policy in Horn, and there may be voting at annual general meetings against the remuneration report or against the re-election of the chairman of the remuneration committee. In summary, the challenge for the remuneration committee after a takeover would be to achieve a consistent policy for senior executive remuneration and to win shareholder support for that policy. Examiner’s comments This question asked about the challenges facing the remuneration committee after a takeover. Answers that sensibly discussed challenges earned reasonable or good marks. Candidates who made general comments about the role of the remuneration committee, without recognising any particular challenge, were not answering the actual question.

© ICSA, 2014 Page 24 of 27

6. Splash plc (‘Splash’) is a UK listed company which specialises in the provision of advertising and marketing services. It operates globally, with subsidiaries in many countries around the world. The newly-appointed chairman of the company has been impressed by the importance that the company’s board and senior executives attach to sustainability issues, and he wants to find out as much as he can about the policies and activities of the company in the area of corporate social responsibility (CSR) and sustainability. The company’s activities cover all aspects of marketing services, in a range of different media, in many countries and many different languages. Sustainability policy, however, is formulated by the board of directors for global application, and the company has a Sustainability Committee consisting of executive and non-executive directors and some senior executives below board level. The chairman has asked the Sustainability Committee to give a presentation about the sustainability and CSR policies of the company and he plans to ask searching questions about the scale and scope of the company’s activities in this area. He has asked you as company secretary to assist him. He has asked you to prepare a short memo for him that sets out the sustainability and CSR policies and activities that should be expected from a company such as Splash, which publicises its sustainability credentials widely. The chairman has a second area of interest. He is aware that the company’s annual general meetings (AGMs) are not well attended, and he is concerned that the company does not communicate effectively with enough of its shareholders. He believes that the AGM would be an ideal forum for the company to develop its relations with shareholders, and that much more could be done to make the AGM a more productive meeting that many more shareholders should attend. He has asked for your views about this matter. Required (a) Prepare a paper for the chairman in which you set out the various aspects of

sustainability or CSR policy in which the company may be engaged. (15 marks) Suggested answer To: The Chairman From: Company Secretary Date: 28 November 2013 CSR policy in Splash A company such as Splash, with its global involvement in advertising and marketing services, is in a strong position to apply socially responsible policies in its business activities. It is able to do this directly through its business operations and indirectly through the work that it does for clients. An advertising company does not affect the global environment as extensively as companies in industries such as oil extraction and refinery, chemicals manufacture, transport and so on. Nevertheless it has a ‘carbon footprint’ and it can contribute to the protection of the environment by means of measures such as discouraging employees from travelling around the world and making more use of teleconferencing and similar facilities. In addition, the company should implement initiatives to reduce the consumption of resources such as paper (by using more electronic messaging and avoiding the use of printed copies) and energy. As a large global company, Splash is also able to influence ‘green’ policies in its supply chain, selecting suppliers with ‘green’ credentials.

© ICSA, 2014 Page 25 of 27

CSR policies relate not just to the environment, but also to employees and society as a whole. Splash can be a socially responsible employer, providing good conditions of employment to its staff as well as education and training to enable staff to develop their careers. Staff can also be given time off work to involve themselves in local initiatives to support their local community. CSR policies must have an ethical foundation, and the board of Splash should promote ethical marketing practices in its work. Although Splash can apply CSR policies in its own internal activities, it can contribute much more significantly through its advertising and marketing work. It can assist client companies to exploit the benefits of their environmentally-friendly products and operations through advertising and promotions. Client companies may be aware of the potential commercial benefits of environmentally-friendly products, but Splash can help them to market their products and the environmental benefits they provide. Marketing the environmental advantages of products also has the effect of making potential customers for those products more aware of environmental issues, and the environmental advantages of the products that their clients are selling. Splash should also provide advertising and marketing services ‘pro bono’ to selected charities and other worthwhile operations. Assisting some clients for no fee will benefit the clients and the causes for which they work. It will also have the commercial advantage of giving our employees an opportunity to develop and demonstrate their advertising skills. Companies are increasingly aware of the potential commercial and regulatory benefits of developing sustainable products and businesses. This process will take time, but it will be assisted by advertising and other forms of marketing. The activities of Splash will be crucial to the development of sustainable businesses over time. Examiner’s comments Anyone preparing for the Corporate Governance exam would benefit from looking at some sustainability reports (or social and environmental reports) of listed companies, and also at some company annual reports. These are easily found on company websites. They provide useful examples of social and environmental policies of companies, and show how these vary between companies in different industries. Many answers to this question may have been affected by a shortage of time, as Question 6, although popular, was often the last question attempted. Many of the answers were fragmented, and lacked structure and sensible presentation. Some answers were little more than suggestions about reducing paper consumption, avoiding child labour, being an equal opportunities employer and contributing vast amounts of money to hospitals and schools is unnamed countries. These were not particularly useful suggestions for a company in the advertising and marketing business. Candidates who made interesting suggestions about policy were given due credit. (b) Discuss, with reasons, your views on the ways in which AGMs could be used to

improve standards of corporate governance in a company such as Splash, and explain the limitations of the AGM for achieving this purpose.

(10 marks) Suggested answer The UK Corporate Governance Code states that a company should use the AGM to communicate with shareholders and to encourage their participation. The chairmen of the audit,

© ICSA, 2014 Page 26 of 27

remuneration and nominations committees should attend the AGM, so that they are available to answer questions from shareholders. Companies are encouraged to send out the notice of the AGM well in advance of the meeting (with at least 20 working days’ notice) so that more shareholders will have time to plan their attendance. The chairman should give shareholders an opportunity to ask questions, and questions should be answered honestly and openly. There should be a separate resolution and vote on each substantial different issue, and shareholders should be able to indicate their choice to abstain on any resolution, as well as being able to vote ‘for’ or ‘against’. The company should also disclose the proxy votes when resolutions are agreed on a show of hands of those present at the meeting. A well-managed AGM can be used by the board to provide constructive communication with shareholders, by presenting an informative view of the company’s performance and aspirations, including the board’s views on risk and future prospects, and also the company’s CSR policies. The chairman should also encourage questi

corporate governance - icsa · she is aware that breakthrough has been suffering from a decline in...

Documents