SUBJECT NO 10J

CORPORATE GOVERNANCE
JUNE 2010
The examination paper is divided into TWO Sections. Section A is compulsory and
carries 40 marks. Candidates should attempt THREE questions from Section B, all of
which carry 20 marks each.

You should allow yourself approximately 70 minutes in total to answer the questions in
Section A, and 35 minutes for each of the questions attempted in Section B.

Wednesday afternoon 9 June 2010 Time allowed: 3 hours

SECTION A
(Compulsory – answer all parts of this question)

1. (a) What is auditor rotation, and how does rotation contribute to good corporate
governance? (4 marks)

(b) Explain the provisions of the UK Combined Code regarding the composition and
chairmanship of a nomination committee, and suggest why these provisions are
considered necessary for good corporate governance. (4 marks)

(c) Describe the four roles of a non-executive director. (4 marks)

(d) With regard to the functioning and effectiveness of the board committees, what
should be the responsibilities of a company secretary? (4 marks)

(e) Outline four of the main provisions on the design of performance-related

remuneration for executive directors, as set out in an appendix to the UK
Combined Code. (4 marks)

(f) What is the nature of accountability, and how is it applied within a system of
corporate governance? (4 marks)

(g) How does a supervisory board in a company with a two-tier board structure,
such as a public company in Germany, differ from a unitary board, such as a
board of directors in a UK public company? (4 marks)

(h) Explain the limitations of the Annual General Meeting of a large listed public
company for the exercise of their rights by the equity shareholders. (4 marks)

(i) What information about risks needs to be contained in a narrative report to

shareholders (such as a business review as required of quoted companies
within the European Union)? Why may this information be of value? (4 marks)

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 (j) Explain briefly the main reasons why a company may adopt a corporate code of
ethics. (4 marks)
(Total: 40 marks)

SECTION B
(Answer THREE questions from this section)

2. The Wigwam Investment Fund (WIF) monitors the performance of all the quoted
companies in which it holds equity shares. Decisions about buying, holding or selling
shares are based partly on reports by its analysts. The head of department is meeting a
newly-appointed analyst to explain the aspects of a company’s performance that are of
particular interest. He says that it is obviously important to look at all financial reports
issued by the company, including the financial statements in its annual report and
accounts, and it is also important to look for information about the company’s business
strategies and future prospects.

He then adds that WIF attaches great importance to corporate governance, and would
be inclined to avoid investing in companies with unsatisfactory corporate governance.
The newly-appointed analyst replies that he was not required to consider governance
issues in his previous job as credit analyst for a commercial bank, and he wants to know
more about what aspects of governance should be included in the reports that he
prepares on companies for his superiors.

Identify the corporate governance issues that should be of interest to an institutional

investor in equities, and explain why these issues may be of particular interest to the
fund managers of WIF. (20 marks)

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3. Luke Graves (Luke) is the long-serving Chief Executive Officer (CEO) of Hornbill plc, a
UK listed company. He had a meeting with the newly-appointed chairman of the
company, Ross Plank (Ross), who happens to be married to Luke’s sister. A number of
different items were on the agenda for discussion.

Luke said that he had recently had a meeting with two institutional shareholders in the
company, who together held 5% of the equity shares. He had discussed the company’s
performance over the past few months and they had been pleased by the profit
forecasts that he had given them. The company’s results would be announced to the
stock market within the next two weeks. He had also discussed the company’s main
business strategies with these shareholders and had informed them that he intended to
establish a strategy committee within the company, consisting of the executive directors
and other senior executives.

They then went on to discuss the retirement and re-election of board directors at the
AGM. Luke said there was a problem with one of the directors, who would be retiring by
rotation this year, who had been an independent non-executive director for almost nine
years. He was very experienced and had contributed enormously to the work of the
board. He was considered to be too valuable to lose from the board, but there was now
a problem with his independent status. Luke felt that he was still as independent now as
he was when he first joined the board.

Luke also informed Ross that he had arranged for additional training for two board
directors: one of the non-executive directors and also the marketing director.

(a) Analyse the evident weaknesses in the company’s corporate governance

practices. For each weakness that you identify, recommend what the
appropriate practice of governance should be. (10 marks)

(b) Discuss the problem facing the company concerning the long-serving non-
executive director, and recommend what the company should do to resolve it.
(10 marks)
(Total: 20 marks)

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4. You are the secretary of a medium-sized listed company. The chairman of the board of
directors has asked for your opinion or advice about performance reviews.

At the moment, the company does not have any system of annual review of the
performance of the board and its directors. He wants to introduce such a system, and
recognises that it is recommended best practice for corporate governance. However, he
has no previous experience with performance reviews and is not sure how they should
be done. He knows that there is a need to review the performance of individual directors,
each of the board committees and the board as a whole, but does not know what he
should be looking for in order to judge performance. In addition, he is not sure how his
own performance should be assessed, or whether this is necessary. He thinks that the
most appropriate solution may be to delegate the responsibility for performance reviews
to the nomination committee.

Taking account of the relevant provisions in the UK Combined Code of Corporate

Governance:

(a) Suggest, with reasons, the aspects of performance that should be measured
and reviewed, in order to make an assessment of the individual directors, the
individual board committees and the board as a whole. (8 marks)

(b) As company secretary, make practical recommendations to the chairman about

how he should set about introducing annual performance reviews. (12 marks)
(Total: 20 marks)

5. The newly-appointed secretary of a UK listed company was previously a company

secretary working for a large company in South Africa. He has commented to the board
of directors that, in his opinion, the company does not give enough attention to its
corporate social responsibility (CSR). In comparison with South Africa, he believes, UK
companies do not sufficiently understand the need to act as responsible corporate
citizens and this is a weakness in the UK Combined Code on Corporate Governance,
compared with the King Report.

In response to his suggestion that the company should publish a Social and
Environmental Report every year, the chairman replied that this is no longer necessary
because of the statutory requirement for quoted companies to include social and
environmental information in their annual business review.

(a) Explain the differences between the UK Combined Code on Corporate

Governance and the King Report with regard to corporate social responsibility
and, on the basis of these differences, give your assessment of the opinions and
comments of the company secretary. (10 marks)

(b) Discuss the view of the company chairman that an annual Social and
Environmental Report is not necessary, because of the social and environmental
information in the annual business review. (10 marks)
(Total: 20 marks)

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6. Brakefoot plc is a small UK listed company. The chairman of the board of directors has
asked the chairman of the audit committee and the company secretary for information or
advice on two matters.

The company does not have an internal audit function at the moment, and the audit
committee will be carrying out a review of the need for one. The chairman is not familiar
with the work of internal auditors, and wants to learn more before the audit committee
presents its report.

The company set up a whistle-blowing procedure four years ago, following the arrest
and criminal prosecution of an executive director for fraud. Whistle-blowers are asked to
report their concerns to the company secretary, who then decides whether the matter
should be referred to the board of directors. Since the procedure was established, there
have been only three instances of whistle-blowing, and in one of these the whistle-
blower was dismissed for making false allegations. The other two whistle-blowers
resigned from the company several months after making their allegations. The chairman
believes that the whistle-blowing procedure is not working as intended, but is not sure
why.

(a) Describe the responsibilities that an internal audit function may be given if it is
established, and suggest with reasons:

(i) who should decide the tasks or projects for internal audit; and
(ii) who the senior internal auditor should report to within the company.
(10 marks)

(b) From the information provided, identify the apparent problems with the whistle-
blowing procedure, and suggest reasons why it may not be functioning as it was
originally intended. (10 marks)
(Total: 20 marks)

The scenarios included here are entirely fictional. Any resemblance of the information in
the scenarios to real persons or organisations, actual or perceived, is purely coincidental.

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