CORPORATE GOVERNANCE AND ETHICS DECEMBER 2021 PAST PAPER

FRIDAY: 17 December 2021.                                                                                                                        Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question.

QUESTION ONE

PIE BITES LIMITED (PBL)

Pie Bites Limited (PBL) established in the year 2000 is one of the most successful franchise food retailers in the Kenyan market with over 300 outlets in major towns in the country. However, lately PBL has experienced negative publicity and has rarely been out of the news in the last two years. In July 2019, the Franchisor carried out a forensic audit of PBL due to a whistle-blower’s claim that PBL had been routinely understating sales with the aim of defrauding the franchisor of royalties. PBL admitted in October 2019 that there could have been accounting irregularities and that it had launched internal investigations into the matter. Preliminary results of the investigation indicated that revenues could have been higher than reported. This implied that the Franchisor had been underpaid in royalties.

The admission of the accounting irregularities raised serious questions about board governance and specifically the structure and the composition of the company’s board of directors, their financial reporting responsibilities and the use of inappropriate accounting policies. The PBL Board had a Chairperson and a Chief Executive Officer in charge of the day to day operations of the company. The Board carries out an annual self-evaluation of its performance.

In a hurriedly convened meeting in December 2019, the shareholders appointed two directors who were not part of the management of PBL. Prior to the appointment of the two new non-executive directors, PBL’s board did not have independent directors. A skills audit conducted revealed that prior to the appointment of the two non-executive directors, the directors of PBL did not have any directors with financial or accounting expertise. This weakness in financial knowledge suggested the board was unlikely to have had the necessary knowledge and expertise to effectively question and challenge the company’s executives on financial and accounting matters. This also extended to the top management team where the Finance Department was headed by an Economist without financial and accounting qualifications. PBL books of accounts and financial reports were prepared by an outsourced accounting firm.

In the most recent external financial audit for the year 2018, the external auditors of PBL’s company Annual report and financial statements discussed the “risk of manipulation” and incomplete records in the recognition of commercial income. However, this did not prevent the company’s first -half figures treating a contingency liability as having crystallised and being treated as a cost and reducing the anticipated profits of the company in the financial year 2019. The accounting treatment adopted was accepted by the Board which also lacked financial accounting expertise and the profit figures subsequently emerged when one of the company’s own employees questioned the accounting treatment under the company’s whistle blowing policy.

An investigative journalist writing about PBL in a business journal suggested that the issues of board composition and income recognition point to failures in the current system of corporate governance of PBL. He pointed out that the Codes of Corporate Governance and the Board Charter of PBL did not require the Board to have non-executive directors neither did it explicitly state that the Board needed members with accounting and financial experience. The journalist noted that the adoption of inaccurate estimates of commercial income reflected a ‘failure to establish adequate regulatory mechanisms for curbing abuses of corporate power’. He suggested that reforms were urgently needed and regulators needed to move in with speed. He recommended the immediate constitution of a Board Audit Committee with the requisite expertise.

On 28 February 2020, PBL held an extraordinary general meeting to reassure and update investors on its financial status and the reconstituted governance structures including the establishment of an Audit and Risk Committee of the Board and recruitment of a Certified Public Accountant and Finance Manager regulated by their respective professional bodies. Together with updating investors on its financial results after restatement, the company announced that the Chairman of the Board and CEO would be stepping down from their positions and that the Chief Operating Officer would take over in an acting capacity until a new substantive CEO was recruited.

On 4 April 2020 the Securities Regulator and the Economic Crimes Unit announced it had launched a criminal investigation into the alleged accounting irregularities at PBL. In the meantime, the shareholders appointed a Governance Consultant to carry out a comprehensive governance audit into the governance practices of PBL with the aim of making recommendations on how to improve governance at PBL.

Required:

1.          Advise the shareholders and management of PBL on how good and effective Corporate Governance could guarantee commercial success and the going concern of the company.                                                                                             (10 marks)

2.         Discuss five directors’ responsibilities on financial reporting for PBL.                                                                               (5 marks)

3.         Explain five ways of how Non-Executive Directors (NEDs) could be made more independent.                                        (5 marks)

4.         Summarise five typical roles of Audit Committee in PBL.                                                                                               (10 marks)

5.         Discuss five ways in which PBL could promote shareholders’ rights.                                                                                (5 marks)

6.         Outline five good corporate governance practices adopted by PBL.                                                                                   (5 marks)

(Total: 40 marks)

 

QUESTION TWO

1.          Discuss five features of the cooperative model of corporate governance.                                                                           (5 marks)

2.          Analyse five barriers to implementing a successful whistle blowing policy in an organisation.                                          (5 marks)

3.          Boards of directors are required to exert due diligence in ensuring that the organisations they govern are achieving their missions effectively and efficiently.

Required:

Discuss the above statement by highlighting fives areas in which due diligence assessments need to be carried out by the board.                                                                                                                                                                        (5 marks)

(Total: 15 marks)

 

QUESTION THREE

1.          Discuss five roles of the board towards effective stakeholders relations.                                                                            (5 marks)

2.          Analyse five ways in which an organisation would fail in implementing an ethics program.                                              (5 marks)

3.           Highlight five objectives of good corporate governance reporting.                                                                                     (5 marks)

(Total: 15 marks)

 

QUESTION FOUR

1.          Procurement as a function in the organisation might result in both ethical and conflict of interest issues as relates to the role of the board of directors.

Required:

With reference to conflict of interest, discuss three ethical issues that might arise during procurement.                              (6 marks)

2.           “Successful chairmen are leaders”. This was the observation made by “John Harper” in his book “chairing the board”.

Required:

In relation to the role of the chairman of the board of directors, explain four reasons why you might agree with the observation made by John Harper.                                                                                                                                      (4 marks)

3.           Assess five key reasons why succession planning in organisations must continually get the attention of the board of directors.     (5 marks)

(Total: 15 marks)

 

QUESTION FIVE

1.           Explain why you consider a stakeholders’ policy necessary in an organisation.                                                   (1 mark)

Identify four key areas that stakeholders’ policy should address.                                                                        (8 marks)

2.          Describe six key steps that are undertaken in the process of adopting Environmental Social and Governance (ESG) investment for an organisation.                                                                                                                                           (6 marks)

(Total: 15 marks)

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