Section A – This ONE question is compulsory and MUST be attempted Hayho is a large international company with direct investments in 65 countries. It is a manufacturer of high technology products, with each Hayho factory typically employing over 3,000 people. Hayho factories also support local supply chains employing many more people so each Hayho plant is considered a vital part of the regional economy in which it is located. Several years ago, Hayho was widely criticised for its operations in Arrland, a developing country with an oppressive and undemocratic government. Investigative journalists produced material showing the poor conditions of workers, and pollution around the Hayho factories in Arrland. They also showed evidence suggesting that Hayho had paid bribes to the Arrland government so that local opposition to the Hayho operation could be forcefully stopped. After this episode, the company became very sensitive to criticism of its operations in developing countries. A press statement at the time said that Hayho, in future, would always uphold the highest standards of integrity, human rights and environmental protection whilst at the same time ‘responsibly’ supporting developing countries by providing jobs and opportunities to enable greater social and economic development. The board of Hayho is now deciding between two possible large new investments, both directly employing about 3,000 people. Both options have a number of advantages and disadvantages and Mr Woo, Hayho’s finance director, has recently made clear that only one can be chosen at this stage. The two options are of similar investment value and are referred to as the ‘Jayland option’ and the ‘Pealand option’. The ‘Jayland option’ is to build a new large factory in Jayland and to recruit a completely new local workforce to work in it. Jayland is a developing country with few environmental and labour regulations. It has a poorly developed education and training system, and is generally considered to be undemocratic. Its president, Mr Popo, has been in office since he seized power in a military coup 30 years ago. Human rights organisations say that he maintains order by abusing the rights of the people and cruelly suppressing any dissent against him. In early exploratory talks between Hayho and the Jayland government, Hayho was given assurances that it could pursue its activities with little regulation from the government as long as the Jayland president, Mr Popo, received a personal annual ‘royalty’ (effectively a bribe) for allowing Hayho to operate in his country. Finance director Mr Woo said that some stakeholders would probably criticise Hayho, perhaps in the international media, for investing in Jayland. Hayho may be accused of supporting the dictatorship of Mr Popo in that country, especially if the ‘royalty’ was ever discovered. Mr Woo calculated that the NPV (net present value) of projected pretax returns of the Jayland option over a ten-year period was $2 billion but that there was also a risk of potential political instability in Jayland during the lifetime of the investment. The ‘Pealand option’ is to buy an existing plant in Pealand which would then be refurbished to facilitate the manufacture of Hayho products. This would involve ‘inheriting’ the workforce of the previous owners. Pealand is a ‘new democracy’, and a transitional economy, having gained its independence ten years ago. In an attempt to purge the corrupt business practices associated with its past, the Pealand government has become very thorough in ensuring that all inward investments, including Hayho’s factory purchase, meet exacting and demanding standards of environmental protection and work conditions. Mr Woo, the finance director, said that the NPV of projected pre-tax returns over a ten-year period was $1 billion for the Pealand option but that the risk of political instability in Pealand was negligible. Both of the returns, the forecast $2 billion for Jayland and the $1 billion for Pealand, were considered to be acceptable in principle. Mr Woo also said that there were issues with the two options relating to the effectiveness of necessary internal controls. Whichever option was chosen (Jayland or Pealand), it would be necessary to establish internal controls to enable accurate and timely reporting of production and cost data back to head office. So a number of systems would need to be put in place to support the production itself. One staff member, Emily Baa, who had previously worked in Jayland for another company, gave her opinion to the board about some of the issues that Hayho might encounter if it chose the Jayland option. She said that Jayland was very under developed until relatively recently and explained how the national culture was unfamiliar with modern business practice and behaviour. She said that property security may be a problem and that there was a potential risk to assets there. She also said that, in her opinion, there was a lack of some key job skills among the potential workforce in Jayland such as quality control and accounting skills. She explained that quality control skills would be necessary to ensure product specifications were met and that accounting skills would be necessary for the provision of internal and external reporting. As a manufacturer of very technologically advanced products, a number of stringent international product standards applied to Hayho products wherever in the world they were produced. Meanwhile, news that Hayho was considering a large investment in Jayland leaked out to the press. In response, Hayho’s chief executive, Helen Duomo received two letters. The first was from a prominent international human rights lobbying organisation called ‘Watching Business’ (WB). In the letter, the lobby group said that because of its ‘terrible track record’ in Arrland and elsewhere, Hayho was being carefully monitored for its ‘unethical business practices’. WB said its interest in Hayho’s activities had been rekindled since it had received intelligence about the possible investment in Jayland and warned Mrs Duomo not to make the investment because it would provide credibility for the ‘brutal dictatorship’ of Mr Popo. Whilst Mrs Duomo, known for her forthright manner, would normally dismiss threats from groups of this type, she knew that WB had a lot of support among senior politicians and legislators in many parts of the world. She believed that WB could achieve some power through mobilising public opinion through effective use of mass media, such as newspapers and television. WB was also respected as a research organisation and its advice was often sought by politicians and trade organisations. Mrs Duomo said she was frustrated whenever anybody got in the way of her accountability to the Hayho shareholders, but that some interests could not be ignored because of their potential to influence. WB fell into this category. The second letter she received was from the head of Quark Investments, Hayho’s single biggest institutional shareholder. The letter sought to remind Mrs Duomo that the Hayho board was employed by its shareholders and that Mrs Duomo should be determined and resolute in maximising shareholder returns. The letter encouraged the board not to be diverted by ‘well meaning but misinformed outsiders concerned with things that were actually none of their business’. Aware that she had to manage two competing demands placed on her, Mrs Duomo sought advice from Emily Baa, who had experience of life in Jayland. So she asked Emily Baa to prepare some notes for the next board meeting to clarify whom the board of Hayho was actually accountable to and how it might respond to the letter from WB. Required: (a) Explain ‘risk appetite’ and demonstrate how different risk appetites might affect the selection of investments between Jayland and Pealand. (6 marks) (b) Use the AAA (American Accounting Association) seven-step model to examine the ethical decision whether to select the Jayland option or the Pealand option. (14 marks) (c) Describe the general purposes of an internal control system and, based on Emily Baa’s views, assess the main internal control challenges that Hayho might encounter if it chose the Jayland option. (12 marks) (d) Prepare briefing notes from Emily Baa to prepare chief executive of Hayho, Helen Duomo, for the board meeting as requested in the case. The notes should cover the following: (i) A discussion of the meaning of accountability at Hayho and of how the Mendelow framework can be used to predict the influence of the Watching Business pressure group; (7 marks) (ii) A brief explanation of the agency relationship between the board of Hayho and Quark Investments, and advice on why the demands from Watching Business should be carefully considered. (7 marks) Professional marks will be awarded in part (d) for the clarity, flow, persuasiveness and structure of the briefing notes. (4 marks)