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  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 greatersocial 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)
 
  (50 marks)
 
  Answer:
 
  (a)Risk appetite
 
  Explanation
 
  Risk appetite describes the willingness of an entity to become exposed to an unrealised loss(risk).It is usually understood to mean the position taken with regard to two notional preferences:risk aversion and risk seeking.Both preferences are associated with different levels of returns:those that are risk-seeking favour higher risks and higher returns with the converse being true for the risk averse.
 
  Risk-averse entities will tend to be cautious about accepting risk,preferring to avoid risk,to share it or to reduce it.In exchange,they are willing to accept a lower level of return.Those with an appetite for risk will tend to accept and seek out risk,recognising risk to be associated with higher net returns.
 
  Risk appetite and selection
 
  The Jayland option has a higher political risk,a threat to the integrity of the company(by paying the bribe)and an element of reputation risk.There is also a risk arising from the lack of business culture in Jayland and a possibility that it will be more difficult to maintain normal operations there than in Pealand.Offset against these risks is the potential return of$2 billion over ten years,which is twice that of the Pealand option.
 
  The Pealand option has negligible political risk but a slightly higher risk that internal controls will be difficult to implement.It has a much lower likelihood of reputation risk and there is no risk connected with bribery.The return is half that of the Jayland option(for an approximately equal investment value).
 
  The two options offer two different risk and return profiles:the Jayland option offers a higher return but a higher risk profile and the Pealand option offers a lower return but also a lower risk profile.If the company has a higher risk appetite it is more likely to choose Jayland and if it has a lower risk appetite it is likely to select the Pealand option.
 
  (b)AAA seven-step model
 
  1.What are the facts of the case?
 
  The facts of the case are that there are two investment options and each has a different ethical and risk profile although the AAA model is mainly concerned with the ethical aspects.The ability to operate the necessary internal controls for Hayho manufacturing also differs between the two options.Only one option can be pursued and both are capable of making an acceptable level of return.
 
  2.What are the ethical issues?
 
  The ethical issues are over the potential complicity of Hayho in supporting a corrupt regime in Jayland,in paying what appears to be a bribe to Mr Popo under the Jayland option and in operating under less stringent regulatory conditions in Jayland compared to Pealand.Another issue to consider is that it is alleged the president of Jayland maintains order by abusing the rights of the people.The company is very sensitive to allegations of human rights abuses after criticisms of Hayho were made in Arrland recently and it is reluctant to expose itself to similar criticisms again.
 
  A further ethical issue is whether there is a corporate social obligation for companies to invest in developing or transitional economies to help stimulate these economies.However,these disadvantages have to be weighed against the likelihood of making twice the return for shareholders in Jayland against the option of operating sustainably in a more stable Pealand.In Pealand,there may be ethical issues concerning taking over an existing workforce and changing working terms and conditions,perhaps in terms of changed expectations,contractual issues and redundancies.
 
  3.What are the norms and principles that apply?
 
  The norms and principles that apply in this situation are that business investment decisions should be taken on a sound commercial basis with risk,return and ethical considerations fully taken into account.
 
  The case says that the company seeks to‘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.’
 
  This would tend to favour decisions that do not involve bribery(against integrity),human rights abuses(perhaps through supporting corrupt governments),but at the same time seeking,where possible,to use investments to support local economic development(perhaps by investing in developing countries,all other things being equal).
 
  4.What are the alternatives?The first alternative is to invest in Jayland,where a‘new-build’factory would enable Hayho to implant its culture and systems but where there is a poorly developed education system,a potentially unstable political environment and an absence of internal control and corporate governance regulations.
 
  The other alternative is the Pealand option,to take over an existing plant and an inherited workforce in a more highly regulated business environment.
 
  5.Which option is most consistent with norms and principles?
 
  Both options have strengths and weaknesses,depending upon how the different factors are evaluated.The Jayland option would meet the criteria for financial acceptability and would be favourable through supporting economic growth and by providing net additional employment in a developing country.
 
  The option most consistent with stated norms and principles is the Pealand option.This option has the benefit of inheriting a trained and competent workforce and avoids the reputation risk of providing credibility for the Popo regime and of being exposed,perhaps by a whilstleblower,for paying the‘royalty’(which is effectively a bribe to Mr Popo).The Jayland option would provide a greater financial return and provide net additional employment in a developing country.
 
  But it also would violate the principle of sound risk management because investing in an unstable and potentially hostile political environment could expose Hayho to unacceptable levels of long-term operational,financial and reputational risk.
 
  6.What are the consequences of each option?
 
  In Jayland,as opposed to Pealand,a completely new factory would be built providing new additional employment,although there could be an issue with sourcing the appropriate staff,given the poor levels of education and training.The Jayland option would provide a higher potential return to shareholders,but at a greater risk.It would make implementing the internal controls potentially easier but would risk reputation-damaging allegations of supporting Mr Popo’s regime.
 
  Were the‘royalty’to be made public,it would have severe consequences for the trustworthiness of the Hayho board,having given the reassurances it did after the Arrland incident.
 
  The Pealand option would make a smaller return and involve lower risk,but could introduce potential problems with implementing the necessary internal controls.This option would be more ethically acceptable.Hayho would be severely criticised for supporting a corrupt regime if it invested in Jayland.But if it invested in Pealand,no bribery would be necessary and it could publicise the fact that it chose to invest in Pealand over Jayland because it is seeking to honour its commitments made after the previous Arrland incident.
 
  7.What is the decision?
 
  The decision most aligned to the company’s stated norms and principles is the Pealand option.Other powerful countervailing factors would also have an influence,however,as risk and internal control considerations would also be taken into account.
 
  (c)General purposes of internal control systems and main challenges.
 
  General purposes
 
  The first general purpose of internal control is to achieve the orderly conduct of business by facilitating effective and efficient operation of an organisation’s activities.In doing this,it must be able to respond appropriately to relevant risks and to configure activities to be able to achieve the organisation’s strategic objectives.This includes safeguarding the assets of the organisation from external and internal threats and to ensure that all actual and potential liabilities and sources of loss are identified and controlled.The protection of value is important in underpinning confidence in internal controls and in providing the capacity for future value adding.
 
  Internal controls are essential in ensuring the robustness,quality and timeliness of both internal and external financial reporting.The provision of this information is important in managing internal systems(e.g.budgetary controls)and in maintaining and cultivating confidence among shareholders and capital markets.This involves maintaining accurate records and processes capable of generating and processing the relevant information.
 
  Internal control is necessary to ensure compliance with any external laws,standards or regulations that apply.These could arise from companies’legislation,listing rules or,in some industries,regulations imposed by sector-specific regulators.
 
  Main challenges
 
  Jayland was very under developed until relatively recently and the national culture is,according to Emily Baa,unfamiliar with modern business practice and behaviour.Achieving effective and efficient operation of the business would be an early priority for the Hayho investment and this limitation would necessitate substantial initial training and cultural-familiarisation.
 
  If these cultural values(e.g.time-keeping,work commitment,honesty of workers,etc)cannot be taken for granted in a national culture then it represents a major obstacle in achieving normal plant operation.
 
  Emily reported an unknown security situation in the region with regard to the safeguarding of assets.Being able to ensure that non-current assets owned by Hayho are secure and being used for the intended purpose is an essential element of internal control.The value of Hayho belongs to its shareholders and it would be irresponsible of the board(as agents)to invest in assets in Jayland unless reasonable assurances could be given that they will be safe from sabotage,damage,theft,deterioration or inefficient utilisation.
 
  Emily’s third point was about the level of necessary skills in the local labour pool.She mentioned the state of quality control and accounting skills and both of these are necessary for a sound system of internal control.
 
  Appropriate quality control staff are necessary to ensure that the product complies with the stringent international product standards that apply to Hayho’s products.Where technical skills such as these are difficult to obtain in local labour markets,unskilled people may need to undergo training,or expatriates may need to be persuaded to move to the Jayland facility.
 
  Guaranteeing that outputs from the Jayland plant were fully compliant with all applicable standards would be an important early priority for customers and investors and so this issue is likely to be of great importance.
 
  Accounting skills are necessary for guaranteeing accurate and complete accounting records and for reliable financial information.Gathering required data and reporting to management at head office is required,for example on metrics such as variance against agreed targets.For a new investment such as those being considered by the Hayho board,the provision of accurate and timely information is essential in controlling activities under either of the options.
 
  (d)(i)Meaning of accountability and Mendelow.
 
  Briefing notes for board meeting.
 
  Prepared for Helen Duomo,chief executive.
 
  By Emily Baa
 
  Wednesday 20 June,2012.
 
  Accountability of the Hayho board
 
  The two letters received raise important issues of accountability,and specifically,the issue of to whom the board of Hayho is accountable.In reflecting on how to deal with this and how to frame our response,it may be helpful to consider the accountability situation we face as a board.
 
  Accountability is a key relationship between two or more parties.It implies that one party is accountable to,or answerable to,another.This means that the accountable entity can reasonably be called upon to explain his,her or its actions and policies.
 
  This means that the accountable party can be held to account and may be required to actually give an account.This has the potential to influence the behaviour of the accountable party,in this case Hayho,because of the knowledge that they will have to answer for it when they give that account.
 
  Whilst it is clear that the board is accountable to the shareholders as stewards of their investment,it may be the case,nevertheless,that the board may need to account to WB because of its influence among politicians and in wider society,as outlined below.
 
  Influence of Watching Business
 
  The Mendelow framework is a way of mapping stakeholders with regard to the two variables of interest and power.The combination of these is a measure of any given stakeholder’s likely influence over an entity such as Hayho.The framework is dynamic in that stakeholders move around the map as their power and interest rise and fall with events.
 
  WB has a moderate degree of power and a variable degree of interest.Because its interest(in Hayho)has recently increased,its overall influence has risen.Our response to WB must be responsive to this.
 
  WB’s power derives from its ability to conduct research and mobilise opinion,including among policymakers and trade organisations,against businesses like Hayho.We do not need to agree with its agenda to appreciate its power.Its power is expressed as influence when its interest is also increased.
 
  It was news of our possible investment in Jayland that increased WB’s interest in Hayho.This,combined with its evident power,increases its net influence over Hayho.This makes WB difficult to ignore in our decision over whether to invest in Jayland or Pealand.
 
  (ii)Agency and demands from WB
 
  Responsibilities to shareholders
 
  The board of Hayho exists in an agency relationship with its shareholders,who collectively own the company and have the legal and moral right to determine objectives.As agents of our shareholders and appointed by them,we have a fiduciary duty to seek to manage the company’s resources for their overall economic benefit.In the case of Hayho,as with most business organisations,this involves maximising returns consistent with our complying with relevant laws,regulations and norms.Quark Investments,as one of our major shareholders,has every right to remind us of this duty and we should take its reminder very seriously.
 
  Lobby group demands
 
  Whilst being well-meaning,the lobby group WB is against one of the investment options we have at this time.It claims that an investment in Jayland would be damaging to human rights in that country.Without commenting on the accuracy or validity of that claim,we should remind colleagues why we might think carefully about the investment,as it would bring us into conflict with WB.
 
  First,WB is respected and its views are trusted by many people.In terms of reputation,it has highlighted our problems in Arrland and,as a result of that,has been monitoring our activities.We may need to consider public opinion before going ahead with a potential Jayland investment as we need the general support of society to operate.
 
  Second,WB has influence among politicians and policymakers both in this country and abroad.We risk the censure of influential people and increase the pressure for increased regulation if we disregard or act against the lobby group’s demands.Our reputation in international markets is one of our strategic assets and it may compromise our commitment,given the Arrland incident,if we were not to uphold the highest standards of integrity,human rights and environmental protection from now on.
 
  Third,WB is very adept at mobilising public opinion through the media.This means that it can stimulate interest in conditions in Jayland and we would be likely to be heavily scrutinised on an ongoing basis were this investment to be made.This could attract public anger and risk disruptions,such as boycotts of our products.
 
  Because of these issues,it would seem prudent to consider these issues as a part of our investment appraisal between the Jayland and Pealand options.