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Section A – This ONE question is compulsory and MUST be attempted
Several years ago, World Justice, a well-known charity, published a report on the activities of three major food companies in their marketing of manufactured baby foods in some of the poorer developing countries. The report, provocatively called ‘Killer Companies’, said it had evidence that the three companies were ‘aggressively mis-selling’ manufactured baby food products in these poorer countries. It was argued in the report that several problems arose with the use of these products in poorer countries which negatively affected the health of the babies, with many babies reportedly dying as a result. These problems included the use of contaminated water in the preparation of the baby food, an inability of parents to read the instructions, making up product at insufficient concentrations (thereby malnourishing the child) and aggressive selling to health facilities in those countries. Doctors often advised against the use of these products for babies because natural feeding solutions were considered safer and more beneficial in most cases.
When the ‘Killer Companies’ report was published, it was widely reported upon and received a lot of social and political attention. Two of the three companies named in ‘Killer Companies’ immediately decided to withdraw from the business but the third company, Xaxa Company (Xaxa hereafter), recognised what it believed to be an opportunity to take the market share left by the other two. It set about increasing its production capacity accordingly. When asked by journalists why Xaxa had not also withdrawn from the criticised business activity, the chief executive issued a press statement saying that it was a profitable business opportunity and, as the steward of shareholder value, he owed it to the shareholders to maximise their returns.
When it became widely known that Xaxa had decided to expand and develop its baby food business in poorer developing countries, Mothers Who Care (MWC), a national charity concerned with infant nutrition, organised a campaign against Xaxa. Strongly believing in the natural feeding of infants, MWC initially organised protests outside the Xaxa head office and also encouraged the public to boycott a wide range of Xaxa products in addition to the baby food products. MWC members started to use the phrase, ‘Xaxa kills babies’ in the hope that it would become widely adopted.
As one of the country’s largest companies and operating in many countries, Xaxa has a large issued share volume with the majority being held by institutional investors. Whilst the overall group profits remained strong, some shareholders began to feel concerned about the baby food issue. One prominent fund manager, Hugh Oublie, organised a meeting for institutional shareholders holding large volumes of Xaxa shares and 50 such institutional shareholders attended the meeting. The group became known as the ‘Oublie Group’. Although all members of the Oublie Group wanted to retain their holdings in Xaxa because of the otherwise good returns, a number of questions were framed which they decided to put to the Xaxa management:
(i) could the company explain the strategic logic of pursuing the baby food business in poorer developing countries？
(ii) was the board concerned about potential reputational damage with phrases such as ‘Xaxa kills babies’ being used widely and in the media？
(iii) would the Xaxa board consider withdrawing from the baby food business in poorer developing countries because of the alleged health impacts on children in those countries？
The company issued a statement through its investor relations department, replying that the strategic logic was based on what activities provided the most profit to shareholders regardless of the effects on other claims against the company strategy. Second, the board was not concerned with reputation risks because it believed that these were ‘temporary concerns’ which would soon be forgotten. Third, no, the board would not withdraw from the baby food market in those countries because, with the loss of two competitors, profit margins were likely to be higher and competition less. The Oublie Group expressed its dissatisfaction with this reply and said it might seek to influence the appointment of non-executive directors (NEDs) to the Xaxa board to increase the scrutiny of the executive members and their discussions on the subject.
Hugh Oublie appeared on television to say that he felt the board of Xaxa lacked balance. He said that, although profitable and a good employer in its home country, the non-executive scrutiny of company strategy had been poor for some time and the board had no meaningful sense of ethics at all. He believed that all of the executive board was dedicated to the mission to produce what he called ‘profit at any social cost’. He further believed that none of the non-executive board members was strong enough to question the strategy and raise the problem of baby food as an ethical issue. It was this lack of non-executive scrutiny which Hugh Oublie believed was a major cause of Xaxa’s unwillingness to reconsider its baby food activity. He said that he had been a long-serving observer and shareholder of Xaxa and he had noticed the company becoming more inward-looking and self-reliant in recent years. He believed this trend was very unhelpful. In addition, he expressed concerns, on behalf of the Oublie Group, about the strategic management of Xaxa and his belief that the board lacked concern for medium-term business risks brought about by the baby food marketing.
As World Justice and MWC continued their campaigns against Xaxa, some other groups became aware of the baby food situation in poorer developing countries. A television programme reported how Xaxa products were actually being used in some of the poorer countries. It claimed to confirm the problems highlighted in ‘Killer Companies’ and it highlighted a number of other Xaxa products which consumers might stop buying if they wanted to put pressure on Xaxa’s management to change their policy on baby food.
Partly in response to these pressures, the Xaxa board decided to consider two new initiatives. The first of these was to consider introducing a corporate code of ethics. By carefully drafting this and placing it prominently on its website, the board believed that it could achieve a number of favourable outcomes including improving its reputation.
The second initiative was to consider instituting a full risk audit system in response to the negative publicity it had experienced, especially from MWC, whose members were considered to be natural customers of Xaxa’s other products. Private research commissioned by Xaxa showed that the baby food business was damaging Xaxa’s reputation and possibly the willingness of some talented people to apply for jobs with the company. Political support for other company plans had also suffered, such that a recent planning application to set up a new factory by Xaxa, in a business area with no connection with baby food, had received opposition. Protestors, mainly local activists and MWC members, opposed the application with placards saying ‘Xaxa kills babies’. Because the idea of risk auditing was a new initiative for Xaxa, the board has asked a local consultancy to produce guidance on the benefits of risk audit and the benefits of an external, rather than an internal, risk audit.
Required:
(a) The underlying principles of corporate governance include transparency, judgement and reputation. Explain these three terms and assess the Xaxa board’s performance against each one. (9 marks)
(b) Explain the purposes of a corporate code of ethics and examine how the adoption of such a code might make Xaxa reconsider its marketing of baby food in poorer developing countries. (11 marks)
(c) Institutional investors are potentially influential stakeholders in a company such as Xaxa.
Required:
(i) Explain why institutional investors might attempt to intervene in the governance of a company. (ii) Discuss the reasons why the Oublie Group should attempt to intervene in the governance of Xaxa following the events described in the case.
Note: The total marks will be split equally between each part. (10 marks)
(d) Produce notes from the consulting company for the Xaxa board in response to its need for guidance on risk audit. The notes should address the following:
(i) Discuss, in the context of Xaxa, the stages in a risk audit. (8 marks)
(ii) Distinguish between internal and external risk audit, and discuss the advantages for Xaxa of an external risk audit. (8 marks)
Professional marks will be awarded in part (d) for the clarity, logical flow, style. and persuasiveness of the notes. (4 marks)
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