Q1b - December 2012

P&J is a long established listed company based in Emmland, a highly

developed and relatively prosperous country. For the past 60 years, P&J has
been Emmlands largest importer and processor of a product named X32, a
compound used in a wide variety of building materials, protective fabrics
and automotive applications.
X32 is a material much valued for its heat resistance, strength and
adaptability, but perhaps most of all because it is flexible and also totally
fireproof. It is this last property that led to the growth of X32 use and made
P&J a historically successful company and a major exporter.
X32 is mined in some of the poorest developing countries where large local
communities depend heavily on X32 mining for their incomes. The incomes
from the mining activities are used to support community development,
including education, sanitation and health facilities in those developing
countries.
The X32 is then processed in dedicated X32 facilities near to the mining
communities, supporting many more jobs. It is then exported to Emmland
for final manufacture into finished products and distribution.
Each stage of the supply chain for X32 is dedicated only to X32 and cannot
be adapted to other materials. In Emmland, P&J is the major employer in
several medium-sized towns. In Aytown, for example, P&J employs 45% of
the workforce and in Betown, P&J employs 3,000 people and also supports a
number of local causes including a childrens nursery, an amateur football
club and a number of adult education classes.
In total, the company employs 15,000 people in Emmland and another
30,000 people in the various parts of the supply chain (mining and
processing) in developing countries. Unlike in Emmland, where health and
safety regulations are strong, there are no such regulations in most of the
developing countries in which P&J operates.

Recently, some independent academic research discovered that X32 was

very harmful to human health, particularly in the processing stages, causing
a wide range of fatal respiratory diseases, including some that remain
inactive in the body for many decades.
Doctors had suspected for a while that X32 was the cause of a number of
conditions that P&J employees and those working with the material had
died from, but it was only when Professor Harry Kroll discovered how X32
actually attacked the body that the link was known for certain. The
discovery caused a great deal of distress at P&J, and also in the industries
which used X32.
The company was faced with a very difficult situation. Given that 60% of
P&Js business was concerned with X32, Professor Krolls findings could not
be ignored. Although demand for X32 remained unaffected by Krolls
findings in the short to medium term, the company had to consider a new
legal risk from a stream of potential litigation actions against the company
from employees who worked in environments containing high levels of X32
fibre, and workers in industries which used X32 in their own processes.
In order to gain some understanding of the potential value of future
compensation losses, P&J took legal advice and produced two sets of
figures,

both

describing

the

present

value

of

cumulative

future

compensation payments through litigation against the company. These

forecasts were based on financial modelling using another product of which
the company was aware, which had also been found to be hazardous to
health.
in
5
years

in 15 years

in
years

25

in 35 years

$(m)

$(m)

$(m)

$(m)

best case

30

150

400

worst case

20

80

350

1000

The finance director (FD), Hannah Yin, informed the P&J board that the
company could not survive if the worst-case scenario was realised. She said
that the actual outcome depended upon the proportion of people affected,
the period that the illness lay undetected in the body, the control measures
which were put in place to reduce the exposure of employees and users to
X32, and societys perception of X32 as a material.
She estimated that losses at least the size of the best case scenario were
very likely to occur and would cause a manageable but highly damaging
level of losses.
The worst case scenario was far less likely but would make it impossible for
the company to survive. Although profitable, P&J had been highly geared for
several years and it was thought unlikely that its banks would lend it any
further funds.
Hannah Yin explained that this would limit the companys options when
dealing with the risk. She also said that the company had little by way of
retained earnings.
Chief executive officer, Laszlo Ho, commissioned a study to see whether the
health risk to P&J workers could be managed with extra internal controls
relating to safety measures to eliminate or reduce exposure to X32 dust.
The confidential report said that it would be very difficult to manage X32
dust in the three stages of the supply chain unless the facilities were
redesigned and rebuilt completely, and unless independent breathing

apparatus was issued to all 2people coming into contact with X32 at any
stage.
FD Hannah Yin calculated that a full refit of all of the companys mines,
processing and manufacturing plants (which Mr Ho called Plan A) was
simply not affordable given the current market price of X32 and the current
costs of production.
Laszlo Ho then proposed the idea of a partial refit of the Aytown and
Betown plants because, being in Emmland, they were more visible to
investors and most other stakeholders.
Mr Ho reasoned that this partial refit (which he called Plan B) would
enable the company to claim it was making progress on improving internal
controls relating to safety measures whilst managing current costs and
waiting to see how the market for X32 fared in the longer term. Under
Plan B, no changes would be made to limit exposure to X32 in the
companys operations in developing countries.
Hannah Yin, a qualified accountant, was trusted by shareholders because of
her performance in the role of FD over several years. Because she would be
believed by shareholders, Mr Ho offered to substantially increase her share
options if she would report only the best case scenario to shareholders and
report Plan B as evidence of the companys social responsibility.
She accepted Mr Hos offer and reported to shareholders as he had
suggested. She also said that the company was aware of Professor Krolls
research but argued that the findings were not conclusive and also not
considered a serious risk to P&Js future success.
Eventually, through speaking to an anonymous company source, a financial
journalist discovered the whole story and felt that the public, and P&Js
shareholders in particular, would want to know about the events and the

decisions that had been taken in P&J. He decided to write an article for his
magazine, Investors in Companies, on what he had discovered.
Required:
Describe what risk diversification means and explain why diversifying the
risk related to the potential claims against the use of X32 would be very
difficult for P&J. (10 marks)
Risk diversification.
Diversification of risk means adjusting the balance of activities so that the
company is less exposed to the risky activities and has a wider range of
activities over which to spread risk and return. Risks can be diversified by
discontinuing risky activities or reducing exposure by, for example,
disposing of assets or selling shares associated with the risk exposure.
Problems with diversification of risks
In the case of P&J, the case highlights a number of issues that make P&J
particularly vulnerable and which would place constraints on its ability to
diversify the X32 legal risk.
A key risk is that the companys portfolio of activities is heavily skewed
towards X32 with 60% of its business in X32 when Krolls findings were
published. This is a very unbalanced portfolio and makes the company
structurally vulnerable to any health threat that X32 poses.
It means that a majority of its assets and expertise will be dedicated to a
single material and anything that might be a risk relating to sales of that
material would be a risk to the whole company.
The case says that the plant cannot be adapted to produce other materials.
A mine, for example, cannot suddenly be adapted to produce a safer
alternative. The case also says that processing plants are dedicated
exclusively to X32 and cannot be modified to process other materials.

This means that they either continue to process X32 or they must be
completely refitted to work on alternative materials.
As a result of that, P&J is unlikely to be able to dispose of X32 assets
profitably now that Krolls findings are known about and the reasons for the
health concerns have been identified. The reaction of society to X32 was
highlighted by Hannah Yin as a key factor in determining the likelihood of
the risk and this might make it difficult to sell the assets on to others.
Finally, the obvious way to diversify the risk is to expand the remaining 40%
of the portfolio to become more prominent. However, the company has little
by way of retained earnings and is already highly geared with little prospect
of further borrowing.
This is likely to limit its options for developing new products as a means of
diversification. Share issues would be a possible way of re-financing, but
with such a high exposure to X32 losses, this would be problematic.
[Tutorial note: Some candidates may attempt to interpret the data in the
case numerically. Allow marks if relevant points are made.]
HIDE ANSWERHIDE MARKING GUIDE
2 marks

for description of risk diversification

2 marks

for each problem with diversification

(10 marks)

HIDE EXAMINERS REPORT

Part (b) asked about the diversification of risk. Overall, this requirement
was done poorly. A minority was able to describe well what the term means.
The requirement was to explain why diversification of its risks would be

very difficult for P&J. Again, it was necessary to study the case in some
detail to answer this well as all the reasons for the difficulties were there.
Weaker answers attempted to fit the TARA framework into the answer
although this was an inappropriate and incorrect approach.

Q4b - December 2010

During the global economic recession that began in mid 2008, many
companies found it difficult to gain enough credit in the form of short-term
loans from their banks and other lenders. In some cases, this caused
working capital problems as short-term cash flow deficits could not be
funded.
Ultra-Uber Limited (UU), a large manufacturer based in an economically
depressed region, had traditionally operated a voluntary supplier payment
policy in which it was announced that all trade payables would be paid at or
before 20 days and there would be no late payment.
This was operated despite the normal payment terms being 30 days. The
company gave the reason for this as a desire to publicly demonstrate our
social responsibility and support our valued suppliers, most of whom, like
UU, also provide employment in this region. In the 20 years the policy had
been in place, the UU website proudly boasted that it had never been
broken.
Brian Mills, the chief executive often mentioned this as the basis of the
companys social responsibility. Rather than trying to delay our payments
to suppliers, he often said, we support them and their cash flow. Its the
right thing to do.
Most of the other directors, however, especially the finance director, think
that the voluntary supplier payment policy is a mistake. Some say that it is a

means of Brian Mills exercising his own ethical beliefs in a way that is not
supported by others at UU Limited.
When UU itself came under severe cash flow pressure in the summer of
2009 as a result of its banks failure to extend credit, the finance director
told Brian Mills that UUs liquidity problems would be greatly relieved if
they took an average of 30 rather than the 20 days to pay suppliers.
In addition, the manufacturing director said that he could offer another
reason why the short-term liquidity at UU was a problem. He said that the
credit control department was poor, taking approximately 50 days to receive
payment from each customer.
He also said that his own inventory control could be improved and he said
he would look into that. It was pointed out to the manufacturing director
that cost of goods sold was 65% of turnover and this proportion was
continuously rising, driving down gross and profit margins. Due to poor
inventory controls, excessively high levels of inventory were held in store at
all stages of production.
The long-serving sales manager wanted to keep high levels of finished
goods so that customers could buy from existing inventory and the
manufacturing director wanted to keep high levels of raw materials and
work-in-progress to give him minimum response times when a new order
came in.
One of the non-executive directors (NEDs) of UU Limited, Bob Ndumo, said
that he could not work out why UU was in such a situation as no other
company in which he was a NED was having liquidity problems. Bob Ndumo
held a number of other NED positions but these were mainly in servicebased companies.
Required:

Define risk embeddedness and explain the methods by which risk

awareness and management can be embedded in organisations. (7 marks)
Risk embeddedness
Risk embeddedness refers to the way in which risk awareness and
management are interwoven into the normality of systems and culture in an
organisation. These two twin aspects (systems and culture) are both
important because systems describe the way in which work is organised and
undertaken, and culture describes the taken-for-grantedness of risk
awareness and risk management within the organisation.
The methods by which risk awareness and management can be embedded
in organisations are as follows:
Aligning individual goals with those of the organisation and building these
in as part of the culture. The need for alignment is important because risk
awareness needs to be a part of the norms and unquestioned assumptions of
the organisation. Training of staff at all levels is essential to ensure risk is
embedded throughout the organisation.
Including risk responsibilities with job descriptions. This means that
employees at all levels have their risk responsibilities clearly and
unambiguously defined.
Establishing reward systems that recognise that risks have to be taken (thus
avoiding a blame culture). Those employees that are expected to take risks
(such as those planning investments) should have the success of the
projects included in their rewards.
Establishing metrics and performance indicators that monitor and feedback
information on risks to management. This would ensure that accurate
information is always available to the risk committee and/or board, and that
there is no incentive to hide relevant information or fail to disclose risky

behaviour or poor practice. A suggestion box is one way of providing

feedback to management.
Communicating risk awareness and risk management messages to staff and
publishing success stories. Part of the dissemination of, and creating an
incentive for, good practice, internal communications is important in
developing culture and continually reminding staff of risk messages.
HIDE ANSWERHIDE MARKING GUIDE
2 marks

for definition of risk embeddedness

1 mark

for each method to a max of 5 marks

(7 marks)

HIDE EXAMINERS REPORT

Part (b) raised the issue of embedding risk into systems and culture, a
subject that has been examined before on a P1 paper. This part was done
quite well by many candidates

Q4a c ii - June 2009

John Pentanol was appointed as risk manager at H&Z Company a year ago
and he decided that his first task was to examine the risks that faced the
company. He concluded that the company faced three major risks, which he
assessed by examining the impact that would occur if the risk were to
materialise.
He assessed Risk 1 as being of low potential impact as even if it
materialised it would have little effect on the companys strategy. Risk 2 was
assessed as being of medium potential impact whilst a third risk, Risk 3,
was assessed as being of very high potential impact.

When John realised the potential impact of Risk 3 materialising, he issued

urgent advice to the board to withdraw from the activity that gave rise to
Risk 3 being incurred. In the advice he said that the impact of Risk 3 was
potentially enormous and it would be irresponsible for H&Z to continue to
bear that risk.
The company commercial director, Jane Xylene, said that John Pentanol and
his job at H&Z were unnecessary and that risk management was very
expensive for the benefits achieved. She said that all risk managers do is to
tell people what cant be done and that they are pessimists by nature. She
said she wanted to see entrepreneurial risk takers in H&Z and not risk
managers who, she believed, tended to discourage enterprise.
John replied that it was his job to eliminate all of the highest risks at H&Z
Company. He said that all risk was bad and needed to be eliminated if
possible. If it couldnt be eliminated, he said that it should be minimised.
Required:
The risk manager has an important role to play in an organisations risk
management.
(i) Describe the roles of a risk manager. ( 4 marks)
(ii) Assess John Pentanols understanding of his role. (4 marks)
Jane Xylene expressed a particular view about the value of risk management
in H&Z Company. She also said that she wanted to see entrepreneurial risk
takers.
(iii) Critically evaluate Jane Xylenes view of risk management. (7 marks)
(i) Roles of a risk manager
Providing

overall

leadership,

vision

and

direction,

involving

the

establishment of risk management (RM) policies, establishing RM systems

etc. Seeking opportunities for improvement or tightening of systems.

Developing and promoting RM competences, systems, culture, procedures,

protocols and patterns of behaviour. It is important to understand that risk
management is as much about instituting and embedding risk systems as
much as issuing written procedure. The systems must be capable of
accurate risk assessment which seem not to be the case at H&Z as he didnt
account for variables other than impact/hazard.
Reporting on the above to management and risk committee as appropriate.
Reporting information should be in a form able to be used for the
generation of external reporting as necessary. Johns issuing of advice will
usually be less useful than full reporting information containing all of the
information necessary for management to decide on risk policy.
Ensuring compliance with relevant codes, regulations, statutes, etc. This
may be at national level (e.g. Sarbanes Oxley) or it may be industry specific.
Banks, oil, mining and some parts of the tourism industry, for example, all
have internal risk rules that risk managers are required to comply with.
[Tutorial note: do not reward bullet lists. Study texts both use lists but
question says describe.]
(ii) John Pentanols understanding of his role
John appears to misunderstand the role of a risk manager in four ways.
Whereas the establishment of RM policies is usually the most important first
step in risk management, John launched straight into detailed risk
assessments (as he saw it). It is much more important, initially, to gain an
understanding of the business, its strategies, controls and risk exposures.
The assessment comes once the policy has been put in place.
It is important for the risk manager to report fully on the risks in the
organisation and Johns issuing of advice will usually be less useful than
full reporting information. Full reporting would contain all of the
information necessary for management to decide on risk policy.

He told Jane Xylene that his role as risk manager involved eliminating all of
the highest risks at H&Z Company which is an incorrect view. Jane Xylene
was correct to say that entrepreneurial risk was important, for example.
The risk manager is an operational role in a company such as H&Z
Company and it will usually be up to senior management to decide on
important matters such as withdrawal from risky activities. John was being
presumptuous and overstepping his role in issuing advice on withdrawal
from Risk 3. It is his job to report on risks to senior management and for
them to make such decisions based on the information he provides.
(iii) Critically evaluate Jane Xylenes view of risk management
There are a number of arguments against risk management in general.
These arguments apply against the totality of risk management and also of
the employment of inappropriate risk measures.
There is a cost associated with all elements of risk management which must
obviously be borne by the company.
Disruption to normal organisational practices and procedures as risk
systems are complied with.
Slowing (introducing friction to) the seizing of new business opportunities
or the development of internal systems as they are scrutinised for risk.
STOP errors can occur as a result of risk management systems where a
practice or opportunity has been stopped on the grounds of its risk when it
should have been allowed to proceed. This may be the case with Risk 3 in
the case. (Contrast with GO errors which are the opposite of STOP errors.)
There are also arguments for risk management people and systems in H&Z.
The most obvious benefit is that an effective risk system identifies those
risks that could detract from the achievements of the companys strategic
objectives. In this respect, it can prevent costly mistakes by advising against
those actions that may lose the company value.

It also has the effect of reassuring investors and capital markets that the
company is aware of and is in the process of managing its risks. Where
relevant, risk management is necessary for compliance with codes, listing
rules or statutory instruments.
HIDE ANSWERHIDE MARKING GUIDE
(i)

1 mark

for evidence of understanding in each type of role

(half mark for identification and half for description) to a
max of 4 marks

(4 marks)

(ii)

1 mark

for each relevant assessment

understanding of the role

comment

on

john's

(4 marks)

(iii)

1 mark

for each relevant point made in the case for jane xylene's
view
(i.e against risk management) up to a max of 4 marks

1 mark

for each relevant point made in the case against jane

xylene's view

(i.e in favour of risk management) up to a max of 3 marks

(7 marks)

HIDE EXAMINERS REPORT

This was question based around themes of risk. Again, the parts based on
bookwork were better responded to than those requiring higher levels of
intellectual

engagement.

Most candidates did well on describing the roles of a risk manager in (a)(i)
but many then failed to see anything wrong with John Pentanols
understanding of his own job.
Part (c)(ii) was a critically evaluate question in which the answer should
have contained arguments for and against Jane Xylenes view on risk
management (she believed the risk managers job was unnecessary and that
risk management was very expensive for the benefits achieved). There are
a lot of comments that can be made in response to a belief such as this and
the model answer includes some but probably not all of the possible
responses. Markers allowed for a range of responses to this question but in
each case were looking for evidence of evaluation of Janes view (not mere
repetition of her remarks, for example).