Poor internal control systems
(75 marks, 15 marks each) Read the case and answer the questions that follow.
The UK group Marconi plc grew out of GEC, a company built by Lord Weinstock, who bequeathed a set of solid, if unadventurous, manufacturing businesses, with large reserves of cash. On his retirement, Marconi adopted a different strategy—to invest in high-tech enterprises. Within a few years, all of the cash had been spent and the company was over £4 billion in debt. Worse, many of the investments were disasters. In July 2001, the company suspended trading in its shares, warning that profits were likely to halve to around £350 million. The company’s share price fell and the chief executive, Lord Simpson, met strong opposition to his proposal that executive share options should be repriced to reflect the fall.
Throughout August 2001, the company refused to comment on rumors that things were much worse. No advice was given to investors, the stock exchange, or the Financial Services Authority. Then, in September 2001, the scale of the disaster became clear, when a loss of £327 million for the three months from June were announced. Various operating explanations were forthcoming: the downturn in the high-tech market was global; the internal control systems had failed to identify financial problems fast enough; the corporate centre was out of touch with its struggling divisions. The opinion that this was a case of poor business judgement as a result of complacence, and not due to poor corporate governance.
Where was the board during this developing debacle? The case raises questions far beyond strategic and operational mismanagement. The issues go to the heart of the board structure and director competence. The case for non-executive directors argues that independence allows them to question top management and to make tough-minded calls for change if necessary. Subsequently, some Marconi non-executive directors claimed that they had questioned both the strategic direction and financial situation of the company, but had not received the necessary information.
A board meeting was called to face the situation, which one director described as ‘Britain’s greatest industrial disaster for decades’. Decisive action was needed. Bonham, as senior non-executive director, took charge. By the end of the meeting, both the chief executive Simpson and the chairman Hurn had been replaced.
(Source: Bob Tricker. (2012). Corporate Governance: Principles, Policies, and Practices. Oxford: Oxford University Press)
Some non-executive directors claimed that they had questioned about the strategic direction and financial situation of the company, but had not received the necessary information. Why do you think this happened? Explain THREE reasons. Analyze the intention of the management for not providing any advice to the investors during the time of its crisis? Explain THREE reasons. One of the reasons for the failure of Marconi was its poor internal control systems, which had failed to identify financial problems that the company was facing. Suggest THREE changes that could have been brought about in the internal control systems of the company, which would have prevented its failure. The given case clearly indicates that the company had failed to follow the Sarbanes-Oxley Act. Suggest THREE changes that can be brought about in the operating structure of the company, which would have made it possible for it to abide with clauses of the Sarbanes-Oxley Act. Do you think it was a right decision made by Simpson to reprice the share options in order to address the crisis? Support your answer with the help of three reasons.
