1

2
3
4
5
6
7
8
The Association of Business Executives
9
10 Advanced Diploma
11
INTERNATIONAL BUSINESS
12
CASE STUDY
CS1208

13
14
15
Marks & Spencer plc
16
afternoon 2 December 2008
17
18
19
This is an open-book examination and you may consult any previously prepared
20 written material or texts during the examination.

21 Only answers that are written during the examination in the answerbook supplied by
the examination centre will be marked.
22
23
24
25
26
27
28
29
30
31
32
33
CS1208 © ABE 2008 D/500/3717
34
35
 BLANK PAGE

CS1208
Notes:

● As in real life, anomalies may be found in this Case Study. Please simply state
your assumptions where necessary when answering questions. The ABE is not
in a position to answer queries on Case data. Candidates are tested on their
overall understanding of the Case and its key issues, not on minor details.
There are no catch questions or hidden agendas.

● After the publication of the Case Study subsequent developments may occur.
The examination is based on the published Case Study and students who do
not mention such developments will not be penalised. However, students may
consider such developments in their answers if they wish.

 [Turn over
 CS1208
 BLANK PAGE

CS1208
 Marks & Spencer plc
Marks & Spencer is a long-established UK-based retail chain selling men’s and women’s clothing
and high quality fresh food and ready made meals.

In 2007 Marks & Spencer (M&S) was the UK’s largest clothing retailer with a market share of 11.1%.
Food sales accounted for 49.8% of its UK business and had a market share of 4.3%. The group’s
international business accounted for 7.1% of turnover and had grown to 219 franchise stores in
34 territories worldwide as well as 8 wholly-owned stores in Hong Kong and 13 in the Republic of
Ireland. During 2007, the company entered four new territories and opened 36 new stores including
the group’s largest ever franchise store in Dubai at 52,000 sq ft. and also opened its first store in
Taiwan under a joint venture with President Chain Store Corporation.
In early January 2008 nearly £1.6 billion was wiped off the value of M&S as the retailer reported
its worst Christmas for three years and its share price dropped by 19% to 409p. The group dashed
hopes that the company might have survived the consumer spending slowdown and it warned that
trading might not improve until spring 2009.
The reaction sparked a collapse across the stock market’s retail sector, with the FTSE 350 general
retailers’ index suffering what was thought to be its biggest one-day loss since 1987. Other high
street retailers also were badly affected: Debenhams tumbled 11%, Kingfisher 8.6% and Home
Retail Group, owner of Argos, 6% (The Times, 10 January, 2008).

M&S Mission, Objectives and Strategy

Chief Executive, Sir Stuart Rose, stated in the Company Report for 2007: “Everything we do has one
key goal: building a sustainable business for the long-term, generating shareholder value through
consistent, profitable growth while making sure that our customers can always trust us to do the right
thing. We will do this by continuing to focus on Product, Service and Environment: offering great
products, in great looking stores with great customer service.”

The group pursued these aims by a continued focus on Product, Service and Environment: offering
“great products, in great looking stores with great customer service.” In addition, it pursued new
routes to growth through the acquisition of new space; new food formats; new product areas such as
home technology; a new website and international expansion. The group also continued to manage
the impact on society and the environment with great care, through an ‘eco plan’.

M&S sold clearly defined clothing brands, home furnishings, food through its own stores and food
products through franchise stores in petrol forecourts, motorway service stations, railway stations
and airports. The group’s international business operated through franchise stores in 34 territories
worldwide as well as wholly-owned stores in Hong Kong and the Republic of Ireland.

[Turn over
1 CS1208
Business Area Sales Performance as at 2007
 
International
International business had grown to 219 franchise stores in 34 territories worldwide as well as 8
wholly-owned stores in Hong Kong and 13 in the Republic of Ireland. During the year, the company
entered 4 new territories and opened 36 new stores including its largest ever franchise store in Dubai
at 52,000 sq ft. In May 2007, it opened its first store in Taiwan under a joint venture with President
Chain Store Corporation. 2007 sales turnover (exc. VAT) was £610.6m, representing a growth of
16.8% over 2006.

Clothing & Home

Clothing & Home sales accounted for 44.8% of the UK business. In womenswear the company
expanded its Autograph range and the fast fashion choice in Limited Collection; in menswear, Blue
Harbour remained the UK’s biggest men’s casualwear brand; the lingerie market share rose to 26.1%,
offering clearly defined brands; and in childrenswear, previous poor performance was reversed with
stronger ranges. Home, representing 5.4% of the UK business, had had two years of strong growth
helped by outstanding value and strong demand in furniture. In 2007 UK divisional sales turnover
was £4,002.8m (exc. VAT), representing a growth of 9.6% over 2006.

Food
Food accounted for 49.8% of UK business and a market share of 4.3%. In 2006/07, the company
launched a range of 120 Nutritionally Balanced ready meals which were free from artificial colours,
flavours and hydrogenated fats and followed government salt, fat and sugar guidelines. Eat Well
accounted for around 30% of food sales and some 1,300 products. Simply Food grew from 144
stores to 205 across the UK, including franchise stores in BP Connect petrol forecourts, motorway
service stations, railway stations and airports. 2007 UK sales turnover (exc. VAT) was £3,974.7m,
representing a growth of 9.7 % over 2006.

Recent Events
On 27 April 2007 the company announced plans to open 150 new international stores over the next
three years, the majority via franchising. The first of the openings were scheduled to take place during
the summer in Ukraine, the Baltic States and Bulgaria, alongside further company-owned expansion
in Ireland. Franchisee-owned developments are also underway in India and Russia. M&S is already
established in 29 countries across Europe, the Middle East, Central and South East Asia.

In May 2007, Marks & Spencer reported its best profits for nearly a decade and pledged to create
10,000 new jobs with its plans to open more stores in Britain and abroad. The company reported a
28% increase in annual profits, at £965m, for the year to the end of March. It seemed that M&S was
now on track to break the £1bn profits barrier – which it achieved in 1998 before the business went
into decline. The only other retailer to make more than £1bn annual profit was rival Tesco.

Chief Executive, Stuart Rose, said he intended to expand the M&S business organically – opening
scores of new stores ranging from huge 120,000 sq ft outlets to small food stores at BP filling
stations.

Online sales were expected to increase from £160m to £500m in the next three years. Mr Rose
said he wanted to “stretch the brand” into new areas, from selling electronic goods to operating
full-service restaurants in stores offering “three-course meals with five-star service.” He also had
plans to open more international stores, with India and China as priorities, alongside “old Europe” –
France, Spain and Germany – where his predecessor, Luc Vandevelde, closed M&S stores. “I have
said that I think coming out was a mistake. There are opportunities.”

CS1208 2
In November 2007 the company announced that it was stepping up investment to £1.1 billion and
moving into China and India in the coming year, despite a lacklustre sales performance. Stuart Rose,
Chief Executive, said: “To get to where we are going, we have to make investments. If I said we are
cutting back on capital expenditure, you would say we have no bottle (courage) and the business is
going nowhere.”

In the UK, the company expected to add 15 to 20% more space in the next three to four years, at
least a year earlier than expected, while its first Chinese store was expected to open in Shanghai in
2008. It planned to open two or three stores fairly quickly to test the market.

Carl Leaver, head of the International division, was already in talks with franchisees in Central and
Eastern Europe about forming joint venture partnerships to run stores and step up investment and
drive growth. The company was also expected to announce a joint venture partner in India.

On international growth, Mr Rose said: “We have to go faster and more boldly.” In the near term,
the focus will be on Ireland, where M&S intends to open up to 40% more floor space in the next five
years. A £35 million distribution centre is expected to open in Bradford (UK) in 2010 to reduce the
number of M&S warehouses. Finance Director, Ian Dyson, said there were “substantial opportunities”
to improve gross margins by creating a more efficient distribution network.

M&S used to own and operate 38 stores across France, Germany and Spain, but they were closed
down in 2001 by previous chairman, Luc Vandevelde, when the retailer ran into problems (see the
section on ‘earlier problems’ below). Stuart Rose – who once headed M&S’s European business
– described Mr Vandevelde’s decision to pull out of Europe as an “unfortunate reversal” and “a
mistake”. At the time he made it clear that he had no immediate plans for a return to Continental
Europe but added: “Watch this space. I wouldn’t rule it out.”

Mr Rose said that online sales had risen by 60% over the half year 2007 and the retailer planned to
push for growth in this area. As a result M&S shares closed up 21p at 653p.

Take-over Threat
In July 2004 M&S unveiled plans to return £2.3bn to shareholders as it sought to fend off a third
takeover offer from UK entrepreneur, Philip Green. One response to the threat of a take-over was
the appointment of Stuart Rose as Chief Executive who announced a package of reforms, saying
his aim was to give M&S “back to our customers” and promised a simplification of the firm to focus
on its core retail side. M&S planned to sell its financial services business to HSBC for £762m and to
buy the popular Per Una (ladies fashion wear) clothing business (which M&S already marketed) from
designer, George Davies, for £125m.

M&S shares showed little reaction to the news and by the close they were down 4p at 364p – well
below Mr Green’s proposed offer of 400p a share.

 [Turn over
3  CS1208
M&S Share price (pence) Jan. 2003 – Jan. 2008

The company planned to shut down stores as part of cost-cutting measures that aimed to save £250m
in the current financial year, rising to £320m by 2006/07. Mr Rose said that M&S would concentrate
on its 11 million core customers – mainly women in the 35-55 age group, cutting product lines and
brands. “Women want good clothes ... our key task is to sell more clothes to core customers – who I
think have been neglected”, he said. “The business has substantial further trading potential.”

A week previously, M&S had dismissed Mr Green’s improved offer of £9.1bn saying it “significantly
undervalued” the firm. As part of his update, Mr Rose pledged to deliver value “significantly in
excess” of the 400p a share currently offered by Mr Green. A spokeswoman for Philip Green said he
was waiting to see how the market reacted to the revival plan.

Mr Rose also planned to make savings of about £175m a year by cutting costs in the supply chain.
These moves, along with store closures, aimed to tackle the group’s sagging sales. Figures released
with the statement showed that M&S’s non-food sales sank 3.7% year-on-year between April and
June 2004, while food sales were down 1.5% during the same period.

A summary of the revival plan is given below:

Focus on core business and brands

Halt roll-out of smaller Simply Food stores
Better product ranges
Improve sourcing and supply chain – expected to save £175m by 2006-07
Fewer product mark downs, less waste in food business – set to save £50m
Cut 650 jobs
Better co-ordination of internal and external advertising
Modernise existing space at a cost of £400m per year
Buy Per Una for £125m
Sell its financial services business to HSBC for £762m – but retain share of profits from
business
Return £2.3bn – or around £1 a share – to investors
Property portfolio revalued – new worth figure of £3.3bn, compared to £2.2bn previously

CS1208 4
Earlier Problems
In late May 2000, M&S announced a dividend cut for the first time ever as it reported a sharp fall in
profits for year ending 1 April 2000. Two months later, Marks & Spencer’s Executive Chairman, Luc
Vandevelde, only five months into his new job, said that he is “more convinced than ever” that the
company will turn around, but stressed shareholders will have to be patient as there are no quick
fixes.

The shareholders’ disappointment and the failure of previous years’ strategies were translated into
the announcement of a new M&S top management team, on 18 September 2000. The Executive
Chairman assumed the responsibilities of Chief Executive from Peter Salsbury, who resigned from
the Board and left the company. Nevertheless, two weeks afterwards, shares in M&S dipped below
200p for the first time in its history.

Sales Op. profit

2000/2001 2000/2001

Group Total (£m) 8,075.7 467.0

UK Retail 6,293.9 334.8

International Retail
Europe:
Continental Europe 285.0 (34.0)
Ireland & European
263.3 22.6
franchises

North America:
Brooks Brothers 448.1 20.2
Kings Super Markets 313.1 11.9

Far East 110.1 7.4

Financial Services 363.1 96.3

At 31 March 2001, the group’s International Retail business consisted of three broad geographic
areas: Europe (including Ireland but excluding the UK), North America and the Far East. The
European International Retail was divided into Continental Europe and the Republic of Ireland,
and European franchise businesses. In North America the group operated two businesses, Brooks
Brothers (menswear) and Kings Super Markets (a food business). Brooks Brothers traded in 221
stores and Kings Super Markets had 27 stores. In the Far East the group operated 10 M&S stores
(mainly clothing) in Hong Kong.

[Turn over
5 CS1208
Refocusing Strategy
In March 2001, and following a wide-ranging and detailed strategic review of its business, the Board
of M&S announced significant changes to the Group strategy and structure. The highlights of the
plan were:

The Company planned to return to selling only own brand products and brands exclusive to M&S so
it could guarantee customers the quality, value and service. Central to the recovery plan was to be
the delivery of significant improvements in product appeal, availability and value, thereby rebuilding
the relationships with core customers. The following comprise the key courses of action:

Clothing
The Company aimed to regain the confidence of its customers in the quality and fit of its clothing
by extending the range of entry-price merchandise (premium quality) and communicating this
clearly to customers.

Food, Home and Beauty

M&S Foods was considered to be a key platform for future growth, with opportunities to expand
reach through new locations and selling channels. The Home (furniture, furnishings, etc) business
had experienced good growth, with home furnishings and gifts the fastest growing product areas.
Beauty, albeit relatively small, was also growing rapidly.

Store Revival
The Company would step up the roll-out of the successful elements of its new concept format
under a plan to refurbish more stores faster and at lower cost. Selling space would be reallocated
to higher growth product areas to maximise returns per square foot. 600,000 sq ft was to be
reallocated within the year to areas such as the new Clothing range supplied by George Davies,
Home, 50 new Beauty Shops, and 30 new Coffee Shops.

In order to be more customer-oriented, some stores in big cities were to be open 24 hours per
day, while others in the UK were to be modernised in order to create a more attractive, easy-to-
shop environment. With all changes, the company expected to raise the operating profit in the UK
by 10% approximately (£40 million) per year.

Financial and Cost Cutting Measures

In order to focus all its efforts on the recovery of the UK business, several courses of action
were proposed by management. In brief, these included the following proposals:

Close the loss-making business in Continental Europe (France, Germany, Belgium, The
Netherlands, Luxembourg and Spain), affecting some 3,350 jobs. The stores were considered to
be too big and the company hadn’t properly understood the markets before investing in them.

Dispose of its two profitable US businesses, Brooks Brothers and Kings Super Markets.

Sell the Company’s 10 stores in Hong Kong and convert to franchises.

Close its loss-making catalogue business including a dedicated call centre and fulfilment
centre. In 2000, losses of the direct catalogue unit amounted to £38.6 million.

Release value from almost half of its extensive property portfolio (78 stores) and rent back the
properties in which it operates.

Reduce the costs of goods sold, using fewer UK suppliers and more foreign suppliers, mainly
from Asia. At present UK suppliers represent 70% of total purchases. This will be reduced to
25%. This measure will allow a reduction in sales price and an increase in profits.

CS1208 6
 Reduce general and administrative costs at Headquarters, where 350 jobs will be axed.

Reduce the investment in inventories by 10%. That means a reduction of £90 million.

Return £2 billion of cash to shareholders by the end of March 2002 in order to create a more
efficient capital structure and improve the potential for a faster rate of earnings growth.

Commenting on these developments, Luc Vandevelde said: “At the heart is a determination to
restore an unquestioned reputation with our customers for quality, value, service and innovation. By
creating a simpler more focused organisation we will be able to get on with what we do best, to be
better positioned to deliver faster recovery and, in time, seize new opportunities both in the UK and
abroad.”

The following table signals the decline in profitability occurring from 1998 onwards:

Year ended Turnover (£m) Profit before tax (£m) Net profit (£m) Basic eps (p)
1 April 2000 8,195.5 417.5 258.7 9.0
31 March 1999 8,224.0 546.1 372.1 13.0
31 March 1998 8,243.3 1,155.0 815.9 28.6
31 March 1997 7,841.9 1,102.1 746.6 26.7
31 March 1996 7,233.7 965.8 652.6 23.3

 [Turn over
7  CS1208
M&S International

For M&S the franchise route evolved towards the end of the 1980s, driven by a desire to control and
manage standards of presentation and the wider M&S brand in selected export markets. ‘St Michael’
(M&S brand name) franchise stores – these being much smaller than the UK stores – were present
in 16 countries by the start of the 1990s.

As part of its strategic review in 2001, M&S announced the closure of its loss-making businesses in
Continental Europe and the disposal of its two profitable US businesses, Brooks Brothers and Kings
Super Markets. These operations were considered not to provide an appropriate platform for future
international expansion.

In 2005, M&S’s international business – headed by Finance Director Ian Dyson – contributed 9%
to group profits. By 2006, M&S operated in 29 countries plus Hong Kong and had 198 franchised
outlets together with 19 directly owned stores in Hong Kong, Gibraltar and Ireland. Of the franchised
stores, 65 were in the Asia-Pacific region, 60 in Europe, 45 in Central Europe with the balance in
central Asia and the Middle East. M&S used to own and operate 38 stores across France, Germany
and Spain, but they were closed down in 2001 by previous chairman, Luc Vandevelde, when the
retailer ran into problems (see the section above on ‘earlier problems’).

The chain’s franchise partner in India was the privately-owned Planet Retail, which was also partnering
M&S competitors, Next and Debenhams, across India. Planet Retail had announced plans to have
130 shops operating in less than a year – more than double its then current total of 59.

In April 2007 the company laid out plans to open 150 new international stores over the following three
years, the majority via franchising. The first of the openings were scheduled to take place during the
summer in Ukraine, the Baltic states and Bulgaria, alongside further company-owned expansion in
Ireland. Franchisee-owned developments are also underway in India and Russia.

For franchised operations (see Appendix 2 for an explanation of franchising), M&S set out how
the stores should look and sell its branded goods, but accepted no responsibility for the running of
each store. Support Services to Franchise Partners comprised:

Relationships: A direct link to a dedicated Country Manager at Marks & Spencer’s London Head
Office, who provides commercial and operational guidance and keeps the franchise partner up
to date with all the latest retailing developments.

Brand Management: Clear guidance is provided on how to use the Marks & Spencer brand to
ensure maximum impact. Marks & Spencer also work closely with the franchise partner to help
them gain maximum value from one of the world’s greatest brands.

Merchandise: Information and practical advice on which merchandise to stock to ensure the
franchise partner stores always have the right products in the right place at the right time.

Systems: The franchise partner also benefits from some of the world’s most advanced systems for
managing every aspect of a fast moving retail business, as well as access to Marks & Spencer’s
leading IT support team.

Operations: Access is provided to Marks & Spencer’s experienced human resources and
finance teams who will provide focus and direction to help the franchisee manage their business
effectively.

CS1208 8
Corporate Ethics and Social Responsibility
In 2006, M&S’s Look Behind the Label marketing campaign was introduced. The aim of this campaign
was to highlight to customers the various ethical and environmentally friendly aspects of the production
and sourcing methods engaged in by M&S including: Fairtrade products, sustainable fishing, and
environmentally friendly textile dyes. All coffee and tea sold in M&S stores is now Fairtrade and in
addition the company offers clothing lines made from Fairtrade Cotton in selected departments.

The company is also looking at how stores can be made more environmentally friendly and in
particular the materials used when fitting out stores, for example using flooring made from natural
rubber. The company is also looking to source electricity from environmentally friendly sources.

In some stores considerable savings are achieved via a combination of powering the store with
green renewable energy, improving air tightness to minimise heat and energy loss and installing
more efficient systems and equipment across lighting, refrigeration and heating and ventilation. As
well as the ‘eco-features’, all suppliers who were contracted to the project worked in a ‘greener’, more
efficient way. This included operating a green travel plan for all construction traffic and managing
waste materials to ensure that they were recycled where possible.

(See Appendix 3 for a view of global corporate responsibility).

 [Turn over
9  CS1208
Appendix 1A

Consolidated income statement 31 March 2007

£m
Revenue – continuing operations 8,588.1
Operating profit – continuing operations 1,045.9
Finance income 33.8
Finance costs (143.0)
Profit on ordinary activities before
936.7
taxation – continuing operations
Income tax expense (277.5)
Profit on ordinary activities after taxation –
659.2
continuing operations
Profit from discontinued operations 0.7
Profit for the period 659.9

Basic earnings per share (p) 39.1

CS1208 10
Appendix 1B

Consolidated balance sheet as at 31 March 2007

£m
Non-current assets
Intangible assets 194.1
Fixed assets 3,674.2
3,868.3

Current assets
Inventories 416.3
Other financial assets 50.9
Trade and other receivables 196.7
Derivative financial instruments 2.4
Cash and cash equivalents 846.4
1,512.7
Total assets 5,381.0

Current liabilities
Trade and other payables 1,043.9
Derivative financial instruments 8.3
Borrowings and other financial liabilities 461.0
Current tax liabilities 87.3
Provisions 5.7
1,606.2
Non-current liabilities
Borrowings and other financial liabilities 1,234.5
Partnership liability to the Marks & Spencer UK Pension Scheme 496.9
Retirement benefit deficit 283.3
Trade and other payables 87.6
Derivative financial instruments 0.2
Provisions 16.8
Deferred tax liabilities 7.3
2,126.6
Total liabilities 3,732.8
Net assets 1,648.2
EQUITY
Called-up share capital – equity 424.9
Share premium account 202.9
Capital redemption reserve 2,168.5
Hedging reserve (4.4)
Other reserves (6,542.2)
Retained earnings 5,397.1
Total shareholders’ equity 1,646.8
Minority interest in equity 1.4
Total equity 1,648.2

 [Turn over
11  CS1208
Appendix 1C

Marks and Spencer 5-Year Financial Summary

£m except share figures

2006 2005 2004 2003 2002
Revenue from continuing operations 7,275.0 7,034.7 7,293.7 7,027.1 6,575.2
Operating profit from continuing
operations (before exceptional items and
asset disposals) 790.1 588.4 762.0 643.8 505.2
Profit before tax from continuing
operations
Before exceptional items and asset disposals 751.4 556.1 746.1 665.1 549.3
After exceptional items and asset disposals 745.7 505.1 722.7 622.8 590.5
Basic earnings per share (pence) 36.4 29.1 24.2 20.7 5.4
Dividend per year (pence) 14.0 12.1 11.5 10.5 9.5
Balance sheet
Net assets (inc. pension deficit) 1,155.3 909.2 2,454.0 2,108.3 3,081.3
Net debt 1,729.3 2,147.7 1,994.7 1,831.4 1,907.0
Capital expenditure 326.8 218.5 433.5 311.0 290.5

CS1208 12
Appendix 2

Note on Franchising
A franchise is a business model where the owner – the franchisor – grants the right to the
franchisee to sell the business model’s proven or well-recognised goods or services, under a
pre-defined set of terms and conditions. The relationship between a franchisor and franchisee is
held together by a contract called the Franchise Agreement which outlines the privileges, terms,
conditions and restrictions of the operation.

There are three types of business concepts that use the franchise model. Some of these ventures
are difficult to launch because of the costs involved, whereas others are more easily attainable.

i) Distributorships grant the right to sell their parent company’s products, examples are car
dealerships, i.e. Renault, Ford, Toyota etc.

ii) Brand Name Licensing allows the licensee the right to use the parent company’s brand in
conjunction with the operation of their own business. Here, the product or service is franchised
(or licensed) and not the business itself. For example, a sports store in a small town is granted the
exclusive rights in that town to sell Nike products. Sports franchises, such as health clubs, fall into
this category as well.

iii) The most common franchise format is the Business Format: where a franchisee purchases the
right to operate a unique business system (retail, home-based, fast food concept etc.) that has an
established history and track record created by the franchisor. In exchange for a pre-determined
royalty structure, the franchisor provides initial and ongoing training, sales and marketing support,
and many other services and assistance to aid in the franchisee’s business success.

 [Turn over
13  CS1208
Appendix 3

Note on Global Corporate Governance

Source: Extract from: Is One Global Model of Corporate Governance Likely, or Even Desirable?
Published: January 09, 2008 in Knowledge@Wharton

Wharton management professor, Michael Useem, says companies around the world are increasingly
converging on a model developed largely in the United States in response to the growing power of
global capital investors. As a result of new technology and liberalisation of government controls
on capital flows, massive pools of investment can move in and out of countries more freely than
ever before. Companies that globalise operations or ownership know that adoption of internationally
accepted governance standards would help them compete against other firms, he argues.

“Put yourself in the shoes of Fidelity or Vanguard or other investors out there who are diversifying out
of US stocks. You want to assure yourself that the companies you are going into are reasonably well
governed – that they have acceptable accounting standards and are transparent,” says Useem.

Perhaps the central focus of corporate governance is the structure of the corporate board. In
general, according to Useem, firms are moving to create boards that are more independent from
management, populated by non-executive members and organised around committees overseeing
management, compensation and auditing. “All these factors point to good governance and thus the
company becomes more attractive to investors and legitimate in the eyes of suppliers and customers,”
says Useem. “An investment manager anywhere in the world looking to put cash in the stock of a
company in Lithuania or Italy will come at the company with an eye to whether it is following good
practices.”

In the next 15 years, he predicts, corporate boards around the world will move toward a model in
which boards typically have 10 to 15 members and three or four major committees. A board size of
11 members is “the sweet spot at the moment for US companies,” he says.

Independent of Management
Charles Elson, Director of the John L. Weinberg Center for Corporate Governance at the University
of Delaware, agrees with Useem.  He points to the International Corporate Governance Network
(ICGN), whose members control $10 trillion in assets. “They are large pension funds in the world and
they have a common interest in creating boards that are independent of management and that act
as an appropriate monitor of investor interaction. That’s the model we’re moving to. No matter where
you happen to be, that model produces the best potential returns.”

According to the ICGN Statement on Global Corporate Governance Principles regarding corporate
boards, “Independent non-executives should comprise no fewer than three members and as much as
a substantial majority. Audit, remuneration and nomination board committees should be composed
wholly or predominantly of independent non-executives.”

Another force driving convergence is regulation. Following the passage of the Sarbanes-Oxley Act
of 2002 in the United States, other countries enacted similar regulatory provisions that also focus
on some of the key elements of board structure and overall governance. Jay Lorsch, professor
of human relations at the Harvard Business School, also contends that corporate boards are
converging toward a common model, a trend he says which has been developing over the past 7
to 10 years. “It’s particularly strong among the industrialised nations of Europe and in the United
States,” Lorsch notes, adding that the impetus comes from regulatory requirements for publicly listed
firms, particularly provisions of the Sarbanes-Oxley Act, which apply to companies seeking capital
investment by trading shares on the New York Stock Exchange and other US exchanges.

CS1208 14
At the same time, he adds, companies have increased listings in London where there is also new
scrutiny. He notes that the United Kingdom’s Combined Code on Corporate Governance, adopted
in 2003, sets out standards for good practice. The Code does not demand compliance in the way
Sarbanes-Oxley does but it requires companies to disclose how they conform to the Code’s standards
and where they differ.

“Maybe the Code does not have the impact of law but there are strong expectations,” says Lorsch,
noting that similar regulatory actions outlining good governance practices have taken place in The
Netherlands, Scandinavia and France. “All these initiatives have some parallel ideas underlying
them.”

India, too, has taken steps to increase the independence of its corporate board members with a
provision known as Clause 49 of the country’s listing agreements. The clause states that half of all
directors must be independent. Compliance with the regulation, which took effect 1 January 2006,
has been somewhat variable – with government-owned companies slow to respond.

According to an analysis by the Asian Corporate Governance Association, Indian enforcement

of Clause 49 is weak and many companies ignore governance codes. “Most mid- and small-
cap companies do not see the value of corporate governance. Most listed companies, including
many large ones, take merely a box-ticking approach,” the association states in a review of Indian
governance.

Divergent Opinions
Wharton management professor, Mauro Guillen, says that despite new regulatory codes and
well-meaning attempts at initiating good governance practices, he is not sure worldwide convergence
on one model is inevitable. He says there was some movement toward US models in the 1990s, but
following the scandals at companies like Enron and WorldCom, other nations became concerned
that the US model is flawed. At the same time, Guillen says, the passage of Sarbanes-Oxley has led
companies to steer clear of US listings, moving instead to exchanges in London and elsewhere to
avoid some of the provisions of the US law.

He stresses that nations and companies will continue to exhibit local characteristics because different
countries have followed varying patterns of economic development. A complex mix of historic, legal,
political and economic factors shapes each nation’s corporate landscape, according to Guillen. As
a result, corporate governance and board structures vary around the world. “We continue to see
companies in different parts of the world continuing to do things the way they always have,” he notes.
“Often there are many cross-national differences.”

According to Guillen, the US model evolved in a country where companies typically have a wide and
diverse base of shareholders and where banks, governments and other interests have little stake in
corporations. In Europe, by contrast, there are fewer, larger stakeholders and often there are cross-
holdings by banks who demand representation on the board. In Germany, labour unions play a far
more important role in society than in the United States, and have long had a place in corporate
governance that reflects their position in society.
In Asia, corporate structures based on diversified business groups, with cross-shareholding by
banks, have propelled national economies out of rice cultivation into sophisticated manufacturing
in just a few generations. Not surprisingly, they are somewhat reluctant to alter a system that has
worked so well.

Guillen argues that different systems of governance are appropriate for different industries and that
global investors stand to benefit from diverse governance structures which might actually enhance
corporate performance.

 [Turn over
15  CS1208
For example, he says the Japanese system, which traditionally has featured large boards of
management directors, might actually be effective for companies in industries that are heavily
capitalised and require a long-term horizon, such as the auto industry. The US system, which is more
independent of management, is more flexible and creates a good environment for start-ups and
innovative companies, such as those based in Silicon Valley. “One system is not better. It depends
on what we’re talking about,” he says. “The whole idea that we would be better off in a flat world, a
homogeneous world, is not going to happen because that’s not the way the world works. But even
from the point of view of investors, it’s not clear at all that they would like that.”

Investors thrive on differences that are reflected in the balance between risk and return. Some want
low-risk secure investments while others may be drawn to higher-risk companies with a greater
potential to pay off big. “What investors want,” says Guillen, “is for the rules to stay the same, not
change unexpectedly. If the rules are different in the United States and Japan, they can cope with
that as long as the rules don’t change suddenly.”

‘Parent’ Firms and Their Offspring

Wharton management professor, Marshall Meyer, who specialises in studying Chinese businesses,
says Sarbanes-Oxley has been a force in setting global standards for governance, although that
may be changing. “In the view of many scholars, Sarbanes-Oxley has had the effect of unilaterally
imposing US corporate governance standards on the rest of the world,” he says. “But lately there has
been some pushback against Sarbanes-Oxley.”

In China, corporate boards typically have 12 or 13 members, including three outside directors.
However, Meyer says boards have a different role in China than in the United States. Typically,
Chinese business organisations are built on a subsidiary system with “parent” firms having many
children, grandchildren and even great-grandchildren. Often, the parent company does not have a
board because it is fully state-owned, but the other companies in the network have their own boards,
although individual members are often the same.

“The argument that we will have a single model of governance so global capital can compare company
fundamentals is interesting,” says Meyer, “but the fact is, the Chinese model isn’t going to change to
the US model”. Independent directors in China typically bring some kind of professional expertise,
such as accountants, lawyers or professors, Meyer adds. These directors help with technical issues,
but are not expected to provide strong strategic or management direction the way an outside director
would at a US firm.

In Hong Kong, where the business community is tightly woven, independent directors are appointed
largely on personal strengths. Less consideration is paid to the industry they work in or the size of
their own company, than might be true in the West. “In Hong Kong, they simply prefer to look at the
track record of an individual,” Meyer notes.

In other parts of the developing world, institutions such as the World Bank and the International
Monetary Fund, which provide financing for emerging economies, have attempted to initiate
governance reforms, particularly in protection for creditors, according to Lorsch. “What makes it so
complicated in the developing world is that the majority of assets are owned by private capital. The
public markets are a small percentage of the total ownership of equity.”

Strong controlling families still dominate companies in many of these countries, he adds. “Whether
they are interested in corporate governance in a particular country or not depends on the financial
interests of these investors. We see a lot of lip-service, but it is never clear where they really stand.
That’s just the way it is. Capital formation has come about through family and private wealth, and
public markets are less developed.”

Wharton management professor, Peter Cappelli, agrees that global capital will play a role in
convergence toward a favoured model, but he says it remains to be seen how much local character
will persist in corporate board structures and in governance practices.

CS1208 16
“The international investment community is the force that will drive convergence if it happens.
Companies which want that money will have to play by their rules. So the question will be: How much
commonality will they want across systems of governance?” Cappelli asks. “My guess is that they
want the same outcome around the world, which is transparency with respect to finances. As long as
they get that, exactly how it occurs is less important. Different national practices can still exist if they
provide acceptable levels of transparency.”

Cappelli says global investors will be less concerned about government efforts to drive good
governance practices. “So my guess is that such reform efforts will play out differently across
countries and may create some variance.”

Elson agrees with Capelli that the most important consideration in governance practices, such as
board configuration, is transparency. “The point is not that our standard should take over the world,
but that it is our standard that has always respected capital and that is becoming global. A strong,
independent board creates greater managerial accountability and better performance long-term.”

Useem, too, says it is not so much the path to transparency that matters, but that companies and
countries protect shareholders and generate higher returns over time. Even small steps that lead to
marginal improvement could have an important impact on the global economy. “Over millions and
millions of shares, that can make a difference. If hundreds of thousands of companies become just
a little better governed and a little higher performing, the world would be a better place.”

End of Case Study

 [Turn over
17  CS1208
 BLANK PAGE

CS1208 18
 BLANK PAGE

 [Turn over
19  CS1208
 The Association of Business Executives
5th Floor, CI Tower, St. Georges Square, High Street,
New Malden, Surrey, KT3 4TE
Tel: +44 (0) 20 8329 2930
Fax: +44 (0) 20 8329 2945
info@abeuk.com  www.abeuk.com

1559-151-1 20 CS1208