P3
1
March 2011
Strategic Level Paper
P3 – Performance Strategy
Senior Examiner’s Answers
SECTION A
Answer to Question One
(a) (i) The Board’s composition has a bias towards the executive members. There are four
executive directors, plus a Company Secretary and only one non–executive. Insufficient
attention is being paid to the potential contribution that non–executive directors might
make in terms of the overall management of DEF. The lack of non–executive directors
means that there can be no supervision in the form of an audit committee or remuneration
committee to exercise oversight of the executive directors.
Understandably, the executive directors all have very specific job titles. The focus is on
facilities, finance and commercial matters. This emphasis on operational and commercial
aspects of the business may exclude adequate consideration of other issues, such as
social and environmental matters or DEF’s responsibilities as an employer.
The chairmanship of any entity is extremely important. DEF’s chairman is in post for only
two years, which does not permit time for a new chairman to establish an agenda and
then to see it through . That could lead to inconsistent pursuit of different strategic
directions with every change of chairmanship. This problem is made worse by the fact
that there are no other non–executive directors in place to ensure a degree of continuity
from one chairmanship to the next.
The fact that each new chairman is appointed by a different LSG in turn may also be a
problem because different LSGs may have different interests in DEF. For example, if
employees tend to live in and travel from one of the local states then that LSG will view
DEF as a major employer and that could have implications for the manner in which it
would like DEF to develop . It would be far better if each of the four LSGs could appoint a
non–executive director.
(ii) Strictly speaking, the Chairman (and the Board as a whole) should act in the interests of
the shareholders and not of the entity itself. It is not for the directors to decide not to
pursue any business proposition that could be in the shareholders’ interests.
Having said that, the LSGs who own DEF may be interested in more than just the
profitability of the airport. The closure of the airport could be costly in terms of
employment or the profile of the four states. Thus, the fears about Max’s motives should
be reported to the LSGs in order to ensure that any decision is fully informed with respect
to the implications for the local population.
March 2011
2
P3
The fact that Max has not revealed the identity of the client suggests that the Board
should be cautious. Max could represent a competitor who is trying to gather information
or may represent a party who does not have the resources to purchase the 51% stake. It
may be that the Board would be justified in withholding information from Max until it
becomes clearer that they will not harm the company by divulging anything to him.
If Max demonstrates that a viable offer will be forthcoming then the Chairman should call
a meeting of the LSGs to decide whether or not to take matters further. The Chairman
should make full disclosure of all relevant facts and should also present any fears
concerning the future of the workforce or the viability of the airport.
(iii) The mission statement provides a sound basis for marketing because it promises a great
deal to customers. In that sense, it could support DEF’s commercial activities.
DEF is committed to outperforming all other regional airports, which ignores the fact that it
may prove impossible to do so. Other airports may have advantages that will make it
difficult or impossible to compete on quality of service. For example, DEF’s location may
make it more susceptible than other airports to delays or flight cancellations and that will
affect its ability to compete. This commitment could, therefore, prove extremely costly.
Aiming for the highest quality may involve unnecessary cost. Airlines and their
passengers may prefer a simple service that is efficient and cost–effective. There may
also be a commercial argument for offering an acceptable service, given that the main
factor affecting passenger choice is the location of the airport itself. Passengers may have
little real choice of airport if they wish to travel to a location in the vicinity of DEF.
The reference to “best people” could be interpreted as elitist. If employees do not believe
that DEF is treating them as the “best” then they could feel resentful.
Promising high ethical standards and good corporate citizenship may be incompatible
with the fact that air travel is frequently viewed as having an adverse impact on the
environment. It is not necessarily for DEF to defend the morality of air travel, but this claim
could leave the company open to challenge.
(b) (i) The biggest risk is that DEF may find that other airlines wish to pay in US$ if they
discover DEF’s new policy. International airlines are likely to have significant receipts and
payments denominated in US$ be hedged to deal with those cash flows. It may be more
convenient for an airline based in, say, Malaysia to pay DEF in US$ than to make
payments in D$. If DEF’s US$ receipts significantly exceed its requirements for the
bureau de change then it could have an unexpected and unwelcome exposure to
movements on the US$.
Managing the US$ account could prove time–consuming and expensive. There could be
significant bank charges for deposits and withdrawals.
In theory, this arrangement will give DEF a natural hedge between its US$ revenue and
outgoings. It is, however, debatable whether it will obtain a significant benefit from this
hedge because the cost of the US$ being exchanged for D$ was already hedged by the
fact that any strengthening of the US$ was passed on to passengers in the form of a less
attractive rate. DEF will always gain from the sale of US$ through the bureau de change
provided it never buys such large quantities that it is left with significant holdings of US$ at
a time when the currency is dropping in value.
It is highly likely that DEF already had a partial hedge in the form of passengers arriving
from the US who wished to exchange US$ for D$ while at the airport.
Overall, the proposal is unlikely to benefit DEF greatly.
(ii) Internal hedging arrangements are generally less expensive than external. The purchase
of financial instruments generally involves premia, professional fees and commissions. In
many circumstances, internal hedging arrangements can cost little or nothing to organise .
For example, a company operating in the Eurozone that is forced to accept payments in
US$ may hedge its exposure by importing materials that are priced in US$. Any
devaluation of the US$ will reduce the revenues but also the costs.
Offsetting or matching currencies is a simple concept which means that internal hedging
is also potentially easier to understand. Many financial instruments are extremely
complicated and may be sold by financial institutions who have little incentive to make the
risks and rewards easy for non–experts to fully appreciate.
Internal hedging can sometimes be used to deal with economic exposure, which is not
always open to being remedied by way of financial instruments. The fact that costs and
revenues are likely to be pushed in the same direction means that there is less risk of
being undercut by an overseas competitor. Financial instruments can be invaluable in
dealing with very specific and short–term exposures, such as a large receivable
denominated in another currency, but long–term fluctuations in costs or revenues cannot
be adequately dealt with by means of derivatives.
(c) It is unlikely that these payments will leave the shops exposed to any significant currency
exposure because the amounts of any given currency are likely to be relatively small and
the balances will be converted to D$ on a daily basis .
