Field of Study : Economics and International Business [611960]

UNIVERSITY OF O RADEA
FACULTY OF ECONOMIC SCIENCES
Field of Study : Economics and International Business
Master Study Programme :
INTERNATIONAL BUSINESS ADMINISTRATION
Type of Studies
Full Time Learning

DISSERTATION THESIS
Corporate Financial Management
Corporate Governance Case Study : Berkshire Hath away,
Galleon, News Corporation and HSBC

Scientific Coordinator :
Prof. Ph.D.,
Leonard Calin ABRUDAN
Graduate Student: [anonimizat]
2019

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CONTENTS

CONTENTS ………………………….. ………………………….. ………………………….. …………………. 2
List of abreviations used in the text ………………………….. ………………………….. ……………. 4
List of figures ………………………….. ………………………….. ………………………….. ……………… 5
List of charts ………………………….. ………………………….. ………………………….. ……………….. 6
List of tables ………………………….. ………………………….. ………………………….. ……………….. 7
INTRODUCTION ………………………….. ………………………….. ………………………….. ………… 8
PART I – THEORETHICAL ASPECTS ………………………….. ………………………….. ………….. 9
Chapter 1. Theoretical aspects of Corporate Finance ………………………….. ………………. 9
1.1. What is Corporate Finance ?……………………………………………. ………………………….. . 9
1.2. Forms of the Corporate Firm ………………………………………………… …………………… 21
1.2.1. The Sole Proprietorship ………… …………………………………. ………………………. 22
1.2.2. The Partnership ……………………………………………. ………………………….. ……… 22
1.2.3. The Corporation ……………………………………………. ………………………….. …….. 23
1.3. Financial Markets …………………………………………………… ………………………….. ……. 24
Chapter 2. The Five Basic functions of Corporate Fianance……………………… .. 26
2.1. The External Financing Function …………………………………………… ……. 26
2.2. The Capital budgeting Function …………………………………………… ……… 27
2.3. The Financial Management Function …………………………………………… 27
2.4. The Corporate Governance Function……………………………………… … ….. 28
2.5. The Risk Management Function …………………………………………………… ……………. 29
Chapter 3. Financial Planning and Management ……….. ………………………….. ………. 30
3.1. Long -term financial planning …………………………………. ……………………… 30
3.2. Short -term financial planning …………………………………. …………………….. 31
3.3. Financial planning model …………………………………. ………………………….. . 33
PART II – CASE STUDY ………………………….. ………………………….. ………………………….. … 35
Corporate Governance: Berkshire Hathaway, Galleon, News Corporation, HSBC .
………………………….. ………………………….. ………………………….. ………………………….. ………. 35
1. Berkshire Hathaway …………………………………………… ……………………….. 35
1. Galleon …………………………………………… ………………………….. …………….. 41
1. News Corporation …………………………………………… ………………………….. 48
1. HSBC …………………………………………… ………………………….. ………………. 55

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CONCLUSIONS AND RECOMMENDATIONS ………………………….. ………………….. 61
Bibliography ………………………….. ………………………….. ………………………….. ……………….. 62
A. Books ………………………….. ………………………….. ………………………….. ………………….. 62
B. Sc ientific Papers / Articles ………………………….. ………………………….. ………………….. 62
C. Documents, Regulations, Agreements and O fficial Reports; Legislation …………… 62
D. Newspapers, Magazin es, Statistics ………………………….. ………………………….. ……… 63
Sitography ………………………….. ………………………….. ………………………….. …………………. 65

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List of abbreviations used in the text

Abbreviati on1 Significance of abbreviation used in the text
aprox. Aprox imatly
C.E.O Chief executive officer
C.N.B.C Consumer News and Business Channel
e.g For example
etc. Etcetera
exp. For example
F.B.I Federal Bureau of Investigation
i.e Namely
I.S.B Indian School of Business
N.I News International
U.S United States

1 In alphabetical order

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List of Figures

Figure no. 1 .1. The Balance -Sheet Model of the Firm ………………………….. ……………………….. 12
Figure no. 1.2. Two Pie Models of the Firm ………………………….. ………………………….. ………… 14
Figure no. 1.3. Hypothetical Organization Chart ………………………….. ………………………….. ….. 15
Figure no. 1.4. Cash Flows between the Firm and the Financial Markets …………………………. 17
Figure no. 2.1. Short -term Financial decision ………………………….. ………………………….. ………. 35
Figure no. 2.2. Long -term Financial decision ………………………….. ………………………….. ………. 36

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List of charts

Chart no. 1: Underwriting earnings and float by division ………………………….. …………………… 40

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List of tables

Table no . 1.1. Cash flow illustration
…………………………… ………………………………………………………………….. ……….. ……………. …..18

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INTRODUC TION

Corporate Financial Management deals with the decisions of a firm related to
investment, financing and dividend.
Corpora te finance matters to everybody. There is a corporate financial aspect to
almost every decision made by a business; though not everyone will find a use for all the
components of corporate finance, or at least for some part of it. Marketing managers,
corpor ate strategists, human resource managers, and information technology managers all
make corporate finance decisions every day and often don’t realize it. An understanding of
corporate finance will help everyone make better decisions.
Although corporate fi nance is quantitative in its focus, there is a significant
component of creative thinking involved in coming up with solutions to the financial
problems businesses do encounter. It is no coincidence that financial markets remain
breeding grounds for innova tion and change.
The two books used to highlight the main core of Corporate Finance are:
Megginson, William; Smart, Scott, Introduction to Corporate Finance and Westerfield –
Jaffe, Ross, Corporate Finance . Finance is such an important part of modern life t hat
almost everyone can benefit from understanding it better. What you may find surprising is
that the financial problems facing PepsiCo or Microsoft are not really different from those
facing an average investor, small business owner, entrepreneur, or fam ily.
For the Case Study, the topic choosen is Corporate Governance. Governance issues
have an impact on companies and countries throughout the world.
Leaders and, especially, directors of corporations need to have the strength,
knowledge and flexibility t o provide the moral compass they need to embrace the highest
standards of governance and independence to meet the increasing expectations of
shareholders and other stakeholders in the new world order.

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Chapter 1. Theoretical aspects of Corporate Finance

1.1. What is Corporate Finance?

Finance is such an important part of modern life that almost everyone can benefit
from understanding it better. What you may find surprising is that the financial
problems facing PepsiCo or Microsoft are not really different from those facing an
average investor, small business owner, entrepreneur, or family. On the most basic
level, these problems are about how to allocate money. The choices are many: Money
can be borrowed, saved, or lent. Money can be invest ed into projects. Projects can be
undertaken with partners or with the ai d of lenders. Projects can be a voided altogether
if they do not appear to be valuable enough. Finance is about how best to decide among
these and other investment alternatives.
When a corporation is first established, its shares may be privately held by a small
group of investors, perhaps the company’s managers and a few backers. In this case the
shares are not publicly traded and the company is closely held. Eventually, when the
firm grows and new shares are issued to raise additional capital, its shares are traded in
public markets such as the New York Stock Exchange. Such corporations are known as
public companies. Most well -known corporations in the U.S. are public companies with
widely dispersed shareholdings. In other countries, it is more common for large
corporations to remain in private hands, and many public companies may be controlled
by just a handful of investors. The latter category includes such well -known names as
Fiat, P orsche, Benetton, Bosch, IKEA, and the Swatch Group.
A large public corporation may have hundreds of thousands of shareholders, who
own the business but cannot possibly manage or control it directly. This separation of

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ownership and control gives corporati ons permanence. Even if managers quit or are
dismissed and replaced, the corporation survives. Today’s stockholders can sell all their
shares to new investors without disrupting the operations of the business. Corporations
can, in principle, live forever, and in practice they may survive many human lifetimes.
One of the oldest corporations is the Hudson’s Bay Company, which was formed in
1670 to profit from the fur trade between northern Canada and England. The company
still operates as one of Canada’s lead ing retail chains.
The separation of ownership and control can also have a downside, for it can open
the door for managers and directors to act in their own interests rather than in the
stockholders interest.
Corporate Financial Management deals with the decisions of a firm related to
investment, financing and dividend. To carry on business, a firm invests in tangible
assets like plant and machinery, buildings, and intangible assets like goodwill and
patents. This comprises the investment decision. These a ssets don’t come free; one has
to pay for them, so a company needs to tap various sources of funds including
promoter’s contribution. This forms the financing decision. The investment in assets
generates revenues and cash flows for a specific period of tim e. The managers of the
company can either retain cash with the company for further investment or distribu te to
the owners of the company, the shareholders. This constitutes the dividend decision.
In short, a finance manager will be concerned with such fina ncial decisions as:
• Which investment/s should the company accept and what are the financial
implications of undertaking the same?
• How should the company finance those investments? What should be the mix of
owners’ contribution, equity and borrowed fund s, i.e., debt at any given point in time?
• How much of the income generated from operati ons should be returned to
share holders in the form of dividends and how much is to be retained for further
investment?
We could think of investment decision as managing the right -hand side of the
balance sheet and financing decision as managing the left -hand side of the balance
sheet.

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The company decides on its investments an d approaches investors through
financial middlemen’ to provide funds in the form of debt and equity. Investors do not
provide money free. They expect something in return. The investor’s expectation is the
cost of money. For instanc e, if someone was to lend you $5,000 for a 5 year period,
s/he would expect interest payments at specified interva ls and the principal repayment
at the end of the loan term. Loan is one type of liability; there are several others. These
liabiliti es have a cost attached to them, the cost of capital. This also means that the
company should earn more than the cost of cap ital to keep the investors happy. An
example will clarif y the point. Suppose you lend $10,000 to a company at an interest
rate of 14 percent. The company should earn more than 14 percent on its investments to
service your debt at all times. If earnings fal l, a default will occur. Do investors not
realize the inherent risk of investing in companies? They do. The inv estor’s expected
rate of return 14 percent in this case is set after assessing risk. In sum, the investor’s
expected rate of return is a function of risk. We have not defined risk yet, nor
established the relati onship between risk and return.
Suppose you decide to start a firm to make tennis balls. To do this, you hire
managers to buy raw materials, and you assemble a workforce that will produce an d
sell finished tennis balls. In the language of finance, you make an investment in assets
such as inventory, machinery, land, and labor. The amount of cash you invest in assets
must be matched by an equal amount of cash raised by financing. When you begin to
sell tennis balls, your firm will generate cash. This is the basis of value creation. The
purpose of the firm is to create value for you, the owner. The firm must generate more
cash flow than it uses. The value is reflected in the framework of the simp le balance –
sheet model of the firm.

The Balance -Sheet Model of the Firm
Suppose we take a financial snapshot of the firm and its activities at a single point
in time. Figure 1.1 shows a graphic conceptualization of the balance sheet, and it will
help intro duce you to corporate finance. The assets of the firm are on the left -hand side
of the balance sheet. These assets can be thought of as current and fixed. Fixed assets
are those that will last a long time, such as buildings. S ome fixed assets are tangible,

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such as machinery and equipment. Other fixed assets are intangible, such as patents,
trademarks, and the quality of management. The other category of assets, current assets,
comprises those that have short lives, such as inventory. The tennis balls that your firm
has made but has not yet sold are part of its inventory. Unless you have overproduced,
they will leave the firm shortly.
Before a company can invest in an asset, it must obtain financing, which means
that it must raise the money to pay for the investment. The forms of financing are
represented on the right -hand side of the balance sheet. A firm will issue (sell) pieces of
paper called debt.

◼ FIGURE 1.1 The Balance -Sheet Model of the Firm

Total value of assets Total value of the Firm to investors
(Source: Book Corporate finance, chap.1 Introduction to Corporate Finance
by Ross Westerfield Jaffe)
Left side, total value of assets. Right side, total value of the firm to investors, which
determines how the value is distributed (loan agreements) or equity shares (stock
certificates). Just as assets are classified as long -lived or short -lived, so to are liabilities.
A short -term debt is called a current liability. Short -term debt represents loans and other
obligations that must be repaid within one year. Long -term debt is debt that does not
have to be repaid within one year. Shareholders’ equity represents the difference
working

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between the value of the assets and the debt of the firm. In this sense it is a residual
claim on the firm’s assets.
„From the balance -sheet model of the firm it is easy to see why finance can be
thought of as the study of the following three questions:
1. In what lon g-lived assets should the firm invest? T his question concerns the
left-hand side of the balance sheet. Of course, the type and proportions of assets the
firm needs tend to be set by the nature of the business. We use the terms capital
budgeting and capital expenditures to describe the process of making and managing
expenditures on long -lived assets.
2. How can the firm raise cash for required capital e xpenditures? This question
concerns the right -hand side of the balance sheet. The answer to this involves the firm’s
capital structure, which represents the proportions of the firm’s financing from current
and long -term debt and equity.
3. How should short -term operating cash flows be managed? This question
concerns the upper portion of the balance sh eet. There is often a mismatch between the
timing of cash inflows and cash outflows during operating activities. Furthermore, the
amount and timing of operating cash flows are not known with certainty. The financial
managers must attempt to manage the gaps in cash flow. From a balance -sheet
perspective, short -term management of cash flow is associated with a firm’s net
working capital. Net working capital is defined as current assets minus current
liabilities. From a financial perspective, the short -term ca sh flow problem comes from
the mismatching of cash inflows and outflows. It is the subject of short -term finance. ”2

Capital Structure
Funding methods determine how the company's value is cut. Individuals or
institutions that buy debt from the firm are called creditors. The holders of shares are
named shareholders.

2 Ross Westerfield J affe, Corporate Finance , Chapter 1 Introduction to Corporate Finance, page 15.

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Ocasionaly it is useful to think of the firm as a pie. Initially, the size of the pie
will depend on how well the firm has made its investment decisions. Once a firm has
made its investmen t decisions, it determines the value of its assets (e.g., its buildings,
land, and inventories).
The firm can then determine its capital structure. First, the company could have
raised the cash to invest in its assets by issuing debt higher than its own ca pital; and can
now consider changing that mix by issuing more equity and using revenue to buy some
of his debt. Financing decisions like this can be taken independently of initial
investment decisions. Decisions to issue debts and equity influence how the pie is cut.
„The pie we are thinking of is shown in Figure 1.2. The size of the pie is the value of the
firm in the financial markets. We can write the value of the firm, V, as :
V = B + S
where B is the value of the debt and S is the value of th e equity. T he pie diagrams
consider two ways of slicing the pie: 50 percent debt and 50 percent equity, and 25
percent debt and 75 percent equity.

◼ FIGURE 1.2 Two Pie Models of the Firm
25% debt
50% debt 50% equity 75% equity
Capital structure 1 Capital structure 2

(Source: Ross Westerfield Jaffe, Corporate Finance, Chapter 1 Introductio n
to Corporate Finance, p age 17)
The way the pie is sliced could affect its value. If so, the goal of the financial
manager will be to choose the ratio of debt to equity that makes the value of the pie;
that is, the value of the firm, V , as large as it can be. ”3

3 Ross Westerfield J affe, Corporate Finance , Chapter 1 Introduction to Corporate Finance, page 16.

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The Financial Manager
In large businesses, financing is usually associated with a company's senior
officer, such as vice president and chief financial officer, and some smaller officers.
Figure 1.3 shows a general organizational structure that highlights the financial activity
within the firm. Reporting to the Chief Financial Officer is the treasurer and the
controller. The treasurer is responsible for managing cash flows, managing capital
expenditure decisions, and making financial plans. The controller manages the
accounting fu nction, which includes taxes, cost accounting and financial accounting
and IT systems. T he most important function of a financial manager is to create value
from the firms’ capital budgeting , financing and liquidity of the enterprise. „How do
financial man agers create value?
1. The firm should try to buy assets that generate more cash than they cost.
2. The firm should sell bonds and stocks and other financial instruments that
raise more cash than they cost. ”4

4 Ross Westerfield J affe, Corporate Finance , Chapter 1 Introduction to Corporate Finance, page 17.

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◼ FIGURE 1.3 Hypothetical Organization Chart

(Source: Ross Westerfield Jaffe, Corporate Finance, Chapter 1 Introduction to Corporate Finance, page
18.)
The arrows in Figure 1.4 trace cash flow from the firm to the financial markets
and back again. Suppose we begin with the firm’s financing activities. To raise money
the firm sells debt and equity shares to investors in the financial markets. This results in
cash flows from the financial markets to the firm (A). This cash is invested in the
investment activitie s of the firm (B) by the firm’s management. The cash generated by
the firm (C) is paid to share holders and bondholders (F). The shareholders receive cash
in the form of dividends; the bondholders who lent funds to the firm receive interest

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and, when the in itial loan is repaid, principal. Not all of the firm’s cash is paid out.
Some is retained (E), and some is paid to the government as taxes (D).
Over time, if the cash paid to shareholders and bondholders (F) is greater than the
cash raised in the financial markets (A), value will be created.

Identification of Cash Flows

Unfortunately, it is not all that easy to observe cash flows directly. Much of the
information we obtain is in the fo rm of accounting statements.

Timing of Cash Flows

The value of an investment made by the firm depends on the time of cash flows. One
of the most important funding assumptions is that individuals prefer to receive cash flows
sooner than later. A dollar received today is worth more than one dollar received next year.
This preference for time plays a role in the price of shares and bonds.
„The Midland Company is attempting to choose between two proposals for new
products. Both proposals will provide additional cash flows over a four -year period and
will initially cost $10,000. The cash flows from the proposals are as follows: ”5

◼ FIGURE 1.4 Cash Flows between the Firm and
the Financial Markets

5 Ross Westerfield J affe, Corporate Finance , Chapter 1 Introduction to Corporate Finance, page 20

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(A) Firm issues securities to raise cash (the financing decision).
(B) Firm invests in assets (capital budgeting).
(C) Firm’s operations generate cash flow.
(D) Cash is paid to government as taxes.
(E) Retained cash flows are reinvested in firm.
(F) Cash is paid out to investors in the form of interest and
dividends.
(Surce: Ross Westerfield Jaffe, Corporate Finance, Chapter 1 Introduction to Corporate Finance,
page 20)
◼ Table 1.1. Cash flow illustration
Year New Product A New Product B
1 $ 0 $ 4,000
2 0 4,000
3 0 4,000
4 20,000 4,000
Total $20,000 $16,000
(Surce: Ross Westerfield Jaffe, Corporate Finance, Chapter 1 Introduction to Corporate Finance,
page 20)
„At first it seems that the new A product would be the best. However, the cash
flows in Proposal B come earlier than those of A. Without further information, we can
not decide which set of cash flows would create the greatest value for bondholders and

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shareholders. It depends whether the amount of cash gain from B above exceeds the
total amount of liquidity in A. Bond and stock prices reflects this preference for
previous cash and we will see how to use them to de cide between A and B. ”

Risk of Cash Flows

Risk must be taken in consideration in a firm, in the way that the amount a nd
timing of cash flows are not usually known with certainty. Most investors have an
hostility to risk.
Corporate finance has an internal consistency that flows from its choice of
maximizing firm value as the only objective function and its dependence on a few
bedrock principles: Risk has to be rewarded, cash flows matter more than accounting
income, markets are not easily fooled, and every decision a firm makes has an effect
on its value.
Investment decisions generally influence financing decisions and vice versa;
financing decisions often influence dividend decisions and vice versa. Although there
are circ umstances in which these decisions can be independent of each other, this is
rarely in practice. It is therefore unlikely that firms dealing with their problems on a
fragmented basis will ever solve these problems. For example, a company that is
experienci ng bad investment may soon be having a dividend issue (with insufficient
funds to pay dividends) and a financing problem (because falling revenues may make
it difficult to cover interest costs).
Corporate finance matters to everybody. There is a corporate financial aspect to
almost every decision made by a business; though not everyone will find a use for all
the components of corporate finance, everyone will find a use for at least some part of
it. Marketing managers, corporate strategists, human resource managers, and
information technology managers all make corporate finance decisions every day and
often don’t realize it. An understanding of corporate finance will help them make
better decisions.
Although corporate funding is concentrated quantitatively, there is a significant
component of creative thinking involved in finding solutions to the financial problems

20
that businesses encounter. It is no coincidence that financial markets remain reasons
for innovation and change.

Social Welfare

Businessmen sho uld be socially responsible and not live in an ethical void. But
the social welfare objective, often pursued by governmental organizations, has
conceptual problems such as: What is society, social welfare? We can better do a
single section of society witho ut making another more serious section and so on.
Moreover, what was morally considered 30 years ago could be immoral now?
Moral standards are continuously changing with the evolution of society. The
executive is an agent serving the interests of his direc tor. When directors start to spend
money for social purposes, they become, in fact, civil servants, even if they remain
employees of the organization.

Corporate Growth

Emerging markets such as India and Korea are dominated by business
conglomerates, some of which control up to 90 (groups) of companies. Large corporations
in Korea typically hold 30 -50 companies in all key business areas; and the big five:
Daewoo, Samsung, Hyundai, LG and SK -account for 20% of all loans and contribute to
almost 50% of GDP. Debt rates in top 30 chaebol are in the range of 550 percent; they
slurp an important part of the available credit and drive away smaller businesses. Chaebol
understands only one language: he lends his hand; focus on size and not on profit; to focus
on growth rather than on productivity; invest aggressively and buy companies. Productivity
in South Korea is about half that of the US. When earnings decrease due to recession, these
companies got into loans. If these companies do not work, banks that have borrowed
money are busting. These banks will then have to find a way to save them because the
banks do not want a hole in their balance sheet. So the Financial Supervision Com mission
of Korea has proposed to redress these businessmen.

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Everything about business groups in Korea or India is not bad. In these countries,
there are some important advantages to be part of a business house that is not available to
other independent com panies for illiquid capital markets, and limited managerial talent and
weak judiciary characterize emerging markets. These business groups often fulfill many
useful institutional roles that are not available in the country. For example, they act as
venture capitalists for initiating group actions; solving customer information problems by
attaching their group brand to products produced by group companies (i .e ensuring a
certain level of quality); act as a business school by providing high -quality management
education to managers, etc. In other words, for business shareholders, business groups that
act as proxy market institutions create more value than more focused, unrelated companies.
Given this advantage, it is probably not prudent to dismantle them. Desp ite this advantage,
several business g roups do not produce too much . This is probably due to the fact that the
liberalization of the economy has led to an increase in competition in most businesses. So
what was unique to these business groups is no longer their domain. For example, capital is
freely available to profitable companies. If necessary, I can get foreign capital. Also, the
number of business schools has increased from a few tens to several hundred over the past
20 years.

1.2. Forms of the Corporate Firm

The firm is a way of organizing the economic activity of many individuals, and
there are many reasons why so much economic activity is done by firms, not by
individuals. However, the theory of companies does not tell us much about what most
large firms are corporations, rather than any of the other legal forms companies can
assume.
A basic problem with the company is how to raise money. The corporate form of
the business, that is, the organization of the firm as a corporation, is the standar d
method for solving the problems encountered in generating large amounts of cash.
However, businesses can take other forms. Lets’ take into consideration the three basic
legal forms of organizational firms and see how businesses have the task of raising
large amounts of money under each form.

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1.2.1. The Sole Proprietorship

A sole proprietorship is a business owned by one person. „Suppose you decide to
start a business to produce mousetraps. Going into business is simple: You announce
to all who will listen, “Tod ay I am going to build a better mousetrap.”
Most large cities require that you obtain a business license. Afterward you can
begin to hire as many people as you need and borrow whatever money you need. At
year-end all the profits and the losses will be you rs.
Here are some factors that are important in considering a sole proprietorship:
1. The sole proprietorship is the cheapest business to form. No formal charter is
required, and few government regulations must be satisfied for most industries.
2. A sole proprietorship pays no corporate income taxes. All profits of the
business are taxed as individual income.
3. The sole proprietorship has unlimited liability for business debts and
obligations. No distinction is made between personal and business assets.
4. The life of the sole proprietorship is limited by the life of the sole proprietor.
5. Because the only money invested in the firm is the proprietor’s, the equity
money that can be raised by the sole proprietor is limited to the proprietor’s personal
wealth.”6

1.2.2. The Partnership

A partnership is a group of two or more individuals that get together.
Partnerships is formed out of two categories: (1) general partnerships and (2) limited
partnerships.
In a general partnership all partners agree to provide part of their work and
money and to share profits and losses. Each partner is responsible for the partnership's

6 Ross Westerfield J affe, Corporate Finance , Chapter 1 Introduction to Corporate Finance, page 23

23
debts. A partnership agreement specifies the nature of the arrangement. The
partnership agreement may be an oral agreement or an officia l document setting out
the agreement.
Limited partnerships to allow the liability of some of the partners to be limited to
the amount of cash each contributed to the partnership. Typically, limited partnerships
require at least one partner to be a general partner and limited partners do not
participate in business management.

1.2.3. The Corporation

According to the law, it is a legal entity owned by its shareholders. As a legal person,
the company may conclude contracts, conduct a business, lent or borrow money , and sue or
be sued. A single corporation can make a takeover bid for another and then merge the two
businesses. Corporations pay taxes – but can not vote! In the U.S., corporations are
constituted according to state law, based on the constitutive act tha t sets the purpose of the
business and how it is governed and operated. Corporations are larger businesses or
businesses that aspire to grow.
There are many forms of business, but corporations are by far the most
important, they are distinct legal entity. As such, a corporation can have a name and
enjoy many of the legal powers of individuals. For example, corporations can purchase
and change ownership.
Corporations can conclude contracts and sue and be sued for legal purposes, the
company is a citizen of t he state of establishment without the right to vote.
Regulations are the rules to be used by corporations to regulate their own existence
and refer to their shareholders, directors and officers. Authorities extend from the earliest
possible statement on co rporate governance rules to hundreds of text pages.
In the simplest form, the corporation has three sets of distinct interests: shareholders
(owners), corporate directors and officers (top leadership).
Traditionally, shareholders control the direction, pol icies and activities of the
company. The shareholders elect a board of directors, who in turn selects the top

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management. Executive members serve as corporate officers and manage the company's
operations in the interest of shareholders. In companies with f ew close -knit shareholders,
there is a large overlap between shareholders, executives and top management. However,
in larger companies, shareholders, directors and top management may be distinct groups.

◼ Table 1.2. Comparison of Partnership and
Corporation

(Source: Ross Westerfield Jaffe, Corporate Finance, Chapter 1 Introduction to Corporate Finance,
page 25)

1.3. Financial Markets

For our purposes, financial markets can be considered supermarkets for risky cash
flows. Unlike regular shopping supermarkets, supermarkets operate as organized

25
exchanges, where to buy and sell financial securities in continuous auctions. Financial
securities are best thought of as cash flow packages and come in all types. Let's look at
some examples.
Most g overnments have to finance their deficits. To do this, they release public debt.
Debt may be short -term, in which case we call it a treasury bill that promises a certain cash
flow sometime the next year. A treasury bill is the typical example of risk -free security,
there is no uncertainty about future payments. If the public debt is long -term over a year, it
is usually issued as government bonds, with annual coupon payments and a repayment of
nominal value at the maturity of bonds. Since governments can alw ays print money, there
is no uncertainty about whether you get the money back when you have a long -term
government bond. But government bonds are not as risky as treasury bills. The reason is
that there is always uncertai nty about the future value of euro, dollar or pound, due to
inflation.
More risky security is corporate or equity. Equity gives the holder the right to a
dividend on the part of the company. The dividend is a function of the company's
profitability. Because this profitability is quite varia ble for most companies, cash flows
from a stock will be risky.
Some of the largest financial markets are derivatives markets, securities whose
payments depend on the price of other collateral, or even real commodity prices (as
opposed to financial ones). Futures markets are markets where a price can be set today for
a future delivery of goods. Option markets are markets where a price can be set today for a
contingent delivery of goods in the future.
We usually make a distinction between the primary and the secondary market. The
primary market is on the release of a guarantee. Treasury bills are often issued to the
general public through an auction in which anyone can submit bids.
This is then the primary market for treasury securities. When a corporation is sues
equities for the first time, the Initial Public Offering, this is the primary market for equities.
When securities are traded after they have been issued (in the primary market), they
are said to be traded in the secondary market. In terms of volume a nd value, the secondary
market dwarfs the primary market.

26

Chapter 2. The Five Basic Corporate Financial Functions

Corporate finance is defined as the activity involved in managing cash flows (money)
in a business en vironment, but a more complete defi nition would highlight that the practice
of corporate finance involves fi ve basic functions:
▪ „Raising capital to support companies’ operations and investment programs (the
external financing function);
▪ Selecting the best projects in which to invest firms’ resources, based on each
project’s perceived risk and expected return (the capital budgeting function);
▪ Managing firms’ internal cash flows, working capital, and their mix of debt and
equity financing, both to maximize the value of firms’ deb t and equity claims and to ensure
that companies can pay off obligations when due (the financial management function);
▪ Developing company -wide ownership and corporate governance structures that
force managers to behave ethically and make decisions that ben efit shareholders (the
corporate governance function); and
▪ Managing firms’ exposures to all types of risk, both insurable and uninsurable, to
maintain an optimal risk -return trade -off and therefore maximize shareholder value (the
risk-management function). ”7

2.1. External financing function

7 William L. Megginson, Scott B. Smart, Introduction to Corporate Finance, Chapter 1 The Scope of
Corporate Finance, page 3 5, Abridged Edition

27
There are two ways that b usinesses collect money in order to support investment and
other activities: either from shareholders or creditors, or through internment by retaining
and reinv esting operating profits. They can obtain capital by selling shares (common or
preferred shares) or by loans from creditors. When corporations are young and small, they
usually have to accumulate private equity, from friends and family, or from professiona l
investors, such as venture capitalists. Risk capital is specialized in making high risk / high
return investments in growing entrepreneurial businesses.

2.2. Capital budgeting function

The function of capital budgeting is the most important activity of the financial
managers of the company, for two reasons. First of all, managers evaluate very large
investments in the capital budgeting process. Second, companies can thrive in a
competitive economy only by looking for the most promising produc ts, processes, and new
services to offer their customers. Companies like Intel, General Electric, Shell, Samsung
and Toyota are regularly making huge capital expenditures. Payments from these
investments determine the value of companies and the wealth of t heir shareholders. For
these and other companies, the annual capital investment budget can exceed several
billions of dollars, so the consequences of capital budgeting processes are really serious.
„The capital budgeting process breaks down into three step s:
1. identifying potential investments;
2. analyzing the set of investment opportunities and identifying those that create
shareholder value;
3. implementing and monitoring the investments selected in Step 2. ”8

2.3. Financial management function

8 William L. Meg ginson, Scott B. Smart, Introduction to Corporate Finance, Chapter 1 The Scope of
Corporate Finance, page 36 , Abridged Edition

28

A key element of the process of managing the operational cash flows of enterprises
as efficiently and profitably as possible , known as the capital structure decision, is finding
a fair mix of debt and equity to maximize the market value of the firm. A second part of
the financial management function ensures that companies have sufficient working capital
for day -to-day operations. Managing circulating capital involves obtaining seasonal
funding, building sufficient inventory to meet customer needs, paying suppl iers, collecting
from customers and investing surplus cash, all while maintaining adequate cash balances.
Managing working capital requires not only technical and analytical skills, but also human
skills.

2.4. Corporate governance function

Governance sy stems determine who benefits most from the company's activities;
then set up procedures to maximize the value of businesses to ensure that employees act
ethically and responsibly. Good management does not develop in a vacuum, is a results
from corporate go vernance systems that encourage the engagement and promotion of
qualified and honest individuals and motivate employees to achieve their company goals
through wages and other incentives.
As you might expect, a variety of governance mechanisms to mitigate c onflicts of
interest have evolved over time. Powerful commissions play a vital role in any well –
functioning government system, as the councils have to hire, fire, pay, and promote high –
ranking managers. Councils must also develop a fixed salary and a conti ngent bonus and
share -based compensation packages that align managers. "
Just as all companies are trying to develop effective corporate governance systems,
so do the countries. Governments everywhere are working to establish corporate finance
frameworks t hat encourage competitive businesses to effectively develop and operate
efficient financial markets. For example, a nation's legal system should allow mergers and
acquisitions to increase economic efficiency, but to block takeovers that significantly
reduc e competition. Commercial laws should provide protection for creditors and minority
shareholders and limit opportunities for managers or majority shareholders to transfer

29
corporate wealth from investors to themselves.

2.5. Risk -management function

From historical point of view, risk management has identified unpredictable risks of
"acts of nature" (fires, floods, collisions and other material damage) to which firms are
exposed, using insurance or self -insurance products to manage these exposures. Th e
current risk management function identifies, measures and manages many other types of
risk exposures, including the loss of predictable business risks that may result from
unfavorable interest rate movements, commodity price chan ges, and currency fluctua tions.
Techniques to manage these risks are among the most sophisticated of all company
financing practices. The risk management task attempts to quantify the sources and
magnitude of the risk exposure of enterprises and to decide whether to accept or mana ge
them. Some risks are easy to assure, such as fire or flood loss, employee theft, or customer
injury to the company's products. Other risks can be reduced by diversification. For
example, rather than using a single vendor for a key input into production, a company may
contract with multiple suppliers, even if it means buying the entries at a slightly higher
price than the lowest possible price. However, modern risk management focuses on the
above -mentioned market risks related to interest rates, commodity prices and currency
values. Many de rivative financial instruments draw their value from other underlying
assets, over the past two decades have been developed to be used to hedge the risk (i .e
offset) many more threatening market risks.

30

Chapter 3. Financial Planning and Management

Financial planning forces the corporation to think about goals and formulates the
method by which financial goals are to be achieved. Incorporates decisions such as capital
budgeting, capital structure, and dividend policy.
Financial planning establishes guidelines for change in the firm. These guidelines
should include an identification of the firm’s financial goals, an analysis of the differences
between these goals and the current financ ial status of the firm and a statement of the
actions needed for the firm to achieve its financial goals.
It has two dimensions: a time frame and a level of aggregation. It can be long -term
financial planning or short -term financial planning.

3.1. Long -term financial planning

Finance plays several role s:
„First, financial managers draw on a broad set of skills to assess the likelihood
that a given strategic objective can be achieved. With respect to a major new investment
proposal, the fi rst que stion to ask is probably not “What does it cost?” or “Can we afford
it?” Rather, drawing on their experience and knowledge outside the real of fi nance,
managers should ask, “Does this investment make sense?” or “Is there a good reason to
expect this propos al to generate wealth for our shareholders?”.
Second, the responsibility to assess the feasibility of a strategic action plan given a
firm’s existing and prospective sources of fu nding falls primarily to the fi nance function.
Though some corporate giants, such as Microsoft or Intel, hold such vast amounts of cash
that they are nearly unconstrained in terms of their ability to make large, new investments,

31
for most companies fi nancial constraints are more binding. Given a broad set of strategic
objectives, financial managers must determine whether the fi rm’s ability to generate cash
internally plus its ability to raise cash externally will be sufficient to fund new spending
initiatives.
Third, finance clearly plays an important control function as fi rms im plement their
strategic plans. Financial analysts prepare and update cash budgets to make sure that fi
rms do not unknowingly slip into a liquidity crisis. The frequency with which these budgets
are constructed and monitored depends on several factors, inc luding the firm’s current
level of liquidity, its access to external funding sources, and the volatility of demand for its
products. At an even more detailed level, analysts monitor individual items in the cash
budget, such as changes in inventories and re ceivables and changes in payables.
Fourth, a major contribution of finance to the strategic planning process involves
risk management. When a firm’s strategy calls for making new investments in overseas
markets (either producing or selling abroad), the fi rm faces a new set of risk exposures.
The finance function is charged with managing these exposures and ensuring, to the extent
possible, that the firm takes those risks that it believes it has a comparative advantage in
taking and that it hedges risks for which it has no advantage. ”9
Almost all firms use an explicit, company wide growth rate as a major component
of their long -run financial planning.

3.2. Short -term financial planning

Involves short -lived assets and liabilities. We discuss two aspects of s hort-term
financial planning:
1. The size of the firm’s investment in current assets, such as cash, accounts
receivable, and i nventory;

9 William L. Megginson, Scott B. Smart, Introduction to Corporate Finance, Chapter 1 5 Financial Planning ,
page 634, Abridged Edition

32
2. How to finance short -term assets.
The primary tool fo r short -term financial planning is the cash budget. It
incorporates the short -term financial goals of the firm and tells the financial manager the
amount of necessary short -term financing.
Short -term finance is an analysis of decisions that affect current assets and current
liabilities and will frequently have an impact on the firm within a year.
The term net working capital is often associated with short -term financial decision
making. Net working capital is the difference between current assets and current liabilities.
The focus of short -term finance on net working capital seems to suggest that it is
an- ccounting subject. However, making net working capital decisions still relies on cash
flow and net present value.
There is no universally accepted definition of short -term finance. The mos t
important difference between short -term and long -term finance is the timing of cash flows.
Short -term financial decisions involve cash inflows and outflows within a year or less. For
example, a short -term financial decision is involved when a firm orders raw materials, pays
in cash, and anticipates selling finished goods in one year for cash, as illustrate d in F igure
2.1. below . A long term financial decision is involved when a firm purchases a special
machine that will reduce operating costs over the nex t five years, as illustrated in Figure
2.2.
Figure 2.1. Short -term Financ ial decision

(Source: William L. Megginson, Scott B. Smart, Introduction to Corporate Finance, Chapter27 Short -term
Finance and Planning, page 744 )

◼ Figure 2.2. Long -term Finan cial decision

33

(Source: William L. Megginson, Scott B. Smart, Introduction to Corporate Finance, Chapter27 Short -term
Finance and Planning, page 744 )

3.3. Financial planning model

Companies differ in size and products, financial plans are n ot the same for all companies,
however, there are some common elements:
1. „ Sales forecast.
All financial plans require a sales forecast. Perfectly accurate sales forecasts are not
possible, because sales depend on the uncertain future state of the economy. Firms can get
help from businesses specializing in macroeconomic and industry projections.
2. Pro forma statements.
The financial plan will have a forecast balance sheet,an income statement, and a
sources -and-uses statement. These are called pro forma statements, or pro formas.
3. Asset requirements.
The plan will describe projected capital spending. In addition, it wil l discuss the proposed
uses of net working capital.
4. Financial requirements.
The plan will include a section on financing arrangements. This part of the plan
should discuss dividend policy and debt policy. Sometimes firms will expect to raise equity
by selling new shares of stock. In this case the plan must consider what kinds of securities
must be sold and what methods of issuance are most appropriate.
5. Plug.

34
Suppose a financial planner assumes that sales, costs, and net income will rise at a
particula r rate, g1. Further suppose that the planner wants assets and liabilities to grow at
a different rate, g2. These two different growth rates may be incompatible unless a third
variable is also adjusted. For example, compatibility may only be reached if outs tanding
stock grows at a different rate, g3. In this example, we treat the growth in outstanding
stock as the plug variable. That is, the growth rate in outstanding stock is chosen to make
the growth rate in income -statement items consistent with the growt h rate in balance -sheet
items. Surprisingly, even if the income -statement items grow at the same rate as the
balance -sheet items, consistency might be achieved only if outstanding stock grows at a
different rate. Of course, the growth rate in outstanding s tock need not be the plug
variable. One could have income -statement items grow at g1, and assets, long -term debt,
and outstanding stock grow at g2. In this case, compatibility between g1 and g2 might be
achieved by letting short -term debt grow at a rate of g3.
6. Economic assumptions.
The plan must explicitly state the economic environment in which the firm expects to
reside over the life of the plan. Among the economic assumptions that must be made is the
level of interest rates.
Financial planning for ces the firm to think about forecast ing the future. It involves the
following:
1. Building a corporate financial model.
2. Describing different scenarios of future development from worst to best cases.
3. Using the models to construct pro forma financial statements.
4. Running the model under different scenarios (condu cting sensitivity analysis).
5. Examining the financial implicatio ns of ulti mate strategic plans.
Corporate financial planning should not become a purely mechanical activity. If it does, it
will probably focus on the wrong things. In particular, plans are formulated all too often in
terms of a growth target with an expl icit linkage to creation of value. Nonetheless, the
alternative to financial planning is stumbling into the future. ”10

10 William L. Megginson, Scott B. Smart, Introduction to Corporate Finance, Chapter 25 Corporate

35

CASE STUDY

Corporate Governance: Berkshire Hathaway, Galleo n,
News Corp oration, HS BC

The fast -changing business landscape continues to present many new and ongoing
complexities for boards and senior management. Leaders and, especially, directors of
corporations need to have the strength, knowledge and flexibility to provide the moral
compass for companies to function and exce l. Compliance with rules, regulations and
standards is only a small part of directors’ roles. More importantly, they need to embrace
the highest standards of governance and independence to meet the increasing expectations
of shareholders and other stakehol ders in the new world order.

1. Berkshire Hathaway

Case Overview
In 2011, Chairman and CEO of Berkshire Hathaway, Warren Buffett, announced the
sudden resignation of David Sokol in a press release, citing personal reasons for the decision.
The news shocked many, as Sokol had long been considered as a leading candidate to
succeed Buffett’s leadership position in Berkshire Hathaway. Sokol’s resignation raised
further questions by stakeholders when it was revealed that Sokol had purchased shares in

Financial Models and Long -term Planning , page 744, Abridged Edition

36
Lubrizol, shortly before he proposed the company to Buffett for acquisition. Amidst
allegations of insider trading and front running, Sokol has maintained that his Lubrizol
purchases were not unlawful in any way. The Sokol incident also caused some observers to
question Berkshire’s corporate governance practices, and dented the company’s once
stellar reputation. This objective of this case is to facilitate a discussion of issues such as
ethics, insider trading, the trust-based governance system in Berkshire Hathaway, factors
affecting the effectiveness of monitoring by the board of directors, and the importance of
succession planning.
Berkshire Hathaway Inc. is a multinational conglomerate holding company that
originated from a merger between Berkshire Fine Spinning Associates and the Hathaw ay
Manufacturing Company in 195 2. In 1962, Warren Buffett began to purchase Berkshire’s
stock (which he believed was underpriced) and by 1967, became the majority owner of the
company. After the discontinuat ion of its textile operations, Buffett used Berkshire as his
investment vehicl e to purchase various companies, amoung which: Geico (insurrance),
Dairy Queen (more than 6000 restaurants), Duracell, Fruit of the L oom. Its share returns
have consistently outp erformed the market du ring the period from 1965 to 20 18, and the
company also ranked 16th in Forbes’ 2012 list of most reputable companies in the U.S.
Berkshire uses float funds, which come from the timing difference between
collecting money and paying for insurance claims, to invest in new businesses for
Berkshire’s gain. The financial statements do not include the gain and size of the float
funds, but “float(s) generate significant investment income because of the assets it allows
us to hold”. In this way Berkshire is able to finance new businesses while keeping minimal
debt. This float, which “grew from $41 billion to $88 billion in 2015“ has created a barrier
to competition.
◼ Chart1. Underwriting earnings and float by division

37
Trust -Based Governance
Despite its sheer size, Berkshire has a relatively simple governance structure. The
basic principle underlying Berkshire’s governance is trust – a principle that is not surprising
because Buffett has always believed that the company is a huge partnership oper ating
based on trust among its partners. This trust -based governance is manifested in some
corporate practices unique to Berkshire Hathaway.
Capital allocation in Berkshire is centralised at its headquarters; decisions on how
to reinvest free cash flows ge nerated by business units are made entirely by Buffett, and at
times after consulting his long -time partner Charlie Munger, but never vetted by any
committees. There is no formal investment committee to perform due diligence on capital
allocation decisions . Operating decisions are made entirely by managers of each business
unit without much consultation with the headquarters; they are not required to submit
budgets or long -term plans for review. Such procedures indicate that a huge amount of
trust is placed by corporate headquarters on its managers to act with integrity. Furthermore,
Berkshire has few, if any, internal controls within the company. No due diligence is
conducted before Berkshire commits to an acquisition and the board seldom reviews
purchase d ecisions; most acquisition decisions are made under the sole discretion of
Warren Buffett. Commenting on this trust -based system, Munger described the governance
system of Berkshire as “a seamless web of deserved trust,” and credited it as instrumental
in helping the company grow from a market capitalisation of $10 million in 1965 to $200
billion in 2011 and $500 bilions by 2019 .

The Rise of David Sokol
David Sokol’s relationship with Berkshire began in 1999 when Berkshire acquired
MidAmerican Energy, a company in which Sokol was the CEO. From 1999 until his
abrupt resignation in 2011, Sokol displayed exceptional managerial performance,
fuelling wide speculation that he was the candidate with the greatest potential to succeed
Buffett as Berkshire’s CEO. Under Sokol’s stewardship, underperforming divisions Johns
Manville and NetJets had gone back on track, further enhancing Sokol’s image as one of
the “star players” within the company. Sokol also played an integral role in the selection of
some of Berkshire ’s acquisition targets. In 2010, Sokol was encouraged to shortlist

38
companies that could serve as potential acquisitions for Berkshire. This subsequently
proved to be catastrophic for Sokol as it became the starting point of a series of events that
eventually culminated to his controversial resignation in 2011.

Acquisition of Lubrizol
The Lubrizol deal began in late 2010, when a group of investment bankers from
Citigroup provided Sokol with a list of potential target chemical companies that Berkshire
might be interested in. From that list, Sokol selected Lubrizol as the only company of
interest. Sokol then conveyed Berkshire’s possible interest in acquiring the company, as
Citigroup had connections with Lubrizol’s CEO. On Sokol ’s request, Citigroup
subsequently arranged a meeting between Lubrizol’s CEO, James Hambrick, and Sokol
who was acting as a Berkshire representative.
In the middle of January 2011, Sokol proposed Lubrizol for acquisition to Buffett
and also informed him of his opportunity to meet the CEO of Lubrizol. During this
conversation, Buffett enquired how Sokol had learnt of Lubrizol, Sokol replied that he had
owned the company’s shares. However, Sokol did not disclose the amounts and timings of
his purchases. On 25 January 2011, Sokol met with Hambrick, and updated Buffett on
what transpired in the meeting the following day. Slightly more than a week after, Buffett
met with Hambrick to negotiate the terms of the acquisition, and on 14 March 2011,
Berkshire and Lubri zol announced the merger agreement. Berkshire had agreed to purchase
Lubrizol for $9 billion in cash. When a Citigroup representative came forward to
congratulate Buffett on the merger, he revealed the role of Citigroup in the acquisition
process. This pro mpted further investigation which eventually revealed that Sokol had
gained a hefty $3 million profit for his purchase of Lubrizol shares just days before
Berkshire’s acquisition proposal. Public accusations of insider trading thus ensued as many
felt that Sokol had abused his position in Berkshire by using privately -held information to
obtain an unfair profit.

David Sokol’s Defence

39
In a bid to defend his reputation amidst speculation surrounding the circumstances
of his resignation, Sokol agreed to an in terview with CNBC’s Squawk Box on 31 March
2011. In the interview, he raised the f ollowing points in his defence . First, the shares were
purchased based on his personal decision and prior to his recommendation of the potential
acquisition opportunity to Bu ffett. Second, he bought Lubrizol’s shares without the
knowledge that Berkshire was interested in acquiring the company. Furthermore, he argued
that he did not utilise any private information provided by Citigroup’s bankers; he
emphasised that the list of companies provided by the Citigroup bankers was public
information, and his decision to purchase Lubrizol’s shares was purely to better manage his
family’s wealth. Finally, Buffett had the sole discretion over investment decisions in
Berkshire Hathaway. He nce, he felt it unfair to be accused of insider trading as he had no
control over Berkshire’s acquisition decision of Lubrizol.

Audit Committee Report
Following Sokol’s resignation, Berkshire’s audit committee decided to investigate
the affair and publish an official view of the company regarding Sokol’s resignation. In an
18-page report publ ished at the end of April 2011 , Berkshire’s audit committee criticized
Sokol’s decision to purchase Lubrizol’s shares and outlined the following reasons as to
why Soko l’s purchase of Lubrizol shares constituted a breach of Berkshire’s policies and
state laws.
First, the transaction violated Berkshire’s Insider Trading Policies and Procedures,
which forbid the trading of securities of public companies when the trader pos sesses
material information relating to them. Even though there was significant uncertainty as to
whether Buffett would support the acquisition, Sokol should have abstained from trading
Lubrizol’s shares from the day he selected it from Citigroup’s list of companies and
initiated acquisition talks.
In addition, the share purchases violated Berkshire’s Code of Business Conduct and
Ethics since Sokol purchased Lubrizol’s shares when he already knew that Lubrizol’s
board would consider Berkshire’s interest, hence increasing the possibility of a successful
merger between the two companies. Even if this information was not material, it was
clearly confidential, and the Code prohibited Sokol from trading on it. Furthermore, the

40
Code was also violated when Sokol took the opportunity from a potential Berkshire
acquisition and profited personally. Sokol’s pre -merger purchases may even have hurt
Berkshire, since it sullied the firm’s reputation for not making hostile acquisitions and
could have undermined the trust b etween the latter and potential partners. Finally, Sokol
failed to fulfill his duty of full disclosure under Berkshire’s Code as well as under the Law
of Delaware, which was applicable to Berkshire due to its place of incorporation.
Transactions that could be reasonably expected to give rise to a conflict of interest and
personal gain should be fully disclosed.

Succession Challenges for Warren Buffett
David Sokol’s resignation has since triggered a wave of criticism about Berkshire’s
corporate governance p ractices and the sustainability of its governance system. On top of
that, another issue had been repeatedly raised , its succession planning. The issue of
succession planning at Berkshire has become a major cause of concern for investors since
Sokol had bee n widely viewed as a frontrunner in the line of potential candidates to
succeed Buffett . Although Buffett has often reassured the public that Berksh ire is prepared
for succession and has identified an internal candidate as well as two back -up candidates,
the issue of succession at Berkshire is still a cause of anxiety for many. This is because the
self-proclaimed robustness of Berkshire’s succession planning has yet to be seen, and the
elderly 82 year old Buffett had been diagnosed with prostate cancer on 11 April 2012 . On 5
May 2012, a shareholder proposal for the disclosure of a written and detailed succession
policy was voted down , after the board argued that there was no benefit in formally
publishing its succession plans.
A clear succession plan is esse ntial for good governance – the real challenge for
Berkshire’s succession planning would be to effectively select and execute a seamless
transition of power to a competent and viable candidate capable of at least fitting into
Buffett’s shoes while also ens uring that the corporate culture that helped Berkshire excel
remains in place.

The Next Step for Berkshire Hathaway

41
The David Sokol scandal has highlighted several questions for Buffett and
Berkshire’s directors regarding the company’s corporate governance system. Should
Berkshire’s overall governance structure be changed? Should more internal controls be
introduced within the company? Has Sokol or other executives engaged in similar trading
previously, but these were simply undetected due to Berk shire’s lack of internal controls?
Does Berkshire need to reform the board and confer real power upon it to monitor the CEO
and his decisions?
Given such concerns, it is imperative for Buffett and his board to act fast in order to
safeguard Berkshire Hatha way’s reputation. After all, it takes 20 years to build a reputation
but only five minutes to ruin it.

Recent Developments
In early January 2013 , the U.S. Securities and Exchange Commission (SEC)
dropped its probe into David Sokol. According to Sokol’s la wyer, Sokol has been
“completely cleared” as there was no evidence against him.
Till this day Warren Buffett did not choose a replacement, but news circulate that
he intends to name two senior executives — Gregory E. Abel and Ajit Jain — to its board.
Abel, 55, will be vice chairman of the non -insurance business, while Jain, 66, will
be vice chairm an of the insurance operations. Buffett and Charles T. Munger, 94, Berkshire
Hathaway’s vice chairman, will continue in their current positions, includ ing being
responsible for significant capital allocation decisions and investment activities.

2. Galleon

Case overview
The Galleon insider trading case is one of Wall Street’s largest cases, involving
confidential information leakage of esteemed global corporations Goldman Sachs and
Procter & Gamble. It led to the fall of two well -known business leaders in the US, Rajat
Gupta and Raj Rajaratn am. Rajat Gupta, once a highly respected and influential

42
businessman, suddenly found himself falling from grace as he faced one count of
conspiracy and five counts of securities fraud .

Who is Rajat Kumar Gupta?
Rajat Kumar Gupta (Gupta) is a renowned Indian American businessman, best
known for being the first Indian -born managing director of McKinsey & Company , a
prestigious management consultancy group. Despite coming from a humble background,
Gupta excelled in his studies and went on to obtain an MBA from Harvard Business
School. Gupta joined McKinsey & Company in 1973 and became the managing director in
1994, durin g which he co -founded the Indian School of Business, the American India
Foundation, as well as Scandent, a broad -based technology solution company. It was also
during this time that he came into contact and built relationships with wealthy Wall Street
investment bankers. Raj Rajaratnam (Ra jaratnam), his alleged partner -in-crime, later
claimed that Gupta was in the “hundreds -of-million -aire’s circle”, but he wanted to be in
the “billionaire’s circle”.
Gupta sat on many boards such as Goldman Sachs, Procter & Gamble, AMR
Corporation, Genpact Limited and Harman International Industries . He also sat on the
boards of educational institutions and non -profit organisations including Harvard Business
School and the Gates Foundation . At the same time, he remained a “s enior partner
emeritus” at McKinsey & Company .

The Friendship
Unlike Gupta, Rajaratnam came from a wealthy family in Sri Lanka. He received
English education since young before going to Wharton Bu siness School to pursue his
MBA . He founded Galleon Group, which was one of the largest hedge fund management
firms in the world before it was wound down in October 2009 . He was the Managing
Member of Galleon Management LLC, general partner of Galleon Management and a
portfolio man ager for the Galleon Tech Fund . Like Gupta, Rajaratnam was a prominent
name on Wall Street. Gupta and Rajaratnam quickly became close friends and business
partners through their investments and joint ventures in private -equity firms Taj Capital

43
and New S ilk Route Partners LLC in 2006 . Gup ta visited Rajaratnam’s office regularly ,
indicating close ties between the two. During the period when the insider trading case
allegedly took place, Rajaratnam appointed Gupta as Chairman of Galleon International
and gave him an ownership stake . Gupta also had $10 million invested in at least two other
Galleon funds .

The Chain of Events
12 March, 2007
Gupta attended a Goldman Sachs’ audit committee meeting from Galleon’s
prem ises through a conference call . During the call, there was a discussion regarding
Goldman Sach’s first quarter earnings which was due to be announced the next day. The
earnings had exceeded analysts’ forecasts. Approximately 25 minutes after this call,
Rajaratnam had one of his funds buy abou t 350,000 Goldman Sachs shares . The next day,
after Goldman Sachs’ earnings announcement, its shares rose by more than $2 per share
from the previous close, rea ping profits for Galleon funds .

10 June, 2008
Gupta allegedly tipped off Goldman Sachs’ quarterly earnings to Rajaratna m after
learning from the firm’s CEO Lloyd Blankfein that its second quarter results would exceed
analysts’ con sensus forecasts substantially. In the morning of 11 June 2008, Rajaratnam
instructed Galleon funds to buy 7,350 out -of-the-money call options on Goldman Sachs
stock as well as 350,000 Goldman Sachs shares, minute s after the open of the market .
When Goldman Sachs announced its sec ond quarter earnings on 17 June 2008, Rajaratnam
sold his positions, making a bout US$19 million for Galleon .

29 July, 2 008
Gupta had a phone conversation with Rajaratnam, disclosing confidential
information from a Goldman Sachs’ board meeting in which the directors considered the

44
possibility of purchasing either commercial bank Wachovia or th e American International
Group .

23 September, 2008
Gupta participated in a Goldman Sachs board meeting call using his phone. During
the call, Goldman Sachs board approved a US$5 billion investment by Berkshire Hathaway
in Goldman Sachs at the height of the financial crisis . Barely 16 s econds after the meeting,
at about 3.54pm, Gupta made a call to Rajaratnam to d ivulge this information to him .
Shortly after, Rajaratnam instructed a number of Galleon funds to buy about 217,200
Goldman Sachs shares for a total of approximately US$27 milli on at 3.58pm, about 2
minutes before the ma rkets closed .
After the market closed, Goldman Sachs made a public announcement of the
Berkshire Hathaway investment . The next morning, Goldman Sachs shares opened at
US$128.44, more than US$3 per share higher th an the pre -announcement closing pri ce of
US$125.05 the day before . Galleon then sold the 217,200 Goldman Sachs shares the same
day, earnin g a profit of about US$840,000 .

23 October, 2008
Gupta attended a conference call with t he Goldman Sachs board, where the senior
executives updated the board abo ut quarterly financial results . According to Goldman
Sachs’ internal financial analyses, the firm lost almost US$2 per share for the quarter
ending November 28 2008, which was significantly worse than the ma rket expectations,
and was the first time in the company’s history as a public -listed firm that a loss was made .
This time, it took Gupta 23 seconds to call Rajaratnam and inform him of Goldman Sach’s
nega tive interim financial results . As soon as the mark et opened the next day, Galleon
Tech Funds started to dispose of its entire long position in about 150,000 Goldman Sachs
shares, avoiding a lo ss of several million dollars.

29 January, 2009

45
Gupta attended an Audit Committee meeting of the Procter & Gamble Board of
Directors at around 9 am, the day before Procter & Gamble’s quarter ly earnings was to be
released . The draft of the earnings results stated, amongst other things, that the company
expected its organic sales to grow by 2 to 5% for the fiscal year, a forecast that fell short of
the previous publicly announce d forecast by Procter & Gamble . Gupta allegedly then
called Raja ratnam at 1.18pm with the news . Shortly after that, at 2.52pm, some Galleon
funds started shorting about 180,000 Procter & Gambl e shares , booking a profit of more
than US$570,000 .

1 July, 2010
Gupta became the Chairman of the International Chamber of Commerce. The Wall
Street Journal revealed that in April 2010, Gupta was under federal scrutiny. This,
however, did not deter organisa tions from keeping him on their Boards of Directors. Gupta
still remained on the Boards of Procter & Gamble, American Airlines, Harman
Intern ational Industries, and others .

1 March, 2011
The U.S. Securities and Exchange Commission (SEC) filed an administrative
complaint against Gupta for insider trading in relation to Rajaratnam’s trial . Gupta
vigorously denied the SEC allegations and filed a countersuit claiming that the charges
were unfa ir and viol ated his constitutional rights . On 4 August, 2011, the SEC withdre w its
complaints against Gupta .

13 October, 2011
Rajaratnam was sentenced to 11 years in prison for the biggest i nsider trading case
in decades . He was also ordered to pay a fine of US$10 milli on and forfeit US$53.8
million .

26 October, 2011

46
Gupta was arrested after he surrendered to the FBI. He was charged with one count
of conspiracy and five counts of securities fra ud. Prosecutors later added another securities
fraud charge ba sed on the 12 March, 2007 discussion with the Goldman Sachs audit
committee all egedly from Galleon’s premises . Gupta pleaded not guilty to all of the
charges and was freed on a US$10 million bail and travel rest rictions, while awaiting trial .
His lawyer ma intained that he w as innocent of all the charges .

The Resignations
Prior to the SEC administrative complaint, Rajat Gupta decided not to stand for re –
election to Goldman Sachs Bo ard of Directors in March 2010 . In a Goldman Sachs’ press
release, Lloyd C. Blankfein, Chairman and CEO, said that Gupta’s “independent advice,
keen understanding of the issues and belief in [Goldman Sachs] culture has had a
tremendous impact on the firm” . Yet, Blainkfein later admitted as a witness in
Rajaratnam’s trial that he “had an inkling” of Gupta’s connection to the Rajaratnam case
prior to Gupta’s resignation but only found out mor e after Gupta had stepped down .
Despite this “inkling”, Goldman Sachs did not take any action.
Procter & Gamble announced through its r egulatory filing and press release that
Rajat Gupta voluntarily resigned from the company’s board on 1 March, 2011 “to prevent
any distraction to the P&G Board and its business” .
Procter & Gamble and its Board of Directors were aware of the planned SEC civ il
action against Rajat Gupta “a few weeks” in advance . Although Gupta had submitted
written assurances to the company that the allegations had no merit, Procter and Gamble
decided not to inform shareholders of the matter, claiming that it was in the best interest of
its shareholders, and that the company was not required to disclose the inf ormation as it is
not material .
After his resignation from the Procter & Gamble Board, Gupta remained a director
in American Airlines and Harman International I ndustries , and when questioned,
spokesmen at these compa nies said they had no comments .

47
On 7 March, 2011, Rajat Gupta voluntarily resigned from AMR Corporation
Board, it s subsidiary American Airlines , as well as the board of Harman International
Industries .
Even th ough Gupta had remained a “senior partner emeritus” in McKinsey with his
own office and assistant, a McKinsey spokesman said in a statement after the insider
trading case became public knowledge that “Our firm no longer has a professional
relationsh ip with Rajat Gupta” .
Genpact Limited, where Gupta was the Chairman, remained supportive of him.
Genpact issued a statement saying Gupta “has made invaluable contributions to Genpact,
and has always sought to hold Genpact to the highest standards of integ rity and corporate
governance” . Besides confirming that Gupta would continue to be Chairman of Genpact
Board, Genpact sa id they had no further comment . However, on 4 March, 2011, Gupta
notified Genpact of his resignation from the boar d.
Similar to Genpact Limited, Indian School of Business (ISB), expressed their
support towards Gupta despite the ongoing investigation. ISB had said that it “is confident
that Rajat Gupta will be vindicated” and that “he [Rajat Gupta] continues to be the
Chairm an of the ISB executive board” . This support created controversies both within and
outside India, as Rajat Gupta resigned from the boards of American institutions but
remained a di rector for Indian institutions . Despite the support, Gupta resigned from t he
ISB Board on 21 March, 2011 .
By April 2011, Rajat Gupta has resigned from all of the boards that he was
involved in.
Gupta’s trial started on 22 May, 2012 , and on 15 June, he was found guilty on three
out of five counts of securities fra ud and one count of conspiracy . On 24 October, Gupta
was sentenced to two years in prison and was also ordered by the co urt to pay a US$5
million fine . After being convicted of insider trading, Gupta’s reputation as a director and a
respected businessman has been irrevocably damaged. This coul d mark the tragic end to an
otherwise brilliant career that Gupta has built for himself over the years.
In March 2016, Gupta completed the last two months of his sentence under house
arrest.

48

3. News Corporation

Case overview
On 10 July 2011, News of the World (NoW) ended its 168 years of existence
when it published its final edition. The paper was one of the many casualties of the phone
hacking scandal which engulfed News Corporation (News Corp). Investigations have
shown that the n ewspaper’s practice of phonehacking started as early as 2005. The matter
was closed when there was no evidence to suggest that it was more than an isolated event.
Subsequently, other newspaper publications alleged that the victims of phone hacking
included many other celebrities and politicians. It was also alleged that NoW’s senior
management was aware and condoned these activities. This prompted shareholders to
question whether the Board was doing their job. In October 2011, many New s Corp
investors voted against the re-election of James and Lachlan Murdoch at the annual
general meeting. However, they were re-elected onto the Board because of News Corp’s
dual-class share structure, which gave the Murdoch family 40% of the votes even though
they owned only 12% of the total outstanding shares. The objective of this case is to allow
a discussion on issues such as ethics and tone at the top, dual -class share structures, board
independence and effectiveness, and shareholders’ activism.

The Making of an Empire
Rupert Murdoch was born in Melbourne in 1931. Young Murdoch inherited his
first newspaper, The Adelaide News, from his father in 1952. Murdoch initially focused on
the Australian market, by starting up new p ublications and acquiring several newspapers
and television channels in Australia. In 1968, Murdoch entered the United Kingdom (UK)
market by buying News of the World Organization for £26 million, which owns News of
the World and several other publications . He was quoted saying, “We see opportunities to
participate in media developments across Europe.” Then in 1973, Murdoch entered the
United States (US) market. After acquiring and buying a string of newspapers during the
1970s in the US and in the 1980s in Australia, Murdoch established News Corp as a global

49
holding company. In February 1981, News International plc (NI), the UK newspaper
publishing division of News Corp, was established. In early 2011, News Corp was valued
at about US$48.29 billion, and its product portfolio includes newspapers, magazines,
books, movies, sporting events, websites, cable programming and satellite television.

Shareholding Structure
Despite the Murdoch family collectively owning only about 12% of News Corp’s
shares, they effec tively control News Corp due to the dual -class share structure which
News Corp had adopted. Under this dual -class share structure, the Murdoch family owned
40% of the Class B shares which have voting rights, even though Class B shares only made
up 30.4% of the total outstanding News Corp shares.

Board Composition
The Board of Directors comprised of 16 directors, 8 of whom were classified as
independent. Murdoch is the Chief Executive and Chairman, while his sons, Lachlan and
James, were also on the board. James was also the Deputy CEO. Four of the other directors
were executive directors. Only two of the independent directors have media industry
experience, and both had worked for companies belonging to the media conglomerate
during their careers. The inde pendence of News Corp’s directors complied with the listing
rules of NASDAQ, which News Corp was listed on. In 2011, James Breyer replaced Tom
Perkins as an independent director on the Board. Perkins, who sat on News Corp’s Board
for 15 years, had previous ly resigned from the Hewlett Packard Board in protest against an
unethical leak investigation ordered by the then Chairperson. Perkins was dubbed as “the
closest thing to a truly independent director” on the Board of News Corp and the “best
hope” for impro ving its governance by a columnist at Reuters. Another independent
director who left the Board in 2011 was Kenneth Cowley, a long -time director and
chairman of an Australian clothing firm.

Board Committees
The Board consists of three committees:

50
– the audit committee
– compensation committee
– nominating and corporate governance committee.
None of the audit committee members is a Certified Public Accountant, have
significant experience in accounting, or risk management expertise.
According to a 2011 interview with Nell Minow, the co -founder of The Corporate
Library, which rates companies on their corporate governance, News Corp had received an
F grade for the past six years “only because there is no lower grade”.

Origins of the Phone Hacking Scandal
In 2000, Rebekah Brooks, Rupert Murdoch’s top aide was appointed as the editor
of NoW. During her tenure at NoW, she reported on the case of Milly Dowler, a 13 -year-
old girl who was kidnapped and murdered. The murder was described as one of the most
notor ious of the decade.
Brooks was subsequently promoted to be the first female editor of the tabloid The
Sun in 2003, and was later promoted to chief executive of NI in September 2009. At the
same time, Andy Coulson, Brooks’ deputy editor since 2000, replaced her as the editor of
NoW.
NoW’s phone hacking practice was first detected in November 2005, when Clive
Goodman, NoW’s royal editor, wrote a story about Prince William’s knee injury. The
leakage of this confidential information prompted complaints by royal officials about
voicemail messages being intercepted. It was reported that Goodman hired a private
investigator, Glenn Mulcaire, to tap phone lines, and paid him more than £ 100,000 a year
for his services . In 2007, Goodman and Mulcaire were jailed for fou r and six months
respectively. The Press Complaints Commission, the newspaper regulation watchdog,
published a repo rt in May 2007, saying that no evidence of wrongdoing was found at
NoW. Moreover, a review of internal emails between Coulson and executives showed that
they were not aware of Goodman’s action. It subsequently led to the conclusion that the
royal family phone hacking case was strictly a one -off event which was orchestrated by the

51
duo. Furthermore, Coulson accepted full responsibility for the sc andal and resigned as the
editor of NoW. He was later appointed by David Cameron as his communications chief.

The Unravelling of the Scandal
Everybody in News Corp thought the worst was over. That was hardly the case
when James Murdoch, CEO of News Corp’ s European and Asian Operations, reportedly
made a dubious payment of £700,000 to Gordon Taylor (a former English professional
footballer) in April 2008. This was made in exchange for a confidentiality agreement. It
was revealed later that Taylor’s phone w as hacked by NoW reporters, and the agreement
barred Taylor from reporting the phone hacking to the authorities.
The Guardian, a competitor newspaper publication in the UK, revealed that there
were other victims, many of whom were also paid off in exchange for confidentiality
agreements. It also alleged that these victims included many other celebrities and
politicians and that NoW’s senior management was aware of and condoned the phone
hacking. However, NoW’s senior management denied knowledge of such acti vities.
Two months after Coulson’s repeated denial of the knowledge of widespread phone
hacking in NoW, Sean Hoare, an ex -NoW reporter, admitted to a New York Times reporter
that phone hacking was encouraged at the tabloid and Coulson had actually asked hi m to
do it. Soon after, another ex -NoW reporter Paul McMullan also confessed to The Guardian
that other illegal reporting techni ques were also prevalent in NoW . In January 2011, British
police opened a new investigation into the allegations of phone hackin g at the tabloid,
called “Operation Weeting”. The truth was eventually exposed when Mulcaire was ordered
by the High Court to provide more information regarding the people behind the scenes.
Three former NoW journalists – Edmondson, chief reporter Neville Thurlbeck and senior
journalist James Weatherup – were arrested in April 2011 on suspicion of conspiring to
intercept mobile phone messages and unlawfully accessing voicemail messages.
NoW had no choice but to admit its role and apologise for its actions . NI set up a
website for compensation seekers and made several compensation payments to victims
who were involved in the scandal. Upon further investigation, some 300 NoW emails from
NI solicitors Harbottle & Lewis were given to Scotland Yard. They allege dly showed that

52
Coulson had authorised payments to police officers. In July 2011, The Guardian revealed
that NoW had hacked Milly Dowler’s phone to gain access to more information about her
kidnap. Subsequently, Brooks reaffirmed her stand that she would s teer the company in the
right direction and ensure that they would appropriately resolve the issue.
Rupert Murdoch, who had hitherto remained silent about the controversy since
British politicians called for an investigation, broke his silence one day afte r Brooks made
her statement. He called the hacking accusations “deplorable and unacceptable” and vowed
to cooperate with any police inquiries. On the same day, he appointed his advisers, Joel
Klein (an executive director of News Corp) and Viet Dinh (an ind ependent director of
News Corp) to investigate the phone -hacking allegations. He continued to back Brooks to
lead NI.

The Descend from the Gutter to the Sewers
“This is the most humble day of my life” said Rupert Murdoch.
Many years have passed since the first phone hacking incident before Murdoch
decided to initiate a formal investigation into the allegations. These actions were taken too
late. On 7 July 2011, James Murdoch announced that NoW will publish its last paper on 10
July after 168 years of circu lation . Within the first two weeks of July, the market
responded with a massive sell -off of News Corp’s shares. The share price fell by about
13% and the volume of shares traded during this period spiked as well. The next day,
Coulson was formally arrested on suspicion of conspiring to intercept communications and
of making illegal payments to police officers. At a separate South London police station,
Goodman was also re -arrested for questioning on corruption. Both arrests came after NI
handed a series o f emails to police in June which allegedly detailed illegal payments
made to Scotland Yard offi cers for sensitive information . A letter from Goodman to NI
executives revealed that phone hacking had been widely discussed in the daily editorial
conference, u ntil explicit reference to the phone hacking was banned by the editor.
Since News Corp is listed in the US, it was required to comply with US laws and
rules. The payments made may have violated the Foreign Corrupt Practices Act . Members

53
of Congress urged t he US government to hold investigations on these payments as well as
the alleged purchase of phone records of 9/11 victims .
Bogged down by the phone hacking scandal, News Corp had to give up the
proposed acquisition of satellite broadcaster BSkyB. It had a lready owned 39 percent of
the shares and wanted to make a bid for full ownership of the broadcaster. Unexpectedly,
on news of the failed bid, shares in N ews Corp rose 3.8% in New York . After repeated
calls for Brooks to take responsibility for the scandal , she finally bowed to pressure and
resigned as the CEO of NI on 15 July 2011. The share pric e fell by 4% in the next 3 days
Brooks was subsequently arrested. On 19 July 2011, Rupert and James Murdoch were
questioned by British Members of Parliament over t he phone hacking scandal. Rupert
Murdoch reportedly told the MPs: “I am not responsible”. He claimed that he was not
aware of the extent of phone -hacking and had been misled by staff. Similarly, James
Murdoch was “surprised and shocked” when he learnt that NI had still been paying the
legal fees of Mulcaire – the private investigator that was involved in the royal family
phone -hacking scandal. The Parliamentary Select Committee cited the event in April 2008
where James Murdoch reportedly made dubious paym ents to Ta ylor and two other
footballers , in exchange for barring them from reporting the phone hacking cases to the
authorities. This revelation suggests that senior management knew of the pervasiveness of
phone hacking within NoW. To reassure the public, Viet Dinh (an independent director)
issued the following statement on behalf of the independent directors of News Corp on 20
July:
“The News Corporation Board of Directors was shocked and outraged by the
allegations concerning the News of the World, and w e are united in support of the senior
management team to address these issues. In no uncertain terms, the Board and
management team are singularly aligned and commit ted to doing the right thing.”
The following month, Rupert Murdoch endorsed deputy chairman Chase Carey as
his succe ssor rather than James Murdoch . In September 2011, amendments and extensions
were made to a lawsuit initiated in March 2011 against News Corp’s acquisition of
Murdoch’s daughter’s company, due to the development of the phon e hacking scandal28.
The shareholders accused the Board of not doing their job properly and said that these
revelations showed a culture that ran amok within News Corp and a Board that provided no

54
effective review or oversight . Thereafter, the Murdoch fami ly faced increasing pressure
and disapproval from shareholders. On 25 October 2011, one third of News Corporation
shareholders voted against allowing James and Lachlan Murdoch to continue serving on
Board, while 14% cast ‘no ’ votes against Rupert Murdoch . Newscorp’s share price rose by
5% over the next three days. Matters worsened in February 2012, when court documents
revealed that NoW journalists had actually asked Mulcaire to hack phones. In total, the
number of phone hacking incidents amounted to 2,226 within a period of five years . James
Murdoch also eventu ally resigned as NI’s Chairman .

Recent Developments
Since the scandal, many arrests have bee n made under Operation Weeting and
Operation Elveden, the investigation into police officers ac cepting in appropriate payments .
In total, US$224 million in legal and related professional fees had been incurred for the
year ended 30 June 2012 in relation to the scandal35. In July 2012, News Corporation
confirmed that it will be split into two separate companies , with Murdoch serving as
Chairman in both companies but only as Chief Executive in one . During the shareholders’
meeting held in October 2012, a shareholder proposal demanding that Murdoch step down
as Chairman of News International was defeated. Despite their unhappiness, shareholders
were still unable to force significant changes in the corporate governance of News Corp.
The impetus for change may have been lost as the share p rice had risen 44% during 2012 .
Brooks and Coulson have been fo rmally charged w ith conspiracy . Both have
denied these allegations and insist that they were unaware of the phone hacking incidents.
It was estimated that the prosecution proces s will last for at three years . Other publications
under NI are also under fire, with 21 of The Sun journalists being arrested. This has stirred
the fear of arrest amongst the remaining journalists – especially the investigative
journalists – who are now unwilling to take on investigative stories . Finally, this issue has
sparked debate about the nee d for media plurality , reducing the concentration of media
power in the hands of a few. However, the issue of media plurality will ultimately be
decided by the British Parliament .

55
Going Forward
With mounting public anger over its unethical practices, Murd och had to make a
swift decision to conduct further internal investigations to determine the pervasiveness and
severity of the unethical conduct in the organisation as part of damage control.
Concurrently, the embattled organisation faces a daunting task i n rebuilding its faltering
public image. Many have expressed their optimism that News Corp will be able to weather
the storm eventually, but the important question is, at what cost? Nobody, not even
Murdoch, has an answer to that, at least for now.

4. HSBC

Case overview
In September 2010, the business world was shocked by a public boardroom d isaster
at HSBC. Chairman, Stephen Green, had announced his pre -mature departure from HSBC
ahead of schedule, putting HSBC’s succession plan into the spotlight. An unforeseen and
public power struggle ensued, with speculation as to whether incumbent CEO Michael
Geoghegan or one of several other possible candidates would get the top job. The chaotic
succession process undermined HSBC’s stellar reputation for smooth ma nagement
succession, and damaged the credibility of the board. The objective of this case is to allow
a discussion of issues such as the importance of board and senior management succession
planning and what it entails, the difference between a Chairman’s and CEO’s roles,
attributes of a good Chairman, and whether former senior executives should become board
chairmen.

HSBC: A Model of Smooth Succession
HSBC has a long history of smooth board and senior management succession
underpinned by clear succession plans. Regular review of these plans by independent non –
executive directors also serves to strengthen its robustness.

56
The succession process for the Board Chairman position involves extensive
benchmarking against external candidates to ensure its internal candidates are up to
standard and not simply chosen by virtue of their insider status. This seeks to ensure that
the best candidate is chosen – one who has the capacity for strategic thinking, authority to
run the board, and personal standing to represent HSBC externally. Institutional
shareholders are consulted with respect to the succession plan, in addition to an
independent search process for potential candidates.
HSBC’s past successions for the Board Chairman position have been low key,
without major d isruptions to the business or public outcry. Successions have also been
traditionally consensus -driven, with the succession receiving unanimous support from the
board of directors.

Overhauling HSBC’s Model of Succession
In May 2006, Michael Geoghegan repl aced Stephen Green as CEO of HSBC, while
Green was promoted to Chairman. Despite executing another smooth CEO -to-Chairman
hand -over, HSBC was criticized for its tradition of promoting its CEO to Chairman, as this
was perceived to impair the Chairman from i ndependently and objectively monitoring the
company. The handover was thrown into focus in part due to a climate of growing focus on
corporate governance. The roles at HSBC had traditionally been such that the Chairman
functioned more as a CEO, while the C EO served as the deputy. Following the handover,
Green concurred with governance critics that the operational management and oversight
roles should be separate and distinct. He spent the next few years of his term as Chairman
taking significant steps to re -define these two roles, transferring the responsibility for
strategy development from Chairman to CEO in 2009 and taking on more of a monitoring
and ambassadorial role as Chairman. In addition to opening the way to a more comfortable
corporate structure w ithin the bank , these actions emphasised HSBC’s renewed
commitment to corporate governance.

The End of an Era of Smooth Succession

57
In late May 2010, news that Green was to step down as Chairman of HSBC within
a year leaked out in various media reports. According to these reports, HSBC’s board was
prepared for the transition and had spent the past three years putting together a succession
plan. This involved ceasing the tradition of promoting the CEO to Chairman, and naming
possibly the bank’s fi rst non – executive Chairman successor – John Thornton – a HSBC
non-executive director who was also a former Goldman Sachs partner. However, these
rumours were refuted by HSBC.
Four months later, on 7 September 2010, an official HSBC announcement
confirmed that Green had agreed to become the U.K. Minister of State for Trade and
Investment. Following the announcement, the bank revealed that it had always intended “to
approve a successor to Mr. Green before the end of the year, and that timetable remains on
schedule”. However, Green had initially announced in May that he would stay on as
Chairman until at least the spring of 2011 but he had suddenly decided to leave before the
year-end, leaving the bank with just three months to appoint a replacement. His prema ture
departure forced HSBC’s board to come to a swift decision regarding the succession. As
Green was highly regarded as a modern influence on the 145 -year-old bank and had led it
admirably through the 2003 U.S. subprime division crisis as well as the 2008 global
financial turmoil, it came as no surprise that HSBC’s share price plunged when news of
Green’s leaving first leaked in May 2010 – investors viewed his departure as the loss of a
major asset for the bank. With no official word from HSBC on the candi dates to succeed
Green, there was widespread speculation in the media.
It was reported that, within HSBC, many wished for the bank to maintain its
tradition of promoting the CEO to Chairman. CEO Geoghegan was a hardworking
“banker’s banker” who had held po sts within HSBC all around the world in his 37 years
with the bank, a decisive and quick -thinking CEO who had earned the respect of many of
his staff. However, certain factors hampered Geoghegan’s appointment. First, it seemed
that his aggressive managemen t style did not sit well with investors, who did not see his
adversarial ways as suited to leading the board and performing the ambassadorial role of a
Chairman. Second, and perhaps more significantly, corporate governance guidelines since
2003 had recomme nded that British companies should not elevate CEOs to Chairmen.
HSBC appeared inclined to abandon its tradition of promoting the CEO to Chairman and
appoint a non -executive Chairman as a more independent check on the CEO -led business.

58
This would leave Geo ghegan out of the race. Given this turn of events, the board’s final
decision on chairmanship was very much unpredictable to observers. This was apparent
from the extensive list of potential candidates generated through public speculation.
Other frontrunne rs for the role included John Thornton, a non -executive director
who was more well -received by investors because of his independence from bank
management, but an unpopular choice internally due to his harsh management style
developed from his stint at Gold man Sachs. Another candidate was Douglas Flint, HSBC’s
Finance Director, who was viewed as a “compromise candidate” to placate both investors
and management, although he had perceivably less showmanship and experience at HSBC
than Green and Geoghegan and f aced the same question on independence. Media reports
also mooted the idea of a temporary Chairman, with Simon Robertson (a senior
independent director at HSBC) taking the role. However, this was widely viewed as
unlikely given Robertson’s role as Chair of the Nomination Committee, designated to
appoint Green’s successor, and his existing duties at Rolls -Royce.
With seemingly no clear successor at the time of Green’s announced departure, and
a myriad of potential candidates that appeared to leave the public and internal stakeholders
divided, the succession looked poised to be the most chaotic that HSBC had seen for a long
time.

Power Struggle in the Boardroom
To add to HSBC’s troubles, news leaked on 21 September 2010 in The Financial
Times that Geoghegan had threatened to resign after being informed at a meeting that the
board did not intend to giv e him the position of Chairman . HSBC’s executives commented
that Geoghegan could be unhappy at the possibility of being passed over in favour of
Thornton. HSBC e ventually followed up with a strongly -worded denial of the incident .
However, the damage had been done – the information leakage had given the public an
insight into the boardroom power struggle. The picture of a fractured board and rifts over
HSBC’s succe ssion were thrust into public spotlight. Even though the official stance of
HSBC and its top management suggests that Geoghegan’s threat to resign might have been
exaggerated and sensationalised, what the public saw at that point in time was an extremely
disorganised and poorly conveyed succession plan within HSBC, which is bad -is-good of a

59
large global bank. Naturally, many questions arose. If this leadership transition had indeed
been planned for, why did stakeholders and in particular, Geoghegan, not see m aligned to
the plan prior to the announcement, leading to internal confusion and the subsequent
uproar? It was clear from an external viewpoint that HSBC had not conveyed the plan and
managed expectations well, both internally and externally. The pressur e was intensified for
HSBC to achieve a resolution as swiftly as possible, in order to assuage investors’
discontent, prevent divisiveness within the organisation on candidate selection, and restore
its public image.

The Dilemma
In selecting a new Chairma n, the Nomination Committee’s dilemma was obvious.
Geoghegan was a long -serving HSBC banker with a wealth of intimate knowledge on
HSBC’s operations. With Green already leaving, the loss of Geoghegan would be a
double -whammy. Yet, condoning Geoghegan’s app ointment and promoting him would
undermine shareholders’ wishes, and impede HSBC’s effort to keep up with changes in the
governance landscape. It seemed like no resolution would be able to completely reconcile
the interests of shareholders and management. The need and urgency for the board to arrive
at a resolution in keeping with the best interests of the company and to quell public
speculation on the internal rift was pressing, while external perceptions of an ill -conceived
and ill -conveyed successio n pla n continued to plague HSBC.
The Resolution
On 24 September 2010, just three days after the reported spat between Geoghegan
and the board, HSBC unveiled a new leadership team. After consideration of numerous
factors, the board made a unanimous decision to appoint Douglas Flint to succeed Green
as Chairman. Stuart Gulliver was appointed Group Chief Executive, while Sir Simon
Robertson remained the senior independent non -executive director and assumed the
concurrent role of Deputy Chairman. Geoghegan would c ontinue to serve in an advisory
capacity until 31 March 2011, after which he would formally retire. John Thornton stayed
on as HSBC’s non -executive director. The appointment of Robertson as Deputy Chairman
was aimed at countering investors’ discontent abou t the newly -installed, predominantly
executive leadership team.

60

Investors’ Reaction
Investors’ reaction to the new leadership team was generally positive. On the day
the leadership changes were announced, HSBC shares increased by 0.4 percent to 666.4
penc e. General investor sentiment was that despite the infighting, “the right men have
ended up in the right jobs1. However, many institutional investors remained upset at the
poorly executed succession, and their disapproval manifested in numerous calls for
HSBC’s non -executive directors to be replaced, to take responsibility for the “bloody
mess”.

61

CONCLU SIONS AND RECOMMENDATIONS

In the first chapter we have discussed how e very business requires money to
operate, and corporate finance seeks to acquire and manage this money. We have presented
several basi c concepts involved with the fi nancial management of corporations, beginn ing
with a discussion of the fi ve basic corporate finance functions that managers practice, and
concluding with a description of debt and equity capital, the two principal types of long –
term funding for all businesses.
In the second chapter we have emphasized that the practice of corporate finance
involve s five basic functions: raising capital, capital budgeting, financial management
function, corporate governance and risk -management function.
In the third chapter we have seen how f inancial planning forces the corporation to
think about goals and formulate s the method by which financial goals are to be achieved.
Incorporates decisions such as capital budgeting, capital structure, and dividend policy.
Case study section has shown that the establishment of good corporate governance
systems is of paramount importance. Governance systems determine who benefits mos t
from the company's activities. European countries like Germany, Austria, and the
Netherlands, require a two -tiered board of directors as a means of improving corporate
governance.
In corporations as per personal life, decision making proces and planning is a key
that has to be discovered with everyday situations.
„Good decisions come from experience, and experience comes f rom bad
decisions. ”11

11 Quote of Mark Twain

62

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