HKU778
SAY GOO
ETHICS MANAGEMENT AT A CROSS-BORDER ENTERPRISE (A) Looking back, I’m proud of what my wife Winifred and I have achieved.1 Through hard work we realised our dreams and built Choi & Leng Paper from a small Hong Kong-based company that employed 22 people into a successful cross-border enterprise. - Gaylord Choi, chairman of C&L2
These recent setbacks have come as a surprise, but we will not be blindsided again. - Gaylord Choi, chairman of C&L3
Choi & Leng Paper Ltd (“C&L”) was a Hong Kong-based company that fell into the category of small- and medium-sized enterprises. It was led by Gaylord Choi and his wife, Winifred Leng. The company consisted of a paper recycling business in Hong Kong and a paper mill in Huizhou, China. Gaylord and Winifred had worked hard to transform the business into a successful and profitable cross-border cross-border enterprise. In recent years, they had recruited a number of young managers to create a new generation of management for the company. The company was doing well, but in mid-December 2007, C&L was hit with an unforeseen setback. It began with Eddie Tse, C&L’s purchasing director, and Xiang Quiling, the accountant at the Huizhou paper mill, leaving the company and joining a competitor. Two days later, Gaylord learned that a company that had been contracted by Eddie to process chemical waste from t he Huizhou mill had been dumping this waste directly into the environment. Authorities were investigating C&L’s possible involvement and there were rumours that C&L could lose its production licence. licence. 1
Names of people and companies used in this case are fictional. Any similarity to actual persons or entities is coincidental and is not the intent of ACRC. 2 Company interview in May 2007. 3 Company interview in D ecember 2007. Jeroen van den Berg prepared this case under the supervision of Say Goo and based on the input of the ICAC for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes. © 2008 by The Asia Case Research Centre, The University of Hong Kong and the Independent Commission Against Corruption of the HKSAR. No part of this publication publication may be reproduced or transmitted transmitted in any form or by any means - electronic, electronic, mechanical, photocopying, recording, or otherwise (including the Internet) - without the permission of The University of Hong Kong. Ref. 08/376C
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Christmas was coming, but this was no time to celebrate. Gaylord and Winifred pondered how these problems arose at a time when the company appeared to be doing better than ever.
China’s Paper Industry China’s strong economy had sparked a huge demand for all kinds of paper, especially paper that was used to package manufactured goods before they were shipped. The industry grew at an average annual rate of 12.9% per year between 2000 and 2005. By the end of 2007, China had become the world’s second-largest producer and consumer of paper and growth was expected to remain strong in the years to come. Containerboard Containerboard was the paper used to produce corrugated packaging and was produced using a mix of different pulps. Most commonly used were wood pulp and its cheaper substitute, recycled paper pulp, which were made by combining either wood or recycled paper with water and chemicals [see Exhibit 1]. The large amount of chemicals and water needed to produce containerboard made the industry damaging to the natural environment.
Figure 1: Containerboard
Figure 2: Corrugated Packaging
Source: Corrugated Packaging Association website: www.corrugated.org (accessed 7 March 2008).
China’s containerboard industry was dominated by two large players that controlled 33% of the industry, while the remainder of the market was held by hundreds of smaller enterprises [see Exhibit 2]. Under pressure from China’s National Development and Reform Commission, the industry was expected to consolidate significantly between 2007 and 2012. It was expected that many of the smaller, less efficient and more polluting paper mills would be forced to close down or merge.
Choi & Leng Paper Ltd C&L was founded in 1958 by Li Cheuk-yin as Victoria Recycling Ltd. In 1978, Gaylord Choi joined the Hong Kong-based paper recycler after completing his education at a Hong Kong technical college. Gaylord’s work ethic, hands-on approach and popularity with both staff and customers impressed Cheuk-yin and, over time, Gaylord was promoted from assistant clerk to CEO and second-in-command. With no sons of his own, Cheuk-yin offered Gaylord the opportunity to buy the business from him when he retired in 1992. By raising money from his family and in-laws, Gaylord was able to take over the business in 1992. His wife, Winifred Leng, quit her bookkeeping job at a local department store and joined her husband to run the company, which they renamed Choi & Leng Paper. Gaylord and Winifred’s determination to succeed, together with their hard work and no-nonsense approach,
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turned the husband-and-wife operation into a flourishing enterprise. However, they quickly realised that, in order to expand the business, they would have to move down the value chain. Acquiring a Paper Mill in Huizhou In order to boost growth, Gaylord and Winifred decided to buy a paper mill producing containerboard in Huizhou, Guangdong province, in 1998. Part of the funding needed for this acquisition came from a close friend of the Gaylord and Winifred, John Ma, an insurance broker by profession who received a 4% stake in the business in return for his investment. They leveraged the fact that they had a recycled paper business in Hong Kong, providing the Huizhou mill with a relatively large quantity of recycled pulp, which was a cheap alternative to wood pulp [see Exhibit 3]. This enabled C&L to keep its production cost below that of its competitors. The containerboard the company produced was sold to companies in southern China and Hong Kong through the Hong Kong-based sales and marketing office, which was headed by Gaylord. Meanwhile, Winifred spent four days a week in China overseeing business at the paper mill. In 2003, the decision was made to double the capacity of the mill from 50 tons to 100 tons. The capacity expansion meant that C&L’s recycled paper needs could not be met internally, so the company evolved from being a net seller of recycled paper to becoming a net buyer. However, thanks to Eddie’s excellent contacts in the recycling industry, the company managed to maintain a high ratio of recycled paper content in its products. In 2006, the mill was refurbished, reducing power consumption and adding a water recycling system that decreased water usage by 46%. Later that year, the mill obtained the ISO 14001 environmental management standard. By mid-2007, business was booming and plans were being drafted to add another 100 tons of capacity to the mill. Key Office Bearers Shareholders and Directors
Gaylord Choi Tak-keung, Chairman • • • • •
Age 50 Married to Winifred Leng Pui-ha Started working in the industry after completing education in a technical institute Based in Hong Kong Held 47% of total shares in C&L.
Charismatic and hard-working, Gaylord had strong industry knowledge, was well respected by his staff and had excellent connections in the industry. As the face of the company, he headed all sales and marketing for the firm.
Winifred Leng Pui-ha, Vice-Chairman • • • • •
Age 45 Married to Gaylord Choi Tak-keung Held a diploma in accounting Spent four days a week in Huizhou, China Held 47% of total shares in C&L.
Winifred was responsible for much of the company’s management, including operations and finance. A minor stroke in 2003, combined with the company’s rapid growth, forced her to
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delegate many of her responsibilities to her nephew, Anthony Leng [see Exhibit 4 for group reporting lines].
John Ma Chi-kin, Partner • • • •
Age 50 Based in Hong Kong Insurance broker by profession Silent partner who owned a 4% stake in C&L.
John became a minor shareholder in 1998 when Gaylord approached him for funds to acquire the Huizhou paper mill. As an insurance broker, he had been handling all insurance matters for C&L since 1992. John had no experience in manufacturing and did not get involved in the management of the company. He had mainly invested because of his good relations with Gaylord and his wife. By 2007, the annual dividends he had been receiving averaged 9.4%.
Eddie Tse Chun-chung, Purchasing Director • • • •
Age 34 Regarded as Gaylord’s right-hand man Held a bachelor in business administration degree from a Hong Kong university Held 2% of total shares in C&L.
Eddie joined the firm as a trainee straight out of university. Gaylord was quick to take him under his wing, recognising in Eddie the same intelligence and ambition he had when he started at the company. After several years, Eddie was promoted to purchasing director, responsible for all purchasing decisions of the firm in both Hong Kong and on the mainland, requiring him to make frequent cross-border trips. Many staff observed that he spoke with the same authority as Gaylord To retain him and keep the purchasing functions of C&L in order, Gaylord had awarded Eddie a 2% share in the company. Executives
Anthony Leng Hok-fei, Financial Controller • • • • •
Age 36 Nephew of W. Leng Held a degree in accounting and was a chartered accountant Based in Hong Kong Was a partner in a small accountancy consulting firm.
Anthony was hired by Winifred in 2003 to help her manage the company’s finances. He proved a valuable and trustworthy employee and, over the years, had reduced her involvement in managing the group’s finances, eventually assuming all her responsibilities.
Yan Gaoyan, General Manager • • •
Age 55 Came from the same village as Winifred’s family Based in Huizhou, China.
Gaoyan was hired in 1998 as general manager of the C&L paper mill. His social and professional network on the mainland was of great value to the firm and gave him the reputation of a trouble-shooter—someone who could get things done with minimal red tape.
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Xiang Quiling, Accountant • • • •
Age 27 Degree in accounting from a university in China Based in Huizhou, China Unbeknownst to all, she was Eddie’s mistress.
Quiling was hired in 2005 on TEddie’s recommendation. As accountant of the paper mill, she reported directly to Anthony. Management for the Future Our current management team is one of the best in the business and I place great trust in them. People like Eddie Tse, our purchasing director, have been with the company for a long time. They have a heart for the company and Eddie even owns a share of the business. I’m confident about passing on the torch to people such as Eddie and Anthony once Winifred and I retire. - Gaylord Choi, chairman of C&L4
Winifred and Gaylord had been working hard at building a new generation of management for the company. They regarded Eddie and Anthony as their successors and had been delegating portions of their responsibilities to them over the years. Gaylord had even given Eddie 2% of the business, making him part of the C&L family and allowing him to share in the company’s profits. However, Eddie and Anthony did not necessarily share their employers’ vision. During my years at C&L, I learned a lot about the paper business. Having established myself in this industry and rendered my service to C&L for such a long period, the time has come for me t o be my own boss. - Eddie Tse, purchasing director of C&L5
Winifred had been in charge of all financial matters until she suffered a minor stroke in 2003. At that point, Anthony was hired and she began delegating her finance responsibilities to him. In 2005, Anthony hired Quiling upon Eddie’s recommendation. After Quiling’s appointment, Anthony reduced the frequency of his visits to the Huizhou plant from once every two weeks to once every quarter. Quiling reported to Anthony by email, fax and phone. She did not come to Hong Kong to report in person. Before joining C&L, I worked exclusively for some of Hong Kong’s most prestigious financial institutions. My original plan was to stay with this industry, but when my aunt suffered a stroke and needed my help, I couldn’t let her down. […] With Gaoyan in charge of general management, Eddie controlling the purchasing function and Quiling keeping an eye on the paper mill’s accounting matters, all facets of C&L’s operations are in good shape. This has also allowed me to spend more time at my accounting consultant firm. - Anthony Leng, financial controller of C&L6 4
Company interview in May 2007. Company interview in May 2007. 7 Company interview in May 2007. 6
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Behind the Scenes at C&L Relations with Recycled Paper Suppliers Good networking skills and close relationships with clients and suppliers are the winning factors in doing business. - Gaylord Choi, chairman of C&L7
Eddie, as Gaylord’s protégé, had used this way of doing business to the fullest. With Gaylord’s consent and the silent approval of the senior management team, Eddie used a combination of entertainment and kickbacks to the staff of suppliers in Hong Kong and on the mainland to ensure steady supplies of recycled paper. These kickbacks were covered as operational expenses by Quiling, who kept two sets of accounts for this purpose: one with the kickbacks subsumed under operational expenses and the second set giving the true picture. However, what the rest of the management did not know was that Eddie and Quiling themselves profited from abusing the double accounting method by overstating the kickbacks to suppliers and fabricating invoices for various goods and services that were never supplied to C&L. Eddie regarded these illicit gains as appropriate in view of his instrumental role in keeping the purchasing functions of C&L in order. In June 2007, while reconciling the accounting and purchasing records, Anthony discovered the abuse of the double accounting method. Although he suggested taking firm action against Eddie and Quiling, Gaylord decided against it because the company relied heavily on Eddie’s extensive network of suppliers to ensure a steady supply of recycled paper. Changing the Chemical Waste Processor The production of paper required the use of chemicals and resulted in significant amounts of chemical waste. This waste had to be properly disposed of under China’s environmental law. Between 1998 and 2006, waste disposal had been taken care of by Huang Liang Co. Ltd (“Huang Liang”). This company employed a consultant that had good connections with some local government officials and guaranteed proper disposal of chemical waste. However, Huang Liang’s services were relatively expensive. In 2006, Eddie approached Gaylord suggesting that C&L halt its long-standing relationship with Huang Liang and give its waste disposal business to a company by the name of Green Beauty. According to Eddie, Green Beauty was significantly cheaper, which meant total cost for waste disposal could drop by 15% to HK$4 million annually, slightly below market rates. Gaylord discussed Eddie’s proposal with Mr Yan Gaoyan, the general manager, because he had originally set up the deal with Huang Liang. Gaoyan opposed the proposal and explained that, although Huang Liang’s fees were slightly higher than average, the extra money spent was worthwhile considering Huang Liang’s strong ties with local officials, which allowed the company to straighten out any unforeseen problems with the local government. The issue was initially laid aside following Gaoyan’s opposition. However, in April 2006, three months after Eddie originally raised the issue, he mentioned it again at the annual meeting of shareholders in Hong Kong, with Winifred, Gaylord, John and Anthony present. With Eddie strongly advocating the deal and John and Anthony agreeing with his argument
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Company interview in May 2007.
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that a cheaper deal would be good for the bottom line, Gaylord decided to give Eddie the mandate to make a deal with Green Beauty. Eddie’s Deal with Green Beauty Little did the company know that Eddie had made a secret deal with Green Beauty whereby it would pay Eddie 12% of all revenue generated by the contract with C&L. This money was to be deposited into Hong Kong bank accounts controlled by Quiling and Eddie. Taking into account the kickback, the total price Green Beauty charged for waste disposal was still more than 20% below the market price. Such a low price was only possible because Green Beauty dumped the chemical waste directly into the environment, causing serious environmental damage in the process.
December 2007: A Month of Setbacks Eddie and Quiling Resign and Join a Competitor On 17 December 2007, C&L received the first in what would be two serious setbacks. In the afternoon of that day, Gaylord received the immediate resignations of Eddie and Quiling. Their contracts called for one month’s notice, but both had been carrying over their leave from previous years and had over 20 days’ leave left, which was enough to cover the remaining working days. Neither Eddie’s nor Quiling’s employment contract contained a non-competitiveness clause; the only employment contract Eddie had ever signed was the one he signed when he joined the firm as a trainee. A day after their resignation, Eddie heard that both had started work at a competing paper company. Persistent rumours emerged that Eddie was one of the major partners of that company and that he was pursuing C&L’s customers on their behalf. Gaylord also realised that, besides being colleagues, Eddie and Quiling were in fact lovers. Green Beauty and C&L’s Waste Management On 19 December 2007, word reached Gaoyan that Green Beauty, the firm managing C&L’s waste disposal, was under investigation by the environmental authority on the mainland. Moreover, his sources told him that C&L, as one of Green Beauty’s largest customers, was also being investigated and, if found guilty of flaunting environmental laws, could lose its production licence. Aware of the immediate threat this rumour posed to the company, Gaoyan informed Winifred, who immediately contacted her husband to give him the bad news.
Time for Change Christmas was just a few days away but Gaylord and Winifred were not in the holiday mood. They had started to suspect that Eddie’s and Quiling’s resignation several days before he got the news about Green Beauty might be connected. An analysis of what had gone wrong was called for. What steps should be taken to prevent similar problems from happening again and how could they secure C&L’s future?
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EXHIBIT 1: CONTAINERBOARD PRODUCTION PROCESS
Water & Chemicals
Recycled Paper
Paper Mill
Paper
Wood pulp
EXHIBIT 2: CHINA’S CONTAINERBOARD MARKETSHARE (2006)
Nine Dragons 21% Lee & Man Paper China Sunshine Paper Dongguan Jinzhou 12% Shanghai Cheng Long
59% 1%
Guangzhou Wan Li Da
2% 2%
Small Mills incl. Choi & Leng Paper
3%
Source: Yeung, P. (2007) “Industry Focus: Containerboard”, DBS Vickers Securities.
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EXHIBIT 3: RAW MATERIAL NEEDS AT CHOI & LENG PAPER
Recycled paper pulp Wood pulp Chemicals Others
EXHIBIT 4: CHOI & LENG PAPER REPORTING LINES
Gaylord Choi Chairman
Winifred Leng Vice-Chairman
(holds 47% of shares)
(holds 47% of shares)
John Ma Partner (holds 4% of shares)
Yan Gaoyan General Manager
Eddie Tse Purchasing Director (holds 2% of shares)
Anthony Leng Financial Controller
Xiang Quiling Accountant
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