Business case study: HIDALGO CONSOLIDATED INDUSTRIES

HIDALGO CONSOLIDATED INDUSTRIES

 

Hidalgo Consolidated Industries (HCI) is a multinational conglomerate corporation whose shares are widely held and listed on most of the world’s largest stock exchanges including the New York Stock Exchange. HCI’s business spans many industries including agriculture, entertainment, finance and mining. HCI’s long-time CEO retired in Summer 2017 and a new CEO, Michael Richter, was appointed from outside the company near the end of September 2017. Richter was seen as a star in the business world. In his previous position as CEO of a large, national insurance company, Richter was able to increase profits by double digits in three consecutive years.

 

HCI’s year end is September 30th and was also the date the long-time, retiring CEO stepped down. Thus, Richter was able to assume the CEO position of the company on October 1, 2017.

 

When hired in 2017 Michael Richter’s compensation package included US$999,900 annual salary, an incentive bonus of US$22.8 million if net income targets were met for the year ending September 30, 2018. Mr. Richter’s annual salary remained at US$999,900 in 2019 and 2020. However, Richter’s incentive bonus was decreased to US$20.3 million in 2019. An incentive bonus for 2020 of US$15.6 million is being recommended for adoption by the board of directors. Stock options and reward units were not included in the first three years of Michael Richter’s compensation package.

 

At the upcoming annual shareholders meeting in December 2020, shareholders are being asked to approve a more lucrative pay package for the CEO that will contain stock options and reward stock units (RSUs) totaling more than US$25 million. Richter’s 2021 proposed compensation package is seen as controversial with one institutional investor, a major teacher’s pension fund, and other individual HCI investors asking for a binding “say on pay” vote on the package instead of the usual advisory vote.

 

Almost immediately after assuming the CEO position at HCI, Richter began a reorganization that allowed him to bring in some of his previous colleagues from the insurance industry including the CFO and several vice-presidents. HCI’s reorganization allowed Richter to ensure these new executives were put in charge of older more established executives and managers who had a history both with HCI and within the various industries of their respective divisions’ operations.

 

Four new vice presidents (VP) were appointed in the first three months of 2018. Alex Wong was appointed VP of mining. Richard Smythe was appointed as the VP of the finance division and Chief Financial Officer (CFO). Grace Cheema was appointed VP for the agricultural division and Astrid Magnan took over as VP of the entertainment division. All four of these VPs had worked with Richter at the national insurance corporation. Additionally, Richard Smythe is married to Richter’s younger sister, Alex Wong is married to Richter’s university friend and Astrid Magnan is Richter’s older sister.

 

Michael Richter is the Chair of the Board of Directors and all four of his vice presidential (VPs) appointments are members of the nine-person HCI board. Astrid Magnan is the vice-chair of the board and serves as the corporate governance committee chairperson. Alex Wong is the chairperson of the compensation committee while Grace Cheema chairs the environmental committee. Robert Smythe is the risk management committee chairperson. Additionally, Smyth, a graduate of a prestigious University accounting program, helped choose the external board director who chairs the audit committee. This audit committee chairperson previously worked for a Big Four audit firm although he presently serves as CFO in a company not related to HCI.

 

The audited September 30, 2020 annual financial statements for HCI became public just over one month ago. In the first complete year following HCI’s reorganization (year ended September 30, 2019), profits increased by 12 percent over the previous year. The increase in net income was primarily due to cost cutting attributed to decreased labor costs in HCI’s agriculture, finance and mining segments. Additionally, mines in three developed countries with strong environmental laws and regulations were closed and new mines were opened in less developed countries with more lenient legal and regulatory regimes. Finally, the entertainment division sold assets including two film studios.

 

In the second year (September 30, 2020) following HCI’s reorganization, net income increased by 10 percent over the 2019 number. This was due to two factors. Part of the 2020 increase in net income came from the agricultural division making additional cuts in costs and to actions taken by the mining division. HCI’s corporate farming operations were required by head office to use a lower cost, less environmentally friendly fertilizer and farming operations switched from hiring full-time, salaried farm employees paid benefits to hiring more part-time, migrant workers who were paid hourly rates and no benefits. Electric and hybrid vehicles, purchased under the preceding HCI CEO’s tenure for use in the mining division, were sold for a profit and replaced with lower cost, used diesel vehicles in several developing countries. In the notes to the 2020 financial statements the change in hiring of employees was not mentioned and it was unclear where the gains from selling the electric and hybrid vehicles were included in the income statement.

 

Robert Smythe is well connected in the elite international business community and as a result has brought in substantial new loan business in the past two years. Shortly after being named VP Finance Division in 2018, Smythe made substantial loans to three high-profile individuals. All three are international real estate developers with connections to Eastern Europe, Asia and the Middle East.

 

The HCI loans made in 2018 total close to US$2 billion and are almost evenly split between the three individual real estate developers. Following a whistleblower complaint, the SEC recently opened an investigation into these three individuals and their HCI loans. Specifically, the SEC is examining whether potential money laundering charges should be filed. Money, processed through two Eastern European banks with links to criminal organizations, was traced to deposits made to the three HCI borrowers’ personal bank accounts. These deposits were used to meet required payments on the HCI loans in 2018, 2019 and 2020.

 

When confronted by reporters about this situation, HCI’s CEO Michael Richter indicated he knew nothing about the finance division’s loans and did not know the three individual borrowers. Reporters have subsequently published articles describing evidence contrary to Richter’s statement. The published articles also contained photos showing Richter and two of the three HCI borrowers at various social and HCI events.

 

At the December 2019 annual shareholders meeting, shareholders asked whether the audit committee was assuming responsibility for reporting on the assessment and management of risks in HCI. As chair of the risk management committee, Robert Smythe assured investors that his committee discussed potential risks with the audit committee. The audit committee chair nodded in agreement at that meeting. It is anticipated that the same question will be asked again at the upcoming December 2020 shareholders’ meeting due to several business articles that have appeared during the past year indicating that audit committees have an important role in risk management reporting. In the US the SEC has updated its responsibilities for audit committees and has emphasized the need for audit committees to report on risk management.

 

 

In December 2017, the common share price for HCI was US$147. This compares to the December 2018 share price of US$117, December 2019 share price of US$106.40 and today’s share price of US$73.20. There are rumors that recently Michael Richter and the four VPs he hired have been quietly buying up HCI shares as the share price has decreased. Also, Richter has been reported as making a case to the board of directors for taking HCI private. To take the company private, a share price offer to existing shareholders will necessarily need to be above the market price.

 

REQUIREMENTS FOR COMPLETION OF THE CASE:

 

  1. Identify five theories or concepts studied in this course that you think are related to issues or problems within HCI as described in the case. Define your chosen five theories or concepts in your own words.
  2. Which of the identified theories or concepts do you think are the three most important with respect to the issues or problems within HCI? Rank order these theories or concepts from most important (#1) to less important (#3).
  3. How do the three theories or concepts explain specific HCI’s issues or problems? In your answer you must: a) Provide specific issues or problems described in the case that are explained by each theory or concept and b) Explain why these specific issues / problems are the most important in terms of HCI and your rank ordered, associated theories or concepts. Ensure that your explanation is consistent with your ranking of the theories and concepts. Your explanation must rely on the facts and context of the case information.

 

NOTE: Your answer must not exceed a total of 750 words for the entire case.

If you quote or paraphrase something from a particular source, the source should be cited and referenced. (Since all of this answer should be in your own words, you should have very few and maybe no citations or references.) However, failure to recognize a direct quote or paraphrase of someone else’s original ideas with the required source is plagiarism and will be a violation of the academic honesty policies of Simon Fraser University.

 

YOU MUST SUBMIT YOUR FINAL EXAM TO CANVAS NO LATER THAN 3:30 PM (PACIFIC TIME ZONE) ON APRIL 21, 2021.

 

RULES FOR SUBMITTING YOUR EXAM:

 

  1. You are not to upload this case or any part of the case including the instructions to Canvas.

Please only submit your answers via Canvas.

  1. PLEASE do not share your answers with others. Identical answers will be greatly penalized.