Question 1 Ferreyros was founded in 1922 by four friends. The company's principal activities are: the import and sale or rental of machinery and equipment and product support through the sale of spare parts and the provision of workshop services. In 1942, Ferreyros incorporated the distribution of Caterpillar machinery and equipment into its business portfolio, and today this is far and away its core business, representing 88% of sales in 2005. Several other well- known product brands are also in its portfolio. Ferreyros as of December 2005 had approximately 1,200 employees and 700 shareholders. To date, the 5 Peruvian pension investment funds (AFPs) hold more than 40% of the company's shares. The following is the list of shareholders having more than 5% of the shares, which includes 4 of the pension funds: n Integra - FONDO 2 - 11.40%; n Nueva Vida - FONDO 2 - 10.03%; n La Positiva Vida Seguros y Reaseguros S.A. - 9.63%; n Horizonte - FONDO 2 - 9.17%; n Horseshoe Bay Limited - 6.46%; and n Profuturo - FONDO 2 - 6.00%. As of the end of 2005, there were only six investors with more than a 5% stake. All other investors hold less than 5% with 43.7% of shares as free float. The company's shares are included in the Lima Stock Exchange Index. Ferreyros's market capitalization reached US$ 191 million by the end of July 2006, representing an increase of 62% as compared to US$ 118 million as of the end of 2005. The year-end market capitalization figure for 2004 was similar to that of 2005. Ferreyros's annual turnover is more than US$ 300 million. Company Overview and Strategy Ferreyros's pattern of ownership and control has experienced significant evolution. The number of shareholders and the structure of their holdings have changed over time. The first generation of founding partners passed on their ownership to a second generation, where not everyone was interested in participating in the business. At this later stage in the company's development, its controlling shareholders determined that Ferreyros should: i) turn over company management to new professional managers; ii) register its shares at the Lima Stock Exchange (BVL) to attract and facilitate the transfer of Ferreyros's stakes to new owners; and iii) institute corporate governance improvements to attract investment and improve the company's controls and performance. That is how and why Ferreyros initially entered the BVL in 1971 and eventually turned into a company with a wide and diverse base of shareholders. In the early 1990s, the company determined that in order to sustain its growth, its participation in the Peruvian capital market should not be limited to the issuance of shares, but would also include the sale of bonds. Thus, in 1994, its first bond issue of US$ 5 million was authorized. Since then, there have been 4 bond issues (1994, 1996, 1999 and 2002). In 2001, a commercial paper program was registered. Over a period of two years, a total of 11 issuances were placed for US$ 49 million. In 2004, another bond program was registered, under which 5 issuances were placed for US$ 50 million. Every time Ferreyros issued these instruments in Peru, it was rewarded with an over-subscribed demand, sometimes amounting to as much as 3 times the amount issued. In March 2006, at the Annual General Meeting, shareholders approved the registration of a mixed bond and commercial paper program of up to US$ 90 million. Corporate Governance In order to include a diversity of experiences and to encourage a diversity of opinions, the company's by-laws provide that the Board of Directors must be made up of 8 to 12 members. Currently, the Board is composed of 8 directors, each with different professional expertise, thus contributing to better decision- making on behalf of the company. For many years, the company had two independent directors. In the 2005 election for the Board of Directors, three independent directors, selected by the pension fund managers, joined the company. Today, there are four independent directors. Also, since 2005, the number of Board committees increased from 1 to 3, namely: the Committee of General Management and Corporate Governance; the Audit Committee; and the Organizational Development and Human Resource Committee. Each committee is composed of 5 directors, one or two of whom are independent. Their sessions are held quarterly or semi-annually. The Board of Directors holds monthly sessions, which are carefully minuted. Board sessions in the last few years had more than 80% attendance. The remuneration of the Board of Directors is determined based on the results obtained by the company. The by-laws stipulate that the Board of Directors is entitled to 6% of freely available profits. There is no other form of remuneration whatsoever for Board members. Board member remuneration and executive compensation as a whole is disclosed in the annual report as a percentage of the company's total income. Approximately 25% of executive compensation is determined based on the company's results. The company has clearly defined all functions of the Board of Directors, the Chairman and management. The Board of Directors is considered by the management as an entity that adds great value and is responsible for approving xuan Koo the company's strategy. The Board of Directors oversees thi . ** the management's performance and prepares a report to the shareholders on such performance, a copy of which is included in the company's annual report. The Chairman of the Board must be someone other than the Chief Executive Officer. Senior managers are selected by the CEO. The market is kept informed about important matters in a timely fashion though the publication of Hechos de Importancia (material events disclosure). Finally, from an organizational point of view, the Corporate Governance Committee is responsible for design and oversight of governance programs in Ferreyros. To ensure information quality and transparency, an internal audit department is in place and reports to the Board. Financial statements are audited by an audit firm selected by and accountable to the Board, pursuant to powers granted by the Annual General Meeting. To this effect, a contract policy was adopted providing the possibility of annual contract renewals and the extension of renewal terms up to 5 years requiring a more thorough assessment of the level of service satisfaction and, in any case, requiring an audit partner and/or staff rotation. As good corporate governance recommends, the company refrains from hiring the external audit firm to perform services other than the audit of financial statements. Legal and tax consultancy services are provided by other unrelated firms. The company has adopted an Internal Code of Conduct to ensure compliance with obligations resulting from the registration of securities with the Public Registry of the Securities Market. These rules reflect the company's policy of openness and best disclosure practices. The Code lays down internal procedures that allow the company's stock market representative to disclose material facts to the market within the required time. This same Code establishes the company's stock trading policy, spelling out obligations and procedures for directors, officers, employees and advisors who deal with privileged information. The company's Code clearly prohibits the misuse or unauthorized disclosure of inside information and penalizes insider trading on that basis. The company notifies the market of material events one day after they have occurred, issues quarterly financial statements and yearly audited financial statements. Ferreyros began publishing its quarterly releases with company financial results many years before any laws required such disclosure and before corporate governance voluntary principles were adopted in Peru. Since 2004, Ferreyros includes a statement on the degree of compliance with corporate governance principles in every annual report. Ferreyros posts its annual report on web pages accessible to the public. The company's ownership structure is also disclosed, listing those shareholders that hold more than 5% on its website, as well as on the website of Peru's Comisin Nacional Supervisora de Empresas y Valores (CONASEVthe Peruvian securities market regulator). Any change in these holdings is reported immediately. The number of shareholders having a specific range of shares (over 5%, between 1 and 5%, less than 1%) is also reported in the annual report. No bloc agreements among shareholders exist. Privately, the company participates in meetings with institutional investors organized by investment banks, delivers a yearly presentation to Peruvian pension fund managers (the country's most important institutional investors) and holds individual meetings with institutional investors at their request or when placements are to be made. In 1997, the company's shareholders approved the dividend policy, which is observed every year when shareholders approve the profit sharing for the financial year. The dividend policy states that cash dividends will amount to 5% of the capital or a ceiling equal to 50% of freely available profits. The remainder will be capitalized and distributed as stock dividend. With regard to minority shareholders, the company will put all its efforts to notify them of any receivables in the form of cash and stock dividends. Since 2001, Ferreyros has taken on a corporate governance leadership role to advance better corporate governance practices in the country as a whole. It has done so through its active participation in Procapitalesan association that promotes corporate governance and has participated in the elaboration of the Corporate Governance Principles for Peruvian Companies, led by CONASEV. The public and the business community recognize Ferreyros's success in implementing good governance. The company's executives receive invitations to talk about their case in at least two seminars every year. Most recently, Ferreyros received the title of Best Treatment of Shareholders from Procapitales and Universidad Peruana de Ciencias Aplicadas in May 2006. The next steps to further improve governance at Ferreyros are to launch a program for evaluating the Board and CEO. Results Ferreyros's successful issuances on the Peruvian capital markets and the historically high demand for the company's shares are largely attributable to the corporate strategy of combining efficient succession plans with adoption of a business model based on professional management and the highest regard for corporate governance principles. For Ferreyros, this meant making the necessary changes to: | Uphold shareholders' rights; n Ensure equal treatment for all shareholders; n Provide unfettered access to information; Guarantee information transparency, quality and timely disclosure; and n Establish an efficient and professionally-skilled Board of Directors. In accordance with Peruvian accounting standards, net sales for the first semester of 2006 were US$ 221 million, up 43.6% from the same period last year. Net income jumped from US$ 3.1 million in 6 month period of 2005 to US$ 14.5 million this year, a whopping 376% jump from the same period last year. EBITDA in the first semester of 2006 was US$ 30 million, compared to US$ 15.4 million in the same period last year. This is a 96% increase over one year.'Other financial figures include: Net operating revenues: 2004 Nuevos Soles 929 million / US$ 282 million; 2005 Nuevos Soles 1,115 million / US $338 million; I Net costs and expenses: 2004 Nuevos Soles 169.8 million / US$ 51.5 million; 2005 - Nuevos Soles 168.6 million / US$ 51 million. Throughout its 84 years of existence, Ferreyros has witnessed and taken part in many economic crises in Perua common situation in the entire region. And more than once, it has seen competitors and clients leave the market. Ferreyros's foundation of good governance-based on the access to capital sources, clearly defined strategies and values, and professional management capable of responding to changing environmenthas allowed it to survive periods of economic turmoil and always get back on the track of growth. Recent history shows how Ferreyros considerably recovered after the 1998-2001 economic crisis in Peru. After its sales fell to a little over US$ 200 mil- Ferreyros share market price 4.00 3.50 3.00 2.50 Date 2.00 1.50 1.00 0.50 0.00 Julio Abril Abril Julio Octubre Abril Abril July-06 2005 Enero Julio Octubre Octubre Octubre 2004 Enero 2003 Enero 2006 Enero Soles per share lion, net sales closed in 2005 at the level of US$ 330 million. The price of shares has shown a very favorable evolution as indicated in the chart below. To conclude, Ferreyros considers corporate governance to be a process, a journey, rather than a final destination. For this reason, even though it is aware of the significant progress it has made, as well as of its perceived status as a forerunner, it is still committed to the ongoing implementation of best practices. 1. Describe the scenario of the case related to "Corporate Governance and Shareholder Wealth. Question 1 Ferreyros was founded in 1922 by four friends. The company's principal activities are: the import and sale or rental of machinery and equipment and product support through the sale of spare parts and the provision of workshop services. In 1942, Ferreyros incorporated the distribution of Caterpillar machinery and equipment into its business portfolio, and today this is far and away its core business, representing 88% of sales in 2005. Several other well- known product brands are also in its portfolio. Ferreyros as of December 2005 had approximately 1,200 employees and 700 shareholders. To date, the 5 Peruvian pension investment funds (AFPs) hold more than 40% of the company's shares. The following is the list of shareholders having more than 5% of the shares, which includes 4 of the pension funds: n Integra - FONDO 2 - 11.40%; n Nueva Vida - FONDO 2 - 10.03%; n La Positiva Vida Seguros y Reaseguros S.A. - 9.63%; n Horizonte - FONDO 2 - 9.17%; n Horseshoe Bay Limited - 6.46%; and n Profuturo - FONDO 2 - 6.00%. As of the end of 2005, there were only six investors with more than a 5% stake. All other investors hold less than 5% with 43.7% of shares as free float. The company's shares are included in the Lima Stock Exchange Index. Ferreyros's market capitalization reached US$ 191 million by the end of July 2006, representing an increase of 62% as compared to US$ 118 million as of the end of 2005. The year-end market capitalization figure for 2004 was similar to that of 2005. Ferreyros's annual turnover is more than US$ 300 million. Company Overview and Strategy Ferreyros's pattern of ownership and control has experienced significant evolution. The number of shareholders and the structure of their holdings have changed over time. The first generation of founding partners passed on their ownership to a second generation, where not everyone was interested in participating in the business. At this later stage in the company's development, its controlling shareholders determined that Ferreyros should: i) turn over company management to new professional managers; ii) register its shares at the Lima Stock Exchange (BVL) to attract and facilitate the transfer of Ferreyros's stakes to new owners; and iii) institute corporate governance improvements to attract investment and improve the company's controls and performance. That is how and why Ferreyros initially entered the BVL in 1971 and eventually turned into a company with a wide and diverse base of shareholders. In the early 1990s, the company determined that in order to sustain its growth, its participation in the Peruvian capital market should not be limited to the issuance of shares, but would also include the sale of bonds. Thus, in 1994, its first bond issue of US$ 5 million was authorized. Since then, there have been 4 bond issues (1994, 1996, 1999 and 2002). In 2001, a commercial paper program was registered. Over a period of two years, a total of 11 issuances were placed for US$ 49 million. In 2004, another bond program was registered, under which 5 issuances were placed for US$ 50 million. Every time Ferreyros issued these instruments in Peru, it was rewarded with an over-subscribed demand, sometimes amounting to as much as 3 times the amount issued. In March 2006, at the Annual General Meeting, shareholders approved the registration of a mixed bond and commercial paper program of up to US$ 90 million. Corporate Governance In order to include a diversity of experiences and to encourage a diversity of opinions, the company's by-laws provide that the Board of Directors must be made up of 8 to 12 members. Currently, the Board is composed of 8 directors, each with different professional expertise, thus contributing to better decision- making on behalf of the company. For many years, the company had two independent directors. In the 2005 election for the Board of Directors, three independent directors, selected by the pension fund managers, joined the company. Today, there are four independent directors. Also, since 2005, the number of Board committees increased from 1 to 3, namely: the Committee of General Management and Corporate Governance; the Audit Committee; and the Organizational Development and Human Resource Committee. Each committee is composed of 5 directors, one or two of whom are independent. Their sessions are held quarterly or semi-annually. The Board of Directors holds monthly sessions, which are carefully minuted. Board sessions in the last few years had more than 80% attendance. The remuneration of the Board of Directors is determined based on the results obtained by the company. The by-laws stipulate that the Board of Directors is entitled to 6% of freely available profits. There is no other form of remuneration whatsoever for Board members. Board member remuneration and executive compensation as a whole is disclosed in the annual report as a percentage of the company's total income. Approximately 25% of executive compensation is determined based on the company's results. The company has clearly defined all functions of the Board of Directors, the Chairman and management. The Board of Directors is considered by the management as an entity that adds great value and is responsible for approving xuan Koo the company's strategy. The Board of Directors oversees thi . ** the management's performance and prepares a report to the shareholders on such performance, a copy of which is included in the company's annual report. The Chairman of the Board must be someone other than the Chief Executive Officer. Senior managers are selected by the CEO. The market is kept informed about important matters in a timely fashion though the publication of Hechos de Importancia (material events disclosure). Finally, from an organizational point of view, the Corporate Governance Committee is responsible for design and oversight of governance programs in Ferreyros. To ensure information quality and transparency, an internal audit department is in place and reports to the Board. Financial statements are audited by an audit firm selected by and accountable to the Board, pursuant to powers granted by the Annual General Meeting. To this effect, a contract policy was adopted providing the possibility of annual contract renewals and the extension of renewal terms up to 5 years requiring a more thorough assessment of the level of service satisfaction and, in any case, requiring an audit partner and/or staff rotation. As good corporate governance recommends, the company refrains from hiring the external audit firm to perform services other than the audit of financial statements. Legal and tax consultancy services are provided by other unrelated firms. The company has adopted an Internal Code of Conduct to ensure compliance with obligations resulting from the registration of securities with the Public Registry of the Securities Market. These rules reflect the company's policy of openness and best disclosure practices. The Code lays down internal procedures that allow the company's stock market representative to disclose material facts to the market within the required time. This same Code establishes the company's stock trading policy, spelling out obligations and procedures for directors, officers, employees and advisors who deal with privileged information. The company's Code clearly prohibits the misuse or unauthorized disclosure of inside information and penalizes insider trading on that basis. The company notifies the market of material events one day after they have occurred, issues quarterly financial statements and yearly audited financial statements. Ferreyros began publishing its quarterly releases with company financial results many years before any laws required such disclosure and before corporate governance voluntary principles were adopted in Peru. Since 2004, Ferreyros includes a statement on the degree of compliance with corporate governance principles in every annual report. Ferreyros posts its annual report on web pages accessible to the public. The company's ownership structure is also disclosed, listing those shareholders that hold more than 5% on its website, as well as on the website of Peru's Comisin Nacional Supervisora de Empresas y Valores (CONASEVthe Peruvian securities market regulator). Any change in these holdings is reported immediately. The number of shareholders having a specific range of shares (over 5%, between 1 and 5%, less than 1%) is also reported in the annual report. No bloc agreements among shareholders exist. Privately, the company participates in meetings with institutional investors organized by investment banks, delivers a yearly presentation to Peruvian pension fund managers (the country's most important institutional investors) and holds individual meetings with institutional investors at their request or when placements are to be made. In 1997, the company's shareholders approved the dividend policy, which is observed every year when shareholders approve the profit sharing for the financial year. The dividend policy states that cash dividends will amount to 5% of the capital or a ceiling equal to 50% of freely available profits. The remainder will be capitalized and distributed as stock dividend. With regard to minority shareholders, the company will put all its efforts to notify them of any receivables in the form of cash and stock dividends. Since 2001, Ferreyros has taken on a corporate governance leadership role to advance better corporate governance practices in the country as a whole. It has done so through its active participation in Procapitalesan association that promotes corporate governance and has participated in the elaboration of the Corporate Governance Principles for Peruvian Companies, led by CONASEV. The public and the business community recognize Ferreyros's success in implementing good governance. The company's executives receive invitations to talk about their case in at least two seminars every year. Most recently, Ferreyros received the title of Best Treatment of Shareholders from Procapitales and Universidad Peruana de Ciencias Aplicadas in May 2006. The next steps to further improve governance at Ferreyros are to launch a program for evaluating the Board and CEO. Results Ferreyros's successful issuances on the Peruvian capital markets and the historically high demand for the company's shares are largely attributable to the corporate strategy of combining efficient succession plans with adoption of a business model based on professional management and the highest regard for corporate governance principles. For Ferreyros, this meant making the necessary changes to: | Uphold shareholders' rights; n Ensure equal treatment for all shareholders; n Provide unfettered access to information; Guarantee information transparency, quality and timely disclosure; and n Establish an efficient and professionally-skilled Board of Directors. In accordance with Peruvian accounting standards, net sales for the first semester of 2006 were US$ 221 million, up 43.6% from the same period last year. Net income jumped from US$ 3.1 million in 6 month period of 2005 to US$ 14.5 million this year, a whopping 376% jump from the same period last year. EBITDA in the first semester of 2006 was US$ 30 million, compared to US$ 15.4 million in the same period last year. This is a 96% increase over one year.'Other financial figures include: Net operating revenues: 2004 Nuevos Soles 929 million / US$ 282 million; 2005 Nuevos Soles 1,115 million / US $338 million; I Net costs and expenses: 2004 Nuevos Soles 169.8 million / US$ 51.5 million; 2005 - Nuevos Soles 168.6 million / US$ 51 million. Throughout its 84 years of existence, Ferreyros has witnessed and taken part in many economic crises in Perua common situation in the entire region. And more than once, it has seen competitors and clients leave the market. Ferreyros's foundation of good governance-based on the access to capital sources, clearly defined strategies and values, and professional management capable of responding to changing environmenthas allowed it to survive periods of economic turmoil and always get back on the track of growth. Recent history shows how Ferreyros considerably recovered after the 1998-2001 economic crisis in Peru. After its sales fell to a little over US$ 200 mil- Ferreyros share market price 4.00 3.50 3.00 2.50 Date 2.00 1.50 1.00 0.50 0.00 Julio Abril Abril Julio Octubre Abril Abril July-06 2005 Enero Julio Octubre Octubre Octubre 2004 Enero 2003 Enero 2006 Enero Soles per share lion, net sales closed in 2005 at the level of US$ 330 million. The price of shares has shown a very favorable evolution as indicated in the chart below. To conclude, Ferreyros considers corporate governance to be a process, a journey, rather than a final destination. For this reason, even though it is aware of the significant progress it has made, as well as of its perceived status as a forerunner, it is still committed to the ongoing implementation of best practices. 1. Describe the scenario of the case related to "Corporate Governance and Shareholder Wealth