BA301 Finance Report: Stock Selection and Corporate Governance

This report, prepared for an Introduction to Finance course, delves into the critical aspects of stock selection and corporate governance. It analyzes the financial performance and corporate governance structures of two Australian companies, BHP and Wesfarmers. The report investigates the relationship between corporate governance practices and investment returns, emphasizing the significance of strong governance for company performance. Stock valuation is performed using the Gordon growth model to assess the relative value of the stocks, and the analysis also includes the dividend discount model. The report compares executive compensation with financial performance, and offers recommendations on stock selection and valuation methodologies. The research utilizes secondary data, including annual reports and academic journals, to support its findings and conclusions. The report aims to provide insights into making informed investment decisions and understanding the dynamics of financial management.

Running head: INTRODUCTION TO FINANCE
Introduction to finance
Name of the student
Name of the university
Student ID
Author note

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INTRODUCTION TO FINANCE
Executive Summary
Many authors have highlighted the importance of the study of finance in their respective
journal. Concerning about the financial study it is also important to know how the financial
management work. It helps to understand the project viability, stock valuation, firm valuation the
key analysis of financial ratios. The paper is all about the understanding of finance in terms of
stock selection to invest. It researches the annual report of BHP and Wesfarmers and articulates
that to select the proper stock, clarity in corporate governance is very important. It has a positive
impact on the company performance. To choose the correct stock to invest this report takes
“Gordon growth model” and after evaluating the stock by the growth model, research suggests
that both the stock value is overpriced. It has been detected that there is a proportionate
relationship between executive remuneration and company’s financial performance. The paper
also concludes which stock is better to invest and which model has to adopt to do the valuation
of stock.

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Table of Contents
Introduction......................................................................................................................................4
Literature review..............................................................................................................................5
Methodology....................................................................................................................................6
Corporate governance......................................................................................................................6
1. Corporate governance structure of BHP and Wesfarmers.......................................................6
BHP..................................................................................................................................................6
Wesfarmers......................................................................................................................................9
Responsibility of the Board.............................................................................................................9
Functions of Board........................................................................................................................10
Independent Directors....................................................................................................................10
The pragmatic relation between corporate governance and firms performance............................12
CEO- Leadership...........................................................................................................................12
Capital Budgeting..........................................................................................................................12
Compensation................................................................................................................................13
Communication..............................................................................................................................13
Competition...................................................................................................................................13
Analysis.........................................................................................................................................13

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2. Comparison between compensation and company performance...........................................14
3. Share valuation.......................................................................................................................15
Constant growth valuation model..................................................................................................15
BHP’s stock valuation under constant growth model....................................................................16
Wesfarmers’s stock valuation under constant growth model........................................................16
Zero growth valuation model.........................................................................................................16
BHP’s stock valuation under zero growth model..........................................................................17
Wesfarmers’s stock valuation under zero growth model..............................................................17
Variable Growth Valuation Model................................................................................................17
BHP vs. Wesfarmers- stocks comparison......................................................................................20
Popular stock valuation model.......................................................................................................22
Dividend discount model (DDM)..................................................................................................22
Discounted cash flow model..........................................................................................................23
Recommendations..........................................................................................................................23
Conclusion.....................................................................................................................................23
Reference.......................................................................................................................................24

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Introduction
In the recent global competitive world, the business entity always intends to expand their
project. They need to produce at a large scale to meet the global demand as a result the company
needs to invest more. One of the most popular ways to raise money to invest is from public
through the issue of shares. The interest of the investors is always look upon the performance of
the stock, return of the stock, growth of the stock so all these depends on how well the company
perform (Revelli and Viviani 2015) The performance of the company will depend on some key
factors like company’s management, service, financial performance, corporate governance
structure. This report is critically analyze two Australian based mining company BHP and
Australian conglomerate Wesfarmers suggest which types of corporate governance should adopt
by them and for strong corporate governance and weak corporate governance what will be the
impact of the returns of investment. This report also highlights valuation techniques of the stock.
To select the right stock to invest an individual should always calculate the trend of the stock.
Therefore, valuation of the stock is necessary in the case of investment. The study researches all
the financial data of the selected two companies in terms of calculate the stock and therefore
suggests which company’s stock will best for investment. Analysis of financial ratio is also
included in this report to suggest the significance and interpretation of those particular ratios in
the selected company. The aim of this report is to provide legitimate research on stock selection
to invest. To make the healthy investment this study analyses various key financial and non-
financials path like corporate governance, this report asks about any correlation between good
corporate governance practice and impact of this on the return on investment. The report also
recommends how to evaluate the stock on depending on the Gordon Growth Model. Introduction
to finance may require acknowledging the financial management sometime (Ruppert 2014), so it

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is very essential that financial decisions look after the shareholders interest. After going through
the study, it was noted that there is some limitations such as dependency on the historical cost,
specific period based; there is some effects on inflation (Velte and Stawinoga 2017).
By doing the research of this financial study, report faced some issues these are:
 The financial statement is prepared on a certain time gap. It usually prepared on a
quarterly basis or half-yearly basis so to extract the accurate financial data is very hard to
get while analyze the stock.
 Ad- hoc transaction usually included in the financial statements, though it will not repeat
in the future.
 It has been observed that in the financial report, closing balances may not match the
economic reality.
Literature review
According to the Ruppert (2014), much of finance is concerned to measure and manage the
financial risk. The return of an investment is its earning revenue as a fraction of the initial
investment. In case of all investments, future returns are cannot be evaluated exactly. Thus, it is a
random variable.
According to the Davies (2016), corporate governance is a strategic approach. Examines
the corporate governance from a philosophical and big picture standpoint. Here the authors
explore a number of key themes.

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Methodology
This research takes all the secondary data of the selected companies. To calculate the
stock valuation this study critically analyzes the company’s annual report and several journal. To
proof the theory of positive relativity of remuneration and the company’s performance this study
has adopted some theoretical part of hypothesis. To calculate the stock price, theory of “Gordon
model” has been implemented.
Corporate governance
Corporate governance is a business practice, which follows certain rules, regulations and
principles by which the organization is regulated. It involves the interest of the shareholders.
Since the corporate governance draws, a framework to achieve the organization’s goal it follows
the management’s actions plan and internal controls of measurement (Tricker and Tricker 2015).
1. Corporate governance structure of BHP and Wesfarmers
BHP
BHP’s governance philosophy, believes extraordinary core value, which creates a long-term
worth creation. Put the good governance in good business, is the primary mechanism is to adopt
the best governance standards in Australia. As per the company’s report good governance is also
the responsibility of the management executives and it is embedded within the group. By
practicing the good governance, the group’s board and management are guided by the company’s
charter values (bhp.com, 2020).
Such corporate governance rules the entity how they deal with their business on a regular
basis, expand them to perform very productively and leading in a very sustainable growth

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strategy. By adopting the corporate governance, management play a vital role in risk inaccuracy,
engagement of public policy and the commitment to the environment and sustainability.
Practicing good governance in the entity, BHP’s Executives superintends the Principal Executive
professional and senior management and assures that suitable procedures and controls are in
place casing management activities in working the company on the basis business principles
(McAlister and Ferrell 2016).
Among the corporate governance of the company, some examples are highlighted below:
The framework of BHP’s governance describes the interaction between their shareholders
and the board and CEO as well. It also depicts the flow of delegation of the stockholders.
Concerning about the major investors in the company first 4 shareholders out of top 10
shareholders are as follows
Shareholder Stake holding No of fully paid shares
HSBC Custody Nominees
(Australia) Limited
24.46% 785,602,425
J P Morgan Nominees Australia
Limited
16.86% 541,596,753
Citicorp Nominees Pty Ltd 5.01% 160,994,616
Citicorp Nominees Pty Limited
<Citibank NY ADR DEP A/C>
4.60% 147,717,926

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The above table shows, major shareholders in BHP, among this HSBC is holding largest part of
the company as 24.46 percent stake, but not control the entity. The controlling power still lays in
hand of BHP.
This study also refers name of the board of directors and the executive management team are
mentioned below:
Board of Directors
Ken MacKenzie Chairman and independent non-executive director
Andrew Mackenzie Non independent director
Terry Bowen Independent Non-executive Director
Malcolm Broomhead Independent Non-executive Director
Ian Cockerill Independent Non-executive Director
Anita Frew Independent Non-executive Director
Carolyn Hewson Independent Non-executive Director
Susan Kilsby Independent Non-executive Director
Lindsay Maxsted Independent Non-executive Director
John Mogford Independent Non-executive Director
Shriti Vadera Senior Independent Director, BHP Group Plc
Caroline Cox Group General Counsel & Company Secretary and
Chairman of the Disclosure Committee
Executive Leadership Team
Andrew Mackenzie Chief Executive Officer
Peter Beaven Chief Financial Officer
Geoff Healy Chief External Affairs Officer
Mike Henry President Operations, Minerals Australia

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Diane Jurgens Chief Technology Officer
Daniel Malchuk President Operations, Minerals Americas
Vandita Pant Chief Commercial Officer
Jonathan Price Chief Transformation Officer
Geraldine Slattery President Operations, Petroleum
Laura Tyler Chief Geoscientist
Athalie Williams Chief People Officer
The directors and the executives are very well structured and they are operating a good corporate
governance within the company.
Wesfarmers
Wesfarmers company having it’s headquarter in Perth. The company working as a
multinational conglomerate. Wesfarmers is listed on ASX index. The company’s governance
framework monitors the Board and Management’s error of the enterprise and enclosed in its
governing documents. The board of Wesfarmers is a strong promoter of good corporate
governance. The board is committed to provide the best interest to the shareholders and ensuring
the corporate governance obligations and responsibilities (wesfarmers.com 2020).
Responsibility of the Board
The employees have conducted the business. Managers and officers are working under
the direction of chief executive officer. Following the principle of good governance practice may
help to create enduring value for the shareholders.

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INTRODUCTION TO FINANCE
Functions of Board
The group’s directors normally have six schedule meetings in a year where it focuses on the
enactment of the company, plans and prospects and the problems facing by the company
(Yarram, 2015). Following the rules and regulations of the corporate governance, the board acts
a several number of functions:
 Approving the groups purpose and values
 Ensuring the business strategy, business plans and policies.
 It regulates the company's strategic direction and portfolio of activities to create business
values.
 Assessing the business risks
 To assure the dividend policy of the company.
Independent Directors
As far, as concern about the directors all the non-management directors will be
independent. The company always wants to have minimum of seven independent directors. Only
the board will determine the independency of the directors and it is the company’s goal that two
third member of the directors will be independent. The board of directors is highly committed to
deliver a satisfactory return to its shareholders and fulfilling the corporate governance
obligations and responsibilities for the best interest of the stakeholders in every aspects.
Some of the board of directors and management executive are under mentioned:

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Board of Directors
Michael Chaney Ao Chairman
Vanessa Wallace Director
Rob Scott Managing Director
Diane Smith-Gander Ao Director
Wayne Osborn Director
Sharon Warburton Director
Tony Howarth Ao Director
Jennifer Westacott Ao Director
The Right Honourable
Bill English Knzm
Director
Mike Roche Director
There are some major shareholders in Wesfarmers, are listed below:
Shareholder Stake holing No. of fully paid shares
HSBC Custody Nominees
(Australia) Limited
22.86% 259,230,418
J P Morgan Nominees Australia
Pty Limited
14.62% 165,763,879
Citicorp Nominees Pty Limited 5.80% 65,763,144
National Nominees Limited 2.62% 29,691,368

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Above table shows some major shareholders out of top10 shareholding and it also reveals HSBC
holds maximum share of 22.86% in this company, thus the controlling power remains lied in the
company’s hand.
The pragmatic relation between corporate governance and firms performance
One of the major aims of the stockholders engagement is the promotion of “sound”
corporate governance practices. That means a relative relation between improvement of
corporate governance and shareholder returns. Now the question simply arises on a pivotal basis
whether the fundamental hypothesis movement is valid. Does a good corporate governance
actually convert into good corporate performance? Presently there have been a several number of
relative studies and most of the articles found that practicing a good governance in the
corporation actually gear up the performance. There are 5 keys on which the corporate
governance measures relatively investment on shareholders. It is called five Cs also (Ayuso et al
2014).
CEO- Leadership
A view of company’s CEO is always depending on the leadership. What the CEO think
about the policy that is matter a lot to the concern of performance (Wu 2015).
Capital Budgeting
It is also to be evaluated the capital budgeting factor to make an investment strategy.
What is the company’s NPV, PV, FV and IRR that should be a matter of concern? (Rossi 2015).

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Compensation
What is the compensation structure in the company needs to be calculated. How the
company provides monetary benefit and the economic worth to the employee in exchange of
their labor that is also be a key indicator of financial performance. Because a good compensation
make the employee productive and align interest between CEO and shareholders (Bolton,
Mehran and Shapiro 2015).
Communication
A strong communication to the investors built up a good governance structure and that
will have repeal effect on the returns of investment.
Competition
Competition in the organization continuously builds up a good productivity among the
employee.
Analysis
The report analyze the study about good governance and the investment returns, provides
such hypothesis that a strong corporate governance systems relate the interest of the
shareholders. This study also scrutinize the utilization the LLSV (1997, 1998) categorization of
the legal environments of countries as an evaluation of corporate governance system (Asongu
2015).
This paper measures a ratio of a firm’s average return on investment (r) to its cost of
capital (i). Ratio defines as qm, where qm= r/i (Khadafi, Heikal and Ummah 2014).

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INTRODUCTION TO FINANCE
The company with good corporate governance system located in country, qm > 1, in case
of weak corporate governance system it refers to the managers to pursue their own goals by the
stockholders’ expense. If there is a weak corporate governance systems, there would be less
payout in dividends and retain larger portion of their cash flows to run their own goals and they
will invest widely. Consequently the expected qms < 1. In shortly, for strong corporate
governance qms >1 and for the weak corporate governance qms <1.
In BHP, return on investment is 7.80% and the cost of capital is 7.0% so, the average return
of BHP= (.078/0.070)%= 1.11, (qm >1)
In Wesfarmer, return on investment is 19.94% whereas the cost of capital is 6.59%,then the
average return= (0.199/0.065)= 3.06, (qm >1)
This study suggests, since wesfarmers has been practicing good corporate governance and its
qm> 1, then there will be a positive investment opportunity where return will reflect positively.
2. Comparison between compensation and company performance
This research has focused based on executive’s compensation or remuneration and with the
close observation of the performance.
It has been seen, that the staffs are motivated by the chance of getting elevation to extend
their salary. In the organization, top management or executives used to get high pay scale, which
motivates the lower level executives to for promotion. This theory also suggests that individual
employee gets motivated. Since the CEOs fellow have to compensate with the extra incentives as
he or she already reached on the highest stage of the association (Haß et al 2015).

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On the other hand, there is an existence of distinctive control and ownership when CEO
operates the organization instead of the company’s shareholders. As shareholders do not have all
the relevant information regarding the business, what a managers have therefor it is completely
hard to regulate the activities that has taken by the management officials. If the remuneration is
based more on equity then the CEO will take an action of increasing the firm value.
This report says a company performance and the compensation of executives are correlated
are as follows:
Total amount of compensation and CEO’s receiving amount is positively related with the
business’s enactment.
The equity-based remuneration of CEO is directly correlated with the company’s
performance. Therefore, both the structure and level of executives’ compensation have a
substantial relationship with the company performance however there is no economic
significance in relation with the company performance (Deysel and Kruger 2015).
3. Share valuation
Constant growth valuation model
The “constant growth model” or “Gordon growth model” (Belomyttseva and Grinkevich
2016) is tools of valuing the stock. This model assumes that the company’s dividend is going to
rise continuously at a stable growth rate. Considering the formula as to calculate the stock price
of above mentioned companies are as:

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INTRODUCTION TO FINANCE
P= D/(r-g)
Where, P is the current market price; D is the next dividend that the company is going to
pay; r is the required rate of return and g is expected growth rate of the company (Shi, Zhang and
Sheng 2017).
BHP’s stock valuation under constant growth model
P = D ÷ (r-g)
P = 2/ (0.15- 0.12) = $66.67
The company annual report reveals that,
$2.35 is expected dividend for the next financial year
15.94% is required rate of return
12.61% is growth rate in dividend
Wesfarmers’s stock valuation under constant growth model
P = D ÷ (r-g)
P = 2.78/ (0.19-0.15) = $69.50
Here, as per the company’s annual report, 2.78 is expected dividend per share in next quarter
Zero growth valuation model
It is an approach of calculation of dividend, which may assume a constant factor of
dividend or non-growing dividend (Penman 2015).

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BHP’s stock valuation under zero growth model
P = D/r
Where, P is Present value of the stock, D is indicating the annual dividend and r is
required rate of return.
PV of the stock = $2.35/ 0.1594 = $14.74
Wesfarmers’s stock valuation under zero growth model
P = D/r
PV of the stock = $2.78/0.19 = $14.63
Variable Growth Valuation Model
Under the dividend valuation approach, this model suggests changes in dividend growth
rate (Budagaga 2017). For example, g1 = initial growth and g2 = next changes in growth rate at
the end of the year N, then the share value will be determined adopting by following steps:
BHP:
Current dividend (D0)= $2.35
Required return= 15.94%
Growth rate= 12.61%

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INTRODUCTION TO FINANCE
Step1
Evaluate the cash dividend value at the end of the year (D),
D1 = 2.35 × 1= $2.35
D2 = 2.35 × (1+0.12) = $2.63
Step2
Now calculate the present value of the dividends at the initial growth stage,
t Dt $
PVIF
15% t
PV of
Dividends
1 2.35 0.8696 2.04356
2 2.63 0.7561 1.98854
Total PV of dividends 4.03210
[PV factor = 1/(1+i)n], where i = rate of return and n = no. of years.
Step3
PV of price of the stock at the end of initial growth period,
P= [D2 / (k-g)], now if we first calculate the price of the stock at the initial growth period then
we calculate the PV of the stock. So,
D2 = 2.63 × (1+0.12) = $2.94
P= [2.63 / (0.15 – 0.12)] = $87.66
PV of stock price = 87.66 × PVIF 15% at 2 (0.7561) = $66.27

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Step4
Now add the PV dividends during the initial growth period and PV price of stock at the
end of growth period,
P0 = 4.03 + 66.27 = $70.30
Wesfarmers:
Current dividend (D0) = $2.78
Required return= 19.2%
Growth rate= 15%
Step1
Evaluate the cash dividend value at the end of the year (D),
D1 = 2.78 × 1= $2.78
D2 = 2.35 × (1+0.12) = $2.04
Step2
Now calculate the present value of the dividends at the initial growth stage,
t Dt $
PVIF
19% t
PV of
Dividends
1 2.78 0.8403 2.3360
2 2.04 0.7061 1.4404
Total PV of dividends 3.7764

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[PV factor = 1/(1+i)n], where i = rate of return and n = no. of years.
Step3
PV of price of the stock at the end of initial growth period,
P= [D2 / (k-g)], now if we first calculate the price of the stock at the initial growth period then
we calculate the PV of the stock. So,
D2 = 2.04 × (1+0.12) = $2.28
P= [2.04 / (0.19 – 0.15)] = $51
PV of stock price = 51 × PVIF 19% at 2 (0.7061) = $36.01
Step4
Now add the PV dividends during the initial growth period and PV price of stock at the
end of growth period,
P0 = 3.77 + 36.01 = $39.78
BHP vs. Wesfarmers- stocks comparison
This report compares the share value and stock performance in terms of growth, dividend
payout, annual returns, splits and highest gains.
Referring to the above calculation, under the constant growth model shows BHP price is
$66.67 and Wesfarmers is $69.50. Zero growth models reveals BHP price is $14.74 and
Wesfarmers is $14.63. Finally, under the variable growth model show the price of BHP is $70.30
and Wesfarmers is $39.78. Now the current market price is $1,659.80 and $45.21 of BHP and

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Wesfarmers respectively. So interpreting the factor the BHP price is highly overpriced and
Wesfarmers price looks good. As per calculation it can suggest that the invest in Wesfarmers
would be good decision as it tends to go up further whereas BHP stock is highly overpriced so it
tends to move down further. As a result the above calculation suggests selection of Wesfarmers’s
stock for better investment. Concerning about the beta of both the stock, BHP’ beta is 0.98 and
Wesfarmers’s beta is 0.32. So the fluctuation of the price of the Wesfarmers is comparatively
less. Since Wesfarmers’s beta is less than BHP then it can be said that Wesfarmers will give
similar return whereas BHP’s return may vary. A graph of these two stocks movement and their
respective returns are charted below:
The above graph suggests that, risk in BHP is very high as it gives very high risk adjusted
return but Wesfarmers has stability in return as well as risk, so choosing the stock of wesfarmers
would be the good planning for investment.

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Popular stock valuation model
The study describes two most popular valuation models are as follows:
Dividend discount model (DDM)
One of the most popular appropriate valuation models is the “dividend discount model”.
This model evaluates a firm’s true value based on the dividends. Therefore, the justification of
using this model is to consider dividends to assess a company where the dividends show the
actual cash flows moving to the shareholders. Evaluating the present value of the cash flow must
provide a value of shareholders wealth (Lazzati and Menichini 2015).
Discounted cash flow model
The above valuation technique only refers to the dividend, now if the company does not
provide any dividends or the company’s dividend is not regular then discounted cash flow
technique will come into consideration. Instead of taking the dividends this model, use the
discounted cash flow technique to assess the firm. The biggest benefit of this model is that it can
be used at a larger part of a firm without giving dividend (Bian 2018).
Therefore, the most approachable technique is the discounted cash flow model to value
the shares.
Recommendations
This study recommends analyzing of corporate governance review since it has a sound
impact on return on investment. To value the stock to invest “Gordon Growth Model” is
appropriate to imply.

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INTRODUCTION TO FINANCE
Conclusion
After analyzing the study, the report concludes that to relate with the financial study is
important to take every financial decisions even though there is several limitations. A company’s
performance reflects both financial and non-financial circulation. Financial report is always
important for the stockholder’s interest. After researching of all the financial information of the
groups it can be suggested that under the non-financial segment corporate governance, practice
in the business entity is very important for the return. On the other hand, financial factor such as
stock valuation, financial report evaluation is having a good impact on the return and the
performance of the company. This report highlighted, there is an optimistic relation between
executive remuneration or compensation and company’s financial enactment.
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INTRODUCTION TO FINANCE
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INTRODUCTION TO FINANCE
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Retrieved 23 January 2020, from https://www.bhp.com
2020/-/media/documents/investors/annual-reports/2019/bhpannualreport2019.pdf#page=108
Retrieved 23 January 2020, from https://www.wesfarmers.com.au
2020/docs/default-source/corporate-governance/2019-corporate-governance-statement.pdf?
sfvrsn=0
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