Directors’ Report

The directors are pleased to present their report to shareholders, together with the financial statements for the year ended 31 December 2001.

Results and dividend The loss for the financial year ended 31 December 2001 was £391m (2000: £179m profit). The loss retained for the year was £568m (2000: £15m profit) and has been transferred to reserves. A final dividend of 13.6p per share is recommended for the year ended 31 December 2001. This, together with the interim dividend already paid, makes a total for the year of 22.3p (2000: 21.4p). The final dividend will be paid on 7 June 2002 to shareholders on the register at the close of business on 15 March 2002, the record date.

Significant acquisitions and disposals Details of these transactions can be found in notes 26 and 27 to the accounts.

Transactions with related parties Details of transactions with related parties, which are reportable under FRS 8, are given in note 31 to the accounts.

Capital expenditure The analysis of capital expenditure and details of capital commitments are shown in note 13 to the accounts.

Directors The present members of the board, together with their biographical details, are shown here. Gill Lewis resigned as a director on 27 April 2001. Details of directors’ remuneration and interests in ordinary shares and options of the company are contained in the personnel committee report. Three directors, Dennis Stevenson, Reuben Mark and Marjorie Scardino, will retire by rotation at the forthcoming Annual General Meeting (AGM) on 26 April 2002. All three, being eligible, will offer themselves for re-election. Details of directors’ service contracts can be found in the personnel committee report. No director was materially interested in any contract of significance to the company’s business.

Corporate governance The board supports the principles of good governance and code of best practice expressed in the Combined Code (the Code) published in June 1998. This directors’ report, including the personnel committee report which has been considered and adopted by the board, describes how the company has applied such principles and, apart from the following exception, has complied with the provisions set out in section 1 of the Code. Given the calibre and experience of the non-executive directors, the board does not believe the identification of a senior independent director is appropriate. If any shareholders have any concerns they wish to raise, they should raise them in the first instance with the chairman who will, as a matter of principle, raise them with the non-executive directors.

The board The board currently comprises four executive directors, including the chairman, who is part-time, and four non-executive directors. All of the non-executive directors are independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement.

The board schedules six meetings each year and arranges to meet at other times as appropriate. There is a formal schedule of matters specifically reserved to the board for decision and approval, and the board is supplied in a timely manner with the necessary information to discharge its duties. A procedure exists for directors to seek independent professional advice in the furtherance of their duties, and all directors have access to the advice and services of the company secretary.

Board committees The board of directors has established the following committees all of which have written terms of reference setting out their authority and duties:

i Audit committee This committee is chaired by Vernon Sankey and its other members are Terry Burns and Reuben Mark. All are non-executive directors. The committee provides the board with the means to appraise Pearson’s financial management and reporting, and to assess the integrity of the Group’s accounting procedures and financial controls. The Group’s internal and external auditors have direct access to the committee to raise any matter of concern and to report the results of work directed by the committee. The committee reports to the full board of Pearson.

ii Personnel committee This committee is chaired by Reuben Mark and its other member is Terry Burns. Both are non-executive directors. The committee meets regularly to decide the remuneration and benefits packages of the executive directors and the chief executives of the main operating companies, as well as recommending the chairman’s remuneration to the board for its decision. It also reviews the Group’s management development and succession plans. The committee reports to the full board and its report, which has been considered and adopted by the board, is set out in the personnel committee report.

iii Nomination committee This committee is chaired by Dennis Stevenson and comprises all directors. The committee meets from time to time as necessary to consider the appointment of new directors.

iv Treasury committee This committee comprises Dennis Stevenson, John Makinson, Vernon Sankey and Rana Talwar. The committee sets the policies for the company’s treasury department and reviews its procedures on a regular basis.

Internal control The directors have reviewed the effectiveness of the Group’s internal control process in accordance with provision D.2.1 of the Combined Code.

The directors are responsible for the Group’s system of internal control and reviewing its effectiveness. They consider that the system of internal control is appropriately designed to manage the risk environment facing the Group and to provide reasonable, but not absolute, assurance against material misstatement or loss.

They confirm that there is an ongoing process, embedded within the Group’s integrated internal control system which allows for the identification, evaluation and management of significant business risks, together with a reporting process to the board. The directors require operating companies to undertake at least annual reviews to identify new or potentially under managed risks. The results of these reviews are reported annually to the board via the audit committee. This process has been in place throughout 2001 and up to the date of the approval of this annual report and accords with the Turnbull guidance.

The main elements of the Group’s internal control system including risk identification are as follows:

i Board The board of directors, which has overall responsibility for the Group’s system of internal control, exercises control through an organisational structure with clearly defined levels of responsibility, authority and appropriate reporting procedures. The board meets regularly and has a regular schedule of matters that are brought to it or its duly authorised committees for decision, aimed at maintaining effective control over strategic, financial, operational and compliance issues. This structure includes the audit committee, which with the finance director, reviews the effectiveness of the internal financial and operating control environment of the Group. The audit committee meets regularly, at least three times per annum, and considers, inter alia, reports from internal and external auditors covering such matters.

ii Operating company controls The identification and mitigation of major business risks is the responsibility of operating management. Each operating company maintains controls and procedures appropriate to its own business environment whilst conforming to Group standards and guidelines, including procedures to identify and then mitigate all types of risks. To this end operating companies are required to undertake at least annual risk reviews to identify new or potentially under managed risks, the results of which are reported to the board.

iii Financial reporting There is a comprehensive budgeting and forecasting system with an annual budget approved by the board of directors. Monthly financial information, including balance sheets, cash flow statements, trading results and indebtedness, are reported against the corresponding figures for the budget and the previous year, with corrective action being taken by the directors as appropriate. In addition, these reports contain summary information of the major business issues and risks facing the operating companies, as well as the actions needed or taken to either mitigate or take advantage of them.

iv Treasury management The treasury department operates within policies approved by the board, and its procedures are reviewed regularly by the treasury committee. Major transactions are authorised outside the department at the requisite level and there is an appropriate segregation of duties. Frequent reports are made to the finance director and regular reports are prepared for the treasury committee.

v Group control The Group control department has the central responsibility for risk control and internal audit, which it exercises through teams located both in the UK and the US. The department reviews business risks, processes and procedures in all the main operating companies, agrees with operating companies their plans to eliminate or mitigate risks where possible, and to improve controls and processes. It monitors operating companies’ progress and reports the results of its work regularly to executive management and, via the audit committee, to the board. Annually, via the audit committee, the Group control department specifically reports on business risk to executive management and the board.

vi Insurance Insurance cover is provided either through Pearson’s captive insurance subsidiary or externally, depending on the scale of the risk in question and the availability of cover in the external market. The events of 11 September 2001 are projected to result in a general and significant increase in insurance premiums. Consequently the Group is undertaking a review of its insurance coverage to ensure that it has the most cost effective balance between insured and uninsured risks.

Going concern Having reviewed the Group’s liquid resources and borrowing facilities, and the 2002 and 2003 cash flow forecasts contained in the Group budget for 2002, the directors believe that the Group and the company have adequate resources to continue as a going concern for the foreseeable future. For this reason, the financial statements have, as usual, been prepared on a going concern basis.

Shareholder communication Pearson has an extensive programme of communication with all our shareholders – large and small, institutional and private. Pearson’s shareholder base has a very wide geographic spread, so we are using the internet and webcasting to ensure that shareholders have ease of access to corporate results and news. We also make a particular effort to communicate effectively and regularly with Pearson’s employees, a big majority of whom are shareholders in the company.

We post all company announcements on our website (www.pearson.com) as soon as they are released. Major shareholder presentations are made accessible via webcast or conference call wherever possible. www.pearson.com has a dedicated investor relations section which contains an extensive archive of past announcements and presentations, historical financial performance and share price data and a calendar of future events.

Each year our AGM – which will be held on 26 April this year – includes information about Pearson’s businesses and the previous year’s results as well as general AGM business.

People Pearson wants to be the best employer in the world. We still have some way to go but we start with the simple idea that people are by far our most important asset. Our commitment to continuous improvement in all areas of people management is stronger than ever and our major training and development initiatives have continued despite the tougher trading conditions in our businesses.

With three major businesses operating in over 60 countries, each unit has responsibility for day-to-day people management including: recruitment; terms and conditions of employment; remuneration, where the aim is to provide an appropriate rate for the job taking into account relevant recruitment markets, business sectors and geographic regions; employee relations; training and health and safety. In the past year Pearson has also played an increasing role in encouraging collaboration across companies within the Group. New targets have been set to encourage people to move between companies.

Pearson’s role is to ensure that businesses have the necessary people to discharge these responsibilities and to set the framework within which detailed employment policies are developed. Pearson itself is responsible for monitoring and overseeing the compensation, benefits, staffing, succession, development and training of the most senior executives; career development and management of potential across Pearson, including graduates; designing and implementing Pearson-wide remuneration plans, including employee share plans and the sharing of resources and expertise.

Pearson, for the fourth consecutive year, has been placed in the Top 100 Companies by the US magazine Working Mother. In the UK, a Sunday Times survey ranked Pearson as one of the best places to work among the UK’s top 50 companies.

On average there were 29,027 people in the company last year.

i Employment The employment policies of the Group embody the principles of equal opportunity and are designed to meet the needs of operating companies and comply with local regulations in their areas of operation. The sole criterion for selection, training, development and promotion is the individual’s suitability for the position of employment offered and his or her aptitudes and abilities. The company takes seriously its statutory obligations relating to disabled persons and seeks not to discriminate against current or prospective employees because of a reason relating to their disability. We always look to make reasonable adjustments to premises, or employment arrangements, if these substantially disadvantage a disabled employee, or prospective employee, compared to an able-bodied person. Pearson contributed to the recent Kingsmill Report set by the UK government on women’s employment and pay and the company has developed internal initiatives on diversity and work-life practices and a common approach to appraisal and development reviews.

We seek to treat all employees decently. Our employing companies enter into proper employment arrangements with their people, always meeting or exceeding their local statutory or regulatory obligations. Each of our companies has appropriate policies should the need for job losses arise.

ii Training and development Pearson’s commitment to training and development is now embedded in the company and during 2001 more people were involved than ever before in development activities. In addition to the curriculum within each business, programmes were delivered in Asia, Australia, the US and Europe.

Much of the responsibility for training and development has been devolved to the operating companies. Pearson Education appointed a dedicated management development director with a portfolio of activities and a learning curriculum that spans all parts of the organisation. Similar programmes operate in the Financial Times, at Penguin and elsewhere across the Group.

Pearson’s Senior Management Programme has run since 1999 and took place in Singapore in 2001. It has now been attended by the top teams from every business. This group addressed many critical business issues and is involved in developing the next phase of the programme. A much greater emphasis has been placed on mentoring and coaching.

The Pearson graduate training scheme recruits new talent into each of the businesses. Graduates work in different parts of the organisation, both in the UK and internationally, and are brought together for training and development. Annually the chairman hosts a meeting at which the graduates present project work undertaken and there is the opportunity for discussion with mentors and other senior managers on their career in Pearson.

Pearson has been involved for a number of years in the Chevening Scholarship scheme, administered by the Foreign & Commonwealth Office in the UK. We have successfully sponsored people from China, India and South Africa on MBA programmes at UK universities. In 2001, Pearson employed a number of these scholars after graduation.

Our relationship with Duke University has strengthened with 20 managers studying the cross-continent MBA. After graduation these managers will be given a major business challenge to address as an opportunity to put their new learning swiftly to the test.

Each year a group of some 100 high potential people is brought together to work with top management on current strategic issues and to provide new thinking and innovation. These FORUMS have a significant impact on motivation and retention of key talent.

The sharing of skills and expertise in the company was greatly helped by the implementation in 2001 of a more structured approach to appraisal, career development and succession planning across Pearson. The introduction of a Pearson policy that provides a consistent and supportive process for moving individuals across businesses has helped to increase international mobility.

iii Employee participation Share ownership lies at the heart of Pearson’s remuneration philosophy and the directors believe that the very best way for our people to profit from Pearson’s success is for them to become shareholders. Pearson operates both worldwide profit sharing and share acquisition plans in over 60 countries. With more than half our people in the US, we have taken special care to make it easy for them to acquire shares in Pearson. The listing of our shares on the New York Stock Exchange allows us to operate a US Employee Stock Purchase Plan that makes owning shares in Pearson accessible to the majority of our employees.

iv Employee communication Employee communication continues to be developed through regular Group-wide communication from the chief executive, Marjorie Scardino; wide-ranging presentations to staff around the world in connection with the publication of Pearson’s results or other important events; the distribution of InPearson, the employee magazine; Pearson to Pearson, the Group-wide intranet and reports to participants in the various benefit plans. The various operating companies also have their own channels of communication such as briefing groups, videos, magazines and newsletters.

v European employee forum Pearson has established a European Employee Forum with elected representatives from each of the Group’s main operating companies and from countries in Europe where the Group’s operations are of significant scale. The forum is intended to provide an arena for the exchange of relevant and appropriate information and to establish a constructive dialogue between management and employees on transnational issues that affect them. Two meetings of the forum were held in 2001. Representatives from the forum and Pearson assisted with some research undertaken on behalf of the European Commission and attended a joint seminar on employee financial participation.

Labour standards and human rights During 2000, Pearson, along with other companies, signed a ‘global compact’ at the United Nations which sets out a series of principles on labour standards, human rights and the environment. In 2001, with the assistance of independent consultants, we have put in place a procedure covering approximately 80% of our workforce primarily focusing in the UK and the US but also some of our businesses in Germany, Italy and Japan.

Some of the UN principles concern the environment and are covered by our environmental policy. Others refer to labour standards and human rights. They are:

Labour Standards

• Freedom of association and the right to collective bargaining
• The elimination of all forms of compulsory labour
• The abolition of child labour
• The elimination of discrimination in employment and occupation

Human Rights

• To support and respect international human rights within our sphere of influence
• To ensure that we are not complicit in human rights abuses.

i Labour Standards
The following guidelines reflect the UN principles and show our key commitments. Through our process, we are confident that, for the businesses surveyed, we meet or exceed the following commitments:

• We offer equal employment opportunities to all. The people we recruit and promote are selected on merit and suitability, and are not discriminated against because of gender, race, origin, background, religion, marital status, sexual orientation, disability or age. We recognise that an aid to further progress will be to establish an overarching diversity policy and we will do this in 2002.
• We comply with the relevant laws relating to employment and employment conditions in each country and business surveyed. We remain committed where such laws are lacking, to introduce our own guidelines, however, this was not an issue in the businesses surveyed. Subject to any laws, we fully respect the right of our people to freedom of association and representation either through trades unions, works councils, or any other appropriate forum.
• We have systems in place to deal with physical and verbal abuse, or the threat of it, and any other form of intimidation within our workforce.
• We recognise that labour standards and conditions may vary from country to country. Pearson companies conduct business in many of the poorer countries of the world where living standards are low. Different attitudes to both adult and child labour prevail. Where Pearson companies directly control their activities in a country, we will ensure that our people have satisfactory wages and working conditions, and that there is no exploitation of labour. Working terms will take account of local economies.

Our survey process identified that more needs to be done to meet our supply chain commitments below. A start has been made in raising issues with our major UK suppliers. In 2002, we plan to contact in writing all key suppliers with whom we have an ongoing relationship to communicate our expectations. This will be accompanied by guidance for our professional buyers on incorporating our commitments into operational practice.

• In addition, we will expect those who provide us with goods and services to assure, and if necessary demonstrate to us, that their businesses at least comply with the UN standards set out above. We also expect third party suppliers to provide satisfactory working conditions for their employees.
• We will advise third party suppliers that we will positively support their efforts to comply with our guidelines to enable them broadly to adhere to the UN ‘global compact’, and we will expect them to do so within an agreed time frame.

We found that the following guidelines were not relevant in the context of the countries and businesses surveyed in the first phase. In 2002, we plan to extend the process to include the remaining 20% of our workforce not covered this time.

• Operating in low cost environments has a financial benefit. It also carries a social responsibility. Any improvement in working conditions or pay agreed with a local supplier has to be pursued with care. There may be occasions when to insist on instant change could lead to immediate and damaging unemployment; or it could create ‘underground’ employment which would be infinitely more dangerous and totally unregulated. In such instances Pearson will agree a timetable for steady and sustained improvement.
• We recognise that there are great social, educational, health or safety problems in areas of the world where we do business and which affect our people. We will help, wherever possible, to educate our people in the workplace about such risks.

In each country, our local subsidiary will be responsible for monitoring activity annually. These reports will be submitted to the director for people at Pearson each year.

ii Human Rights
Pearson companies and people operate globally. Our products are produced and manufactured across the world and sold in many countries, often by companies we do not own which are operating on our behalf. We will, in the course of conducting business in ‘high risk areas’, ensure that we are not complicit in human rights abuses. This assurance can only come with regular monitoring. If we were to find ourselves inadvertently implicated in abuses of human rights, we would take immediate steps to rectify such a situation.

iii Board Responsibility
David Bell, as director for people, is the board director with overall responsibility for labour standards, human rights and environmental issues.

Environmental Policy
Pearson does not directly operate in industries where there is a potential for serious industrial pollution. Our main products are based on intellectual property. However, in our normal operations we do things that have an impact on the environment in many ways.

Pearson has had an environmental policy since 1992. In an ever-changing world, environmental issues concern the company and its shareholders, customers, staff and the general public alike. During 2000, we reviewed our policy and concluded that, although most of the original principles were still valid, we needed to enhance our efforts and measure them better. During 2001 we have worked with independent consultants to put in place a benchmarking procedure to allow us to measure our progress. The procedure has been tested with our businesses in the US and UK involving buildings that house over 100 people or are over 25,000 sq ft in size. The data collected from our surveys has allowed us to set benchmarks to report against.

For the buildings and companies involved in this first phase we can confirm we meet the principal commitments we have set for ourselves:

• We comply with the relevant environmental laws and regulations applicable in each country in which we operate.
• We work with regulatory agencies and advisers as necessary in the implementation of effective environmental policies, and, where no regulations exist, we set our own guidelines.
• We take account of environmental issues when placing contracts with our top suppliers of goods and services.
• In 2002, we plan a major communication programme with all our suppliers in this area.
• We continue to introduce energy efficient systems into our buildings and to manage sensibly our energy requirements.
• A senior executive, Alan Miller, has the responsibility for ensuring that our environmental principles are followed and we progress towards the targets we set ourselves. The board is taking an active interest in our progress, and each of our operating companies has nominated a senior person to take responsibility for implementing our policy in those businesses. An annual report on our progress is being reviewed by the board later in 2002.
• Our environmental policy and our annual environmental report are available to everyone in Pearson through our website, and we have encouraged people to participate and contribute to the development of environmental initiatives as they affect our business.

Health and Safety We continue to be committed to protecting our people through our health and safety practices in the workplace and some details of our progress will form part of our environmental report 2001 available on our website in late March.

ABI disclosure guidelines on social responsibility We intend to put in place procedures during the year to enable us to comply with the ABI disclosure guidelines on social responsibility.

Supplier payment policy Operating companies are responsible for agreeing the terms and conditions, including terms of payment, under which business transactions with their suppliers are conducted. It is Group policy that suppliers are made aware of such terms of payment and that payments to suppliers are made in accordance with these terms, provided that the supplier is also complying with all relevant terms and conditions. Group trade creditors at 31 December 2001 were equivalent to 33 days of purchases during the year ended on that date. The company does not have any significant trade creditors enabling it to produce creditor information for this purpose.

External giving
In 2001, Pearson’s external giving totalled £2.39m (2000: £1.79m). This was split between the UK (£745,000; £847,000 in 2000) and the rest of the world (£1,648,000; £938,000 in 2000).

The rest of the world figure includes $759,850 donated by Pearson to the Pearson Relief Fund to support those affected by the tragic events of 11 September 2001. Pearson made an initial donation of $500,000 and a further $259,850 to match employee donations, bringing the total raised to more than $1,000,000. The Pearson Relief Fund decided to focus on children, with donations being made to a number of projects including The Families of Freedom Scholarship, GNYHF Disaster Fund for Post-Traumatic Stress Counselling, The Robin Hood Foundation and Relief Fund and The Survivors’ Fund in Washington DC.

Pearson, its businesses and its people have a history of supporting a range of community and charitable causes through donating cash and products, matching employee fundraising and supporting volunteering initiatives.

In 2000 we conducted a major review of our community involvement, with the aim of focusing our support more closely around themes with a particular social need and where Pearson could make a unique contribution. In July 2001 we launched the Pearson ‘Teachers First’ programme as part of a major corporate philanthropic partnership with a Boston-based non-profit organisation, Jumpstart. Jumpstart connects college students who aim to become teachers with low-income pre-school children across the US. Pearson has made a $2.5m, three-year commitment which will support college students who have trained with the Jumpstart programme to become full-time teachers in a ‘Head Start’ or other early childhood centre.

Pearson and its operating companies continue to support a number of other community projects such as Book Aid International which distributes books and educational materials in Africa. The Financial Times Group continues to support schools and charities in its local London borough of Southwark including reading and mentoring schemes at local schools and colleges. Penguin UK has donated to the London Connection, a day centre for the homeless. Pearson has supported Literacy Partners in the US for a number of years which focuses on adult and family literacy programmes.

While Pearson does not make party political donations, it does support a number of independent research institutes across the political spectrum.

Share capital Details of share issues are given in note 24 to the accounts. At the AGM held on 27 April 2001, the company was authorised, subject to certain conditions, to acquire up to 79 million of its ordinary shares by market purchase. Although circumstances have not merited using this authority and there are no plans at present to do so, shareholders will be asked to renew this authority at the AGM on 26 April 2002.

At 4 March 2002, beneficial interests amounting to 3% or more of the issued ordinary share capital of the company notified to the company comprised:

Annual general meeting The notice convening the AGM to be held at 12 noon on Friday, 26 April 2002 at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE, is contained in a circular to shareholders to be dated 26 March 2002.

Registered auditors In accordance with section 384 of the Companies Act 1985 (the Act) resolutions proposing the reappointment of PricewaterhouseCoopers as auditors to the company, at a level of remuneration to be agreed by the directors, will be put to the shareholders at the AGM.

Statement of directors’ responsibilities Company law requires the directors to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the company and Group as at the end of the year and of the profit or loss of the Group for that period. The directors are also responsible for the maintenance of adequate accounting records in compliance with the Act, for safeguarding the assets of the Group, and for preventing and detecting fraud and other irregularities. In preparing the financial statements, the directors consider that appropriate accounting policies have been used and applied in a consistent manner, supported by reasonable and prudent judgements and estimates, and that all relevant accounting standards have been followed.

JULIA CASSON SECRETARY 4 MARCH 2002