Business Ethical Failure: Worldcom - Research Paper Example

BUSINESS ETHICAL FAILURE - WORLDCOM Introduction The large number of corporate scandals that we are handlingtoday is not special in any way but just like those that from time to time continue to undermine our system of free enterprise and the efficient use of resources. These scandals have posed significant effects to both the American business as well as the financial communities in the country (Holmstrom & Kaplan, 2003). A good example that demonstrates a failure of corporate governance at this early age of the century is the WorldCom case that this research aims at analysing and recommending possible remedial measures that can assist in restoring ethical behavior in our corporations. Analysis of the Failure Upon the disclosure of massive accounting irregularities, WorldCom, which was the second biggest telecommunication company in the world, filed for insolvency in the summer of 2002 in the federal court of Manhattan. The major departures from the desired corporate behaviour experienced in the company came because of the failure of the directors to identify and effectively, combat abuses leading to the widespread culture of greed. The failure also resulted from irresponsible members within the corporation to perform their fiduciary duties to the shareholders (Pulliam & Solomon, 2002). The other failure resulted from lack of transparrency in the operations and the management of the company. There was no proper co-ordination between the board of directors and the senior management of the company. The system of checks and balances in the leadership of the company did not play its role leading to a complete failure of the system of governance. The real fraud in the company comprised of a series of topside manipulations to the accounting entries to cover dwindling earnings. Mostly, these comprised of wrong drawdowns of accumulated reserves from the acquizition program as well as other sources and innappropriate cost capitalizations that were to be added as expenses. In other words, according to Kuhn and Sutton (2006), it was a very good incident of the so called ‘books cooking’. The company overstated its earnings by about eleven billion dollars and its balance sheet by about seventy five billion dollars. Consequently, there was a shareholder loss of approximately two hundred and fifty billion dollars. The desirable market views of the company in the 1990s sustained by a number of acquizitions. During this time, WorldCom was in a constant mode of acquizition as the means of expanding its operations. In turn, this caused a very great pressure of keeping price of its stock high in order to boost the acquizition spree as well as providing worthwhile cash-outs for options of executive stock (Scharff, 2005). To achieve this goal, WorldCom had to meet the earning expectations of Wall Street. However, in 2000, the disapprovement of the proposed merger with Sprint by the government and the end of the telecommunication boom in the industry saw the beginning age of reduction in the company’s earnings. As a means of covering the eroding financial picture of the company, the management resolved into aggressive techniques of accounting. Upon the exhaustion of this, the management decided to put fraudulent entries to achieve the so called legitimate earnings and enable the company appear to be meeting the requirements of WallStreet targets of earnings (Brickey, 2003). Consequently, the company managed to report consistent results that it met the required targets by around eleven out of thirteen. In reality, during the final four quarters the company should have reported significant losses. In 2002, the company collapsed when the internal auditors pointed out the irregularities that finally led to firing and resignation of the top officials of the company. WorldCom finally declared bunkrupt and legal action against the individuals involved iniated. The major responsibility to this failure goes to the board of directors more specifically, those who served in the compensation and audit committees (Akhigbe, Martin & Whyte, 2005). The company’s CEO, Bernard Ebbers and the CFO, Scott Sullivan dominated these entities. The members of the board exercised very little deligence, asked very few and simple questions and acted as puppets for the fulfillment of the ambitions of the two persons. There was the culture of accommodation within the company that rendered Ebbers and Sullivan excessively, powerful to direct the company to their place of interest (Coffee, 2009). For example, the company’s approach during the acquizition period was totally, ad hoc with very little meaning or proper strategic plans. The board regularly, approved multibillion dollar dealings without adequate information or thorough discussions. There was no adequate information availed regarding the nature of the deals, the terms, the conditions and the implications of the transactions involved. In addition, on the part of officers and directors, no one proved to have made any efforts in curbing, stopping or challenging the behavior that they suspected doubtful or innappropriate for the company (Grant & Visconti, 2006). It proved that both the directors and the officers moved together with Ebbers and Sullivan even on circumstances that showed a violation of the principles of corporate governance or when they observed inappropriate or fraudulent actions. Also, there was no evidence to show that the directors scrutinized the debt level of the company and its capability of meeting its exceptional obligations (Gendron & Spira, 2009). The issuance of twenty five billion dollars by WorldCom in debt securities about four years before its bunkruptcy occurred because of its enormous accounting fraud that allowed the company to appear as creditworth as well as investment grade. The board again approved these borrowings regardless that there was no adequate information or discussions regarding the deals. Furthermore, there are considerable concerns about the conditions that surround the WorldCom loans of about four hundred million dollars to Ebbers. The compensation committee approved these gigantic loans without initial information to the full board and taking the necessary measures required to safeguard the company (Lyke & Jickling, 2002). With the increase in both the loans and the guaranty, the compensation committee did not perform proper diligence to demonstrate that Ebbers collateral was grossly, not enough to meet the credit extensions of the company to him. The entire board was also to blame for not raising questions regarding the loans and simply, accepting the recommendations of the compensation committee without serious considerations (Cohen et.al. 2005). From the perspective of corporate governance, these loans to Ebbers were very disturbing for an extra reason. These loans manifested the level of Ebber’s business dealings that did not relate to the company. Ebber’s investments included the timber interest in Mississippi and the puchase of big tract real estate in Canada. The board should have asked whether all these non WorldCom dealings aligned with the need for Ebbers to devote adequately and pay attention to the management of a very complex organization like WorldCom. Instead, the board provided enough funding for Ebbers to continue carrying out personal commercial activities. Another important factor that revealed unethical conduct in the company was the absence of transparency within the management of the company. The board of directors did not directly; translate to the big accounting racket committed by WorldCom, a factor that assisted in fostering an atmosphere and culture, which allowed the fraud to grow exponentially (Giroux, 2008). This culture that discourages or does not allow thorough scrutiny provides a suitable breeding ground for fraudulent activities. There was also failure by the audit committee to devise a suitable work plan to establish the required seamless network of audit capabilities for monitoring the activities of the company. In general, it appears that neither the internal auditors nor the audit committee seized the real notice of the accounting fraud. They only took important steps too late after the discovery of the shortcomings in 2002. Last to mention, the company adopted a program called tax minimization in the 1990s that aimed at avoiding state taxes. WorldCom designed some twenty billion dollars in obligations through its own subsidiaries called royalties in what the company nominated as management foresight. The accounting of these royalties occurred in a manner that largely, reduced the amount of taxable income for some of the company’s subsidiaries (Sidak, 2003). The designation of the management foresight as an insubstantial asset able to be a subject of genuine royalty compensation was very questionable. Perhaps the program enabled WorldCom to avoid large sums of money that had to pay to the state as part of income taxes. The activities of the company demonstrated very high level of unethical conduct and a breach of the principles of corporate governance (Scharff, 2005). Stakeholder Analysis More important is to put emphasis on the individuals who have invested in the company or those who were heavily relying on the company as their most important source of income. Upon the announcement of the fraud to the public in 2002, the company took new measures to reform and restore confidence in the public. This followed the removal of the top management where Ebbers earlier resigned while Sullivan forced to leave. Myers also resigned and a new president took over (Pandey & Verma, 2005). This also followed a replacement of the entire board to ensure objectivity and independence in the management decision. There was closure of the accounting and finance departments at Mississippi and Clinton. The company hired more than four hundred new persons in the accounting and finance departments while seventeen thousand out of the original eighty five thousand employees forced out. To continue, the NewYork State Common Retirement Fund, the second biggest civic pension fund, invested the assets of the state and those of employees. The fund therefore lost more than three hundred million dollars of the investments in the so called WorldCom Company (Cronje, 2014). HGK Asset Management, which is registered advisor of investment, had purchased around one hundred and thirty million dollars of the securities offered by the company and lost all the money. The few investors that did not suffer any significant losses were the institutional investors as well as creditors because of their diversification of investments. Regarding the banks, accountants and brokers that in one way or the other facilitated the spread of the fraud received purnishment in different ways; losses because of the loans extended to the company, financial punishments or settlements that they had to sign, through litigations, losing their stock market value because of their relationship with WorldCom and the costs to meet compliance and legal measures (OConnell & Bligh, 2009). The settlements of Wall Street with SEC and the Attorney General summed to one and a half billion dollars and included costs of annual compliance of around one billion dollars for a period of five years. This led to a decline in its research budget by about fourty percent. This in turn caused several companies to drop from the coverage of Wall Street that was needed to meet investment from institutional investors. Upont the fall down of Evron, there was high public demand that the regulators were to take action. By the early times of 2002, no action had yet been taken and the pressure had declined. However, with the failure of WorldCom, the Congress rapidly, enacted the Sarbanes and Oxley Act just within one month. The act aimed at protecting investors and improving the reliability and accuracy of disclosures by public companies (Ge & McVay, 2005). Many stakeholders argue that, though the act came as a political reaction, it was needed earlier in the economic atmosphere of the country. Action Plan for Remediation Although legislation provides a means of restoring ethical behavior in our companies, I do not agree to the fact that it is the best method to employ. Ethics are there for the benefit of all individuals and the country at large. Based on the harmful consequences that we learn from the unethical conduct of some individuals like Ebbers, no one has to be forced to be ethical. Measures have to be in place in every organization that if one cannot practice ethical behavior then he should leave the organization for others (Stead, Worrell & Stead, 1990). There should aslo be expression of great discomfort and opposition to all forms of unethical conduct. However, depending on the magnitude of the behavior, we can let one remain in the organization while he tries to make the necessary changes. The management of every organization, according to Omolewu (2008) should consider ethical behavior as the topmost agenda in the management of the organization. There must be well established codes of conduct in the operations of the company that each member must understand and adhere to. In addition, every member must have a good understanding of the unethical practices that may occur in the organization as well as the consequences to appreciate the benefits of maintaining ethical conduct. There should be good training of employees on the best means of detecting, reporting and dealing with unethical activities that they may come across in their day-to-day business operations. Lastly, there is need to encourage good communication as well as transparency in the management of business organizations as a means of detecting any possible form of misconduct in the organization to allow for earlier action before everything goes wrong (Omolewu, 2008). Conclusion Unethical behavior is a very important issue of concern that continues to undermine our culture of free enterprise and economic development. The WorldCom scandle was one of the biggest manifestations of unethical behavior that exist in the management of our corporations. It is very evident that such behaviors cause very serious financial losses to the various stakeholders involved. With the proper measures put in place to allow for transparency and ethical conduct in the management of our corporations, such cases will not recur. It is the responsibility of every individual to understand the importance of embracing ethical conduct for the benefit of the society and the country at large. References Akhigbe, A., Martin, A. D., & Whyte, A. M. (2005). Contagion effects of the worlds largest bankruptcy: the case of WorldCom. The Quarterly Review of Economics and Finance, 45(1), 48-64. Brickey, K. F. (2003). From Enron to WorldCom and beyond: Life and crime after Sarbanes- Oxley. Washington University Law Quarterly, 81. Coffee, J. C. (2009). What went wrong? An initial inquiry into the causes of the 2008 financial crisis. Journal of Corporate Law Studies, 9(1), 1-22. Cohen, M., Mindina, G., Shulgin, L., Campus, R., & Robinson, R. (2005). WorldCom–Its Rise and Fall: Financial and Ethical Implications. Management. Cronje, C. (2014). Corporate accounting scandals: reconnaissance. Word and Action= Woord en Daad, 53(423), 15-17. Ge, W., & McVay, S. (2005). The disclosure of material weaknesses in internal control after the Sarbanes-Oxley Act. Accounting Horizons, 19(3), 137-158. Gendron, Y., & Spira, L. F. (2009). What Went Wrong? The Downfall of Arthur Andersen and the Construction of Controllability Boundaries Surrounding Financial Auditing*. Contemporary Accounting Research, 26(4), 987-102 Giroux, G. (2008). What went wrong? Accounting fraud and lessons from the recent scandals. Social Research, 1205-1238. Grant, R. M., & Visconti, M. (2006). The strategic background to corporate accounting scandals. Long Range Planning, 39(4), 361-383. Holmstrom, B., & Kaplan, S. N. (2003). The state of US corporate governance: Whats right and whats wrong?. Journal of Applied Corporate Finance, 15(3), 8-20. Kuhn, J. R., & Sutton, S. G. (2006). Learning from WorldCom: Implications for fraud detection through continuous assurance. Journal of Emerging Technologies in Accounting, 3(1), 61-80. Lyke, B., & Jickling, M. (2002, August). WorldCom: The accounting scandal. In Congressional Research Service Report for Congress, August (Vol. 29). OConnell, W., & Bligh, M. (2009). Emerging from Ethical Scandal: Can Corruption Really Have a Happy Ending?. Leadership, 5(2), 213-235. Omolewu, G. (2008, March). Strategies for improving ethical behaviors in organizations. In Forum on Public Policy: A Journal of the Oxford Round Table. Forum on Public Policy. Pandey, S. C., & Verma, P. (2005). Organizational decline and turnaround: insights from the Worldcom case. Vision: The Journal of Business Perspective, 9(2), 51-65. Pulliam, S., & Solomon, D. (2002). How three unlikely sleuths exposed fraud at WorldCom. The Wall Street Journal, 1. Scharff, M. M. (2005). Understanding WorldComs accounting fraud: Did groupthink play a role?. Journal of Leadership & Organizational Studies, 11(3), 109-118. Scharff, M. M. (2005). WorldCom: A failure of moral and ethical values. Journal of Applied Management and Entrepreneurship, 10(3), 35 Sidak, J. G. (2003). Failure of good Intentions: The WorldCom Fraud and the Collapse of American Telecommunications after Deregulation, The. Yale J. on Reg., 20, 207. Stead, W. E., Worrell, D. L., & Stead, J. G. (1990). An integrative model for understanding and managing ethical behavior in business organizations. Journal of Business Ethics, 9(3), 233-242. Read More