Corporate Companies such as Worldcom - Term Paper Example

Critical Analysis of Worldcom Collapse Name Institution Course Date Critical Analysis of Worldcom Collapse Introduction Corporate collapses and scandals have plagues America and also has sent shivers through stock markets and has caused the downfall of the mighty dollar. Renowned individuals have gone further to dissociate themselves to these corporate companies due to the scandals that take place within their management (Li, Pincus and Rego, 2008). On the other hand, not every scandal is the same and the businessman a crook. America has been internationally known to having the best economy globally comprising of the most productive workers developing the most innovative companies. On the other hand, these same corporate companies are going under the water as a result of poor leadership characterized with corrupt executives who enrich themselves at the expense of their shareholders who are directly assisted by greedy accountants as well as bankers (Patra, 2004). Therefore, corporate companies such as Worldcom have experienced scandals over the years which eventually leads to their collapse. Particularly, Worldcom is a telecom group which served Americans with the long-distance MCI network was involved in fraudulent activities especially with regard to their accounting which caused their collapse (Zekany and Braun, 2004). Therefore, this report will critically analyze a case study of Worldcom. It will also explain the various causes of its downfall with regard to its board, management and its internal and external auditors. Furthermore, it will discuss the impacts of these scandals on the countries’ governance, regulations and corporate law. Causes of the Collapse of Worldcom Corporate companies such as Worldcom have fallen victim of scandals and an eventual collapse due to cases of poor leadership within the company (Zekany and Braun, 2004). This is so due to the poor governance either demonstrated by their board of directors or their accountancy team. Due to these kind of lack of integrity, corporate companies end up incurring hefty fines, going into enormous debts as well as risks being sued by the parties affected by their mismanagement. The Collapse of Worldcom This is another big telecoms which owns the American long-distance MCI network. The corporate firm admitted to their misappropriate bookings of about $3.8 billion of their expenditures as a capital expenditure (Kuhn & Sutton, 2006). They also admitted that the profits they recorded from the year 2001 over five quarters ought to have been recorded as losses rather than profits. A republican who investigated the case of telecoms giant Worldcom, Billy Tauzin, claimed that these frauds regarding the well-being of the company were in existence as early as the year 2000. In addition, Worldcom terminated their chief financial officer and had their accounts audited by the controversial audit firm Arthur Andersen (Pandey and Verma, 2004). Furthermore, their chief executive as well as their founder was forced out and his confessions were not enough to please the SEC which was responsible for investigating their accounts. The chairman of SEC described the Worldcom accounts as inadequate as well as incomplete. Currently, the company is in default due to the large amounts of its debts since their state of their accounts fails to conform to the American accounting standards. Additionally, the corporate firm has to renegotiate their debts and is required to sell itself in order to ensure its survival, therefore, with telecoms in collapse, there are not many purchasers (Kuhn & Sutton, 2006). Board and Management Weakness The downfall of the company was primarily because of executive hubris. The fraud that occurred within the corporate firm was due to the methods with which the companies CEO, Bernard J. Ebbers, conducted the welfare of the company (Pandey and Verma, 2004). An earlier report mentioned that the CEO was considered the source of the culture to the company therefore, he was the one who caused so much pressure that gave birth to his fraud. The company filed for bankruptcy after a huge accounting fraud was unveiled amounting to a total of $9 billion. One of the reports mentioned that the timing of the fraud can be connected to a threat to the personal fortune of the CEO and furthermore, the fraud was not detected until when he finally left the company (Sidak, 2003). The executives blamed for promoting the fraud was the CFO, Scott D. Sullivan for overlooking the fraud with guilt from the other executives. Since then, almost 40 executives have been relieved off their responsibility with the company due to their involvement in the fraud. Another report demonstrated managerial weakness within the company due to the direct involvement of the CEO in the fraudulent activities within the company due to his obsession in generating his own personal fortunes that led to him misleading both Wall Street and his own employees (Zekany, Braun and Warder, 2004). In addition, it demonstrated the board’s weaknesses since they were very passive and ineffective. Their accountants were very preoccupied and their bankers very permissive that they couldn’t even uncover routine warning signs. Internal Auditor’s Weakness The firm comprised of an internal audit committee, which was formed in order to maintain a relation with their external auditors, Arthur Andersen. The internal audit committee included the number of board members who met often to discuss the advancement of the audit (Zekany, Braun and Warder, 2004). They were involved in the accounting fraud since the committee chairman, Max Bobbitt was said to be very loyal to the CEO, Ebbers. It has been mentioned that he was probably aware of the fraudulent misstatements that were conducted from the year 1999 through to 2001 and hence chose to ignore it. In addition, the Worldcom’s Audit Committee failed to meet with the Internal Auditors of the firm (Pandey and Verma, 2004). The internal auditors of the company were not adequately staffed to handle the internal controls as well as the audits of the company which contributed to their failure to adequately communicate to the Audit Committee on all the operations as well as the financial situations at Worldcom. The Internal Audit department is aimed at reporting directly to the Audit Committee so as to avert the decisions of the top management taking part in their decision making. This form of order lacked in Worldcom (Klein, 2002). In addition, Ebbers incorrectly linked the functions of the internal auditors with those of an external auditors. This was so because the functions undertaken by the internal auditors included observing the financial statement of a firm as well as enhancing the operations of the firm. The CEO allowed the internal auditors to conduct actual operations which may have increase the risks which may have caused losses as well as loss of operation efficiency (Kuhn & Sutton, 2006). External Auditor’s Weakness The now-disgraced audit firm, Arthur Andersen also played a major role in the fall of Worldcom. They failed their role in exercising due diligence so as to cover up for the fraud that was being committed within the corporate firm (Rittenberg & Mark, 2001). In addition, the external auditors, Arthur Andersen, failed to notice the fraud within the company and this was due to both their negligence and in part to tight control top management kept over information. Furthermore, Arthur Andersen’s flaws were that they actually limited their testing of the account balances therefore depending on the internal control environment of the firm. On the other hand, the internal control environment of the firm was weak such that it allowed Arthur Andersen to oversee the various serious deficiencies that existed within the firm’s internal environment (Gillian and Martin, 2007). Finally, Arthur Andersen also failed to bring to attention the suspicion in the top management with regard to the control over information to the Audit Committee. This played a part in the collapse of the corporate firm. In addition, the former Worldcom comptroller, David Myers, mentioned that Arthur Andersen’s largest audit was the one they conducted on Worldcom. He also mentioned that the external audit firm wanted to retain the corporate firm as their client and this was primarily due to their need for consultation revenue that it brought to the firm (Frankel et al., 2002). The external audit firm used most of their time selling their consultation services rather than critically analyzing the financial status and performance of Worldcom. Due to this, it resulted to a conflict of interest since the auditors first consulted the firm on ways in which they could increase their financial performance and at the same time audit the firm. Senior management at Worldcom were very aware of this and hence they designed the journal entrances in such a way that they could be accessed by the external audit firm, Arthur Andersen. Furthermore, David Meyers also mentioned that Arthur Andersen had the pressure to get the job done with as soon as possible and therefore they did not overlook the particulars on purpose. Thus, Arthur Andersen, Worldcom’s external auditors, valued their relationship with the corporate firm rather than the quality of work they performed (Frankel et al., 2002). Finally, the relationship between the external auditors and the firm’s CEO, Ebber, led to the deficiency of professionalism which is the questioning attitude an auditor ought to have when in the field. Impacts of Corporate Scandals on Governance Regulations and Corporate Law Corporate scandals have resulted to independence of boards and audit committees. The independent directors are considered better at monitoring the progress of their managers. Therefore, companies with independent directors are likely to experience lower incidences of accounting fraud as well as earnings management (Patra, 2004). Furthermore, corporate scandals has encouraged the development of financial expertise of boards and audit committees. Therefore, corporate firms ought to ensure that their board members as well as their audit committee members are financial literate and have an expertise in accounting. This can aid them in identifying company’s accounting irregularities as soon as possible so as to avoid any form of corporate collapse. Furthermore, it has addressed the issue of auditor conflict. After the case of Arthur Andersen, most accounting firms have decided to divest their consulting business. Furthermore, the influence of the CEO to the board has also been adequately been addressed (Patra, 2004). The more influence a CEO has on the board, there are less chances that the board will recognize any irregularities. Therefore, it has ensured that CEO’s have less privileges and influence on the board of a corporate firm. Additionally, corporate scandals affects other governance mechanisms. Apart from the independence and financial expertise of both the board and the audit committees, other governance mechanisms have the probability of restating a company. For instance, CFO within a firm is responsible f taking care of the firm’s financial activities. Therefore, the influence of a CFO in a board or audit committee has the ability of minimize the overall effectiveness of an oversight operation. Then again, the presence of a CFO within an audit committee may enable the flow of relevant information within the committee. Conclusion To sum up, corporate collapse is most influenced by the management who are inclusive of the CEO, CFO as well as the auditors involved. From the case study on corporate firms such as Worldcom, it was found out that the fraudulent activities which cost the company to collapse. This is due to the negligence portrayed by the firm’s governance. In addition, issues such as management weakness, internal and weakness play a major role in the spread of fraudulent activities within the firm. Although consequences are inevitable for those that are involved in such activities, such corporate scandals have brought about consequences to the governance regulations such as introduction of an independence board and audit committees, development of financial expertise as well as audit conflict. References Frankel, Richard M., Marilyn F. Johnson, and Karen K. Nelson 2002, The relation between auditors’ fees for non-audit services and earnings management, Accounting Review, 77 Supplement, p. 71-105. Gillan, SL & Martin JD 2007, Corporate governance post-Enron: Effective reforms, or closing the stable door?. Journal of Corporate Finance, 13(5), p. 929-958. Klein, April, 2002, Audit committee, board of director characteristics, and earnings management, Journal of Accounting and Economics, 33, p. 375-400. Kuhn, J & Sutton, S 2006, Learning from WorldCom: Implications for fraud detection through continuous Assurance, Journal of emerging technologies in accounting, 3(2006), 61-80. 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