Corporate Collapse: Accounting, Regulatory and Ethical Failure - Assignment Example

Name Class Unit Table of Contents Table of Contents 2 Introduction 2 Facts relating to the scandal and how the scandal occurred 3 HIH insurance 3 Lehman brothers’ case 4 Existing similarities between the two scandals 6 Stakeholders involved 7 Ethical, legal, accounting and corporate governance issues involved in the scandal including how the issues were able to occur 7 Comparison of Enron and both scandals 9 Enron and HIH 9 Enron and Lehman brothers 10 Improvements and changes based on theories of Unitarianism and deontology to regulations and codes of conduct that would be included in case of scandals to ensure they does not happen in future 10 Conclusion 11 References 13 Introduction Corporate scandals in most cases involve ethical lax and poor corporate social responsibility (Shuhui & Matthew, 2012). After the scandals, the business suffers loss while others collapse. Companies such as Enron saw a decline in their stocks after their scandals which affected the shareholders. Most of the decisions leading to a corporate scandal are ethical dilemma. A global corporate collapse as a result of scandal acts as a defining moment for the contemporary corporate governance debate (Colley, Doyle, Logan & Stettinius, 2003). The collapse of Lehman brothers and the HIH insurance has been some of the largest corporate scandals. This case investigates the collapse of HIH insurance and the Lehman brothers to prepare a case for presentation to board of directors. The report looks at the facts relating to the corporate scandal and how it occurred. The case also looks at the existing similarities between the two scandals, stakeholders involved in the scandals and how they were affected. It also includes ethical, legal, accounting, and corporate governance issues and how they occurred and comparison with Enron scandal. Lastly, the essay suggests the improvement and changes based on the theories of utilitarianism and deontology to regulations and codes of conduct to ensure that these scandals do not happen in future. Facts relating to the scandal and how the scandal occurred HIH insurance HIH insurance failure is one of the largest corporate failures in Australia which occurred in 2001. This led to the federal government to establish a royal commission to carry out the investigations on the failure. HIH was seen to have a conservative corporate culture. This made the deficiencies in governance which made its failure to be a surprise to many. The CEO was charismatic and dominating. Over the years, HIH engaged in high risk practices in highly competitive markets. Another problem which faced HIH insurance was lack of independent directors. Three of the eleven directors were former partners as the company auditor firm known as Arthur Andersen. This made it easy for the few independent directors to be misled on the true firm financial position (Owen, 2003). The company had an aggressive acquisition strategy which aimed at attaining growth at all costs. The firm also had a culture of not giving bad news to the stakeholders. This led to a conflict between profit maximisation and good corporate governance structures (Shuhui & Matthew, 2012). HIH had bad management which lacked a well understood policy. The group had deficiencies in its corporate culture and structure. There was filtering of information through unscrupulous accounting which disguised the serious financial crisis faced by the firm. Lack of professional skeptism led to the failure. The firm also failed to deal with accounting anomalies which would have helped in resolving the crisis. HIH is one of the most notorious Australia corporate scandal and collapse was a subject to Australian $40 million Royal Commission. HIH was rated as the second largest general insurer at the time of liquidation in 2001(Owen, 2003). Lehman brothers’ case The fall of Lehman brothers in September 2008 remains one of the largest bankruptcies. The company assets were worth $639 billion. The company was formed in the 1850s by Henry Lehman and his brothers. The bank expanded to become one of the largest investment banks globally. Due to its size, the bank was complex and advanced with opaque structures. Before the collapse, the business areas of operations were fixed income, equities, investment management and capital market (Wiggins, Thomas & Andrew, 2014). The bank made several strategic mistakes that led to its eventual bankruptcy. Lehman brothers increased their focus on long term investment instead of focusing on brokerage. This made the bank to consume more capital than through brokerage. Due to the bank small equity base, the liquidity risk increased. This created a cycle that made it hard for the bank to borrow capital. The company exposed itself to liquidity risks which could have been avoided. Lehman brothers continued pursuing their aggressive growth strategy despite the financial crisis they had exposed themselves to. They believed that the subprime crisis would not spread to other markets or world economy (Wiggins, Thomas & Andrew, 2014). Lehman brothers failed to reduce risks as compared to the rivals. This led to increased credit and operational risks caused by enlarged market risk. The losses became larger due to unmanaged risks where the firm exceeded their own risk limit several times. Lehman started trading with its own money for own profit instead of the clients. In 2006, Lehman came up with a new business strategy where they capitalised on their experience in real estate. The company made aggressive investment in real estate through purchase of real estate related assets. This made the company to hold a significant position in the commercial real estate market. The strategy made it hard for Lehman brothers to raise cash, reduce risks and sell assets. Despite the decline in US housing prices, the company continued in increasing their real estate holdings. This contributed to a lot of write-offs in 2008 (Wiggins, Thomas & Andrew, 2014). The bonus system acted as an encouragement for the bank to take huge risks. The bank took bonuses related risks. The bank could have avoided risks if it had invested more on correlated assets. Due to high ties with assets especially in the real estate, Lehman encountered loses in many fonts. They lacked large portfolio due to fact that it lacked diversification. Long term investments exposed the bank to liquidity risks and credit risks through subprime loans (Wiggins, Thomas & Andrew, 2014). The risk taking by the firm which was excess led to a damaged reputation. The financial market could not trust Lehman brothers with funding. All these contributed to a fast downfall for the firm (Shuhui & Matthew, 2012). Existing similarities between the two scandals The two scandals have several similarities especially in the risk taking. Both firms engaged in high risk taking ventures which led to their collapse. The management in both firms engaged in extremely risky ventures. In the case of HIH, the bank took risks through its business practices which failed to look at the prudential insurance margins (Owen, 2003). The company also failed to carry out due diligence checks when acquiring another insurance company. In the Lehman brothers’ case, the company took excessive risks which exposed them to the failure. The company exceeded their internal risk limits and took practices which manipulated its liquidity pools. This risk taking eroded the company reputation (Shuhui & Matthew, 2012). Another similarity lies on the fact that both companies acted against the stakeholders interests. This is through engaging in activities that endangered the stakeholder. For example, HIH insurance failed to disclose their activities to their shareholders. This is against the Australians laws where it was required to have continuous disclosure. The directors failed to ensure that there shareholders were well informed (Owen, 2003). In the case of Lehman brothers, the firm failed to act in the interest of the shareholders through acting in excessive risks (Wiggins, Thomas & Andrew, 2014). Lastly, both firms had poor corporate social responsibility. This is seen in their activities which were aimed at growth at expense of their stakeholders. There is poor evidence of shareholders participation in the governance of the firms. The failure in both firms displays poor regulations in their finances. The board failure in both cases led to their scandals in both cases. This is through poor monitoring and legitimising the practices of the firm. The board of the directors in both cases were poor in accountability (Shuhui & Matthew, 2012). Stakeholders involved The stakeholders involved are; customers, employees, regulators, community, intermediaries and suppliers. The interests of these stakeholders are vast in both banking and the insurance sectors. Both the firms had a block of shareholders. For example, 50% of the stakes in HIH was held by Winterthur Swiss before selling the entire shareholding to the public after concerns of the company performance (Owen, 2003). The public who held the shares from both firms suffered a loss due to the failures. The firms collapsed with a lot of shareholders investment. Employees lost jobs while suppliers lost their contracts. The collapse made it vital to evaluate regulators and improve them since they looked weak. The collapse of Lehman brothers affected the community through the impact on the global economy. The collapse of Lehman brothers acted as the beginning of the world financial crisis (Wiggins, Thomas & Andrew, 2014). Ethical, legal, accounting and corporate governance issues involved in the scandal including how the issues were able to occur Failures of both HIH and Lehman Brothers give insight on the ways in which accounting can misused to mislead. In the case of HIH, the company poor accounting was a major cause of the failure. HIH failed to set aside payment for future claims. The board in this case was under-reserving. The board relied on reports from independent actuaries which were assessed by the company auditors Arthur Andersen. The auditors used lacked professional skeptism. Andersen failed to engage any experts in their work which made HIH more venerable. The auditors accepted actuary report in unquestioning manner which became a principal failure. The audit firm relied on HIH internal business reports without evaluating or testing the operations. Anderson failed to deal with accounting anomalies which were evident in HIH (Owen, 2003). The four anomalies which were not acted on are; future tax benefits, goodwill, deferred information technology costs. In the case of Lehman Brothers, poor accounting led to the firm taking excessive risks in the real estate industry. The collapse of Lehman brothers is credited to intricate accounting rules among other issues. The firm reduced the leverage in right hand side of balance sheet while at the same time reducing their assets on left hand side. Auditors failed to follow the strict accounting rules (Clarke, Dean & Oliver, 2003). For corporate governance to be successful there is need for high quality accounting and auditing. This includes parties such as the directors, regulators, credit rating agencies and the investors to play different roles. In both cases, there was poor corporate governance (Thallner, 2002). It is also important to note that good corporate governance cannot exist without an ethical culture. HIH and Lehman brothers failed in their ethics. Poor management and greed at HIH combined with lack of accountability led to the failure of the firm (Owen, 2003). There was lack of integrity in the firm processes. In both cases, the management did not act in the interest of the company. The boards of directors clearly failed to adopt an oversight and monitoring role which would have made them familiar with the company financial status. There was poor corporate governance which would have ensured that there are maximised shareholders returns (Clarke, Dean & Oliver, 2003). Comparison of Enron and both scandals Enron and HIH Enron came to existence in 1985 as a leading natural gas and pipeline system company in US. The company main source of failure is accounting practices and valuation of the corporate assets in 2001. A whistle-blower gave Enron CEO Information regarding the flawed accounting procedures. The company used Arthur Andersen as their regular auditor (Li, 2010). Compared with HIH, both firms had flawed accounting procedures. Both firms used Andersen as their accounting firm who tolerated flawed accounting reports. Arthur and Andersen disposed of the documents for Enron after the scandal was exposed. There was no due diligence in both firms in their accounting activities. Both Enron and HIH failed to fully disclose the right information to their stakeholders at the right time. This was against the company ethics and corporate governance. In the case of HIH, the company had a culture of hiding information. This is also seen at Enron where there is poor disclosure of information. The accounting firm in both cases acted unethically. This is through actions which were against professional ethics. In Enron case, documents relating to the accounting for the firm were destroyed by Andersen (Li, 2010). Andersen in the case of HIH acted contrary to the ethics. This is through unquestioning acceptance of the results from HIH internal audit. Andersen also acted without the required independence in the case of HIH. This is due to fact that some of the board members in HIH were former Andersen members leading to conflict of interests (Owen, 2003). Enron and Lehman brothers Both Lehman brothers and Enron used accounting for transactions which were designed to make them stronger than they are. Reckless investment by both firms led to their financial problems (Shuhui & Matthew, 2012). There were a lot of similarities between the collapse of Lehman brothers and Enron. In Enron case, the top executives acted in a wrong manner due to lack of action by the board and auditing firm. The firms engaged in wrong auditing methods and poor disclosures which accelerated the scandal. Enron used pre-pay transactions which led to wrong financial ratios (Li, 2010). This is familiar with Lehman brothers’ use of Repo 105 which is the equivalent of pre-pay. This enabled both firms to fool the analysts and investors. Through use of Repo 105 program, it was possible to alter the firm financial position. There was poor corporate ethics in both firms which made it possible for the firm to act against stakeholders’ interests. The board of directors in both cases acted against the company interests (Colley, Doyle, Logan & Stettinius, 2003). Improvements and changes based on theories of Unitarianism and deontology to regulations and codes of conduct that would be included in case of scandals to ensure they does not happen in future Utilitarianism seeks to do greatest good for the largest group of people. Utilitarianism would have been used in this case to ensure that the management did the greatest good for the firms’ stakeholders. This is through ensuring that their actions were not self-centred and were carried out to benefit the shareholders. HIH insurance would not have taken excessive risks that put their shareholders into greater risk. The shareholders were also not well informed about the risks the firm was taking due to poor disclosure. This implies that the insurance was not acting for the greatest good for stakeholders. The firm would not have engaged in unscrupulous accounting methods which put their shareholders in risk (Owen, 2003). For Lehman brothers, the risks taken by the bank exposed the stakeholders to credit, liquidity, operations and reputation risks. The bank would not have invested heavily in correlated assets putting the stakeholders into risks. The management would have diversified their investments instead of consolidating their portfolio. The bank would also have started damage control earlier to ensure that they do not suffer a lot of loss. Excessive risk taking acted to damage their reputation which highly contributed to their downfall. There is need for firms to create an ethical climate in their operations. This is through demonstrating a commitment to upholding ethics and integrity without sacrificing their commitment to attaining best results. There is need to establish global standards for behaviour to ensure there are few ethical problems and less cases of conflict of interests (Thallner, 2002). Managers are expected to ensure legal and ethical developments in a firm so that they can address any ethical issue that may arise. There is need for firms to have strict corporate social responsibility which involves having social concerns beyond their corporation financial performance. This is through ensuring that there are economic, legal and philanthropic responsibilities. This will ensure that there is shared value and the organisation is able to act in a way that is meaningful to the society. Being ethical can help a lot in ensuring that corporate scandals do not occur in future (Shuhui & Matthew, 2012). Conclusion To sum up, the corporate scandals at HIH insurance, Lehman brothers and Enron had a great impact on the corporate governance. HIH insurance group scandal was Australia biggest corporate failure leading to formation of a commission to investigate. The management had poor systems, lacked monitoring and breached their duties. This is through taking high risks in competitive markets and flawed accounting. The accounting firm used failed in their duties. In the case of Lehman brothers, the firm also engaged in high risk investments and also failed to diversify their portfolio. The firm invested heavily in the real estate taking excessive risks which damaged their reputation and also brought their downfall. The firm also engaged in unscrupulous accounting procedures. Compared to Enron, it is evident that poor corporate governance, misleading accounting and lack of ethics among others led to failure. It is possible to ensure that these risks do not happen in future through use of utilitarianism. This is though doing the greatest good to the greatest number of people. Ethics should be incorporated in the corporate management to ensure that the management are acting for the benefit of firm and other stakeholders. References Clarke, F., Dean, G., & Oliver, K. 2003. Corporate collapse: Accounting, regulatory and ethical failure, rev (2nd ed.). Cambridge: Cambridge University Press. Colley, J.L., Doyle, J.L., Logan, G.W. & Stettinius, W. 2003. Corporate Governance, New York: McGraw-Hill. Li, Y. 2010. “The case analysis of the scandal of Enron.” International Journal of Business and Management, Vol.5, no.10, p37. Owen, N., 2003, HIH Royal Commission Final Report’, Viewed 16th Nov. 2015, http://www.hihroyalcom.gov.au/About/index.asp Shuhui S. C. & Matthew W. S., 2012, “Lessons Learned from Organizational Crisis: Business Ethics and Corporate Communication”, International Journal of Business and Management, Vol. 7, No. 12, p.74-84. Thallner, K.A. 2002. “High-profile cases generate interest in corporate responsibility”, Journal of Health Care Compliance, Vol.4, no.5, p.14-19. Wiggins, R. Z., Thomas P. and Andrew M., 2014, The Lehman Brothers Bankruptcy An Overview, Yale Program on Financial Stability Case Study (3A-V1). Read More