ACCOUNTING FRAUD AT WORLDCOM ANSWER KEY CASE SUMMARY 1. Brief Background and Context WorldCom was the amalgamation of many mergers and acquisitions during the consolidation phase of the US telecom industry. Ironically, it was less than twenty years since the US had forced the break up of AT&T. Its business and moved beyond long distance and had become a big player in both the local markets as well as the Internet. While a very fast growing company, WorldCom’s growth was through acquisition or by renting excess capacity. Its stock price had really benefited from both the dot.com and telecom bubbles. Unfortunately, its senior leadership and the resulting corporate culture was fixated on maintaining its high price and began to take/make ever increasingly aggressive accounting decisions to artificially prop up the stock. As time went on, these accounting decisions moved from earnings management to fully crossing the line into a massive accounting fraud. Eventually, the accounting fraud was exposed by Cynthia Cooper (Head of Internal Audit) and WorldCom’s financials had to be restated; its pre-tax income had been overstated by some $7 billion and assets had to be written down by over $80 billion. The resulting outcome of WorldCom’s failure was huge: market cap fell by almost $180 billion wiping out shareholders, 17000 employees lost their jobs and all employees’ retirement accounts became nearly worthless, telecommunications service was jeopardized to 20 million retail customers as well as critical parts of the US government. The case reveals that so single factor led to the onset and sustainability of the accounting fraud. Catastrophic failures usually arise from the cumulative effects of many small failures, any one of which, if detected in time, could have prevented the fatal outcome from occurring. In the case of WorldCom, there was a failure of leadership, culture, internal controls, internal audit, external audit and the board of directors. It is a remarkable and sobering story that so many safeguards and controls failed simultaneously.
1)What are the key factors for the collapse of two companies in the view of Corporate Governance?
The following key factors resulted the two companies to a collapse.i)Senior Executives were encouraged to lie, cheat and manipulate records by providing them high margin of profits.ii)Executives were interested in their personal reward structure ignoring thestakeholders’ benefits.iii)Board members were mostly highly rewarded and consist of the friends,who did not raise questions on any doubtful and ambiguous records.iv)Non-Executive Directors were also highly rewarded and they workedindependently.v)Audit Team was bribed, so that the team will produce a clean audit report.vi)Illegal profits were generated and it was shown that all the policies andrules implemented from the top were for the benefit of the company andshareholders, and hence, were ethical.vii)The cost of heavy machinery purchased in a particular period was notspread by the company in the next coming financial years.
2)Who was mainly responsible for the downfall of Enron and WorldCom?
Almost every person involved in any type of unhealthy activity was responsible for the downfall of both companies. However, they can be arranged in a sequence frommost responsible to less responsible as in the following:i)
Board of Directors firstly
: As they were involved in fraudulent and cheat.ii)
Non-Executive Directors secondly
: As they were involved with Board of Directors in unhealthy activities.iii)
Internal Audit Team thirdly
: As they were bribed by Board andManagement to show their audit report clean.
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