1) What Pressures Led the Executives and Managers to "Cook the Books"?
Slowing down of the revenue growth and the falling of stock prices in 1990 was one of the significant issues which forced WorldCom to 'cook the books.' Following a successful rapid evolution of the telecommunication industry in 1990,s, WorldCom changed its strategy to concentrate on building revenues and acquiring capacity sufficient to handle adequate growth (Hadzir, 2017). Their main goal was to be the number one stock on Wall Street rather than capturing the market share. As a result, their expense to revenue ratio was their measurement for their main goal which was to increase revenues and become the number one stock on Wall Street. However, due to the heightened competition; overcapacity and reduced demand for telecommunication services owing to the economic recession gave the company intense pressure to increase its revenue. The CEO, Ebbers, demanded the employees to increase the revenue since it was keyed to increasing the company's market value (Hadzir, 2017). This led to the need of the managers and executive to show an increase in the revenues hence entering false revenue figures.
Another main reason leading to the cooking of figures was that their interests also surrounded the lead executives. Maintaining their good position, good name in the company and getting a good salary being at the top of their priorities list made them tolerate the company's current position. Illuminating the actual company performance would mean their downfall as well. They, therefore, ended up covering the company's real performance by exaggerating figures in the books. In the onset of 2000, WorldCom was having returns pricing and it is extremely dedicated line costs pressures making it hard to keep up an E/R ratio of about 42% which led to Ebbers moving speech about how he and the other directors would lose everything if the company didn't show good performance (Hadzir, 2017). From the standpoint of the managers and other executives, if the company did not improve they would lose the employee reimbursement that they had received due to WorldCom great performance, hence they opted to engage in fraud rather than lose their jobs.
Ensuring that the investors wanted to stay vested and that the principal shareholders kept on trusting the company and kept on investing, and also ensuring that new investors were being attracted was another main pressure which forced the executives into committing fraud. This was of so much importance because the investors trust greatly depended on the company's exemplary performance. No shareholder wants to remain vested in a business that is not making much profit. If the performance indicator showed that the company was not doing well, this would have led to the investors withdrawing their investment hence affecting the company's stock prices (Hadzir, 2017). The executives and managers hence cooked the books to portray a well-performing company and therefore maintain its financiers. In conclusion, the economic depression and the consequences of the dot-com bubble fall which caused the deterioration of the companies conditions. Besides the managers and executives prioritized their needs instead of those of the company and the general pressure to maintain their current financiers and attracted new investors were among the leading pressures which led to the cooking of books by WorldCom leaders.
2) What is the Boundary Between Earnings Smoothing or Earnings Management and Fraudulent Reporting?
The Earnings Management or the Earnings Soothing concerns the use of accounting methods to produce financial results. Such results may prove a slightly positive picture of a company's business actions and fiscal position which is considered normal for the company. It is not considered an illegal act but if the earnings management involves substance and deliberate misrepresentation, then the action does become unlawful, and fines may be issued by the SEC (Hadzir, 2017). Income soothing is the decrease of the variance in episodic earnings overtime to the point permissible by accounting and management principals. Smoothing earnings leads to reduced net income fluctuations from one period to the next. Most companies perform this because of the shareholder that that prefers to get premium paid for stocks that are steady in their earnings. Earnings smoothing can mainly be about three things which include the acknowledgment of one-time items, altering the accounting methods and accelerating returns to bring about preferred short term earnings results. The main benefits of income smoothing comprise of reducing the predictable risks of a business, maximizing the company's riches, enhancing the companies value and plummeting tax and political costs (Hadzir, 2017).
On the other hand, fraudulent reporting is the purposeful action of issuing deceptive financial statements in an attempt to evade unhelpful impacts on the financial constancy of a company. The law does not lawfully accept fraudulent reporting since it involves the management manipulating or leaving out critical financial figures and information to the public. These omitted or manipulated figures can drastically change the stock prices of a company. A company that is caught committing fraudulent reporting faces substantial penalties. Not only will the company executives be facing actual jail time, but they are also expected to pay huge fines and compensate their shareholders (Hadzir, 2017). While earnings smoothing is the non-illegal managerial use of discretion to influence reported earnings and has several benefits like enabling the company to make its revenues relatively stable, fraudulent reporting is deliberately hiding and misreporting the actual company's financial figures and information.
As from the case, we can see that the company was not doing income smoothing but were as an alternative was doing fraudulent reporting. The leading authoritative figures such as Scott Sullivan were forcing the subordinates to cook the book figures to show a positive and maintained performance for the sake of maintaining its shareholders and protecting their benefits. For example, they released a total of 3.3 billion dollars all through the year 1999 to 2000 (Hadzir, 2017). Then, instead of recognizing the unexploited surplus network capacity as an expense, it capitalized it and identified it as an asset. The differences between income smoothing and fraudulent reporting are thin. Both actions are misleading the investors and creditors as they make their decisions since they rely on the company's financial information.
3. (a) Why Were the Actions Taken by WorldCom Managers not Detected Earlier?
There are several reasons that actions taken by WorldCom officials were not detected early enough. These factors can be divided into internal and external factors.
Internal Factors. The persons involved in fraud were mostly the ones holding the topmost positions in the company. Top management is crucial in any company. They manage the company, make the most important of decisions, supervise the employees and generally ensure the smooth running of the business. Looking at WorldCom, the people involved in the cooking of books were the top authoritative figures. This meant that they could be able to effectively manipulate their power to ensure that their unlawful actions are not opened up to the public (Hadzir, 2017). Also, this meant that the employees had limited channels to report to. The mindset of the employees was to follow instructions and mind their own business.
Secondly, the business culture itself did not push the employees to come forward and voice out their varied opinions. They were taught to merely listen to their superiors and do what they were asked to do by those above in the command chain. There lacked official written policies and code of conduct. Most employees preferred to remain silent to earn favor from their supervisors (Hadzir, 2017). In addition to this, the operation in every department was not coordinated. There was a lack of proper communication between the various departments. Communication is vital since it eases the exchange of information, acquiring new updates and making of important decisions.
External factors. The external auditor, Arthur Anderson, also had many incentives that prohibited the auditing company from reporting WorldCom's suspicious actions. Arthur had carried out various kinds of audit on WorldCom, starting from the old fashioned way until more refined and competent audit procedures. His is considered the most 'highly coveted' client made him want to uphold a long term association with WorldCom (Hadzir, 2017). With these aims in mind, Anderson ignored WorldCom's many denials for relevant financial information and meetings. He went on to audit at a 'modest risk' level instead of an 'utmost risk level' Anderson's blinded auditing and the fact that the board of directors had too little relations with WorldCom to recognize the fraudulent practices which were taking place made it hard for them to be detected earlier.
3. (b) What Processes or Systems Should be in Place to Prevent or Detect Quickly the Type of Actions that Occurred in WorldCom?
Enhancing the code of corporate governance in the company is the leading recommendation. The corporate culture should encourage the employees to stand up and voice out their opinions on anything that they regard essential. This was one of the main issues which contributed to the fraud activities at WorldCom not being detected earlier. If the employees were given a chance to be heard, this would neutralize the power held by persons in the top leadership making it challenging to practice fraudulent reporting since it would encourage transparency within all the workers of different levels and different departments (Hadzir, 2017).
There should also be open and luminous dealings with the external auditor which will automatically reflect the critical role they play in ensuring that a company makes the right choices. If the auditor is in a compromising situation which does not allow him or her to reveal the real conditions of the company, then the auditor's role will diminish as they will analyze the wrong results. It is very wrong of the auditor to know well that the company is in a high-risk position and still not report it to the relevant authorities.
Some of the measures that should be put in place to ensure reduced fraud activities of a firm include enhancing the code of corporate governance, providing open and luminous dealings with the external auditors. Other measures include improving the communication between employees of different levels and different departments and ensuring that the top authority of the company is comprised of people who put the company's survival needs before their own.
Hadzir, H. (2017). CASE 3: Accounting Fraud at WolrdCom BKAL 3063 Integrated Case Study 0 Table of Contents (Undergraduate). Northern University of Malaysia.
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