WorldCom initially started its operations as a reseller of long distance services under the name Long Distance Discount Services in 1983 in Hattiesburg, Mississippi. In the year 1985, an early investor Bernard Ebbers (the central figure of the WorldCom scandal) was chosen as its CEO. In 1989, the company did a merger with Advantage companies and the same year it also went public.(Beresford, Katzenbach, & Rogers, 2003)
All over 1990s WorldCom grew at a rapid pace through mergers with over 60 telecommunication companies. (Sutton, 2006). This expansion of the company could be reflected fairly by its reported revenues which increased from a nominal $154 million to $39.2 billion in 2001; placing the organization at 42nd position among Fortune 500 companies.(Lyke & Jickling, 2002). The merger with MCI which valued $37 billion was the biggest merger ever until that time. The merged entity titled as MCI WorldCom turned into the second largest long distance carrier which handled over half of the internet traffic in the US(Sutton, 2006) .
WorldCom, on the road to its expansion, announced a $115 billion merger with Sprint in 2000 but the United States Department of Justice and European regulatory authorities obstructed it because of the probable monopoly that the biggest merger of the history would have resulted in. WorldCom and Sprint, at that time, were the America's second and third largest long distance carriers and had the deal been successful, their combined market share of 36% would have had held a tremendous lead on the other players. Some competitors and regulators were even more concerned about the power and the control that the merged companies would gain over the universal internet traffic. These concerns among the key players and regulatory authorities resulted the obstruction of the merger (Cantwell, 2000)(Assosiates, 2000)
What went wrong at WorldCom?
Many analysts and researches believe that the failure of the merger with sprint, in essence, marked the beginning of decline for WorldCom. A few significant factors contributing to the fraud and eventually the bankruptcy of the organization are discussed as follows.
The growth, peak and recession of the Industry:
A vast range of business entities go through the periodic fluctuations in economic activity such as; growth, peak, recession, trough and recovery. These phases are typically termed as the Business Cycle.("Business Cycle Definition | Investopedia," n.d.)During the early 90s, the internet industry was at its boom which tempted many telecommunication companies including WorldCom to overly estimate the demand projections. These companies consequently rushed into laying the Fiber optic networks and other infrastructure but as the dot-com boom ended with the overall recession in the country, these companies faced unusually large imbalance among the expenses and revenues..(Lyke & Jickling, 2002)
Growth through acquisitions:
Starting from a small reseller just about two decades ago (from the date of its bankruptcy), WorldCom was one of the fastest growing organizations in 1990s. Most of the growth and expansion was mainly a result of numerous acquisitions and mergers which WorldCom did. The strategy of growth through acquisitions primarily depended on the consistent increase in company's stock prices. Although, these acquisitions apparently contributed in inflating the stock prices and surfacincg positive perceptions about the company, but they certainly had their negative impacts too from management's point of view; such as; reconciling with diverse cultures from the acquired organization, standardizing the accounting and business practices among companies, improving customer satisfaction experiences and so on and so forth. Often, a large number of hidden or underestimated costs incur as a result of mergers and acquisitions and shareholders often suffer short ends to the deals in rapid acquisitions.("Bank Director :: The Costly Myth of Growth Through Acquisition," 2004.) . WorldCom underwent more than 60 acquisitions and mergers in the span of ten years and when an organization involves in such a high volume of M&A activity, there is, naturally, a fair chance to forsake due diligence while researching the costs and benefits of the deal. As a result, top management is often tempted to manipulate the financial statements by misreporting expenses and capital expenditures. (Jackson, 2004)
Ebbers Loans from WorldCom to flourish his other businesses:
(Beresford et al., 2003)refers that starting from September, 2004 Compensation Committee advanced a series of loans and guaranties to Ebbers which by the end of first quarter of 2002 had reached about $408 million. These loans and guaranties enabled Ebbers to evade selling the majority of his WorldCom stock as majority of the banks, who had lent him large amounts of money, were demanding to sell the stock to meet the margin calls. Ebbers had also received numerous loans from WorldCom to conduct, invest and flourish his personal businesses (hotels and real estate ventures). This abuse of stockholder's money is one of the prime examples of ethical issues in corporate governance. Although, these loans at that time were considered lawful but subsequently, (partly because of such a big scale abuse by a large organization's CEO) have now been declared illegal by the federal legislation.
2.1; GENERALLY ACCEPTED ACCOUNTING PRINCIPLES BREACHED.
"The special investigative committee of the board of directors of WorldCom" (Beresford et al., 2003) establishes that WorldCom commenced fraud mainly through (1) reporting reduced line costs( a brief explanation to line costs will be presented in the next section) and (2) by reporting increased or inflated revenues. The report has further examined the abnormalities that led to WorldCom' s declaration that it deliberated to republish its financial statements for the years 1999 through 2002, and it also analyzed certain other irregularities by the BOD such as; advancing huge loans to Ebbers to bail him out from his other debts and to manipulate stock prices.
Line Costs:
According to (Beresford et al., 2003)"Line costs are the costs of carrying a voice call or data transmission from its starting point to its ending point". WorldCom upheld its own lines for local service in urban areas and most housing and commercial calls outside the aforementioned regions must run partly via non WorldCom networks such as; local companies. In other words, line costs consist mainly of access fees and transport charges that the WorldCom had to pay other local companies for connecting the line through an outside region of its domain. For instance, when a customer made calls outside the WorldCom's infrastructure areas, the company must had to pay the local companies for carrying portions of the call on its network. Line costs are often the major costs that a telecommunication organization incurs and in case of WorldCom, these costs are the largest single expense. WorldCom faced a major problem with lowering its line costs in its final years and therefore, the cost reduction analysts and the senior management intended to focus on reducing these costs.
Line Cost to Equity Ratio:
Line cost to equity ratio is often considered as one of the most important financial indicators for telecommunication companies and it is for this reason, the top management including Ebbers, Beaumont, and Sullivan, eventually decided to manipulate the numbers of these costs so that the company could reflect a low figure of 42% for this ratio.
(Sutton, 2006) discusses the implications of line cost revenue to expenditure ratio as a vital indicator of performance within the telecom industry. Management at WorldCom continually presented a lower E/R ratio than the other players in the industry. This manipulation of E/R ratio gained an apparent advantage to WorldCom over its competitors in terms of stock prices, investment opportunities and the M& A projects.
On June 25, 2002, WorldCom confessed that the company had misreported over $3.8 billion in payments for line costs as capital expenditures rather than current expenses (The figure eventually reached a stunning approximately $11 billion). Recording these capital expenditures to asset accounts were not in compliance with generally accepted accounting principles ("GAAP" ).(Beresford et al., 2003). Reportedly, $3.055 billion was misstated in 2001 and $797 million in the first quarter of 2002. According to the company, another $14.7 billion in 2001 line costs was treated as a current expense. The company inflated its net income and assets by recording expenses to a capital account as net income increases when expenses are decreased while assets increase if capital costs are treated as investments. This maneuver would have allowed WorldCom to spread its current expenses into the future.
Image source :(Worldcom, Martin, & Ph, n.d.)
Less than one month later from the initial disclosure (on june 25, 2002), WorldCom and considerably each one of its U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code.
Debt to Equity Ratio:
(Elkind, 2008) discusses the debt to equity ratio as it was reflected from the WorldCom financial statements of 2001. The article refers that the total assets for 2001 10-K were shown to be $104 billion whereas the stock holder's equity was indicated to be $58 billion. The debt to equity ratio computed from these figures is 79%. Such a ratio for a telecommunication company looks reasonably decent to investors and other stakeholders. However, about half of the assets ($54 billion) were goodwill and other intangible assets. The total cash account reflected to be about one and a half billion dollars ($1.5 billion). Although, these figures were inflated and manipulated, still the net income was about three times less than the previous year ($4.1 billion).
3.2; THE JUDICIAL PROCESS AND THE TRIAL.
On June 26, 2002, (the very next day to when Wordlcom declared its violation of GAAP) the United States Securities and Exchange Commission ("SEC") filed a lawsuit against Worldcom under caption Securities and Exchange Commission v. WorldCom, Inc.,(Beresford et al., 2003). U.S. Securities and Exchange Commission (SEC) raised the allegations of huge accounting fraud and attained court order barring WorldCom from obliterating financial records, limiting its payments to all executives, and calling for an independent examination.(Lyke & Jickling, 2002)
Reorganization and Acquisition:
(Fraud & Consequences, 2011)WorldCom initiated its reorganization process by undergoing many significant projects, including securing $1.1 billion in loans, employing Michael Capellas as chairman and CEO. WorldCom, further, emphasized on restoring the image of the company by getting rid of those personal of board of directors who were unsuccessful in identifying, analyzing and ultimately preventing the accounting fraud. Furthermore, WorldCom under the new leadership underwent drastic changes on the middle level management by laying off incompetent managers, restructuring the finance and accounting departments, employing transparent policies, standards and practices. To mitigate the future fraud risks and to deliberate its commitment to legal accounting practices the audit department hired new and competent staff who would report, fearlessly( of losing their jobs) and diligently directly to the new board. The company emerged from the bankruptcy proceedings by the end of 2004 and had already changed its title to MCI by 2003. The company was eventually acquired by Verizon in year 2005 as its reputation as an independent entity was still under a question mark and it lacked the confidence from outside investors and stakeholders.
(EDIT)The WorldCom accounting fraud shifted the paradigm for the whole telecommunications industry. As part of their overvaluing strategy, WorldCom had also overestimated the rate of growth in Internet usage, and these estimates became the basis for many decisions made throughout the industry. AT&T, WorldCom/MCI's largest competitor, was also acquired. Over 300,000 telecommunications workers lost their jobs as the telecommunications struggled to stabilize. Many people have blamed the rising number of telecommunication company failures and scandals on neophytes who had no experience in the telecommunication industry. They tried to transform their startups into gigantic full-service providers like AT&T, but in an increasingly competitive industry, it was difficult for so many large companies could survive.
Assosiates, T. law. (2000). International Law Update (p. 116).
Bank Director :: The Costly Myth of Growth Through Acquisition. (n.d.). Retrieved December 10, 2012, from http://www.bankdirector.com/magazine/archives/4th-quarter-2004/the-costly-myth-of-growth-through-acquisition
Beresford, D. R., Katzenbach, N., & Rogers, C. B. (2003). Report of investigation.
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Cantwell, R. (2000, January 22). Worldcom-Sprint merger hits rough waters. interactive week, p. 14.
Elkind, P. (2008). Gary Giroux What Went Wrong ? Accounting Fraud and Lessons from the Recent Scandals. Social Research, 75(4), 1226-1227.
Fraud, A., & Consequences, I. T. S. (2011). WorldCom ' s Bankruptcy Crisis.
Jackson, P. (2004). Worldcom : An Ethical Case Study. Chemistry & …, 1-12. Retrieved from http://onlinelibrary.wiley.com/doi/10.1002/cbdv.200490137/abstract
Lyke, B., & Jickling, M. (2002). CRS Report for Congress.
Sutton, S. G. (2006). Learning from WorldCom : through Continuous Assurance, 3, 61-80.
Worldcom, H., Martin, J. D., & Ph, D. (n.d.). Accounting fraud P a r t I : T h e p r o b l e m s Capitalizing on oldest trick in book Case Study Expert :, 1-14.
2.1; GENERALLY ACCEPTED ACCOUNTING PRINCIPLES BREACHED.
2.2; ROLE OF THE CEO IN THE SCANDAL.
2.3; THE ROLE OF THE CFO'S IN THE FRAUD.
3.1; INVESTIGATION BY THE FBI AND SEC
3.2; THE JUDICIAL PROCESS AND THE TRIAL.
3.3; THE VERDICT.
4.1; THE ROAD TO RECOVERY.
4.2; PRESENT STATE OF AFFAIRS AT HEALTHSOUTH.
5.1; PREVENTING UNETHICAL BEHAVIOR IN THE WORKPLACE.
6.1; CONCLUSION
