The Bankruptcy of Lehman Brothers

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THE BANKRUPTCY OF LEHMAN BROTHERS

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The Bankruptcy of Lehman Brothers: Causes of Failure & Recommendations Going Forward

Amirsaleh Azadinamin

Doctorate of Finance Candidate

March 6, 2012

Electronic copy available at: http://ssrn.com/abstract=2016892

THE BANKRUPTCY OF LEHMAN BROTHERS Abstract This paper looks at the failure of Lehman Brothers as the biggest bankruptcy case in the US history and the events that followed. The first part of the paper reviews factors that led to the failure and consequently the bankruptcy event. Some of the causes leading to the crisis, namely the market for Credit Default Swaps (CDOs), misrepresentation of financial statement, complex structure of the company, low standards, and unethical behavior of top managers are reviewed in the paper as the essential causes. In misrepresentation of financial statements there is an extra emphasis on the misuse of the Repo 105 procedure and how Lehman used it to make its financial statements appear healthier than what they were in actuality. Many also suggest that the misrepresentation by the top managers also violated the Sarbanes-Oxley Act. The second part of the paper reviews whether the failure could have been prevented before the crisis was spiraled out of control with devastating consequences. Numerous analyses and their conclusion suggest that there were many signs suggesting the coming of a crisis, but numerous people, whether analyst, auditors, or even employees, failed to recognize them or deliberately turned a blind eye to the warning signs. The most prominent sign is mentioned as the net negative cash flows that Lehman was running three years prior to the crisis despite healthy looking balance

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sheets as well as income statements. The last part of the paper offers solutions for going forward and ways to avoid another failure of a giant financial institution. As for solutions going forward, paper recommends companies to abandon dubious and wrongful accounting practices in order to attain unattainable targets as well as using new methods to assess the health of the organization.

Electronic copy available at: http://ssrn.com/abstract=2016892

THE BANKRUPTCY OF LEHMAN BROTHERS The Biggest Bankruptcy in the US History The failure of Lehman Brothers in 2008 was the largest case of bankruptcy in US history. But the failure was the beginning of a series of events that were yet to be unfolded. The news and negative effects of the bankruptcy rippled through the market. The Dow Jones

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Industrial Average declined by more than 500 points by the end of the trading session of the day (Mamun & Johnson, 2012). Tremendous research has been done on the failure of Lehman Brothers including the causes of failures and whether it could have been prevented. A devastating report in March 2010 “recounted in minute detail the practices carried out by Lehman Brothers, an institution founded in 1850 that declared bankruptcy on September 15, 2008. Notably, the executives were accused of “gross negligence” in their duty of disclosure” (Morin & Muax, 2011, p. 38). This also sheds light on unethical practices that were either directly exercised by top managers or were supervised under their watch. Also, many blame accounting standards and techniques and how they are used to portray financial statements as not what they are, but how management wants them to portray. These practices leave open windows of opportunities for those whose intentions are to misuse their position, whether it is for personal reasons or short-term gains of the organization. In case of the Lehman it seems that it was more of the latter. Lehman failed to disclose various transactions in the notes to their financial statements. This may be due to negligence of accountants and auditors that leads many to argue for the reexamination of Generally Accepted Accounting Standards (Jeffers, 2010). Many also blame the techniques that are currently used to predict firms’...
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