Accounting Fraud at WorldCom
1) What are the pressures that lead executives and managers to “cook the books?”
After the rapid evolution of the telecommunication industry in the 1990s, WorldCom shifted its strategy to focus on building revenues and acquiring capacity sufficient to handle expected growth. Their biggest goal was to be the No. 1 stock on Wall Street rather than capturing the market share. As a result, their Expense-to-Revenue (E/R) Ratio was their measurement for their main objective (increase revenues and become the No. 1 stock on Wall Street).
Due to heightened competition, overcapacity and the reduced demand for telecommunication services at the onset of the economic recession and the aftermath of the dot-com bubble collapse, the telecommunication industry conditions began to deteriorate. Prices were falling and WorldCom had no option but to cut their prices as well. This action placed severe pressure on WorldCom’s most important measurement, the E/R ratio.
The E/R ratio was being affected due to revenue and pricing pressures while the committed line cost was still the same.
2) Is there a boundary between earnings management and fraudulent reporting? If so, what is it?
“Earnings Management is recognized as attempts by management to influence or manipulate reported earnings by using specific accounting methods (or changing methods), recognizing one-time non-recurring items, deferring or accelerating expense or revenue transactions, or using other methods designed to influence short-term earnings” (Akers).
We do not see any boundaries between earnings management and fraudulent reporting. Both actions will prevent the seeker-of-information (investors, Government … etc) from receiving consistent and non-tampered-with results. To use an analogy, murdering someone with a knife (earning management) or a gun (fraudulent reporting) does not add any substantial difference to the final situation; at the end of the day you have committed a murder.
Both earnings management and fraudulent reporting will alter either existing data or the way the existing data is portrayed.
3.1) Why were the actions taken by WorldCom managers not detected earlier?
The fraudulent actions taken by WorldCom managers were not detected earlier because of WorldCom’s organizational structure and distant relations with both WorldCom’s external auditor and Board of Directors. First, WorldCom’s departments were spread out across the country (The finance department in Mississippi, the network operations headquarters in Texas, human relations in Florida, and legal department in D.C.) made it difficult for the different departments to fully coordinate and realize what was occurring in each department. Furthermore, each department had its own rules and management style, making the entire WorldCom operations uncoordinated. This organizational setup would make it easier for accounting fraud not to be detected by different departments.
Second, WorldCom, headed by CEO Bernie Ebbers, encouraged a corporate culture that “employees should not question their superiors, but simply do what they were told.” Thus, when financial times were difficult, subordinate employees were ordered to maintain World Com’s 42% Expense to Revenue ratio, and accounting managers were ordered to release accruals that were too high. The managers had incentives to do so in order to continue receiving high compensation and to avoid personal criticisms or threats that were commonplace to employees who did not obey orders. In later years, starting in 2001, staff members were ordered to treat costs of excess network capacity as capital expenditures, instead of operating costs.
Third, Ebbers and Sullivan granted compensation and bonuses beyond the company’s approved salary rate, creating an incentive for employees to go along with the fraud even if they detected it. The staff in the accounting department especially had personal ties to WorldCom, which made...
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