Fiasco Report

WorldCom

Founded in 1983 in Mississippi Bernard Ebbers appointed CEO in 1985 Company went public through merger with Advantage

Companies Inc. in 1989

“To be the most profitable, single-source provider of communication services to customers around the world” 1998 Mission Statement

Growth Through Acquisitions

Aggressive growth through acquisitions strategy Between 1991 & 1997 completed roughly 65

acquisitions worth over $60 Billion However, accumulated $40 Billion in debt

Ebbers was able to take stock price from pennies per share to well over $60 per share by 1997

Beginning of the end

Financed acquisitions mainly through shares of soaring WorldCom stock Bull Market of late 1990’s Wall Street had an extremely positive opinion

On the inside, an inconsistent M&A strategy was starting to crumble the company I.E. Customers calling for help being told that they weren’t

customers

Results Controls

WorldCom’s top management was rewarded primarily based on the firm’s stock performance, representing a result control to align the interests of top management with the company itself

Cultural Controls

WorldCom’s corporate culture was focused on “teamwork” and encouraged employees to be a strong “team player” with the purpose of reducing dissenting opinions

WorldCom’s mission statement of “Our objective is to be the most profitable, single-source provider of communication services to customers around the world” was used to shape their culture

Personnel Controls

Decision making was centralized to top management resulting in a personnel control

8 of the 11 board of directors were considered independent

Action Controls

WorldCom’s audit committee consisted of 4 people

Stock option compensation for senior management

Top management provided revenue and earnings growth guidance to capital market investors

Missing Controls

Lack of controls prohibiting top management from collateralizing their stock holdings for personal finance purpose

Lack of a financial decision control mechanism to object any unrealistic decisions made by the CEO

Missing Controls

Lack of controls prohibiting personal financial dealings between top management and board of directors

Lack of controls enforcing regular audit committee meetings and accounting system learning

Lack of controls between the equity research function and investment banking function

Missing Controls

The existing control system was not comprehensive enough and was lacking some necessary controls

There needs to be a combination of action, result, and people controls in place in order to supplement each other and avoid “side effects” from a specific control

Fall of WorldCom

Can be described in three parts:1. Corporate strategy of acquisition without

integration2. The use of loans to executives3. the threats to corporate governance based on the

friendliness of the executives and lack of “at-arm’s-length” dealings

Corporate strategy of acquisition without

integration Over 6 years spent $60 billion on 65 companies

amassing $41 billion in debt WorldCom used a liberal approach to accounting:

From the acquired companies they would capitalize operating expenses, recognize all the revenue thus gaining profits from the acquisition to boost share price

This came to an end when the US government blocked the massive acquisition of Sprint and so they had to “cook” the books even further

“Sweetheart” Loans to Executives

Bernie Ebbers had a passion for creating enterprise and so create other companies besides WorldCom.

He levered his share in WorldCom stock to build these companies.

The stock began to drop and so the bank required Bernie to put up for a margin call, essentially to cover what was lost

Didn’t have enough in personal assets and the board did not want him selling his shares dropping the share price even lower.

Authorized $341 million in loans to Bernie

Conflicting Interests

At the time there was no legislation in place that strictly enforced the impartiality of analysts Jack Grubman was the key telecom analyst and seen as a top player on

Wall Street

At the time, his intimate relationship with WorldCom execs was seen as good relationship management

Additional complications arose with the oft-maligned accounting firm Arthur Andersen

Discovery of the Fraud

Internal audit department head Cynthia Cooper received complaints of bad debt accounting being taken from business segments

The audit team began working late at night so as not to be noticed by executives

Only through backdoor access to the system were the improperly capitalized items discovered

The discoveries were reported to newly appointed audit firm KPMG and on June 25th, 2002 WorldCom announced their earnings inflation

Recommendation

Because of the WorldCom fiasco, along with what happened at Enron, Tyco and others the Sarbanes-Oxley Act was enacted to help shield against fiascos from happening again.

Some key points from that include Accountability of executives Protection for whistle blowers Shield against analysts conflict of interest

Recommendation

Some additions to the act that we thought would be beneficial: A more morally centered mission statement to give

employees a moral sense in the company Teamwork that is more focused on ethics through

Team charter Sense of community

Deliberate role modeling giving new employees a sense of the values of the organization, which would have been laid out

Thank You