The paper discusses the WorldCom accounting fraud case in detail. The author employs psychological concepts in order to evaluate the reasons for the decisions of the cases participants. Moreover, the research defines the companys accounting fraud influence on the WorldCom shareholders and society, in general. The ethical judgment of the perpetrators of the incident is also an object of the researchers interest. The study uses the method of psychological concepts with the aim to define the motive and conditions, which made participants collude in a fraudulent plan. The analysis of the case circumstances provides an author with the information about the intentions and rationale behind the actions of people involved in the case. The key result of the study is the definition of measures, which can allow companies to organize their working process in the way that avoids the possibility of mistakes, similar to the WorldCom crisis. The author summarizes reasons for the negative situation development and gives his recommendations for the avoidance of such issues in the future.
Keywords: accounting fraud, fairness principles, corporate social responsibility
Accounting Fraud at WorldCom Case Study
Summary of the Situation
WorldCom, one of the biggest U.S. companies in the sphere of telecommunications, was prosecuted on charges of the accounting fraud. The WorldCom Company, which had achieved the international fame owed to the acquisition of a large number of well-known companies in the US and abroad, had made a significant progress before the recession in the telecommunication industry, which took place in the early 2000s. In the 1990s, the WorldCom was rapidly growing and developing a competitive advantage by swallowing the leading players in the telecommunications market. The corporate strategy of the company demanded a complete submission of the personnel to the management requirements, as well as the maximum suppression of any initiatives of employees in matters that related to the key management decisions. At the same time, the absence of a written policy led to the disruption of the companys regulation as a whole and the independence of each unit. The ambition of the companys leaders was to maximize the revenues despite the possibility of future problems, including some issues with the law.
The enterprise management was concentrated in the hands of a few individuals; the board of directors played a purely formal role and was not responsible for the current and strategic business management. The WorldCom external auditing firm, Arthur Anderson, was seriously concerned about the preservation of the partnership with the WorldCom. Therefore, it often went to meet it in the matters of accounting and financial control and turned a blind eye to obvious drawbacks and the limited access to the companys financial information.
The accounting fraud, which was disclosed in the first quarter of 2002, was a result of the WorldCom executives intention to distort the performance of the company profitability. Chief Executive Officer, Bernard Ebbers, Chief Financial Officer, Scott Sullivan, and Controller, David Myers, were the key players in the fraudulent collusion. According to Tran (2002), WorldCom’s chief executive, John Sidgmore, blamed the company’s former chief financial officer, Scott Sullivan, and the former controller, David Myers. The two were fired for claiming $3.8bn in regular expenses as the capital investment in 2001. Ebbers and Sullivan made a decision about the funds transferred between items of expenditure statements to raise revenue and passed instructions to their subordinates: Betty Vinson and Troy Normand. Myers monitored the fulfillment of the requirements provided by the authorities.
WorldCom key stakeholders included the earlier acquired companies, the companys top management, and the WorldCom external auditing firm, Arthur Anderson, which achieved significant profits from this cooperation. Among other stakeholders, there were enterprises employees, commercial partners, and investors. Ebbers used his personal WorldCom stock in order to secure commercial bank loans that were directed to the development of other businesses, which he owned.
In order to estimate the contribution of each player to the accounting fraud in WorldCom, the consideration of their actions from the point of ethical correctness is necessary. The discussion of frauds effect on stakeholders and environment is required for the evaluation of the degree of the top management guilt.
First of all, while implementing the enforced scheme of accounting fraud, the WorldCom management violated the principles of the Corporate Social Responsibility (CSR). Ultimately, the violation of their fiduciary duties by Ebbers and Sullivan led to the collapse of the enterprise, as well as the infringement of stakeholders interests. For Ebbers, the violation acquired the form of the conflict of interests. Since the man used the reputation of WorldCom to support his other business, the fraud was important to him despite its adverse effect on the company itself. In this case, he acted in contrary to the duty of providing care and loyalty. The same violation of ethical principles was present in Sullivans decisions. Besides, the violation of top management operational responsibilities also had a negative effect on the company and its stakeholders. Under circumstances of the low freedom of action for employees, managers have created the situation of the low effectiveness of the business, which led to the accounting fraud in the end.
The effect of the accounting fraud on the companys stakeholders was extremely negative. Though it could provide certain advantages for some of them, the duration of this effect would be short enough. Since the management decided to distort the financial results for once, it would be forced to resort to this procedure again in the future. Thus, the positive influence of accounting fraud disappeared in the short term, and all the concerned parties faced the negative impact of administrative errors.
The bankruptcy of WorldCom shocked the whole telecommunication industry in the US by creating problems to branches of the economy, which were connected with the companys activities and society as a whole. The disappearance of the major player in the telecommunication market led to a decrease in the number of services offered to consumers and a general deterioration of the market. According to Romero and Atlas (2002), WorldCom’s collapse has already reverberated through jittery financial markets, and is likely to be felt in the wider economy, with banks, suppliers and other telephone companies devising strategies to contain their exposure.
Companys shareholders, investors, and employees also suffered difficult consequences of the disclosure of the fraud. The artificial overvaluation of profitability led to false expectations of shareholders and investors and the loss of their means. The violence of the fair treatment of the customers principle caused investors considerable losses. According to Romero and Atlas (2002), Shareholders, who owned what was once one of the world’s most valuable companies, worth more than $100 billion at its peak, are expected to be virtually wiped out. For employees, the fraud resulted in the loss of jobs and pensions.
If one considers the question of the enterprises social responsibility to stakeholders and society, the estimation of the environment effect on business is needed. It means that while trying to decide whether the company should be guided by interests of stakeholders only or the society as a whole, the manager should take into account the outcomes of the environment for the business. It is no doubt that securing stakeholders interests is necessary in order to ensure an efficient operation of the enterprise. Without taking care of investors and employees, the management will lose resources for the business development. Nevertheless, the society as a whole is also crucial. The business should take into account the interests of the society, as Mackey offers; otherwise, an increase in the profitability by itself will lead to the development of the society as Friedman claims. The discussion concerning the countries and companies experience in economic development shows that the rapid growth of profitability does not always cause an improvement in the societys quality and characteristics. The business should be interested not only in the revenues growth but also in the development of the community since this condition gives rise to incentives for the to-be business development. By taking care of the interests of the society today, the business enforces own interests in the future. It is reflected in the improvement of the employees intellectual capital and private characteristics, as well as some positive changes in the business environment that create possibilities for the companies growth.
The determination of reasons, which led to the occurrence of the accounting fraud in WorldCom, is very useful from the standpoint of their possible elimination and avoidance in the future. It may involve a tool of psychological concepts in the behavior analysis. The evaluation of each actors behavior in the case of WorldCom can help other companies use its negative experience and improve their organization rules.
In the case of WorldCom, the analysis of each participant of the fraudulent collusion, as well as his/her motivation and intended purpose is needed. For the companys top management, psychological biases were figured out to be among the main reasons for the fraud commitment. As soon as Ebbers and Sullivan aimed at the continuous improvement of the enterprise profitability, even at the expense of the companys long-term interests, the presence of barriers to the growth created an internal psychological conflict, which required an appropriate solution. In this situation, old-fashion tools for the growth stimulation, for example, the acquisition of promising companies in the market, were no more useful. Thus, the industry faced an inevitable decline, and the implementation of the accounting fraud seemed to be the only easy measure for solving the problem. In this case, the confirmation bias and self-serving bias ensured the leadership in the correctness of their actions and the absence of negative consequences in the future. Despite the wrong and illegal nature of their decisions, the WorldCom managers were sure in their rightness, because it provided them with the desired result. According to the article What Went Wrong at WorldCom? (2002), The company felt that treating the line costs as capital expenditures was somehow correct despite the rules, as Sullivan claimed.
The mistake of the management was multiplied by the fact that the expert opinion in the field of accounting did not meet their interest. In this case, the violation of the procedural justice principle led to the deterioration of the companys situation as a whole. At the same time, the violation of the distribution justice principle contributed to the low level of personnels interest in the real development of the company. Instead, employees were motivated to create the illusion of the company’s stability for the management because, in this case, they were given an opportunity to increase their salary.
However, not all the personnel had the same opinion about the facts of the fraud. Betty Vinson, senior manager in General Accounting, and Troy Normand were shocked by their bosss requirement of the fraudulent manipulations in the account. Both refused to comply with the demand of the chief. Nevertheless, when Yates emphasized the fact that the command came directly from the top management, they agreed to carry it out. In this case, the social influence aspect of the desire to be accepted affected the decision of the two employees. Despite both Vinson and Normand understood the illegal nature of the request, they did not manage to refuse it for the fear of losing the top managements favor. Later, they have regretted their choice and decided to resign. Later, Sullivan had a talk with them and assured them that their actions were legal, and he was taking all the responsibility for himself. As a result, the two continued working. In this case, the desire to be accurate affected Vinson and Normands decision. In the situation of crisis, both of them preferred to rely on the authority of Sullivan and agreed to cooperate.
Since the top management and personnel were encouraged to engage in an accounting fraud, the only agent that could prevent the negative consequences for WorldCom was Arthur Anderson. Taking into account its powers, it could point to the accounting shortcomings and bring the situation back to normal. Nevertheless, for Arthur Anderson, it did not happen. There is a list of reasons for such a reaction of the auditor. First of all, the psychological attachment to WorldCom determined its desire to please the client and not to be fired. However, the main reason for such actions of the auditor was the psychological familiarity. If an auditor finds out that his decision can cause harm to a client or investors, he prefers to do harm to investor and apply wrong accounting results. In this case, he does not lose his main objective clients payment.
Ethical Systems Design
After the definition of the reasons that affected the occurrence of the accounting fraud situation in WorldCom, the discussion of measures aimed at the prevention of these phenomena in the future is important for such businesses.
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First of all, the companys management should not have underestimated the importance of the correct definition of corporate values. These values not only affect the companys strategy but also determine the choice of measures of the goals achievement. For WorldCom, the primary corporate value was reaching a high level of revenue despite any negative consequences. In the case when the management sets more adequate targets, containing not only a condition for improving the profitability but also the condition of securing stakeholders interests and the rule of law, the choice of measures is more efficient. Thus, the selection of the relevant and efficient corporate values is the key condition of the companys successful development and the avoidance of any issues, similar to the WorldCom problem.
The next step that helps in minimizing the fraud risk is the implementation of the fairness principles in the enterprise. It includes the realization of the distribution and procedural justice. As a result, the implementation of these principles allows personnel to affect not only the results of their own work but also the managers decision. When an employee can tell leaders about his or her concerns and ideas, the solution of the enterprises issues can be easier. For WorldCom, the absence of the procedural justice might have had fatal consequences. It is entirely possible that the lower management had some ideas about the WorldComs development. However, without the right to speak their thoughts, they could not pass them to the leaders. The implementation of the distribution justice provides motivation for personnel to improve its working results. When employees see that their salary depends on their performance and not on the ability to satisfy desires of the management, they develop incentives for the professional growth and development.
The changes in the corporate culture are also necessary in order to avoid WorldComs mistakes. One of the reasons for the companys crisis was the personnels fear of authority and a desire to please the top management. In the modern world, a desire for the maximum autonomy of management in decision-making is popular. Indeed, when the management of lower levels experiences no excessive pressure and enjoys a certain freedom of choice in their field of action, it is easier to navigate and find creative methods for solving management problems. For WorldCom, if this principle had been implemented, the Vinson and Normand would not have been crushed by the leaders authority. They would not have committed mistakes of accounting fraud and might have even offered the management a better way out.
For the audit quality improvement, the realization of the procedural justice increases the effectiveness of internal audit. The audit personnel can clearly reflect the current situation to the top management and not to be afraid of negative news. For the external audit, the company must be interested in the cooperation with the most objective enterprises and estimate the level of their desire to advance in order to meet the most optimistic expectations of the management. If auditor shows familiarity, he must be fired, and a more objective partner should be found. In this case, the right audit of companys accounting could have been provided.
All of these measures should help contemporary businesses increase their results and avoid negative experience of WorldCom. These means could have also been used by the WorldComs management in order to save the company. As one can note, the implementation of the fairness principles is the key factor in the contemporary business success.