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 ...view middle of the document...
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 them go along with the fraudulent practices for many years. For example, Cynthia Cooper, head of the internal audit department, grew up in the same town as WorldCom’s accounting headquarters and had personal relationships with family members of senior employees. Thus, Cooper had the incentive to go along with accounting fraud to continue making a large salary and to not ruin personal relationships.
Arthur Anderson, the outside auditor, also had many incentives that prevented the auditing company from reporting WorldCom’s suspicious actions. Anderson considered WorldCom its most “highly coveted” and “flagship” client, and wanted to maintain a long term relationship with WorldCom. With these goals in mind, Anderson ignored WorldCom’s many denials for pertinent financial information and meetings and continued to audit WorldCom at a “moderate-risk” level, instead of a “maximum risk” level which Anderson’s risk management software program rated WorldCom as.
Finally, the board...