Assignment on WorldCom
Overview:
WorldCom Inc. origins can be traced back to 1983 when it was formed with the breakup of AT&T and it enabled small, regional companies gain access to AT&T’s long-distance phone lines at deeply discounted rates. LLDS (Long Distance Discount Services) provided services to those regions where well-established companies, such as MCI and Sprint, had very little presence. At an early stage of the company, Bernard J. Ebbers, was given the charge to run the show. He firmly believed in inorganic growth and focused company’s strategy on acquisitions. Acquiring small long-distance companies with limited geographic service areas and consolidating third-tier long distance careers with large market shares delivered economies of scale, which were critical in the crowded long-distance reselling market. As shown in Exibit-1 of the case the company made numerous acquisitions, which helped them grow not only across the America but also expand internationally in Europe and Latin America. Throughout the 1990s the telecommunications industry grew, giving WorldCom a greater market share. By 1998, WorldCom had become a full-service telecommunications company, able to provide services to virtually any size of business with a full complement of telecom services. Its integrated service packages and Internet strengths gave them substantial competitive advantage. After its unsuccessful attempt to acquire Sprint in 1999, due to regulatory hurdles, WorldCom began drifting as Ebbers lacked strategic sense and he knew that acquisitions were not anymore a viable means of growth. Telecom market was becoming more and more competitive, revenues were falling, profits margins were depleting, and it was becoming increasingly difficult to sustain in the current market scenario.

Company Culture: * Autocratic style of management and followed a top down approach (No one questions top management). * Numerous acquisitions led to a mishmash of people and cultures; No unified culture in place. * Post merger integration focused only on physical networks rather than on full integration of departments such as, accounting, billing, sales, human resources, legal, etc. * Ebbers created a culture were legal function was not influential. * Ebbers believed that any internal effort to create a corporate code of conduct was “colossal waste of time”. * Selected and presumably loyal employees (especially in the finance, accounting and investors relations department) were granted special compensations and no one ever objected. * Working atmosphere for sub-ordinates was unhealthy, discouraging and non-cooperative.
Corporate Governance: * Board of directors blindly believed top management, never met outside board meetings, never scrutinized company accounts reports and never gave employees opportunity to raise concerns directly to them. * Internal audit was rendered powerless and it reported directly to Scott Sullivan. Conducted operational audits and financial audits conducted by Arthur Anderson (independent auditor, reported directly to board of directors on reliability and integrity of reported financial reports). * Many senior executives, including Ebbers took private finances and debt on company stocks. Board approved loans to Ebbers without any collateral or knowledge of use of those funds. * No vertical transparency and no horizontal synchronization. * Extreme pressure to maintain the targeted E/R ratio of 42%. * Do whatever it takes to increase revenues and be no. 1 stock on Wall Street.

The Fraud:
As business operations continued to decline, company started facing revenue and pricing pressures and struggled with its high committed line costs. This led CFO Sullivan to use accounting entries to achieve targeted performance. Sullivan and his staff used two main accounting tactics:
1.> Accrual Releases in 1999 and 2000 * Ideal method: According to the accepted accounting principles company had to estimate the line costs, and match these expected payments (expenses) with revenues in the income statement. As cash was not paid initially the offsetting entry was an accounting accrual to a liability account for future payment. When cash was used to pay the bills it reduced the liability and if bills came lower the company reverse accruals to the income statement as a reduction in line expenses. * Actual method adopted: Improper analysis was done to estimate line costs and they were deemed too high relative to future cash payments. Thus Sullivan asked senior managers in each department to release large amounts of overaccruals without apparent analysis. From 1999 to 2000, WorldCom released almost $3.3bn worth of accruals and businesses were left with amounts below actual amounts they would have to pay when the bills arrived in the next period.
2.> Capitalization of line costs in 2001 and 2002. * Ideal method: According to the accepted accounting principles excess network capacity should be identified as operating cost and no guidelines were given to treat them as capex. * Actual method adopted: By 2001 there were very few accruals left to exploit and achieve target performance. Sullivan devised a solution by identifying excess network capacity and treating them as capex rather than operating costs. $771mn of non-revenue-generating line expenses were capitalized into an asset account, “construction in progress”.
Similar, recurring measures, to cook the books by releases and capitalizations, were taken by the company. WorldCom reported $4.1bn of line costs and capex that included $544 in capitalized line costs. This helped them to report $9.8bn in revenues (even though the industry all together was reporting massive losses) to achieve E/R ratio of 42%, which ideally would have been 50%. All the three elements of the fraud triangle model (Pressure, Opportunity and Rationalization) existed in the case of WorldCom that led to late detection of the fraud committed.

Betty Vinson, Consequentialist: * Joined in 1996 as a manager. Hard working, loyal employee who would do “anything you told her”. * She was incentivized for her loyalty and hard work and was soon promoted to senior manager. * Initially when she was told to release $828mn of line accruals to income statement, she raised concerns and commented that the proposal “not good accounting”. But her loyalty (integrated with the flawed company culture and corporate governance) and the fact that her boss (Yates) assured her it was a one-time thing, she agreed to make the transfer. However once results were published, she realized her mistake and wanted to do the right thing, hence offered to resign out of guilt. * She had blind faith in the top management, especially Sullivan (“whiz kid” reputation”), and when assured by Sullivan that there was nothing illegal and the situation was temporary, she rested her doubts about the fraud and decided not to resign. Also she was assured that she wouldn’t be accountable for her wrongdoing. * Other two important factors that made her go with the fraud were family pressure (financial support for her family) and difficulty to find an alternative to the current high paying job. * However similar releases requests kept on coming again and again and she made the transfers thinking this would be the last. Though she felt guilty and trapped in the situation she still kept on making the changes, given her personal and professional obligations. Betty acted as a consequentialist in her decision making process. She was driven more by the outcome rather than doing the right thing. Finally when she understood that she was stuck in a death spiral, she decided not to go ahead with such requests. However she was given a promotion to director and a hefty raise for her work, which led her to continue supporting the fraud till it was too late to back out.

Cynthia Cooper, The Whistle-blower: * Worked in WorldCom since 1998 as Director of Internal Audit. * She was a deontological decision maker and was more inclined to do the right thing no matter what the consequences might be. When she discovered $2.3bn of capex as opposed to $174mn through her operational audit she raised concerns. Eventually she started getting complains on illegal transfers and asked for explanation from Anderson who told her that orders to do the transfers came directly from Sullivan. She exposed the fraud in front of the audit committee but faced a lot of challenges from Sullivan. However driven by morals and pushed by SEC’s “request for information” memo she and her team went out of their way to conducted a financial audit and uncovered the accounting fraud at WorldCom. Though she knew the result of her actions (exposing the fraud would lead to filling bankruptcy and possible firing of employees) she believed in following the ethical behavior and tackle any challenges she faced while doing the right thing. * The main difference between Cynthia and Betty was that Cynthia being a deontological decision maker was driven by the right approach no matter what the result as opposed to Betty (consequentialist), who though knew she was doing something wrong, still adopted the unethical behavior. Also Cynthia was not influenced as Betty by the already flawed company culture and corporate governance which led Cynthia to go out of her way and make the apt choice to expose wrong doing in the company. Also Cynthia had more courage than Betty as being a deontological decision maker, she was more driven by ethical leadership.

My View:
If I were in Betty’s position, I would have taken a deontological approach and would have done what was right. If I were exposed to similar pressure, I would have tried to come up with alternative approaches to deal with the situation. This would mean doing extensive analysis and coming up with alternative solutions to achieve the said target performance. If need be suggesting the top management to hire an external consultant to help get out of the current situation. I would have not committed to the existing pressure and would have made sincere effort to try to reach out to as many stakeholders possible to create sufficient resistance to the unethical behavior by the company management. However, even after taking all alternative measures possible, if I would have still landed in a position to perform the fraud I would have resigned at the first go, no matter what the consequences, instead of prolonging it till it was too late. As we see in the case, Betty eventually had to suffer more consequences committing the fraud than if she would not have committed it.