Fiasco Report

1. Fiasco Report

2. 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

3. 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

4. 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

5. 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

6. 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

7. Personnel Controls • Decision making was centralized to top management resulting in a personnel control • 8 of the 11 board of directors were considered independent

8. 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

9. 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

10. 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

11. 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

12. Fall of WorldCom • Can be described in three parts: • Corporate strategy of acquisition without integration • The use of loans to executives • the threats to corporate governance based on the friendliness of the executives and lack of “at-arm’s-length” dealings

13. 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

14. “Sweetheart” Loans to Executives • Bernie Ebbershad 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

15. 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

16. 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

18. 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

19. 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

20. Thank You