Final Paper: Case Study of WorldCom Financial Statement Fraud
This paper will discuss the financial statement fraud committed by WorldCom by examining what led up to the fraud, who committed it and why, and the impact it caused on various stakeholders and the economy. WorldCom applied aggressive and undisclosed accounting tactics to provide financial statements that reflected a $10 billion profit for the years 2000 and 2001, rather than the actual combined loss of $73.7 billion that occurred (Romar, 2006). Opportunity, pressure, and rationalization were all present in this severe example of financial statement fraud which had a devastating impact on stakeholders ...view middle of the document...
In an aggressive growth tactic, WorldCom purchased MCI in 1997 at a high price tag of $37 billion, which was $12.1 billion higher than the next highest offer. WorldCom was expected to use MCI’s strong marketing skills and presence in addition to synergies from shared networks to increase revenue and decrease costs. However, these synergies, for the most part, would not be achieved. The MCI purchase also came with a high amount of debt, including the 20% share payable to British Telecom.
CEO Ebbers relied upon and consistently proclaimed the impressive revenue growth of his company. “He believed that continuing revenue growth was crucial to increasing WorldCom’s stock market value so that the stock could be used as currency for corporate acquisitions. In addition, top executive compensation and bonuses were dependent on achieving a double-digit rate of revenue growth. Corporate performance just had to meet expectations. Miraculously, even when market conditions throughout the telecommunications industry deteriorated, WorldCom continued to post impressive revenue growth numbers” (Zekany, 2004).
The Beginning of the End
The high expectations set for WorldCom by Bernie Ebbers could not be met by sheer will. While the company continued to be aggressive with its technological advances and other capital expenses, the market would need to cooperate in order to achieve the revenue to compensate for such expenses. “Unfortunately, the demand boom expected did not happen and all that resulted was the gross mismatch between supply and demand” (Gollakota, 2004, p.67) Furthermore, WorldCom was denied by the Justice department of the right to merge with wireless carrier Sprint. This left WorldCom without a strong wireless presence, which would turn out to be fastest growing demand segment.
In addition to demand needed to hit revenue targets, WorldCom leadership was also very interested in controlling expenses. The most costly of these expenses was line cost, which attempted to be controlled through “effective utilization of the network, favorable contracts with carriers, and network efficiencies” (Zekany, 2004). This key measure to track this expense by leadership was the line cost E/R ratio. “An increase in the line cost E/R ratio indicates deteriorating performance, either the under-usage of leased capacity or overpayment for leased capacity” (Zekany, 2004).
“As economic conditions worsened, the search for cost savings became more intense” (Zekany, 2004). The goal of a line cost E/R ratio of 41 was impossible due not only to increased expenses and reduces revenues, but also because the prior year this goal was met, a reserve was released to offset costs. The economy and excess capacity pushed this ratio to closer to 50 percent. However, leaders Ebbers and Sullivan were determined to produce the results needed to meet their boasting predictions to analysts. They began an aggressive exercise to track projected and budgeted revenue which they called...