Pressure of Worldcom - Earnings Management and Fraudulent Reporting

PRESSURE OF WORLDCOM

Behind the accounting fraud at WorldCom, there were three clear pressures that influenced WorldCom to commit to the fraudulent accounting activities. The first pressure was the unrealistic goal that the WorldCom had set for itself. The goal of the WorldCom was to be the No. 1 stock on Wall Street. In order to achieve that goal, WorldCom had to maintain an unrealistically low E/R ratio, which put a tremendous pressure for WorldCom to decrease expense and increase revenue. In conjunction with unrealistic goal, a strong goal-driven culture of WorldCom had increased the pressure to "cook the books". WorldCom had a corporate culture, which devalue the code of ethics, and overly emphasize the end product of activities. This goal-driven culture was a direct reason for the "demand for revenue growth that was in every brick in every building" and a push for revenue that encouraged managers to spend whatever was necessary to create revenue. Second pressure was the increased competition and the recession, which decreased the revenue of WorldCom dramatically. As competition heightened, WorldCom could not generate the revenue that it once generated as WorldCom had to match the low price of new entrants and suffer from reduced demand. The reduced revenue would significantly damage the E/R ratio, which is the most important performance indicator. Even under this market condition, the strong goal-driven culture of WorldCom pressure managers to create the end product (a desired E/R ratio). Therefore, the severe market condition, which resulted in decreased revenue, created a clear pressure for the managers to cook the books. The last source of pressure is the lack of strategy. The main strategy that WorldCom utilized to create new source of revenue was through merger and acquisition. However, after the failure to acquire Sprint, it was clear that the merger and acquisition was not a viable mean to expand the business and create new source of revenue. With stalled size of the market and source of revenue, there still was a pressure to maintain E/R ratio and grow the revenue. Witt no strategy to create a new source of revenue, the managers were forced to cook the books to achieve the goal.

EARNINGS MANAGEMENT AND FRAUDULENT REPORTING

Earnings management and fraudulent reporting are very similar concepts except for the one critical difference, which is that one is within the scope of GAAP and the other is not. Earnings management does deliberately manipulate the earnings to reach a certain level of target, it is still within the scope of GAAP, whereas fraudulent reporting is not. The activities of WorldCom clearly were not in the scope of GAAP, which constitute them as fraudulent reporting. In the case, it specifically mentions that the top executives "reviewed and discussed the logic of capitalizing excess capacity and can find no support within the current accounting guidelines that would allow for this accounting treatment". Clearly, the accounting procedures that they have implemented could not be supported by GAAP, which constitutes an accounting fraud.

FAILURE OF EARLY DETECTION

There are several reasons why the accounting fraud at WorldCom was not detected earlier. The first reason was the leadership and culture. When CEO of the company deliberately says that creating code of conduct is a colossal waste of time, it clearly shows the tone that the top management imposes upon the entire company. Even further, WorldCom had grown through merger and acquisition, which means that it is the congregation of different companies with different cultures. WorldCom did not show any effort to unite these cultures to facilitate the process.