Worldcom

CASE TAKEAWAYS

* Illustrates pressures that lead executives and managers to "cook the books"

* Addresses the boundary between earnings smoothing or management and fraudulent reporting

* Demonstrates the role for internal control systems and internal audit to prevent or rapidly detect accounting fraud

* Brings to focus the expectations about governance processes performed by external auditors and the board of directors

* Demonstrates the pressure and consequences when middle managers follow orders that they know are wrong.

WORLDCOM

* WorldCom is a for profit organization that specialized in local, long distance and international plans, high cable internet, prepaid cards, and collect calling

* Provided telecommunications to customers nation wide with business corporations making up the majority of the 20 million customers they served.

* It began in the early 1980's and its main marketplace was domestic, however their products were available for global use.

GROWTH THROUGH ACQUSITION

* WorldCom achieved its position as a significant player in the telecommunications industry through the successful completion of 65 acquisitions.

* Between 1991 and 1997, WorldCom spent almost $60 billion in the acquisition of many of these companies and accumulated $41 billion in debt.

* Two of these acquisitions were particularly significant.

- The MFS Communications acquisition enabled WorldCom to obtain UUNet, a major supplier of Internet services to business

- MCI Communications gave WorldCom one of the largest providers of business and consumer telephone service.

CHALLENGES WITH ACQUISITION STRATEGY

* Management must deal with the challenge of integrating new and old organizations into a single smoothly functioning business.

* This is a time-consuming process that involves thoughtful planning and considerable senior managerial attention if the acquisition process is to increase the value of the firm to both shareholders and stakeholders.

* With 65 acquisitions in six years and several of them large ones, WorldCom management had a great deal on their plate.

* The requirement to account for the financial aspects of the acquisition.

- The complete financial integration of the acquired company must be accomplished, including an accounting of assets, debts, good will and a host of other financially important factors.

- This must be accomplished through the application of generally accepted accounting practices (GAAP).

PROBLEMS WITH ACQUISITION STRATEGY - POOR INTEGRATION

* Every division and business unit was like its own silo, separate from all the other businesses.

* Senior management made little effort to develop a cooperative mindset among the various units of WorldCom.

* Inter-unit struggles were allowed to undermine the development of a unified service delivery network.

* Many processes were duplicate and inefficient.

* Capacity was expensive and very underutilized...There was far too much redundancy, and WorldCom paid far too much to get it

END TO ACQUSITION STRATEGY

* In 2000, the government refused to allow WorldCom's acquisition of Sprint.

* The denial put an end to WorldCom's acquisition-without-consolidation strategy

* Left management a stark choice between focusing on creating value from the previous acquisitions with the possible loss of share value or trying to find other creative ways to sustain and increase the share price.

WHAT WENT WRONG?

* There was a perceived need to meet unrealistic securities market expectations and they had a culture that emphasized making the numbers above all else and the keeping of financial information hidden from those who needed to know.

* There was a systematic attitude conveyed from the top down that employees should not question their superiors, but simply do what they were told and there were not outlets through which employees believed they could safely raise their objections.

WHY DID THEY DO THIS?

* Any time there is pressure to provide more than either a person is capable of or more than a person is willing to do, there is a tendency to take shortcuts.

* Pressure

* To further their career

* To protect their livelihood.

FINANACIAL MISREPRESENTATION

* In an effort to make it appear that profits were increasing, WorldCom would write down in assets it acquired while, at the same time, it included in this charge against earnings the cost of company expenses expected in the future.

- The result was bigger losses in the current quarter but smaller ones in future quarters, so that its profit picture would seem to be improving.

* The acquisition of MCI gave WorldCom another accounting opportunity. While reducing the book value of some MCI assets by several billion dollars, the company increased the value of "good will," that is, intangible assets by the same amount.

- This enabled WorldCom each year to charge a smaller amount against earnings by spreading these large expenses over decades rather than years.

- The net result was WorldCom's ability to cut annual expenses, acknowledge all MCI revenue and boost profits from the acquisition.

* WorldCom managers also tweaked their assumptions about accounts receivables, the amount of money customers owe the company.

- Management chose to ignore credit department lists of customers who had not paid