WorldCom, the telecommunications giant, once was the largest telecommunications company in the world, with more than $30 billion annual revenue, $104 billion in assets and more than 20 million customers. John Sidgmore (2002), Ebbers’ successor after the scandal, said “WorldCom is a key component of our nation’s economy and communications infrastructure.” However, the giant collapsed in 2002.
2. The Main Issue: Earnings Management
3.1 Definition of Earnings Management
A commonly acknowledged definition of earning management by Healy and Wahlen (1999) demonstrates that managers implement personal judgement in financial reporting and transactions to manipulate ...view middle of the document...
3.3.2 To Meet Expectation of Analysts and Industry Observers
Secondly, Burgstahler and Eames (1998) indicate that firms manage earnings for meeting analysts’ forecasts, especially to manipulate earnings upward to avoid falling to meet analysts’ expectation. Failing to meet the expectation would lead to a plunge of the company’s stock value (Skinner and Sloan, 2002). As for the WorldCom case, the E/R ratio, the most important performance indicator, was closely observed by industry, which put significant pressure on WorldCom’s senior managers.
3.3 Manipulation of Earnings and Pressures for Senior Managers
3.4.3 Two Accounting Manipulation Methods
Releasing Accruals. From 1999 to 2000, CFO Sullivan and Controller Mayor forced employees of sub business units to release accruals of line cost which they claimed was too high relative to future cash payments. And the left accruals were below the amount of cash the company have to pay in future. Overall, in-between 1999 and 2000, $3.3 billion worth of accruals were released.
Capitalizing expense. At the beginning of 2001, there were so few accruals left to release that Sullivan had to start a new method - treating line costs as capital expenditure rather than operation cost. This action totally violated accounting rules, because the expenditure had been consumed already and there were no future benefits at all. As a result, in April of 2001, $544 million of line costs was capitalized.
3.4.4 Pressures to Senior Managers
There were several issues that were compelling the senior management. Firstly, the most direct pressure to senior managers was from the CEO. Ebbers personally owned large amount of shares of WorldCom and therefore he wanted to lift share price zealously. After industry environment began to deteriorate, as a CEO, he pushed the senior managers aggressively for promoting company’s performance which could also boost its share price. Secondly, senior management was very keen to sustain the 42% E/R ratio, any rise in the E/R would result in the plunge of WorldCom share price and its credit rating.
3.4 Earnings Management or Fraudulent Reporting?
3.5.5 Differences Between Earnings Management and Fraudulent Reporting
Earning management means manipulating reported number for certain purposes through objectively selecting and judging accounting methods which may be misleading. The Treadway Commission Report (1987) states fraudulent reporting as deliberate or irresponsible behaviours, whether act or commission that causes materially misleading financially. The Panel on Audit Effectiveness (2000) demonstrates earnings management has little difference from fraud reporting. In many occasions, fraudulent reporting is considered as an extreme point on the scale of earnings management (Lawrence, 2009).The line between earning management and fraudulent reporting seems blurred.
Despite the difficulties, there are researchers trying to scale and...