WorldCom

WorldCom took the telecom industry by storm when it began a frenzy of acquisitions in the 1990s. The low margins that the industry was accustomed to weren't enough for Bernie Ebbers, CEO of WorldCom. From 1995 until 2000, WorldCom purchased over sixty other telecom firms. In 1997 it bought MCI for $37 billion. WorldCom moved into Internet and data communications, handling 50 percent of all United States Internet traffic and 50 percent of all e-mails worldwide. By 2001, WorldCom owned one-third of all data cables in the United States. In addition, they were the second-largest long distance carrier in 1998 and 2002.

The rise and Fall of WorldCom

TIM

Major aspects concerning the industry, their part in growth and consequent fall

Strategies
RAPID EXPANSION

Machiavellian approach Became a full service telecommunication company Boosted growth in primal years by eliminating competition Driven by short term goals, securing deals was often overpriced Over-expansion and ill-judged acquisitions. The company personnel didnt substantiate the ROI, group synergies and the mid-term effects. Lack of both financial, management, technical and HR integration. Help maintain favorable E/R ratio of 42%, most important performance measure High revenue growth Consolidated position in the stock market Use of accounting measures like release of accruals and capitalization of expenditure were not in accordance with GAAP. Negligence of long standing debt collection, only focus on building up revenue on books. Encouraged employees in the financial, accounts and investor relation departments Affirmed employee relationships Biasness against those in other departments viz. networks, technology, Public Relations, HR, etc. Increased rivalry amongst departments. Lead to reduced inter and intra departmental coordination and unity.

FINANCIAL GIMMICKRY

EMPLOYEE INCENTIVES

Culture
Company Policies
According to the CEO Ebbers, this was a colossal waste of time Little importance to the legal, internal audit, sales and marketing departments. Unhealthy, discouraging and non-cooperative working atmosphere for subordinates Rendered internal audit powerless. Only focus on integrating physical networks, largely ignored sales, accounting and billing systems. Clash of working culture, especially after MCI mergers Senior officials favored those especially loyal, preferable from financial, accounting and Investor relations depts. No vertical transparency, no horizontal synchronization.

Stringent hierarchy Failure in integration after M&A

Bias between departments and employees

Corporate Governance
Board of Directors

Habit of rubber stamping senior managements decisions without scrutinising detailed performance indicators. Never met outside board meetings. No vent for employees for reporting malfunctioning even if they felt so.. Not bothered to look into the accounts of the company

Audit:
Internal audit
Limited scope and power. Perform mostly operational audits rather than financial audits. Reported directly to the CFO Limited its testing of account balancing relying on the adequacy of WorldCom's control environment. Overlooked serious deficiency in the accounting ledgers, which were exploited. Considered WorldCom as a flagship client and a crown jewel of its firm

External Audit: Arthur Anderson Firm

Personal Finances
Many senior executives, including the CEO Ebbers had private finances and debts taken on stocks of the company. The board (Compensation Committee)approved sweetheart loans (over $400 million) to Ebbers, without any collaterals or assurances or knowledge of use of those funds

Industry Growth
Failure of Telecommunications Industry Prices for long-distance communication services were falling Local markets with high access charges were unprofitable DOT COM Bubble Burst

Technology
WorldCom was weak in wireless network and Technology Lower demand for Long Distance services in market. Attempted to achieve economies of scale by acquisitions Refusal of merger with Sprint (Largest wireless network company then) by US Justice Department to regulate the Telecommunications Industry.

Line Costs
WorldCom outsourced some portions of its calls Paid the outside service providers for carrying WorldCom customers calls on their lines.

Took majority of its lines on lease.

Increase in E/R causes:

Hefty fines for unutilized leased networks. Decline in the growth of telecommunication industry reducing the demand Anticipated high demand in the industry. Increased their leased networks

Release of Accruals
WHAT?
Recognizing the estimated line cost (after proper analysis) before they had occurred. Set up a liability known as accrual in the balance sheet Release of this accrual when the company actually pays the outstanding bill. Reduce the previously established accruals accordingly. Release of accruals without apparent analysis of the accrual account and improper analysis of line costs. Did not release the excess accruals in the period in which they were identified, but to keep them as reserve for bad period. Release of accruals from the accounts which had been reserved for other purposes WorldCom faced the prospect that their operating cash flow (EBITDA) would suffer. To cut down the increasing expenses to revenues (E/R) ratio. Consolidate their position in stock market Window-dressing the final accounts

HOW?

WHY?

Capitalization and Other Adjustments

CAPITALIZATION
Avoided recognizing standard operating expenses when they incurred, instead postponed them into future saying work in progress Improperly shifted these expenditures from income statement to balance sheet, increasing current income and inflating assets. Reducing line costs and capitalizing entries significantly improved the line cost E/R ratio.

OTHER ADJUSTMENTS
Improperly booked of $312 million in revenue associated with Minimum Deficiency Charges Accounted for over $215 million of credits that it had issued to Telecommunications Customers. Recognized $22.8 million in revenue from Early Termination Penalties.