CORPORATE GOVERNANCE

Features and a case study (WorldCom)

Submitted By:

Tajeshwar Singh

071278

Mechanical

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CORPORATE GOVERNANCE, SOME DEFINITIONS:
Traditional:
“Ways in which a firm safeguards the interests of its financiers”

Modern:
“Framework of rules and practices by which a board of directors ensures
accountability, fairness and transparency in the firm’s relationships with all its
stakeholders (financiers, customers, management, employees, government and
community)”

International Chamber of Commerce:

“Corporate Governance is the relationship between corporate managers, directors
and the providers of equity, people and institutions who save and invest their capital
to earn a return. It ensures that the board of directors is accountable for the pursuit
of corporate objectives and that the corporation itself conforms to the law and
regulations.

Some more definitions:

“Corporate governance is the system by which companies are directed and
controlled...”
- Cadbury Report (UK), 1992

An Indian definition:

“...fundamental objective of corporate governance is the enhancement of long term

shareholder value while at the same time protecting the interests of other
stakeholders”

- Sebi Report on Corporate Governance, Jan 2000

WHAT IS CORPORATE GOVERNANCE?

 Manner in which a corporation is run
o Achieving its objectives
o Transparency of its operations
o Accountability & Reporting
o Good Corporate Citizenship
 Processes & Operating relationships that best receive goals.
 Control Mechanisms to distribute power and influence.
 Relationship between Board, Management, Stakeholders and Shareholders.
 Interests of Shareholders and Stakeholders is safeguarded

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OVERVIEW OF CORPORATE GOVERNANCE STRUCTURAL
ELEMENTS/FUNCTIONS

Major Global Initiatives on Corporate Governance:

Year
1992

1999 & 2004

1999

2002
Name of committee/body
Sir Adrian Committee Report

OECD

CACG

Serban-Oxley Report
Areas/Aspects Covered
Financial Aspects of
Corporate Governance
Principles of Corporate
Governance
Principles for corporate
governance in
commonwealth
Public Company corporate
and auditing acts

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Major Indian initiatives on Corporate Governance:

Year Name of committee/body Areas/Aspects Covered

1998 Confederation of Indian Desirable Corporate
Industry Governance – a code
1999 Kumar Mangalam Birla Corporate Governance
Report (Clause 49 of SEBI Listing
Agreement)
2003 Narayana Murthy Commitee Corporate Governance for
revised clause 49

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WORLDCOM : A Case Study
WorldCom was formed in 1983 as Long Distance Discount Services (LDDS) which was
involved in buying large blocks of capacity from the larger long-distance companies at
reduced rates and reselling that time to small businesses and individuals at a slight markup
over its cost. It then grew by acquiring several companies like UNNet & MCI and posted
handsome results. But, due to the slowdown in economy, telecom sector started making
heavy losses. However, to cater the Wall Street analyst and shareholder’s expectations,
major fudging of accounts begun in the company which eventually led to its demise.

Accounting Scandal
CEO Bernard Ebbers became very wealthy from the rising price of his holdings in WorldCom
common stock. However, in the year 2000, the telecommunications industry entered a
downturn and WorldCom’s aggressive growth strategy suffered a serious setback when it
was forced by the US Justice Department to abandon its proposed merger with Sprint in mid
2000. By that time, WorldCom’s stock was declining and Ebbers came under increasing
pressure from banks to cover margin calls on his WorldCom stock that was used to finance
his other businesses (timber and yachting, among others). During 2001, Ebbers persuaded
WorldCom’s board of directors to provide him corporate loans and guarantees in excess of
$400 million to cover his margin calls. The board hoped that the loans would avert the need
for Ebbers to sell substantial amounts of his WorldCom stock, as his doing so would put
further downward pressure in the stock's price. However, this strategy ultimately failed and
Ebbers was ousted as CEO in April 2002 and replaced by John Sidgmore,
former CEO of UUNet Technologies, Inc.

Beginning modestly in mid-year 1999 and continuing at an accelerated pace through May
2002, the company (under the direction of Ebbers, Scott Sullivan (CFO), David Myers
(Comptroller) and Buford Yates (Director of General Accounting)) used fraudulent
accounting methods to mask its declining earnings by painting a false picture of financial
growth and profitability to prop up the price of WorldCom’s stock

The fraud was accomplished primarily in two ways:

1. Underreporting ‘line costs’ (interconnection expenses with other telecommunication

companies) by capitalizing these costs on the balance sheet rather than
properly expensing them.
2. Inflating revenues with bogus accounting entries from "corporate unallocated
revenue accounts".

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In 2002, a small team of internal auditors at WorldCom worked together, often at night and
in secret, to investigate and unearth $3.8 billion in fraud. Shortly thereafter, the company’s
audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan
was fired, Myers resigned, Arthur Andersen withdrew its audit opinion for 2001, and
the U.S. Securities and Exchange Commission (SEC) launched an investigation into these
matters on June 26, 2002.

By the end of 2003, it was estimated that the company's total assets had been inflated by
around $11 billion

Corporate Governance issues

Following issues related to corporate governance came to light on analysis of the WorldCom
scandal.

Management Issues
 Culture of greed and forbidding scrutiny
The management’s endeavour was to meet the Wall Street’s expectations, by hook or
crook, to avoid a beating of the stock price. This led to greed and fear amongst the top
managers. Moreover they discouraged scrutiny and detailed questioning which
catalyzed such fraudulent practices in the company.
 Fudging of accounts
The top management was directly involved in fudging of accounts which involved
improper drawdown of reserves and capitalization of costs. This was directed by the
CFO of the company.
 Misguiding the committees & employees
The top management adopted the practice of directing the employee to adopt
fraudulent practices. Moreover, when asked by audit committee for an investigation,
Mr. Sullivan asked Ms. Cooper not to interfere in accounting matters and focus on
efficiencies.

Board Issues
 Inability to perform duty of diligence
The board failed to discharge the duty of diligence and care as it failed to catch the
large-scale fudging of accounts prevalent in the company.
 Lending of company funds to Mr. Ebbers
The board agreed to lend Mr. Ebbers company funds to repay his personal debt. In the end, Mr.
Ebbers owed company $400 million. The board should not have allowed lend him amount to
repay personal debt.
 Improper handling of committees
The board failed to supervise the audit, acquisition and the compensation committee which led
to major faulty practices such as accounts fudging, company reserves for paying off Mr, Ebbers
debt etc.

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Stakeholders
 Internal Audit Committee
The committee failed to discharge the duty of diligence and care as it failed to catch the
large scale fudging of accounts prevalent in the company during its initial phase.
However once the committee was cognizant of a malpractice, it did try to investigate
and bring the matter to notice of chair.
 Compensation Committee
The massive loans granted to Mr. Ebbers from the company reserves showed that the
compensation committee was either absent or made negligence on its part while
performing duties.
 External Auditors
The external auditors failed to find the massive fudging of accounts. Moreover, when
the malpractices were brought to their notice by the internal audit committee, they
refused to look into the same.

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