The Earnings Management Issue of WorldCom Case Study Report
Introduction
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.
1. The Main Issue: Earnings Management
1.1 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 financial reports for misleading some investors about a company’s financial performance or influencing contractual outcomes that reply on the numbers.
Based on several researches, Lawrence (2009) concludes that earnings management generally involves some level of deceptions, and its accounting manipulations usually motivated by negative behaviours such as opportunistic maximization and avoiding debt covenant violations. Nevertheless, others argue it is unreasonable for managers to manage short-term earnings which will be adjusted in future, and it is a way of releasing blocked inside information (Healy and Wahlen, 1999) and so on.
1.2 Incentives for Earnings Management: Two Main Incentives
1.2.1 The Incentive of Earnings Management for Personal Compensation Plan
Daniel and Thomas (2006) states that if CEOs’ potential total compensation is more closely related to the price of stock and option holdings, the firms are more inclined to manipulate reported earnings. In the WorldCom case, in 2002, the CEO, Ebbers personally held 27 million shares of the company; he even borrowed some money to buy WorldCom’s shares (The Wall Street Journal, 2002). Hence, Ebbers had high level of motivation to manipulate reported earnings to inflate share price for personal benefits.
1.2.2 To Meet Expectation of
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.
1. The Main Issue: Earnings Management
1.1 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 financial reports for misleading some investors about a company’s financial performance or influencing contractual outcomes that reply on the numbers.
Based on several researches, Lawrence (2009) concludes that earnings management generally involves some level of deceptions, and its accounting manipulations usually motivated by negative behaviours such as opportunistic maximization and avoiding debt covenant violations. Nevertheless, others argue it is unreasonable for managers to manage short-term earnings which will be adjusted in future, and it is a way of releasing blocked inside information (Healy and Wahlen, 1999) and so on.
1.2 Incentives for Earnings Management: Two Main Incentives
1.2.1 The Incentive of Earnings Management for Personal Compensation Plan
Daniel and Thomas (2006) states that if CEOs’ potential total compensation is more closely related to the price of stock and option holdings, the firms are more inclined to manipulate reported earnings. In the WorldCom case, in 2002, the CEO, Ebbers personally held 27 million shares of the company; he even borrowed some money to buy WorldCom’s shares (The Wall Street Journal, 2002). Hence, Ebbers had high level of motivation to manipulate reported earnings to inflate share price for personal benefits.
1.2.2 To Meet Expectation of
References: Corporate Governance Principles and Recommendations with 2010 Amendments, 2010, Asxgroup, Viewed 10 October 2013, http://www.asxgroup.com.au/media/PDFs/cg_principles_recommendations_with_2010_amendments.pdf. Panel on Audit Effectiveness, 2000, Report and Recommendations, Panel on Audit Effectiveness, Viewed 10 October 2013, www.pobauditpanel.org/download.html. Sidgmore, J, 2002, Wrong numbers: The Accounting Problems at WorldCom, Testimony Before the House Committee on Financial Services, Viewed 10 October 2013, http://news.findlaw.com/hdocs/docs/worldcom/070802jstst.pdf. Amanda R, 2008, Q&A: Whistle-Blower Cynthia Cooper, Time, Viewed 10 October 2013, http://content.time.com/time/arts/article/0,8599,1709695,00.html. The Wall Street Journal, 2002, Former WorldCom CEO Built An Empire on Mountain of Debt, Viewed 10 October 2013, http://online.wsj.com/article/SB1041285560418700753.html.