Business Ethics,

The paper is an analysis of the case “Accounting Fraud at WorldCom” (the case is included in the Course pack – we will discuss this case in class on March 30, the same day the paper is due). Evaluation of Paper: Good performance on this assignment consists of systematically and thoroughly applying relevant concepts and methods from the course to the case. When you introduce a concept, please explain what it means and how it applies to the case (make sure it is clear that you know what the concept means and why it is relevant). Please explain the concepts in your words, not mine (from slides). Apply concepts from class! In preparing your paper, you may read outside articles and books on the topic of the WorldCom scandal. In doing so, you will likely read other people’s opinions and analysis regarding what happened and why it happened. This analysis will likely apply concepts that we have not covered. These concepts will probably not help you write your paper. Your assignment is not simply to analyze the case; it is to use concepts from this course to analyze the case. You will be graded on how well you explain and apply concepts from class. If your paper is based heavily on other people’s analysis of the situation, you will likely fail to adequately cover concepts of class and will likely introduce foreign concepts that are not meant to be part of this assignment. The paper is due by 5:30pm on March 30, 2016. Please submit the paper (preferably as a Word doc) on the Blackboard website for the course. The paper should be 12-pt font, 1-inch margins, double-spaced. Penalties for late submission: Because we are discussing the case in class on March 30, it is critical that you submit your paper on time (before class starts that day). It is not a good strategy to wait until after class discussion that day to turn in your paper. To discourage this approach, late papers will be penalized as follows. A paper submitted on March 30 but after 5:30pm will be penalized 5 points (out of the 100 total). Papers submitted on March 31 will be penalized 8 points, papers submitted on April 1 will be penalized 11 points, and so on (with each additional day late adding 3 points to the penalty). There is a separate document (called “schedule of late penalties”) that lists the penalty associated with each possible date of submission. -------------------------------------------------------------------------------------------------------- Organize your paper as follows, with these section headings: I. Summary of Situation(length: .5 - 1 page): Summarize the situation. What happened? Don’t focus too much on the technical details (e.g., the specific accounting practices). Don’t give a step-by-step description of the sequence of events. Instead, imagine you are trying to explain what happened to someone with no business experience. What would you say? First, set the scene that leads up to the accounting fraud. Describe WorldCom and its general situation at the time. What is WorldCom like as a company? How is the company organized(e.g., the composition of the board of directors and its relationship with the company; the company’s relationship with Arthur Anderson, its external auditing firm)? What is WorldCom’s business model or strategy? How are things going financially, for the company and for the broader telecommunications industry? Second, describe the accounting fraud itself. Who are the key figures and what role did they play? You do not need to describe the specific accounting practices in detail. You also do not need to explain whyeach person did what he or she did (that would be causal analysis – you can save that for the causal analysis section). Instead, you should just summarize the series of actions that led to the fraud being committed and ultimately reported. Finally, end by briefly identifying the key stakeholders of WorldCom (i.e., who is impacted by the operation of the company and thus has a stake in its success or failure?) II. Normative Analysis(length: 2-3 pages):In this section you should use concepts from class to evaluate the people in question and explain why what they did was, or was not, ethically wrong. Did anyone violate their fiduciary duties and if so, how? How were stakeholders impacted? The Fraud The purpose of this section is for you to explain why the fraudulent accounting and other behavior described in the case was ethically wrong. What makes it wrong? To do so you should use the concepts from class. Think about fraudulent accounting in general (not just this case, specifically). Why is it wrong? Those in charge at WorldCom had an ethical responsibility to its shareholders (this responsibility has a name!) and perhaps also to other stakeholders (e.g., employees, customers, potential investors, society as a whole). How does fraudulent accounting (e.g., misrepresenting financial performance to make a company look more valuable than it actually is) affect these various stakeholders? For example, from the perspective of shareholders, why is this so bad (how are shareholders impacted)? From the perspective of potential investors, why is this so bad (how are potential investors impacted)? From the perspective of society, why is this so bad (how is society impacted)? After explaining the impact on various stakeholders, you could take a stance on whether or not you think the company has an ethical responsibility to take these various consequences (for non-shareholders) into account or whether the impact on shareholders should be their sole concern (recall the Friedman/Mackey debate). Other Behavior Apart from the fraudulent accounting, were there any other ethical violations? Think carefully about fiduciary duty (and its different types). Do you see any other instances where someone violated their fiduciary duties? If so, describe and explain. III. Causal Analysis(length: 2-3 pages): In this section your job, you should use concepts from classto explain why things happened the way they did. Apply the concepts you’ve learned in the course. What elements of moral or social psychology were operating here? Did you see anything like this situation in any of the cases we have read, or the situations we have discussed during the course? Here are some key concepts that may be relevant (this is not a comprehensive list) normative social influence, informational social influence, ambiguity, escalation/slippery slope, bounded ethicality, ethical fading, motivated blindness, discounting, overconfidence bias, conflict of interest, confirmation bias, moral foundations (e.g., concerns about harm, fairness, loyalty, and respect for authority), corporate governance. Note: Do not attempt to mention every single possibly relevant concept from class (or the above list). It would be better to pick a few factors/concepts that you think are most important and then explain, clearly and thoroughly,what they are and how they contributed to the fraud. IV. Ethical Systems Design(length: 2-3 pages):If you were in charge of a company like WorldCom, how could you apply concepts from class to prevent situations like this from arising? More generally, how could you change the rules, norms, or other aspects of the environment so that the organization was less prone to this sort of ethical problem in the future? These recommendations should follow directly from the causal factors you identified in the previous section. For example, if your causal analysis focused on how factors X, Y, and Z were the primary reasons for the accounting fraud, you should suggest ways that the company could be changed to lessen (or eliminate) the influence of factors X, Y, and Z. Be concrete! If you think some aspect of the company can be improved, explain the specific, concrete steps you will take to change it. It is not enough to say, for example, “I will make the corporate culture better.” How exactly will you make it better? And why will your plan work? How would your plan address the needs/rights of key stakeholders? Reference Section: When you reference an article (e.g., an article that we read for class), please include an in-text citation and add it to a reference section. Use APA (or MLA) style for the reference section and in-text citations. Citing Lecture/Slides: You may find yourself referring directly to lecture or lecture slides. If you do so, you should explain the concepts in your own words, not mine. Also, if you quote anything word-for-word from the slides (which I don’t recommend because you should be explaining the concepts in your won words), you must put it in quotation marks. To cite lecture slides in the following way: In-text citation:insert a parenthetical citation that says “Sherman” and the date of class. For example: (Sherman, September 9) Reference section: In the references section, add a full reference for the lecture. You can use the title from the first slide. For example: Sherman, G. (September 9, 2015). Foundations: Moral Philosophy and Psychology. Lecture Slides. Total Length:Each section has a specified page range (see above). Please be sure to at least hit the minimum length for each section. It is perfectly fine to be on the shorter end of the page range as long as you are able to apply the relevant concepts concisely and clearly. In other words, I care about substance not length. 9-104-071 REV: SEPTEMBER 14, 2007 ________________________________________________________________________________________________________________ Professor Robert S. Kaplan and Senior Resear cher David Kiron, Global Research Group, prepared this case. The case was developed from published sources and draws heavily from Dennis R. Beresford, Nich olas deB. Katzenbach, and C.B. Rogers, Jr., “Report of Invest igation,” Special Investigative Committee of the Board of Directors of WorldCom, Inc., March 31, 2003. References to this report are iden tified by alphabetic letters which refer to information in the endnotes. HBS cases are developed solely as the basis for class discussion . Cases are not intended to serve as endorsements, sources of primary data , or illustrations of effective or ineffective management. Copyright © 2004, 2005, 2007 President and Fellows of Harvard College. To order copies or request permission to reproduce mate rials, call 1- 800-545-7685, write Harvard Business School Pu blishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of thi s publication may be reproduced, stored in a retrieval system, used in a spre adsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. ROBERT S. KAPLAN DAVID KIRON Accounting Fraud at WorldCom WorldCom could not have failed as a result of the acti ons of a limited number of individuals. Rather, there was a broad breakdown of the system of internal cont rols, corporate governance and individual responsibility, all of which worked together to create a culture in wh ich few persons took responsibility until it was too late . — Richard Thornburgh, former U.S. attorney general 1 On July 21, 2002, WorldCom Group, a telecommunications company with more than $30 billion in revenues, $104 billion in assets, and 60,000 empl oyees, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. Between 1999 and 2002, WorldCom had overstated its pre- tax income by at least $7 billion, a deliberate miscalculation that was, at the time, the largest in history. The company subsequently wrote down about $82 billion (more than 75%) of its reported assets. 2 WorldCom’s stock, once valued at $180 billion, became nearly worthless. Seventeen thousand employees lost their jobs; many left the company with worthless retirement accounts. The company’s bankruptcy also jeopardized service to WorldCom’s 20 million retail customers and on government contracts affecting 80 million Social Security beneficiaries, air traffi c control for the Federal Aviation Association, network management for the Departme nt of Defense, and long-distance services for both houses of Congress and the General Accounting Office. Background WorldCom’s origins can be traced to the 1983 br eakup of AT&T. Small, re gional companies could now gain access to AT&T’s long-distance phone lines at deeply discounted rates. 3 LDDS (an acronym for Long Distance Discount Services ) began operations in 1984, offering services to local retail and commercial customers in southern states where well -established long-distance companies, such as MCI and Sprint, had little presence. LDDS, like other of these small regional companies, paid to use or lease facilities belonging to third parties. For example, a call from an LDDS customer in New Orleans to Dallas might initiate on a loca l phone company’s line, flow to LDDS’s leased network, and then transfer to a Dallas local phon e company to be completed. LDDS paid both the 1 Matthew Bakarak, “Reports Detail WorldCom Execs’ Domination,” AP Online , June 9, 2003. 2 WorldCom’s writedown was, at the time, the second largest in U.S. history, surpassed only by the $101 billion writedown taken by AOL Time Warner in 2002. 3 Lynne W. Jeter, Disconnected: deceit and betrayal at WorldCom (Hoboken, NJ: John Wiley & Sons, 2003), pp. 17–18. For the exclusive use of S. Kim, 2016. This document is authorized for use only by Soobin Kim in Business Ethics (Spring 2016) taught by Gary Sherman, Stony Brook University from January 2016 to May 2016. 104-071 Accounting Fraud at WorldCom 2 New Orleans and Dallas phone company provid ers for using their local networks, and the telecommunications company whose long-distance ne twork it leased to connect New Orleans to Dallas. These line-cost expenses were a significant cost for all long-distance carriers. LDDS started with about $650,000 in capital but soon accumulated $1.5 million in debt since it lacked the technical expertise to handle the accounts of large companies that had complex switching systems. The company turned to Bernard J. (Bernie) Ebbers, one of its original nine investors, to run things. Ebbers had previously been employed as a milkman, bartender, bar bouncer, car salesman, truck driver, garment factory foreman, high school basketball coach, and hotelier. While he lacked technology experience, Ebbers later joked that his most useful qualification was being “the meanest SOB they could find.” 4 Ebbers took less than a year to make the company profitable. Ebbers focused the young firm on internal grow th, acquiring small long-distance companies with limited geographic service areas and consolidating third-tier long-distance carriers with larger market shares. This strategy delivered economies of scale that were critical in the crowded long- distance reselling market. “Because the volume of bandwidth determined the costs, more money could be made by acquiring larger pipes, which lowered per unit costs,” one observer remarked. 5 LDDS grew rapidly through acquisitions acro ss the American South and West and expanded internationally through acquisitions in Europe and Latin America. (See Exhibit 1 for a selection of mergers between 1991 and 2002.) In 1989, LDDS became a public company through a merger with Advantage Companies, a company that was already trading on Nasdaq. By the end of 1993, LDDS was the fourth-largest long-distance carrier in th e United States. After a shareholder vote in May 1995, the company officially became known as WorldCom. The telecommunications industry evolved rapidl y in the 1990s. The industry’s basic market expanded beyond fixed-line transmission of voice and data to include the transport of data packets over fiber-optic cables that coul d carry voice, data, and video. Th e Telecommunications Act of 1996 permitted long-distance carriers to compete for local service, transforming th e industry’s competitive landscape. Companies scrambled to obtain the capa bility to provide their customers a single source for all telecommunications services. In 1996, WorldCom entered the local servic e market by purchasi ng MFS Communications Company, Inc., for $12.4 billion. MFS’s subsidiary, UUNET, gave WorldCom a substantial international presence and a large ownership stak e in the world’s Internet backbone. In 1997, WorldCom used its highly valued stock to outb id British Telephone and GTE (then the nation’s second-largest local phone company) to acquire MCI, the nation’s second -largest long-distance company. The $42 billion price represented, at the ti me, the largest takeover in U.S. history. By 1998, WorldCom had become a full-service telecommunicati ons company, able to supply virtually any size business with a full complement of telecom services . WorldCom’s integrated service packages and its Internet strengths gave it an advantage over its ma jor competitors, AT&T and Sprint. Analysts hailed Ebbers and Scott Sullivan, the CFO who engineered the MCI merger, as industry leaders. 6 In 1999, WorldCom attempted to acquire Sprint, but the U.S. Justice Department, in July 2000, refused to allow the merger on terms that were acceptable to the two companies. The termination of this merger was a significant event in WorldCom’s history. WorldCom executiv es realized that large- scale mergers were no longer a viable means of expanding the business. a WorldCom employees 4 Jeter, p. 27. 5 Jeter, p. 30. 6 CFO Magazine awarded Sullivan its CFO Excellence award in 1998; Fortune listed Ebbers as one of its “People to Watch 2001.” For the exclusive use of S. Kim, 2016. This document is authorized for use only by Soobin Kim in Business Ethics (Spring 2016) taught by Gary Sherman, Stony Brook University from January 2016 to May 2016.