DIAGNOSES
WorldCom Inc.
presents analyses of the
management case by
academicians and practitioners
Satish C Pandey and Pramod Verma
Case Analysis I
Pradip N Khandwalla
Former Professor
IIM, Ahmedabad
e-mail: pradipkhandwalla@yahoo.co.in
S
The October-December
2004 (Vol. 29 No. 4) issue
of Vikalpa had published a
management case titled
‘WorldCom Inc.’ by Satish C
Pandey and Pramod Verma.
This issue features five
responses on the case by
Pradip N Khandwalla,
Mukund R Dixit, Rishikesha
T Krishnan, Jayanth R
Varma, and Salma Ahmed
and Ashfaque Khan.
herlock Holmes would find the case of who shot WorldCom interesting. Was
it Bernard Ebbers, the larger than life but greedier than Shylock CEO of
WorldCom? Was it Scott Sullivan, the brash young man making some $20
million a year, hungry for more, and clever as a fox in ‘creative accounting’? Was
it the Arthur Andersen audit team that was so very accommodative to the ambitions
of Ebbers and Sullivan? Was it the somnolent board of WorldCom that pampered
Ebbers and for a long time buried its eyes and ears in sand? Was it Saloman Smith
Barney, the investment bankers, and their telecom analyst Jack Grubman, who
appeared to specialize in luring swarms of dumb investors to potentially junk stocks?
Was it Cynthia Cooper and her internal audit team that stood tall and talked straight
while others in the company cowered and whispered and thus spoiled the ‘party’?
Or, was it the Great American Greed System of making money by manipulating
market valuations that played the Professor Moriarty role in the stalking and shooting
of WorldCom?
I find it fascinating that the American system is so alert after a major corporate
crime has become public knowledge. Then the Securities and Exchange Commission,
committees of the Congress, investor groups, bankers, the media and so forth descend
like vultures on the scene. Until then, the system glorifies high-flying corporate
cowboys! Fortune elevated Ebbers to the top of the list of ‘People to Watch 2001’
(in 2003, the irony must have elicited groans from the stakelosers) and Sullivan was
awarded the CFO Excellence Award by the CFO magazine. So long as the wealth
bubble keeps getting bigger, few questions are asked. There is applause for acquisitions and mergers even when some in-depth probing might reveal them to be
reckless or worse; financial acumen is praised as being astute when it is only clever
VIKALPA • VOLUME 30 • NO 2 • APRIL - JUNE 2005
137
window-dressing that could be exposed by some tough
questioning. The logic of this get-rich-fast-at-any-cost
system seems to be: ‘We will treat you like a God so long
as you succeed in making money for us, no inconvenient
questions asked; but God save you if you fail, and if you
do, we will pick you and your past actions apart with
sharp claws and beaks!’
Enron and WorldCom demonstrate how clever
crooks can take corporate governance for a ride. Legislation and oversight bodies can be hoodwinked — all
one needs is a complacent board, a compliant statutory
auditor, and a team of fellow thugs at the top that can
keep the growth bubble growing with fair means and
foul. Once this coalition is in place, corporate crime
becomes easy and detection becomes difficult. How many
American corporations admitted to overstating their past
profits when Sarbanes Oxley created the prospect of
their top executives going to jail for reporting false
profits (these false profits had earlier justified mindboggling remunerations to these executives)!
This system may well be spreading like a virus
throughout the globe. There is evidence of growing
business corruption not only in the US but also in Europe,
Japan, and China. India? Liberalization has probably
reduced black money. But, we may well be getting sucked
into a wheeler-dealer sort of corporate criminal system.
When top executive remuneration is tied to stock market
performance of the company’s shares, there is a nearly
irresistible desire to manipulate the stock market performance of the share. Liberalization has facilitated the
commodification of businesses — takeovers and mergers on the basis largely of illusory gains — and this,
in turn, can lead to hush-hush deals in which millions
change hands and stock prices are temporarily jacked
up with widespread weeping when they crash in due
course.
What can be done? At the system level? At the
WorldCom level? Much. The prime instigator of corporate crime of the Enron-WorldCom-Parmalat-BCCI-AIG
type is the unbridled greed of investors and the managers they appoint to run these corporations. Certainly,
money is an important motivator of the ‘free’ enterprise
system. But, does it have to be the only motivator? Is
it not possible to lay down legally enforceable norms of
decent money-making and to evaluate — in an open
forum — the track record of CEOs in terms of these
norms before appointing or re-appointing them? After
all, many appointments of the American President have
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to be confirmed in open hearings of Congressional
committees. Is it not possible to represent on the corporate board — by law — only people with ethical track
records, selected not by the shareholders’ board but by
the stakeholders’ board on which not just the shareholders but also employees, vendors, customers, civil society
institutions, regulators and so forth are also represented?
Is it not possible to require all corporations to adopt a
code of conduct and have an independent audit of the
ethicality of certain critical transactions that present
money-making opportunities to corporate executives? Is
it not possible to tie the remuneration of top executives
not to share valuation but to a basket of desirable
outcomes such as gains in brand loyalty for the company’s products, in the morale of employees, in productivity and quality of its products, in the company’s
record of ethical conduct and corporate social performance, and in long-term profitability? At stake is the
future of the ‘free’ enterprise system. The market economy
has an enormous potential for good — if the incentive
and the regulatory structure is right for our times. But,
with a wrong incentive and/or regulatory structure, it
also has the potential to unleash corporate AIDS that can
destroy people’s confidence in a market economy of
greed-driven ‘free’ enterprise.
As far as WorldCom is concerned, can the company
be salvaged? Yes, of course! We know from corporate
turnaround research that companies in far worse financial straits than WorldCom have been resuscitated. After
all, WorldCom’s assets appear to be far greater than its
liabilities and Chapter 10 protection is also available in
the US. What WorldCom needs is first-rate turnaround
leadership. Is Sidgmore, a finger-pointing, apologetic
insider, the right choice? Probably not. A transformational leader like Vaughan Beals who turned around
Harley Davidson, Gil Amelio who turned around National Semiconductor, George Fisher who turned around
Eastman Kodak, Jack Smith who turned around GM or,
to step outside of the US, Jan Timmer who turned around
Philips Electronics, Colin Marshall who turned around
British Airways, Marisa Bellisario who turned around
Italtel, Gerhard Schulmeyer who turned around Siemens-Nixdorf, V Krishnamurthy who turned around
SAIL is needed.
Such a leader would excite the staff with a bold
vision rather than resort to intimidation; get commissioned a decent diagnostic study; talk around widely
with all the stakeholders and invite them into crafting
WORLDCOM INC.
a viable turnaround strategy; encourage the staff to
bring about changes, innovations, and improvements in
their respective areas of operations; seek to optimize,
through teams and task forces, the use of existing assets
rather than rush off to a buying/divestiture flurry;
identify dynamic professionals — or get them from
outside — and put them in charge of SBUs, functions,
and profit centres; engage in two-way communications;
set a personal example for probity and commitment to
the organization; seek to institutionalize, through ap-
propriate human resource management systems, a culture of participative decision-making, staff empowerment, customer care, creativity and innovation, and
ethical conduct; and redefine the mission of WorldCom
as raising the quality of life of the people profitably.
Dozens of corporations around the world have been
turned around by actions like the foregoing. These steps
will build internal and external credibility and could
transform WorldCom from a pariah into an icon of
corporate excellence.
Case Analysis II
Mukund R Dixit
Faculty, Business Policy Area
IIM, Ahmedabad
e-mail: dixit@iimahd.ernet.in
T
he happenings in WorldCom, a company that
began as a discount long-distance service provider in 1983, point to the following general schema
of ‘boom to bust company.’
SCHEMA
The maturity of an industry or change in technologies
or regulations open opportunities for new entry. The
new entrants succeed by competing on either price —
emergence of discount chains — or new product or
service features — dot com services or mobile telephony.
They question the existing practices in the industry. As
the incumbent struggles to adapt to the changes, they
innovate and sustain their entry. Not all companies that
enter succeed in sustaining their entry. Failures arise
from their inability to put their internal act together and
deliver what they have promised. The successful sustainer consolidates its position by acquiring the failed
companies or those that want to exit. As it succeeds, it
builds expectations of further success. It expands domestically, internationalizes, and diversifies through
further acquisition. It attracts the attention of venture
capitalists, bankers, equity investors, equipment suppliers, and employment seekers. Customers migrate to it.
Together they form an ecosystem of their own and look
forward to high rewards from their involvement in the
industry.
The promoters and managers of the company become celebrities and win awards from professional
VIKALPA • VOLUME 30 • NO 2 • APRIL - JUNE 2005
bodies. The members of the ecosystem tend to rely more
on the pronouncements of the managers and promoters
and less on their own homework and learning. They fail to
question the strategy, resources, and competencies of the
company. They build an illusion of their own. Hiccups,
if any, are seen as temporary. They depend on the
company to mould their future and fortunes. The allround favourable situation is exploited by some members to serve their personal interests.
In its hunger for growth and for meeting the expectations of the ecosystem members, the management of
the company fails to notice the imbalances across aspirations, strategy, systems, processes, and resources.
Audits and control systems are seen as irritants. The
cracks and inefficiencies that surface are not recognized.
Those who notice them are not allowed to express themselves. Those who express themselves are snubbed and
removed from the membership of the ecosystem. When
the management notices the fall either by internal accidents or by an external evaluation or by an unfavourable development in the external environment, it resorts
to window-dressing to maintain its image, power, and
prestige. Some members of the ecosystem oblige by
conniving with the companies to hide the facts and
suppress failure. They subserve their own selfish goals.
Together they exploit the ignorance and illusion of several
other ecosystem members. Their fraud goes without
being questioned. One day, someone from within blows
the whistle and the fraud comes to light. It is too late
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to do anything. Investors, suppliers, employees, and
customers lose. Everyone is aghast. The legal system
institutes enquiries, lawyers become active, promoters
resign or go underground, employees seek opportunities elsewhere, customers support the competitors, and
a once successful company faces bankruptcy.
SIDGMORE TAKES CHARGE
When John Sidgmore took charge as the CEO of WorldCom on April 30, 2002, the imbalances in WorldCom had
already showed up. The acquisition of Intermedia was
probed by the Antitrust Division of the US Department
of Justice and the company was ordered to sell all the
assets of Intermedia Communications. The Security
Exchange Commission questioned the decision of the
board to lend more than $400 million at an interest rate
of 2.5 per cent to Ebbers, one of the early investors in
WorldCom and an empire builder as the CEO of the
company since 1985. Ebbers was asked to leave with
a golden handshake worth $1.5 million for life. The
company itself was sinking under $28 million debt and
a fall in the stock price to $1.79 against the peak of $64.50.
The credit rating agencies had downgraded the company’s ratings. The 2001-02 revenues had dropped by 10
per cent while the profits had dropped by 64 per cent.
Amidst this, Sidgmore expressed his commitment
to operate WorldCom ‘in accordance with the highest
ethical standards.’ He articulated a strategy of downsizing
and restructuring that would provide ‘unwavering’
support to the customers and drive ‘fundamental changes
at WorldCom.’
THE SHOCKS
The public pronouncements of Sidgmore on taking charge
indicate that he was either not aware of the accounting
frauds that were happening since 1999 or was trying to
create an illusion. I would like to give the benefit and
say that he was naïve and that he was not a part of the
coterie that cooked the accounts. He may have been
involved in the technical and business building aspects
of the company.
The developments between June 20, 2002, when
Cynthia Cooper disclosed her findings of inappropriate
‘line cost transfer,’ and July 21, 2002, when WorldCom
filed for protection to allow it to continue operations
shocked all the stakeholders including the regulatory
authorities. The company’s own enquiry and investigations by independent agencies indicated an attempt to
140
hoodwink the investors and perpetuate a fraud. Underlying the fraud was the fundamental imbalance in the
strategy, resources, and capabilities of the company. The
company had failed to integrate its acquisitions and craft
a sustainable strategy. It had not challenged the assumptions behind the business logic of growth through acquisition in an emerging sector. It had failed to invest
in learning and building management control systems.
When the internet boom went bust and the global demand for telecom services declined, the cracks in the
strategy surfaced. The board believed what was told to
it. When the fraud surfaced, it provided a knee-jerk
response by asking the senior officials to relinquish their
responsibilities. The board did not question the revealed
imbalances in strategy, structure, and processes. Nor did
it question the veracity of the golden handshake for
Ebbers. In a way, the board said, “I am not responsible
for this. Catch the accountants and fire them.” This was
an attempt to get the first scapegoat and absolve oneself
of the blame.
THE TASKS
Against the shocks and the bankruptcy petition, Sidgmore faces the tasks of determining the ‘true performance’ of the company, discovering the fundamentals of
the company, facing negative publicity, realigning helpful forces to provide support in divestment, focusing,
and building trust. The strategy of growth through
acquisition is not possible now. As a CEO succeeding
Ebbers, he is in the worst situation. He is required to
keep a bold face and spend his time in answering
questions of commissions of enquiries, analysts, employees, and customers. Where would he have the time
and inclination to review the strategy and its execution?
The only operations that appear to be anchors for
building forward are the MCI operations and the international communications services. The hope, however,
is limited. He is unlikely to find significant support for
any of his moves to clean up and build. The negative
publicity and the image of being with a company that
cooked accounts are likely to drive away the ‘value
conscious’ customers, investors, and employees. There
are viable options for them in the converging telecom
sector. In view of this, the preferred option for Sidgmore
is to sell free assets, if there are, find buyers for the viable
operations, pay off the debts, and close WorldCom.
Sidgmore can find a job elsewhere.
WORLDCOM INC.
THE LESSONS
The experience of WorldCom makes us recount some
time-honoured lessons in management. When you are
successful, check the sources of success and the assumptions of your business logic. Distinguish between nurtured and conferred sources of advantage. The conferred
sources belong to others and if they are determining the
path of your growth, your path is unsustainable. Do
build at the earliest your own sources of advantage.
Similarly, when there is a discontinuity in your strategy
or the stage of your growth, examine the need to learn
and unlearn. With every stage, you get new stakeholders
who bring new expectations and sources of anxiety. Do
build a control system to check the balance in personal
aspirations, strategy, structure, and processes. Exaggerate negative signals, however weak, and initiate corrective actions when the environment is still favourable. Do
not follow short cuts or illegal means to fulfil the expectations of stakeholders, however strong they may be.
One day they would surface as imbalances and ruin the
company and the society.
Case Analysis III
Rishikesha T Krishnan
Faculty, Corporate Strategy and Policy
IIM, Bangalore
e-mail: rishi@iimb.ernet.in
F
or the practising manager, the WorldCom case
provides fascinating insights into how a large
company can rapidly unravel if the climate in the
organization encourages unbridled unethical behaviour.
Based on what is stated in the case, this is what
happened at WorldCom:
The company inflated its profits by recognizing
income prematurely and by capitalizing expenses
that should have been expensed immediately. The
company’s top management resorted to these accounting malpractices in an attempt to shore up
the price of the company’s stock. A high stock
price was necessary to enable the company to
continue on its strategy of growth through mergers and acquisitions for which stock was the main
currency. Such continued growth was required to
keep up the position of the company in the Fortune
list, and perhaps more importantly, maintain
Bernard Ebbers’ profile as one of the key movers
of the telecom industry. Keeping the stock price
high was essential to Ebbers personally as well
— he was financing other business interests with
loans taken using his WorldCom stock as collateral.
This effort to manipulate the financial statements
at WorldCom was facilitated by the lack of a
credible control system within the company.
Decisions regarding accounting statements were
VIKALPA • VOLUME 30 • NO 2 • APRIL - JUNE 2005
centralized at the highest levels of the finance
function. Managers who asked questions were
told to keep quiet and sidelined; in contrast, the
rewards for those who collaborated were high.
Naturally, the company valued ‘loyalty’ highly
where loyalty was defined as cooperation with
those who controlled the company. The CFO
controlled the flow of information to the board,
though given the fact that the board consisted
largely of people who had worked with Ebbers
at different times, it is an open question of how
they would have responded to information that
raised doubts about accounting policies. In any
case, there is no evidence that the board asked the
CEO and CFO any tough questions about the
financial performance of the company. The company’s auditors appear to have been quite content
to go along with the window-dressing done by the
company, influenced perhaps by their perception
of WorldCom as one of their most prestigious
clients. Others who could have asked questions
(most notably the analysts working for investment banks) failed to do so either because of the
business that WorldCom gave them or a close
nexus that had formed between the WorldCom’s
top management and individual analysts.
Being a highly leveraged company, WorldCom
was particularly vulnerable to bad news. The
141
moment its accounting malpractices came to light,
its stock tumbled and its debt was downgraded
as analysts questioned the company’s ability to
repay its creditors. Ironically, though, the sudden
transformation of its debt to ‘junk’ status also
gave the company the opportunity to seek protection under US bankruptcy laws and gain time
and space for restructuring.
The happenings at WorldCom as described in this
case are similar to what happened in a number of companies at that time as has been subsequently revealed
by other admissions of accounting mis-statements.
Executives of companies ‘talked up’ stock prices to enable
expensive acquisitions assisted at least in part by analysts who were willing to ‘buy into’ the story. To meet
the enhanced expectations of the market, executives
inflated company results. Efforts by middle managers
to question such moves internally were portrayed as
disloyal and squelched by charismatic and powerful
CXOs. Boards packed with nominally independent directors (with long-time links to the company and the
CEO) failed to exercise any oversight and may have
indirectly benefited as long as the going was good. Hubris
and a sense of infallibility, often buttressed by supportive analysts and the business press, accentuated the top
management’s sense that there was nothing wrong with
what they were doing.
This reminds me of one of the all-time classics on
ethics in business in which Gellerman explains “Why
‘good’ managers make ‘bad’ ethical choices” — a belief
that what they are doing is not really unethical or immoral
— “everyone does it;” a belief that what they are doing
is in the best interests of the company and is, in fact,
what is expected of them; a belief that what they are
doing would not be detected; and a belief that since what
they are doing helps the company, the company will
actually condone it and even protect the person who
engages in it even if it is detected. These beliefs get
enhanced when the organization promotes a culture in
which only results matter and not how they are achieved.
In such organizations, high performers who have used
questionable means rise quickly to the top with steep
increases in compensation. The external environment
plays a role as well — when every company is reporting
outstanding results and expectations show no sign of
cooling down, CEOs are under tremendous pressure to
show results and may resort to window-dressing to keep
up with their peers. More so, when the CEO is used to
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seeing his picture on magazine covers! We live in an era
in which people seek quick results and instant gratification. Few organizations or individuals have the patience to tread the ‘slow and steady’ path to success. The
irony is that studies of companies that have demonstrated long-term superior performance such as Jim
Collins’ Good to Great show that the leaders of such
companies work quietly, do not seek external publicity,
and are driven by humility and a fierce resolve, a far
cry from the high-profile CEOs who dominate stories in
the popular business press!
Any system depends on checks and balances for its
effective functioning. Markets are no exception. When
different yet powerful elements of the market collude,
the functioning of markets can be impeded. Though the
alignment of performance and incentives is an oft-suggested means of addressing the principal-agent problem, there is a big problem when the agent also controls
the information that reflects his own performance. Also,
when the incentives become too large, the temptation
to resort to underhand means of showing performance
swells. And it becomes easier to join hands with others,
either by sharing a part of the incentive or aligning with
the incentive structures of those players themselves (e.g.,
brokers and analysts). Here, the role of external regulatory agencies is crucial — if they play their oversight
role more aggressively, there is a smaller likelihood of
brazen violation of norms. Note that even in the
WorldCom case, it was the SEC’s investigation of lowcost loans given to Ebbers that led to his exit from the
company.
The recovery of a company from a WorldCom-like
situation is far from easy. Moving from denial to a quick
acceptance of all wrong-doing is the first step. Rewriting
the financial statements to reflect the true financial
position accompanied by an external audit by a credible
outside source has to follow immediately. Since such a
rewriting will expose large gaps in the company and
convert profits into losses, a sale of assets and restructuring of the business will be inevitable. All senior
executives who have been a part of the cover-up need
to go and soon. The more difficult part is a cultural
transformation. Public recognition of those who struggled against great odds to expose what went wrong
would help kick-start this process. Reconstitution of the
board with at least a few genuinely independent persons
of high integrity would help. In the long-run, the company should formulate a code of conduct and implement
WORLDCOM INC.
it across the organization. Since actions speak louder
than words, the company should ensure and demonstrate that the code is being followed right from the top.
In addition, it needs to facilitate whistle-blowing by
employees by creating a reporting system that ensures
confidentiality. It has to also demonstrate that action is
taken on issues reported by whistle-blowers. An influential person of high moral stature should be brought
in as an ombudsman to ensure that whistle-blowers are
protected.
Long treatises have been written on corporate
governance in the wake of the implosion of Arthur
Andersen, Enron, WorldCom and other large compa-
nies. Even governments that are traditionally pro-business and anti-regulation — such as the US government
— have felt compelled to tighten control through measures such as the Sarbanes-Oxley Act. The quality of
investigation and high rate of conviction in the US may
ensure a fair degree of compliance with enhanced standards of corporate governance. High profile convictions
and jail terms served by white-collar violators such as
Martha Stewart will also have an impact. Such efforts
to use the legal framework to improve corporate governance will not work in India unless they are backed
up by similar steps to make the detection, investigation,
and conviction of white-collar crimes more effective.
Case Analysis IV
Jayanth R Varma
Faculty, Finance and Accounting
IIM, Ahmedabad
e-mail: jrvarma@iimahd.ernet.in
T
he case by Pandey and Verma provides a description of the WorldCom debacle focusing on the
organizational and governance aspects of the
situation. In my view, however, these aspects are largely
irrelevant to the challenges that Sidgmore faces in mid2002. What Sidgmore needs to do is to identify the value
in the WorldCom business and take quick steps to extract
that value.
There are four reasons why I make this claim:
• Unlike in some of the other high profile corporate
failures of the same time, it is clear that in WorldCom, the problem was confined to the CFO, Scott
Sullivan, the Controller, David Myers, and a few key
subordinates apart from the CEO, Bernard Ebbers.
The reason is that the principal fraud at WorldCom
was a very simple capitalization of line costs masterminded by Sullivan himself. This required just
one accounting entry every quarter at the Head
Office. Therefore, we do not see the kind of allpervasive fraud that is in evidence at Enron, for
example.
• The key actors of this fraud — Ebbers, Sullivan, and
Myers — have all either resigned or been terminated. There is a new CEO and a court appointed
monitor. This has more or less set the governance
right.
• The prime responsibility for any further investiga-
VIKALPA • VOLUME 30 • NO 2 • APRIL - JUNE 2005
tion and governance reforms would fall not on Sidgmore but on the court appointed monitor, Richard
Breeden. For example, some of the board members
may have to go too for their failure to check the
misdeeds of Ebbers and Sullivan but, it is not really
Sidgmore’s job to fire the board to whom he reports.
The unpleasant task of engineering that would fall
on Breeden.
• The company has filed for bankruptcy and emerging out of this bankruptcy is, therefore, a matter of
extreme urgency.
Sidgmore’s task, therefore, is to identify the businesses of the company that have value and try to salvage
whatever value is possible under the existing difficult
circumstances. The body of the case provides too little
information on the value of the WorldCom businesses
but, it is possible to make some estimates from the
information in the exhibits.
The key step in this is to go back to the merger with
MCI back in 1998. From the Fortune rankings for 1997
(Exhibit 2, Table 3E), we find that MCI was nearly three
times as large as WorldCom in terms of revenues and
employees before the merger. However, MCI was not
very profitable then and the MCI part of the merged
business has not been very profitable since the merger
either as may be seen from the segment results in Exhibit
2 (Table 1). It is clear from the body of the case that the
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MCI business was a conventional telecom business (local
and long distance telephones) while WorldCom was
predominantly in the business of internet infrastructure.
The natural conclusion to draw is that the dot com
bubble of the late 1990s had provided WorldCom with
a valuable currency (its own shares) to buy the much
larger business of MCI. In 2002, after the dot com bubble
burst, the internet-related business (the original
WorldCom) is probably worthless or close to worthless
while the bulk of the value of the old MCI business is
probably still there. Some caution is appropriate even
here as the dot com meltdown is probably putting severe
pressure on all telecom companies and not just on the
internet infrastructure providers.
The problem then reduces to figuring out what
value there is in the old MCI business and finding out
ways to extract this value. It is clear from the Fortune
rankings (Exhibit 2, Table 3E) that back in 1997, the old
MCI, while being bigger than WorldCom, was still an
also-ran in the telecommunications business. It was only
marginally profitable then and would probably be even
less profitable in 2002. It is, in all probability, not a viable
business today on a stand-alone basis. Quite possibly,
it was not a viable business on a stand-alone basis
even in 1998 and that is why it agreed to be bought by
Worldcom.
What this means is that the company (which for all
practical purposes means the old MCI) must be sold. In
some sense, Sidgmore needs to turn the clock back by
five years and arrange a new buyer for MCI. The natural
buyer would be one of the other conventional telecom
companies.
But, before Sidgmore can get that far, he needs to
deal with the company’s debt and its ongoing bankruptcy proceedings. Under our assumption that the only
valuable assets are of the MCI Group (which is only
13.4% of the total assets of the company), the value of
the assets is only about $ 14 billion (13.4% of $104 billion
from Exhibit 2, Table 1). This is less than half of the total
debt of $ 30 billion (again from Exhibit 2, Table 1). Of
course, this is a very crude estimate. On the one hand,
there are many intangible assets (the customer base of
MCI, for example) that are not reflected on the balance
sheet. On the other hand, some of the telecom assets of
even the MCI business may be worth less than book
value because of the steep fall in prices of telecom assets
after the collapse of demand for telecom services. What
is clear, however, is that a significant debt reduction is
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essential though at first sight it appears that the debt
is only 30 per cent of the assets on the balance sheet.
Sidgmore must, therefore, evolve a strategy for
negotiating with the debtors to write-off a large amount
of the debt and emerge from bankruptcy as a saleable
entity. Creditors are bound to be very angry at the fraud
that has been perpetrated on them. A key element of
Sidgmore’s strategy would have to be to deflect this
anger from WorldCom itself to other actors — Ebbers,
Sullivan, the old directors, and the auditors. Sidgmore
must also encourage the creditors to sue anybody else
with deep pockets who could be linked to the fraud in
some way. This would improve the total recovery for
the creditors and make them more willing to countenance a reasonable deal with the company itself. With
the creditors’ anger thus deflected from the company to
the true perpetrators of the fraud and other defendants,
Sidgmore can work towards a reasonable restructuring
of the debt. Even with this, however, the creditors could
end up owning a significant fraction of the firm under
a debt equity swap.
One final question remains. Should the businesses
of the company be sold under the bankruptcy process
itself (a sale of assets) or should the company itself be
sold as a whole after emerging from bankruptcy? The
following factors point to a sale of the company after
emerging from bankruptcy:
•
The scale of fraud is small enough to be isolated and
exorcised. Once this has been done, the company
can put its past sins behind it and restore its relationships with its customers and other stakeholders.
•
The corporate and retail telephony businesses of the
old MCI involve valuable customer relationships
and intangible assets that are more easily extracted
by selling the entire company than through a sale
of assets.
•
By emerging from bankruptcy and then putting
itself up for sale, the company could avoid a distress
sale. With the debts down to manageable levels, the
company could wait for a more favourable economic environment to sell its assets. By waiting for a
couple of years, Sidgmore could hope to conjure a
bidding battle between the large telecom companies. With the entire telecom sector in bad shape in
2002, it is much less likely that such a bidding war
would take place if the assets were sold immediately.
WORLDCOM INC.
It is an essential element of this strategy that
WorldCom dissociate itself from the old management in
every possible way. It is only in this way that the company can gain the goodwill of the creditors and of the
court. It needs their goodwill to emerge from bankruptcy
successfully. This almost certainly means that the old
directors will have to go (whether or not they are guilty),
but this unfortunately is not in Sidgmore’s hands. He
can only hope that Breeden will do this job for him. In
this limited sense, corporate governance reforms are an
element of Sidgmore’s strategy but by no means the most
important element. He must not forget that he is the CEO
and his most important responsibility is to preserve and
enhance the value of the business.
Case Analysis V
Salma Ahmed
Faculty,
Faculty of Management Studies and Research
AMU, Aligarh
e-mail: salmaahmed6@rediffmail.com
M
ergers are being announced worldwide at an
unprecedented rate. There can be four major
reasons for any merger activity:
• To improve operational efficiency and focus on cost
reduction by cutting overheads — HP and Apollo
Computer merger was on these lines.
• To obtain access to new technologies or intellectual
talent.
• To increase market share.
• To eliminate competition — Compaq merging with
Digital Equipment to outdo IBM is one such instance.
However, no such reason was seen in the case of
WorldCom’s merger or acquisition exercise. Apparently,
the CEO entered a deal simply to get headlines and make
the company bigger! WorldCom’s spate of acquisitions
did not seem to fit in with the strategic vision of the
company. Initially, the merger with MCI was to increase
dominance in the telecom industry; later on, there was
no strategic direction.
WHAT WENT WRONG?
WorldCom grew tremendously in both size and complexity in a relatively short period of time because of
the dramatic rise in the value of its stock. It needed to
keep its stock price at high levels to continue its phenomenal growth. In 1997 and 1998, it completed three
major acquisitions, the most significant involving MCI.
WorldCom’s growth evolved, as it appears, from its
belief that competition and capital requirements in the
telecommunications industry would result in consolidaVIKALPA • VOLUME 30 • NO 2 • APRIL - JUNE 2005
Ashfaque Khan
Executive, Red Hat India
New Delhi
e-mail: akhan@redhat.com
tion of competitors to a few dominant companies; in
order to survive, it needed to grow its services, customer
base, and facilities rapidly and continually; that the most
effective means to grow was the acquisition of existing
telecommunications companies with desirable shares of
geographic or service markets and investment in new
technologies in order to reduce marginal costs, attract
customers, and meet their demand for new and better
services.
WorldCom did not achieve its growth by following
a pre-defined strategic plan but rather by opportunistic
and rapid acquisition of other companies. The unrelenting pace of these acquisitions led the company to constantly redefine itself and its focus. In fact in the light of
the pace of change, the identity changes were so rapid and
discontinuous that they created identity ambiguity. Its
unceasing growth and metamorphosis made integration
of its newly acquired operations, systems, and personnel
much more difficult. Probably its own management,
systems, internal controls, and also personnel could not
keep pace with that growth. Probably organizational
members collectively faced change overload. It is also possible that these dramatic growth and related changes
made it difficult for investors to compare the company’s
operations to historical benchmarks.
Ebbers appears to have dominated the course of the
company’s growth as well as the agenda, discussions,
and decisions of the Board of Directors. Critical questioning was discouraged and the board did not appear
to evaluate proposed transactions in appropriate depth,
even though several members of the board had a sig-
145
nificant percentage of their personal wealth tied to the
value of the company’s stock. The Audit Committee of
the Board of Directors did not appear to operate effectively or aggressively and, therefore, did not do justice
to its role. Worldcom’s culture was dominated by a
strong chief executive officer, who was given virtually
unfettered discretion to commit vast amounts of shareholder resources and determine corporate direction
without even the slightest scrutiny or meaningful deliberation or analysis by senior management or the Board
of Directors. This suggests that the CEO and only a few
close to CEO-Ebbers and CFO-Sullivan were at the helm
of affairs which finally led to the downfall of the company. The culture of the company was individualistic
and highly autocratic. There also existed a strong culture
of secrecy in the company; as such the management
repeatedly buried financial data from its board and
auditors. The management fostered a culture that implicitly forbid scrutiny and detailed questioning.
The failure of the internal audit department to
develop and implement a comprehensive risk-based and
financial controls-oriented internal audit plan contributed to the weakness of WorldCom’s internal controls.
It appears that the personnel assigned to the internal
audit department apparently attempted to perform their
responsibilities in a diligent and professional manner.
However, their ability to do so was limited by two
significant factors. First, its focus was directed to the
operational as opposed to financial matters. Second, it
suffered from a seeming lack of adequate support from
WorldCom’s senior management, its Board of Directors,
and the Audit Committee.
Also, the relationship between Arthur Andersen
and the company needs to be reviewed. This is because
Arthur Andersen’s review of the working of the company between 1999 and 2001 reflects that WorldCom was
a ‘maximum risk’ client. Yet, it reported the company’s
practices to be fair. Therefore, it does not appear that
the audit procedures employed by Arthur Andersen
were appropriate for the risk profile it ascribed to
WorldCom.
The volume of the transactions undertaken by
WorldCom as presented in the case was enormous. Many
a times, some of the transactions were the largest ever
undertaken (at that point of time) by any company in
the world. While WorldCom’s series of impressive acquisitions is notable, the company also executed numer-
146
ous other types of transactions. For instance, it issued
several large debt offerings, registered equity securities,
entered into long-term outsourcing contracts, became a
venturer in international joint ventures, and issued its
two-tracking stocks.
The mergers and acquisitions by WorldCom varied
in type and size. However, an analysis of these varied
transactions and related circumstances emphasizes a
common theme — WorldCom was continually embarking on its next ‘deal.’ Within a month’s time, a new
merger would take place each of which lacked the detailed
study and the analysis undertaken before a merger. It
appears that the number, type, and size of these transactions contributed to WorldCom’s problems and may
have placed an unhealthy strain on systems and personnel.
It appears that a culture of greed had crept in at the
top management levels of WorldCom apparently without effective check by the company’s Board of Directors.
The compensation and benefits received by the members
of WorldCom’s top management were extremely generous and are a testimony to this fact. For reasons that
still need to be investigated, the compensation packages
of a significant number of senior WorldCom employees
became more lucrative in the final two years before the
company declared bankruptcy. Under basic principles
of corporate governance, the company’s compensation
committee should have checked the payment of unreasonable or improper compensation and benefits. However, it appears that the committee did not critique or
challenge the compensation decisions presented by
Ebbers or other members of the company’s management.
An analysis also reveals that WorldCom put extraordinary pressure on itself to meet the expectations
of securities analysts. This pressure created an environment in which reporting numbers that met these expectations apparently became more important than accurate financial reporting (no matter how these numbers
were derived). As the growth slowed down in telecom
industry, the management at WorldCom was forced to
adopt unethical practices and continue presenting a rosy
picture. However, the crisis was not caused due to any
structural changes in the industry but because the glorious days of WorldCom caused the executives to lose
touch with the reality. This, in turn, led them to ignore
or disregard warning signs and continue chasing growth
at all costs which finally led to the largest bankruptcy
in the US history.
WORLDCOM INC.
HOW TO GET BACK ON TRACK?
The company was reeling under a situation of low
corporate governance, fraudulent accounting practices,
low valuation of shares, loss of image, loss of customer
goodwill, and loss of investor faith. How can it be turned
around?
• First, and foremost, the turnaround process should
start with managerial overhaul. (In fact a change in
CEO did take place with John Sidgmore taking over
as CEO replacing Ebbers.) A new corporate leader
and leadership structure should be created and this
team should chalk out the strategic direction for the
company. Fundamental changes are desired in structure, operating methods, product mix, financial
controls, etc., to name a few.
• The company should create a culture of open communication and transparency where every employee should feel comfortable to speak his or her mind.
The CEO and his team should interact with employees, understand their problems, elicit opinion, and
initiate other measures emphasizing on behavioural
change aimed at improving the work culture and
morale of the employees. This is needed to restore
the confidence of the employees.
• Customer focus should be a critical concern considering that customers would be skeptical of the
company’s credibility. Customer confidence can be
regained by consistent quality of services and continued communication. Also, undertaking customer
relationship management and customer contact
programme is advisable to improve relationship
with customers. In addition, it needs to focus on new
customers by developing key new products. Further, it could identify different market segments and
offer customized plans to meet their needs.
• Various measures should be undertaken to drastically reduce cost. A reduction in the workforce could
be realized across the organization. With a purpose
to align costs with its projected revenue, it should
reduce its US-based staff force. New compensation
scheme should be taken up keeping in mind the
competitive structure in the industry. Also, spinning off non-core business is another option open
to the company to reduce costs.
• Actions that would quickly improve the management’s financial or operating control should be undertaken such as reduction in capital expenditure
VIKALPA • VOLUME 30 • NO 2 • APRIL - JUNE 2005
•
•
•
or control over cash disbursements. Fresh finance
through short-and long-term borrowing and equity
issues may also be resorted in order to improve the
financial position of the company.
The company should focus on corporate integrity
and continuously stress on the fact that it is a
company with sound principles of corporate governance and that ethical conduct forms the foundation for its business. It should lay down a code of
conduct that would define the way it would work.
This code should be approved by its Board of
Directors and should apply to everyone who acts
on behalf of the company—employees, executive
officers, members of the Board of Directors, agents,
consultants, contractors, and others. Violations, if
any, should become the cause for disciplinary action.
The executive management team should assist the
company in its efforts to furnish investors and the
marketplace with a strong and effective disclosure
programme. This should provide a consistently high
level of transparency. The company should ensure
that all disclosures made in financial reports and
public documents filed with the Securities and
Exchange Commission and other public communications are full, fair, accurate, timely, and understandable. Consistent standards should be maintained for financial reporting and the treatment of
shareholder interest making the boardroom accountable and the standards of corporate governance a
global issue. Further, it should ensure that the
company complies with applicable restrictions on
securities trading and disclosures. In other words,
it should not engage in improper trading or disclosures about the securities of the company.
Improved board performance will eventually translate into better corporate governance. In fact, it is
important that there be a clear definition of the roles
and responsibilities of the board and the corporate
executive team in the process of corporate governance. The role of a board can be evaluated by using
the BCG framework. The parameters to be considered may be role clarity, focus, independence of
directors, effective processes and structures, experience capability, evaluation of performance of
directors, relationship of board with the chief executive team, and culture and protocol.
147
•
The company’s Board of Directors should approve
the change of auditor. Also, it should build a strong
internal audit team, set the right tone, and create
a strong control environment focusing on integrity,
independence, and timeliness of reporting.
•
The company should lay down metrics to measure
performance. This should be done for the short-as
well as the long-term.
A myriad of changes starting with restructuring of the
top management, change in corporate culture, customer
focus, customized and innovative products, strict financial control and corporate integrity initiatives, and laying down of metrics to continuously review performance
could go a long way in helping WorldCom get back on
its track. Therefore, a mix of surgical as well as humane
approach is desirable to restore WorldCom to its lost
glory.
You cannot stay on the summit forever;
you have to come down again.
So why bother in the first place?
Just this: What is above knows what is below,
but what is below does not know what is above.
One climbs, one sees.
One descends, one sees no longer, but one has
seen.
There is an art of conducting oneself in the lower
regions
by the memory of what one saw higher up.
When one can no longer see, one can at least still
know.
René Daumal
148
WORLDCOM INC.