Professional Documents
Culture Documents
Earnings Management & Different Scandals
Earnings Management & Different Scandals
Enron
Fortune Magazine selected Enron as "America's most innovative company" for six straight years from 1996 to 2001. Stogy gas transmission company started with massive debt Formed a gas trading company, expanded into electricity, risk mgt. & telecom; expanded internationally Based on economic reality, many of these were failures Based on earnings magic, all were successful
Enron 2
Gas trading: deregulated & volatile, need for spot market purchases & related derivatives, volatility increased trading profits Problem of massive & potential junk bond ratings Use of special purpose entities (SPEs) to reduce perception of too much debt
Enron 3
Importance of meeting quarterly earnings, initially through cost savings, then increasingly more gimmicks Scheme 1: revalue physical assets using fair value models (SFAS 125, designed for financial assets)front-loading profits Scheme 2: using SPEs in virtually any complex context to record earnings
Enron 4
SPEs were mishandled CFO Andy Fastow manipulated these for his own enrichment + independence problem Particularly shady SPEs approved by auditor Arthur Andersen, attorneys, & board of directors; accommodated by investment banks & no obvious oversight by SEC
Enron 5
Some operations were successful, others were major blunders; the net effect was to dramatically increase financial risk, & Enrons unwillingness to disclose real losses as they occurred Mid-2001: stock price dropped, executives bailed out of stock options, bond ratings back to junk status Enron restated earnings in 3rd quarter 2001 With no credibility, Enron declared bankruptcy in December 2001, the biggest bankruptcy until
WorldCom
Bernie Ebbers started long-distance telecom company in 1983 (name changed to WorldCom in 1995) Growth through merger strategy (note earnings magic of business combinations) WorldCom looked solid, with total assets of $104 billion & debt-to-equity of 79.3%, but half the assets were goodwill & other intangibles In 2002 internal audit found operating expenses capitalized
WorldCom 2
New auditor KPMG reviewed the books, old auditor Arthur Andersen was fired; Ebbers resigned in April In June 2002 WorldCom announced $3.8 billion in accounting errors, mainly by capitalizing line costs (fees to other telecom companies for network access rightsthese are operating expenses)
WorldCom 3
WorldCom restated earnings, CFO was fired Actual capitalization misstatements totaled over $11 billion WorldCom filed for bankruptcy in July 2002, replacing Enron as the largest bankruptcy in US history
Tyco
Starting as a research lab, Tyco became a conglomerate through acquisitions CEO Deal a Day Dennis Kozlowski acquired 750 companies, using the earnings magic of combination accounting Acquisition of CIT Group a particular fiasco, resulting in big losses (& extra financial reporting that showed many of Tycos manipulation shenanigans
Tyco 2
Big loss on sale of CIT & total $9.4 billion loss for 2002 Kozlowski indicted for evading taxes & raiding Tyco Tyco did not go bankrupt Despite obvious manipulation & deception on a vast scale, its not clear that the company actually engaged in criminal acts (court cases pending)
Adelphia
John Regas transformed a cable franchise into a communications empire Restated earnings in 2002, including billion in off-balance-sheet co-borrowing agreements Filed for bankruptcy in June 2002 Regas & others charged with financial fraud