LEADERSHIP AND CORPORATE GOVERNANCE

QUESTION

1. Choose two issues that have appeared in the media during this semester that relates to issues of Governance. Identify the key issues and use concepts covered during the semester to explain the governance related issue.( Clarke T. 2007 International corporate governance: A comparative approach. London, Routledge)

1. Answer the questions to the Wearing Enron case using material covered this semester.

1. Answer the questions to the Wearing WorldCom Case using material covered this semester.

SOLUTION

Enron Financial disaster

The major reasons for downfall of corporate giant like Enron are the corporate governance and lack of work ethics and greed. Enron the energygiant held the reputation of being 7^th largest corporate giant in U.S., but with its accounting messesand personal greed of the chief financial officer and many others it was reduced to trashes. The key issues here were:

• Hiding debt in disguise of SPV’s and to show inflated profits
• This led to downslide in  share prices and decreasing credit rating of the company
• The retire4ment savingsof the employees was totally lost due to bad financial accounting.
• Arthur Anderson and Enron hid the financial situation from everyone will it was out in public. They even shredded the important financial documents and audit related documents

Results of Enron Fall out

This collapse puts a big question mark on the free trade policy and regulations of government, tax evasion of rich and powerful and heavy taxes levied on poor and middle class

The myth of deregulation has been busted as had there been powerful and strict norms of regulation related to power , energy and energy derivatives such kindof financial disaster could have been diverted.

Campaign Finance Reform prevalent in U.S has been given a high empowerment as Enron was financing campaigns of G.W. Bush in the country with huge amounts just to get some political favours.

The dual face of wall Street was also uncovered due to fall of Enron , on one hand the big banks push big investments by granting loans and on the other hand they create enthusiasm for these stocks in the financial markets thus befooling the shareholders.

Since the life savings of several employees was wiped out due to collapse of Enron the government needed to take a look its taxpaying schemes and allow the tax payers to save and invest some amount into their private accounts.

This finally leads to the culture of greed which has been breeding in the society at all the levels; however it was because of financialaccountingdisaster, but the bottom-line out here is just greed and not following the ethics

.

• There has to be a total overhauling of the structure of the system.
• The cases related to corporate irresponsibility needs to be punished with dire consequences to teach them lesson.
• The employees should get more powers and participation in management decisions or corporate decision making process.
• Free markets and the capitalism should be questioned very closely.( Puscas 2002)

WorldCom Fallout

Clarke, T. Has highlighted that the reason for major financial scandal of a company like WorldComare not just financial issues , there are stringent corporate governance lack and ethics less society which has lead to the downfall of World com.(WorldCom Case study 1999)

• Used illusionary accounts to fool shareholders
• Overstated profits
• Sullivan gave instructions to record expenses as capital investments to show WorldCom as financially stable company.
• Wrong spreading of operation costs by WorldCom
• They gave hefty personal loans to Ebber and recorded them as financial losses
• This resulted in profit irregularities in company
• Department were standing competitors against each other thus raising internal politics in the organization
• Autocratic leadership roles performed by the topmost leaders
• Negligence of achieving targets or results through the right way
• Followed the philosophy of ends justifying the means.
•  Main tools used for achieving results were external rewards, punishment or power.
• The organizational structure was totally hierarchical and the leaders followed the policy of command and control.
•  The primarymotivators out here were money, fear and perkthat it. The only relationship that existed in the organization was work and get pay checks.

This culture of greed followed led to the downfall of WorldCom. As there were no ethics training or complainedprograms. The leaders followed the autocratic rule and the workers were treated with disrespects and dishonour. The leaders never followed the policy of executive leadership which could have brought ethical and law abiding climate in the organization. Since the workers never exercised autonomy and never acted as per free will so they never felt responsible for any actions they took personally. On the other hand the autonomous workers are allowed to organize and take decision while working and they have the power to control their work too. It is not just training which can bring change but the leaders have to be autonomous to bring the change and an effective workculture. The main issue which gets highlighted out here so leadership and corporate governance which has to be ethical in any case for an organization to run successfully in the long run. There is dire need of re learning for corporate executives to lead their organization and then only we can expect some change in work culture. SO it’s is not all about greed it is a mix of many issues like work culture, corporate governance, ethics etc. (Sarno, J.J. 2009)

1. Answer the questions to the Wearing Enron case using material covered this semester.

1.  Discuss the relative risks of companies with substantial physical assets

Compared with companies which have substantial intangible assets.

If we compare the risk factor of companies with substantial physical assets to the companies with intangible assets, it is very well evident from the “Enron Case” that having physical assets makes the company more secure and the skewing towards risk factor becomes leer. While in case of companies with intangible assets the risk factor is much more. The reason being if there is any risk to a company which has many physical assets it can cover its losses and risk by selling off those physical assets and we saw that till the time Enron was investing in gaining physical assets it was much safer. But as it started investing in intangible assets like Weather derivatives and shares etc. Its capacity to recover the risks decreased and finally resulted in its fall out.

1.  The phrases ‘train crash’ and ‘houses of cards have been used by commentatorsto describe Enron’s collapse. Do you believe these analogies are useful in this case?

The analogies in the Wearing Enron Case are apt when it has been called “traincrash” or “house of cards” because the fall of Enron was also just like a house of cards. Such a big corporate profit making company fell off within a year because of major accounts and financial problems. Just like a house of cards which falls by a light blow of air same way just a whistle blower resulted in the fall of Enron, so the comparison is totally correct. Same way as in train crash hardly anyone survives same way out here top management to all the companies associated with Enron also suffered because of Enron.

1.  If Enron shareholders had been fully aware of the LJM partnership agreements, do you believe they would have been willing to continue investingin Enron?

Had the shareholders known the fact and figures related to LJM partnership agreement they would have never continued investing in Enron, the reason being they knew that the SPV or Special Purpose Vehicles created by Fastow were merely temporary hideouts for Enron just to cover their debts and portray them as sales this means increase in profit and revenues of Enron but in reality it was Loans in disguise.

1.  Discuss the potential problems with Kenneth Lay taking over as CEO and president in August 2001 (as well as continuing to be chairman).

The potential problems with Kenneth Lay taking over as CEO and president of Enron in August 2001, were that at that time the company’s stock prices were at the lowest during the whole lifetime of Enron and there was no proper and authentic justification available with Kenneth about the whole situation.Moreover during this time the whistleblower Watkins had sent the anonymous memo too to Lay about the concerns and the problems within Enron. The Raptor transactions and Condor vehicles showed the valuation issues of the assets and with the resignation of Skilling’s there were severe accounting problems too arising in Enron.

1.  Identify the stakeholders who suffered as a result of the Enron bankruptcy.

The major stake holders who suffered due to Enron bankruptcy were:

• PortlandGeneral electric :It was sold off for just $3.1 billion
• Prisma Energy International Inc.: The major employee pool was reduced and Prisma was left with just 5000 employees in 14 countries with just few power assets and mixture of pipelines.
• Arthur Anderson: The key auditor and major non-audit service provider for Enron also was reduced to trashes due toEnron Collapse.
• JP Morgan Chase: It was fined $300 million for dealing with Enron.
• Citigroup : It was fined $300 million for dealing with Enron
• Merrill Lynch: It was fined $80 million for doing a transaction with Enron where it earned a profit of just $500, 00.

1.  Discuss whether potential whistleblowers should be encouraged to report their concerns of poor corporate governance. Should they report their concerns within or outside the organization?

Potential whistleblowers should be definitely encouraged as they help in lifting the curtain off from the big corporate giants like Enron; just like in case of Enron Sharron Watkins the whistleblower took the courageous step to take her concerns to the top management. They should report theirconcernwithin and outside the organization, because corporategenerally take them as bad people trying to harm the interests of the company. But they should take legal help and help from media too to raiseawareness amongst people and shareholders about the issues of corporate governance.

1.  What particular features about Enron’s board of directors reduced the likelihood

That the company’s problems would be properly addressed?

The main features of the board of directors which resulted in not addressing eth company’s problems properly were an audit committee was set up and that too very strategically to avert the financial disaster on behalf of the board of directors. They were situated at remote and far locations and did not have the nerves to challenge the engineers beforehand. They were too much dependant on the management and during the meetings with management they did ask many questions and did not bother to challenge the decision taken by management. All this led to collapse of Enron.

1. Answer the questions to the Wearing WorldCom Case using material covered this semester.

1.  Is it possible that the UK quoted company sectorcould experience its own version of WorldCom?

This is very true that even UK has chances of experiencing its own version of WorldCom, because in recent past it has experienced many such financial scandals like Maxwell Polly peck and BCCI.Financial reporting, auditing and corporate governance were not the only major reasons for downfall of WorldCom. If UK has perfect systems and guidelines for auditing , financial reporting and policies for corporate governance even US has these policies , however there might be some differences in few policies, but here the big questions is ethics. These are the same worldwide. So mainly if Ebbers would have followed business ethics and proper financial management this wearing of WorldCom would have never happened out here in US.

Although Peter Wyman, 2002 said that all the financial policies and auditing is perfect in UK but after major scandals too Beth Holmes says that UK has not learned anything from these scandals in the past, there are not any major changes in corporate governance policies in UK, so they have been just lucky to divert WorldCom or Enron like financial fall downs however they are equally susceptible to them.

1. Should short-sellers be described as ‘stakeholders’?

Short sellers are mainly the investors who ask the broker to shorten N number of shares in some company say WorldCom. The broker does so by borrowing N number of shares from another client and then sells these shares in the market. The position or time period of short sellingismaintainedtill the broker has option of buying these shares from another client. Now the investor will buy these N numbers of shares form the market and close the position.Thus here the sale and purchase of the shares is exactly equal. The main motive of any investor out here in short selling is to increase the share price of its company by creating demand or short fall of the shares in the market.Thus if there are lesser shares in the market people will be tempted to buy it more and thus the selling is done beforehand any purchase.Thus the stake holders can be or mostlyhave been seen as the part of short selling especially here in case of WorldCom.(Wearing R.T. 2006)

1.  Identify the stakeholders who lost out when WorldCom filed for bankruptcy and describe the extent of their losses.

Bernard Ebbers: He was the key stakeholder and the founder of WorldCom was asked and rather forced to resign in March 2002 because of bankruptcy of WorldCom.

Scott Sullivan: He was the main mastermind behind the whole scandal and was theChief Financial officer who was fired because he was the part of the financial scandal.

David Myers:  He was senior Vice President and controller of WorldCom, he too was fired and the reason is part of the financial scandal.

Buford Yates: He was the former director of Accounting of WorldCom and he too was fired.

Betty Vinson: She was former Accounting Department manager at WorldCom and even she was pressurised to resign due to her alleged involvement in the scandal.

ArthurAnderson: were removed as financial auditors of World Com and were replaced by KPMG.

(WorldCom Case study 1999)

1.  Identify the main lessons that can be learned from WorldCom’s Bankruptcy?

The main lessons that can be learnt from WorldCom bankruptcy are:

The company although so big ignored the mobile communications market and just concentrated on internet basic services only which were very important.

It tells us that the disaster of WorldCom is not just greed driven but also due to conservative corporate culture which was fostering dependent workers and workers with low self esteem.This resulted in workers who just worked for externalrewards and were never allowed to exercise free will.Thus promote work culture which is not active and optimistic.

Since the values of WorldCom were materialistic and deterministic there were no code of conducts or programmes for work compliance or ethics training , SO every organization should have them in proper state.

The corporate governance should make lows so that organizations cannot promote personal interest and profits and should not just work towards making the shareholder value high at any cost.

Leadership has to be transparent and can be evaluated at any given point of time. The leaders should be not autocratic and should be open to any kind of information sharing and giving feedbacks. Thus it should be holistic in approach and should offer free will transparency and personal responsibility.(Sarno, J.J. 2009)

1.  To what part can ethics be considered part of the solution to prevent future bankruptcies such as WorldCom?

Ethics plays an important role and are a key role player in preventing financial scandals like WorldCom. Ethics like open communication should be encouraged so that the whistleblowers can avert such financial crisis without any fear. It will promote whistleblowers which will be treated both legally important issues and will help in sharing information and the need o bring change in any organization.

Although coaching along with mentoring are very important parts of any corporate ethics.This will bring self esteem and dignify any kind of worker in the organization. Thusethics play very important part by developing trend of transparent leadership. Ethics needs to be combined with the work culture in the organization for a better and stable organization , just ethics training or compliance programs will not work well if the work environment is totally materialistic or if the workers are not respected and treated with dignity in the organization. This is what happened in WorldCom and led to its downfall.

(Sarno, J.J. 2009)

Reference

• Puscas, D. 2002, A Guide to the Enron Collapse: A few points for clearer Understanding, Polaris Institute.

• Sarno, J.J. 2009, Lessons from WorldCom, Employers association of New Jersey.http://www.slideshare.net/JohnJS/lessons-from-world-com-presentation

• Wearing R.T. 2006, Are short-sellers stakeholders? University of Essex, Essex
• WorldCom Case study, Ethics Institute of South Africa, 1999, South Africa, viewed on 21 October 2011 from http://www.irmsa.org.za/library/WorldCom.pdf

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