Accounting Fraud at Worldcom

Accounting Fraud at WorldCom

Earnings management

  It is widely accepted that, earnings management can be defined as it occurs when managers estimating financial reports and structuring transactions in order to modify financial reports, which help avoid either mislead part of stakeholders about the underlying economic performance of the firm or effect contractual outcomes which depend on the accounting numbers of reports1 (Healy & Whalen, 1999).

  However, this definition is focus on the intent of management that cannot be evaluated precisely, so it is hard to direct operationalize when using attributes of reported accounting numbers, therefore some accounting researchers suggest that, implementing this type of definition requires a reliable measure of the true results of management's decisions, which means the earnings number will come from an appropriate process that operate independently without some form of managerial intent2 (Dechow & Skinner, 2000). For example, researchers measure distributions of analyst forecasts for evidence of a pattern corresponding to the pattern observed in realized earnings, this can impound earnings management by analyst forecasts to avoid losses and earnings decreases3 (Burgstahler & Dichev, 1997).

Motivations for managing earnings

  It is difficult for researchers to describe the earnings management in documental form because researchers have to estimate earnings before the influence of earnings management first that used to identify whether earnings have been managed. Thus, the preliminary thing that researchers need to aware about is motivations for manager to manage earnings. There have two motivations listed as follow:

  (1) Capita market motivations: investors and financial analysts using accounting information to value stocks gives an incentive for managers to manipulate earnings which would effect short-term stock price performance1 (Healy & Whalen, 1999).

  (2) Contracting motivations: the firm and stakeholders can use accounting data to develop monitoring and regulating the contracts between them, compensation of management contracts can be used to align the incentives of management and external stakeholders1 (Healy & Whalen, 1999).

WorldCom’s earnings management

  It is clear that, competitive environment gives kinds of pressure on WorldCom’s most significant performance indicator, the E/R ratio, which is closely monitored by analysts and industry observers. However, as the performance of operating business is declined continuously, preventing WorldCom’s stock and high-growth rate from declining drive the CFO Sullivan using accounting methods to achieve targeted E/R ratio.