FINANCIAL SCANDAL

Financial scandal: Company survival versus non-survival

Table of Content

INTRODUCTION4

BACKGROUND5

THE ROLE OF STRATEGY11

OUR FINDINGS16

THE FEATURES OF THE FINANCIAL REPORTING PROBLEMS16

DIFFERENCES BETWEEN THE US AND EUROPE17

CONCLUSION24

REFERENCES29

Abstract

Our analysis of the strategies of 12 companies involved in serious misreporting of financial information shows that there were strong commonalities in the strategies pursued. In particular, all the companies were strongly orientated towards growth — especially into new markets — and all made heavy use of mergers and acquisitions and debt finance. This suggests a remarkable lack of risk aversion. A more important observation was that all the companies — to a greater or lesser extent — pursued strategies that appeared unlikely to deliver long-run success: the strategies tended to fit poorly both with the requirements of their industry environments and with their internal resources and capabilities.

An important feature of our company sample is that it included both US and European companies. One of the limitations of most research investigating the recent wave of corporate scandals has been its US focus with the result that there has been a heavy emphasis on the role of managerial incentives (notably stock options), equity overvaluation and the “cult of short-term stockholder value [that] has been corrupting” to US business.21 A key finding of our study was that the European companies involved in major accounting scandals also displayed the same characteristics of over-ambitious, risk-orientated strategies which fitted poorly with either their internal resources and capabilities or with the requirements of their external business environment.

Financial scandal

Introduction

The late 1990s and early years of the 21st century witnessed misreporting by public companies on an unprecedented scale. In the US, the number of companies restating their financial results more than doubled between 1998 and 2004, despite a declining total number of public corporations. An increasing number of these restatements were by large companies and a significant number were catastrophic — they were accompanied by losses in shareholder wealth of more than $1bn and, in some cases, precipitated bankruptcy.1 Among these Enron and WorldCom stand out as landmarks in recent business history. Enron's earnings restatement of November 8, 2001 and WorldCom's on June 25, 2002 were swiftly followed by bankruptcy for both companies. The demise of these two companies was significant not just because of their size and importance — in the Financial Times 2000 ranking of US companies by market capitalisation, Enron ranked 90th and Worldcom was 17th — but their status as exemplars of the US model of shareholder value-driven, entrepreneurial capitalism. The demise of Enron and WorldCom marked the end of the “golden era” of euphoria, financial engineering and the technology-driven stock market boom that had characterised the “roaring 1990s”.

Accounting manipulation leading to corporate failure and massive shareholder losses were not restricted to the US. In Europe, accounting scandals engulfed a number of prominent public companies. The most spectacular was the collapse of the Italian dairy giant, Parmalat, in December 2003. Scandals involving manipulation of financial reports also brought several other leading European-based multinationals to the brink of ruin, including Royal Ahold and ...