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For the exclusive use of S. Alhagbani, 2019.
Accounting Fraud at WorldCom
WorldCom could not have failed as a result of the actions of a limited number of individuals. Rather, there
was a broad breakdown of the system of internal controls, corporate governance and individual responsibility,
all of which worked together to create a culture in which few persons took responsibility until it was too late.
— Richard Thornburgh, former U.S. attorney general1
On July 21, 2002, WorldCom Group, a telecommunications company with more than $30 billion in
revenues, $104 billion in assets, and 60,000 employees, filed for bankruptcy protection under
Chapter 11 of the U.S. Bankruptcy Code. Between 1999 and 2002, WorldCom had overstated its pretax income by at least $7 billion, a deliberate miscalculation that was, at the time, the largest in
history. The company subsequently wrote down about $82 billion (more than 75%) of its reported
assets.2 WorldCom’s stock, once valued at $180 billion, became nearly worthless. Seventeen thousand
employees lost their jobs; many left the company with worthless retirement accounts. The company’s
bankruptcy also jeopardized service to WorldCom’s 20 million retail customers and on government
contracts affecting 80 million Social Security beneficiaries, air traffic control for the Federal Aviation
Association, network management for the Department of Defense, and long-distance services for
both houses of Congress and the General Accounting Office.
WorldCom’s origins can be traced to the 1983 breakup of AT&T. Small, regional companies could
now gain access to AT&T’s long-distance phone lines at deeply discounted rates.3 LDDS (an acronym
for Long Distance Discount Services) began operations in 1984, offering services to local retail and
commercial customers in southern states where well-established long-distance companies, such as
MCI and Sprint, had little presence. LDDS, like other of these small regional companies, paid to use
or lease facilities belonging to third parties. For example, a call from an LDDS customer in
New Orleans to Dallas might initiate on a local phone company’s line, flow to LDDS’s leased
network, and then transfer to a Dallas local phone company to be completed. LDDS paid both the
1 Matthew Bakarak, “Reports Detail WorldCom Execs’ Domination,” AP Online, June 9, 2003.
2 WorldCom’s writedown was, at the time, the second largest in U.S. history, surpassed only by the $101 billion writedown
taken by AOL Time Warner in 2002.
3 Lynne W. Jeter, Disconnected: deceit and betrayal at WorldCom (Hoboken, NJ: John Wiley & Sons, 2003), pp. 17–18.
Professor Robert S. Kaplan and Senior Researcher David Kiron, Global Research Group, prepared this case. The case was developed from
published sources and draws heavily from Dennis R. Beresford, Nicholas deB. Katzenbach, and C.B. Rogers, Jr., “Report of Investigation,”
Special Investigative Committee of the Board of Directors of WorldCom, Inc., March 31, 2003. References to this report are identified by
alphabetic letters which refer to information in the endnotes. HBS cases are developed solely as the basis for class discussion. Cases are not
intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2004, 2005, 2007 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication
may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
This document is authorized for use only by Salman Alhagbani in 2019-Summer-Strategic Management_1 taught by TSUHSIANG HSU, Niagara University from Jun 2019 to Aug 2019.
For the exclusive use of S. Alhagbani, 2019.
Accounting Fraud at WorldCom
New Orleans and Dallas phone company providers for using their local networks, and the
telecommunications company whose long-distance network it leased to connect New Orleans to
Dallas. These line-cost expenses were a significant cost for all long-distance carriers.
LDDS started with about $650,000 in capital but soon accumulated $1.5 million in debt since it
lacked the technical expertise to handle the accounts of large companies that had complex switching
systems. The company turned to Bernard J. (Bernie) Ebbers, one of its original nine investors, to run
things. Ebbers had previously been employed as a milkman, bartender, bar bouncer, car salesman,
truck driver, garment factory foreman, high school basketball coach, and hotelier. While he lacked
technology experience, Ebbers later joked that his most useful qualification was being “the meanest
SOB they could find.”4 Ebbers took less than a year to make the company profitable.
Ebbers focused the young firm on internal growth, acquiring small long-distance companies with
limited geographic service areas and consolidating third-tier long-distance carriers with larger
market shares. This strategy delivered economies of scale that were critical in the crowded longdistance reselling market. “Because the volume of bandwidth determined the costs, more money
could be made by acquiring larger pipes, which lowered per unit costs,” one observer remarked.5
LDDS grew rapidly through acquisitions across the American South and West and expanded
internationally through acquisitions in Europe and Latin America. (See Exhibit 1 for a selection of
mergers between 1991 and 2002.) In 1989, LDDS became a public company through a merger with
Advantage Companies, a company that was already trading on Nasdaq. By the end of 1993, LDDS
was the fourth-largest long-distance carrier in the United States. After a shareholder vote in May
1995, the company officially became known as WorldCom.
The telecommunications industry evolved rapidly in the 1990s. The industry’s basic market
expanded beyond fixed-line transmission of voice and data to include the transport of data packets
over fiber-optic cables that could carry voice, data, and video. The Telecommunications Act of 1996
permitted long-distance carriers to compete for local service, transforming the industry’s competitive
landscape. Companies scrambled to obtain the capability to provide their customers a single source
for all telecommunications services.
In 1996, WorldCom entered the local service market by purchasing MFS Communications
Company, Inc., for $12.4 billion. MFS’s subsidiary, UUNET, gave WorldCom a substantial
international presence and a large ownership stake in the world’s Internet backbone. In 1997,
WorldCom used its highly valued stock to outbid British Telephone and GTE (then the nation’s
second-largest local phone company) to acquire MCI, the nation’s second-largest long-distance
company. The $42 billion price represented, at the time, the largest takeover in U.S. history. By 1998,
WorldCom had become a full-service telecommunications company, able to supply virtually any size
business with a full complement of telecom services. WorldCom’s integrated service packages and its
Internet strengths gave it an advantage over its major competitors, AT&T and Sprint. Analysts hailed
Ebbers and Scott Sullivan, the CFO who engineered the MCI merger, as industry leaders.6
In 1999, WorldCom attempted to acquire Sprint, but the U.S. Justice Department, in July 2000,
refused to allow the merger on terms that were acceptable to the two companies. The termination of
this merger was a significant event in WorldCom’s history. WorldCom executives realized that largescale mergers were no longer a viable means of expanding the business.a WorldCom employees
4 Jeter, p. 27.
5 Jeter, p. 30.
6 CFO Magazine awarded Sullivan its CFO Excellence award in 1998; Fortune listed Ebbers as one of its “People to Watch 2001.”
This document is authorized for use only by Salman Alhagbani in 2019-Summer-Strategic Management_1 taught by TSUHSIANG HSU, Niagara University from Jun 2019 to Aug 2019.
For the exclusive use of S. Alhagbani, 2019.
Accounting Fraud at WorldCom
noted that after the turndown of the Sprint merger, “Ebbers appeared to lack a strategic sense of
direction, and the Company began drifting.”b
Corporate Culture
WorldCom’s growth through acquisitions led to a hodgepodge of people and cultures. One
accountant recalled, “We had offices in places we never knew about. We’d get calls from people we
didn’t even know existed.” WorldCom’s finance department at the Mississippi corporate
headquarters maintained the corporate general ledger, which consolidated information from the
incompatible legacy accounting systems of more than 60 acquired companies. WorldCom’s
headquarters for its network operations, which managed one of the largest Internet carrier businesses
in the world, was based in Texas. The human resources department was in Florida, and the legal
department in Washington, D.C.
None of the company’s senior lawyers was located in Jackson. [Ebbers] did not include the
Company’s lawyers in his inner circle and appears to have dealt with them only when he felt it
necessary. He let them know his displeasure with them personally when they gave advice—
however justified—that he did not like. In sum, Ebbers created a culture in which the legal
function was less influential and less welcome than in a healthy corporate environment.c
A former manager added, “Each department had its own rules and management style. Nobody
was on the same page. In fact, when I started in 1995, there were no written policies.”7 When Ebbers
was told about an internal effort to create a corporate code of conduct, he called the project a
“colossal waste of time.”d
WorldCom encouraged “a systemic attitude conveyed from the top down that employees should
not question their superiors, but simply do what they were told.”e Challenges to more senior
managers were often met with denigrating personal criticism or threats. In 1999, for example, Buddy
Yates, director of WorldCom General Accounting, warned Gene Morse, then a senior manager at
WorldCom’s Internet division, UUNET, “If you show those damn numbers to the f****ing auditors,
I’ll throw you out the window.”8
Ebbers and Sullivan frequently granted compensation beyond the company’s approved salary and
bonus guidelines for an employee’s position to reward selected, and presumably loyal, employees,
especially those in the financial, accounting, and investor relations departments. The company’s
human resources department virtually never objected to such special awards.9
Employees felt that they did not have an independent outlet for expressing concerns about
company policies or behavior. Several were unaware of the existence of an internal audit department,
and others, knowing that Internal Audit reported directly to Sullivan, did not believe it was a
productive outlet for questioning financial transactions.f
7 Jeter, p. 55.
8 Personal correspondence, Gene Morse.
9 Kay E. Zekany, Lucas W. Braun, and Zachary T. Warder, “Behind Closed Doors at WorldCom: 2001,” Issues in Accounting
Education (February 2004): 103.
This document is authorized for use only by Salman Alhagbani in 2019-Summer-Strategic Management_1 taught by TSUHSIANG HSU, Niagara University from Jun 2019 to Aug 2019.
For the exclusive use of S. Alhagbani, 2019.
Accounting Fraud at WorldCom
Expense-to-Revenue (E/R) Ratio
In the rapid expansion of the 1990s, WorldCom focused on building revenues and acquiring
capacity sufficient to handle expected growth. According to Ebbers, in 1997, “Our goal is not to
capture market share or be global. Our goal is to be the No. 1 stock on Wall Street.”10 Revenue growth
was a key to increasing the company’s market value.11 The demand for revenue growth was “in
every brick in every building,” said one manager.g “The push for revenue encouraged managers to
spend whatever was necessary to bring revenue in the door, even if it meant that the long-term costs
of a project outweighed short-term gains. . . . As a result, WorldCom entered into long-term fixed rate
leases for network capacity in order to meet the anticipated increase in customer demand.”h
The leases contained punitive termination provisions. Even if capacity were underutilized,
WorldCom could avoid lease payments only by paying hefty termination fees. Thus, if customer
traffic failed to meet expectations, WorldCom would pay for line capacity that it was not using.
Industry conditions began to deteriorate in 2000 due to heightened competition, overcapacity, and
the reduced demand for telecommunications services at the onset of the economic recession and the
aftermath of the dot-com bubble collapse. Failing telecommunications companies and new entrants
were drastically reducing their prices, and WorldCom was forced to match. The competitive situation
put severe pressure on WorldCom’s most important performance indicator, the E/R ratio (line-cost
expenditures to revenues), closely monitored by analysts and industry observers.
WorldCom’s E/R ratio was about 42% in the first quarter of 2000, and the company struggled to
maintain this percentage in subsequent quarters while facing revenue and pricing pressures and its
high committed line costs. Ebbers made a personal, emotional speech to senior staff about how he
and other directors would lose everything if the company did not improve its performance.i
As business operations continued to decline, however, CFO Sullivan decided to use accounting
entries to achieve targeted performance. Sullivan and his staff used two main accounting tactics:
accrual releases in 1999 and 2000, and capitalization of line costs in 2001 and 2002.12
Accrual Releases
WorldCom estimated its line costs monthly. Although bills for line costs were often not received
or paid until several months after the costs were incurred, generally accepted accounting principles
required the company to estimate these expected payments and match this expense with revenues in
its income statement. Since the cash for this expense had not yet been paid, the offsetting entry was
an accounting accrual to a liability account for the future payment owed to the line owner. When
WorldCom paid the bills to the line owner, it reduced the liability accrual by the amount of the cash
payment. If bills came in lower than estimated, the company could reverse (or release) some of the
accruals, with the excess flowing into the income statement as a reduction in line expenses.
10 R. Charan, J. Useen, and A. Harrington, “Why Companies Fail,” Fortune (Asia), May 27, 2002, pp. 36–45.
11 Zekany et al., p. 103.
12 The company also used aggressive revenue-recognition methods at the end of each reporting quarter to “close the gap” with
Ebbers’s aggressive revenue forecasts; see Zekany et al., pp. 112–114, and Beresford, Katzenbach, and Rogers, Jr., pp. 13–16.
This document is authorized for use only by Salman Alhagbani in 2019-Summer-Strategic Management_1 taught by TSUHSIANG HSU, Niagara University from Jun 2019 to Aug 2019.
For the exclusive use of S. Alhagbani, 2019.
Accounting Fraud at WorldCom
Throughout 1999 and 2000, Sullivan told staff to release accruals that he claimed were too high
relative to future cash payments. Sullivan apparently told several business unit managers that the
MCI merger had created a substantial amount of such overaccruals. Sullivan directed David Myers
(controller) to deal with any resistance from senior managers to the accrual releases.
In one instance, Myers asked David Schneeman, acting CFO of UUNET, to release line accruals for
his business unit. When Schneeman asked for an explanation, Myers responded: “No, you need to
book the entry.” When Schneeman refused, Myers told him in another e-mail, “I guess the only way I
am going to get this booked is to fly to D.C. and book it myself. Book it right now, I can’t wait another
minute.”j Schneeman still refused. Ultimately, staff in the general accounting department made
Myers’s desired changes to the general ledger. (See Exhibit 2 for a partial organizational chart.)
In another instance, Myers asked Timothy Schneberger, director of international fixed costs, to
release $370 million in accruals. “Here’s your number,” Myers reportedly told Schneberger, asking
him to book the $370 million adjustment. Yates, director of General Accounting, told Schneberger the
request was from “the Lord Emperor, God himself, Scott [Sullivan].” When Schneberger refused to
make the entry and also refused to provide the account number to enable Myers to make the entry,
Betty Vinson, a senior manager in General Accounting, obtained the account number from a lowlevel analyst in Schneberger’s group and had one of her subordinates make the entry.k Employees in
the general accounting department also made accrual releases from some departments without
consulting the departments’ senior management. In 2000, General Accounting released $281 million
against line costs from accruals in the tax department’s accounts, an entry that the tax group did not
learn about until 2001.
Over a seven-quarter period between 1999 and 2000, WorldCom released $3.3 billion worth of
accruals, most at the direct request of Sullivan or Myers. Several business units were left with
accruals for future cash payments that were well below the actual amounts they would have to pay
when bills arrived in the next period.
Expense Capitalization
By the first quarter of 2001, so few accruals were left to release that this tactic was no longer
available to achieve the targeted E/R ratio.l Revenues, however, continued to decline, and Sullivan,
through his lieutenants Myers and Yates, urged senior managers to maintain the 42% E/R ratio.
Senior staff described this target as “wildly optimistic,” “pure fantasy,” and “impossible.” One senior
executive described the pressure as “unbearable—greater than he had ever experienced in his
fourteen years with the company.”m
Sullivan devised a creative solution. He had his staff identify the costs of excess network capacity.
He reasoned that these costs could be treated as a capital expenditure, rather than as an operating
cost, since the contracted excess capacity gave the company an opportunity to enter the market
quickly at some future time when demand was stronger than current levels. An accounting manager
in 2000 had raised this possibility of treating periodic line costs as a capital expenditure but had been
rebuffed by Yates: “David [Myers] and I have reviewed and discussed your logic of capitalizing
excess capacity and can find no support within the current accounting guidelines that would allow
for this accounting treatment.”n
This document is authorized for use only by Salman Alhagbani in 2019-Summer-Strategic Management_1 taught by TSUHSIANG HSU, Niagara University from Jun 2019 to Aug 2019.
For the exclusive use of S. Alhagbani, 2019.
Accounting Fraud at WorldCom
In April 2001, however, Sullivan decided to stop recognizing expenses for unused network
capacity.13 He directed Myers and Yates to order managers in the company’s general accounting
department to capitalize $771 million of non-revenue-generating line expenses into an asset account,
“construction in progress.” The accounting managers were subsequently told to reverse $227 million
of the capitalized amount and to make a $227 million accrual release from ocean-ca …
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