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$ase Analysis %he $oo&s that Spoilt the 'orl($o) *roth - Jatin Pancholi The telecommunications industry is characterized by massive technological investments, rapid technology obsolescence, a long payback period and a high demand of `value-for-money' services by the customers. The nature of the industry just does not allow a large number of players to operate in the market. n the long run, in any economy, only a few players survive. gradually, the players go on a merger and ac!uisition spree in order to survive and grow. The smaller companies are bought by the not-so-big companies and the not-so-big companies are ac!uired by the big companies. The above scenario leads to the e"pectations of the capital market increasing as mergers and ac!uisitions are often seen as an opportunity to encash and earn. #hareholders in general use such strategic alliances to enhance the value of their own portfolios. $ence, it is !uite natural that the concerned company feels the need to meet these e"pectations of the shareholders %and the capital market at large& during mergers and ac!uisitions. The way 'orld(om tried to meet these e"pectations was through trying to `facelift' its financial statements. 'hy look for a face-lift) * genuine improvement in the financial statements could have been brought either by cutting the costs drastically or by improving sales. Truth be told, 'orld(om simply found both these options too cumbersome. Thus, it decided to manipulate the financial statements. (onsidering the fact that the company was just taking the easy way out, would definitely not agree that its actions were justified just because of the typical nature of the industry it was operating in. +ven if one would accept that financial statement manipulation was the only way out - the immature way in which 'orld(om did so is very surprising. *ccounting theory distinguishes very clearly between revenue and capital e"penditures. *ny accountant would be aware of the rules regarding classifying e"penditure in the financial statements. The regulatory mechanism in the ,# -comprising the .inancial *ccounting #tandards /oard %.*#/& and the #ecurities and +"change (ommission %#+(&0 is designed to ensure proper understanding and compliance of accounting rules. n fact, the 1enerally *ccepted *ccounting 2ractices %1**2& of the ,# are believed by many to be superior even to nternational *ccounting #tandards % *#&. $ence, the manipulations resorted to by 'orld(om cannot be attributed to the lack of design in the legal framework. t is the role of accountants and auditors that needs a closer scrutiny. +arnings before nterest, Ta"es, 3epreciation 4 *mortization %+/ T3*& was %and still is& a very popular indicator for measuring business performance. +/ T3* is calculated by taking operating income and then adding back nterest, Ta"es, 3epreciation and *mortization. t theoretically indicates the operating profitability of the company. +/ T3* reveals the operating profits without paying for the nterest, without charging for depreciation and amortization %both are non-cash e"penses& and without providing for ta". 5ow, all these deductions are certain and definite

transactions, hence increasing +/ T3* figures create an image of a `fast-growing' company. 5ews items announcing an increase in +/ T3* portray the company in a positive manner. $owever, the fact is that +/ T3* does not reflect cash-profits. 5or does it reflect the superiority of a company as a potential investment candidate. (onceptually, +/ T3* ignores %a& capital e"penditures and the depreciation provided for the same, %b& cash re!uirements for the working capital, %c& potential for investment in its shares, %d& debt payment and interest on the same. Therefore, believe that +/ T3* is not a strong indicator to measure the business performance of any company which is characterized by any of the above four aspects. ,nfortunately, +/ T3* did help 'orld(om in creating a wrong image among the shareholders. The media too has played a pivotal role in the mess surrounding +/ T3*. t seemed to have conveniently forgotten the simple truth that companies could in all probability release only `relevant' information to attract investors. t is the intellectual and moral responsibility of the media to take care of these issues and aid the common man in understanding them. $owever, it would not be prudent to claim that `+/ T3* is all bogus' - it might be an effective measure for some other company in some other industry. n the wake of the numerous corporate scandals in the ,#, the issue of the wrongdoings on part of 'orld(om's auditors does not come as a major surprise. $owever, looking at the issue in isolation, one can not but help thinking that auditors are responsible for ensuring that companies adopt fair accounting practices. /ut since they are paid by the companies involved, it becomes difficult to differentiate between `intentional crime' and `unintentional bias' on their part. *lso, since the world's top auditors provide consultancy services to the same companies, the issue becomes even more complicated. ,ndoubtedly, the role of 'orld(om's top management in this accounting fraud is !uite shocking. $owever, would personally not agree that only +bbers and #ullivan led the company towards bankruptcy. *ny company's success or failure can never be due to a few people. 6ust like success, failure too is the result of team effort. n addition to the accountants, auditors and the media, the 'orld(om scandal is the team effort of the company's top management, e"ecutives, politicians and lastly, the shareholders themselves. t cannot be denied that the naivety of shareholders played a major role in 'orld(om going down the path of financial manipulations. $aving said this, would also say that the conduct of 'orld(om's board of directors is amongst the most shameful aspects of this story. The board should have designed policies which measure the business performance in totality along with measuring performance of the individual e"ecutives. $ad this been ensured, the company could have done a lot to avoid what happened eventually. +ven now, more than treating this as a `fire-fighting-e"ercise,' the company should take it as a preventive measure for the future. The world is looking right now towards 'orld(om. The investors have burnt their hands. The employees have lost their jobs. The market has lost its faith. $owever, just firing the then (+7 %and some other e"ecutives& would be no solace to the small stakeholders. .or the ne"t 8-9 years, 'orld(om has to show a high level of integrity, commitment and fairness in all its dealings. *s we have discussed, scams like 'orld(om can teach us a lot. 7ne of the more significant take-aways from this scam according to me is that understanding of industry specific financial implications is e"tremely vital rather than just being aware of general finance and investment rules. The author is faculty member at NMIMS (deemed university), Mumbai : (.* 2ress. *ll ;ights ;eserved.

$ase Analysis +essons ,alore - Ruzbeh Bodhanwala .ollowing a rather simplistic approach, the 'orld(om debacle can be looked at as the sum of various forecasting errors. The profitability of any project is based on sales estimates, and when actual sales turn out to be radically different from the projections, the officials involved begin looking for avenues to shift the blame in a bid to save their own skin. /ut when there is no possibility of doing so, the only option left seems to be to report the least possible loss %this is where the issue of `'indow 3ressing' in accounting statements comes into the picture&. n ndia too, many companies in the telecommunications industry %such as the ones offering broadband nternet and <o 2 services& have suffered a lot in the name of technological obsolescence. #ince technological changes are hard to predict, a shift in the market dynamics resulted in many of these companies running into substantial losses. Typically, the management of such companies refuses to accept the responsibility for the losses. 7n the contrary, they argue that they should be allowed to operate as long as they recover their variable costs= The ,#->? scam, which rocked the ndian stock market not too long ago, also took shape on these lines, as the management tried to portray a rosy picture to the shareholders. That it could not do so for a long time, is a fact well-known by now. 7perating e"penses, as per the matching concept of accountancy, should be debited to the 24@ account. /ut something !uite contrary happened at 'orld(om. The company had incurred heavy e"penses %in the form of telecommunication system maintenance e"penses and line costs fee&. 'hen the revenues it was e"pecting failed to materialize, the company decided to capitalize the operating e"penses. The logic was that since the revenues and e"penses did not match, the e"tra financial burden should be borne by the 24@ account= .ictitious assets were thus created that began eating into the company's long-term financial stability. The company even transferred funds from the reserve account to the revenue account, resulting in an artificial increase of A>.8 bn in profits. @et us now take a look at the lessons that this case provides us with. 'e begin with the debate on +/ T3*. +/ T3* is certainly a measure of earningsbut it should always be seen in the light of sales achieved net of ta"es. #ales from operating and non-operating activities should also be considered before arriving at an investment decision. f there is a substantial amount of increase in sales because of an increase in the selling price, then the effect of inflation and rise in price should be nullified. 7ne should arrive at growth in terms of sales by looking at increase in volumes rather than selling price. f non-operating income forms a big part of the total income, then one should look for the possible sources of revenues, and while calculating the growth statistics, it should be eliminated. repeat that sales should always be considered net of ta"es because an increase in sales can be due to a variety of factors. The moral of the story is that +/ T3* should not be used as a financial performance measure in isolation. 5ow we come to the issue of auditors. * look at 'orld(om's balance sheet from 6une 8B, CBBD to Earch 8D, CBB8 would reveal that the ratio of net receivables to total current assets has changed substantially. 7n 6une 8B, CBBD the ratio was ?BF whereas on Earch 8D, CBBC it was 9?F. This was primarily related to a decrease in cash whereas the receivables were !uite high in comparison to other current assets. 7f the total assets as on Earch 8D, CBBC, 9BF is accounted for by goodwill - essentially an intangible asset. .rom DGG> till CBBD %as per the data given in +"hibit &, the interest e"penses rose continuously, denoting a high use of debt in proportion to e!uity. *round DHF of the total income before ta"es of AC.8G bn in CBBD %around one-fifth& came from non-operating activities. *n issue as simple as this should have been noticed easily by the auditors. t is clear that the lapses on the part of *rthur *ndersen had nothing to do with #ullivan not furnishing crucial information to it. t is thus necessary for the regulatory authorities to factor in the possibility of auditors concealing critical information in

the pursuit of getting their auditing contracts renewed. The ne"t lesson is that the appointment of /oard of 3irectors, their term of stay and their remuneration should not be guided by the top management, the promoters or the (+7s. f the reverse happens, it is !uite possible that the /oard members might not do justice to their role %being afraid of losing their positions&. f the appointment and termination of non-e"ecutive directors and auditors is controlled by an outside agency, both of them could act more independently and without the influence of the promoters and other parties who hold a substantial interest in the company's financial performance. t is also essential to ensure that the /oard is e!uipped enough to deal with financialsso that it can detect any irregularities well in time. ;ecently, the #+( has taken another big name %*7@ Time 'arner& to task in the conte"t of accounting irregularities. The reason for bringing up this e"ample is to assert my point that until the system of recording accounting transactions is not made foolproof, companies would continue to indulge in unethical business practices. (oming back to 'orld(om, the company can still survive and emerge as a profitable company. * massive reorganization at the higher level has already taken place. 7n the part of the regulatory authorities, perhaps they can look at making it mandatory for companies to rotate their auditors every year. They can even stipulate that companies get the audit done by two different companies. The author is Professor at Fore school of management, New ;eference I D?-B8-BH-BC : (.* 2ress. *ll ;ights ;eserved elhi!