The Hindu : The WorldCom mess and another lesson for India

Online edition of India's National Newspaper
Saturday, Jul 06, 2002

Business

Business

The WorldCom mess and another lesson for India

By C. R. L. Narasimhan

The fallout of yet another major accounting disaster among leading American corporates is affecting India both directly and indirectly. Like the infamous Enron failure in the U.S., the WorldCom accounting jugglery impacts on Indian business interests immediately. Enron's connection with the Dabhol power project in India and the multi-dimensional controversies in its wake are too well known. The chances of reviving the massive power project in the near future with or without (the now bankrupt) Enron in the role of the major stakeholder appear to be receding. An even more recent report links the serious accounting shenanigan at Xerox in the U.S. with certain alleged bribes paid to Indian government officials. The allegation is that the latter took money to boost the sales of Xerox's Indian affiliate. Xerox, like WorldCom, has been forced to restate its earnings.

The WorldCom disaster has had a different kind of impact altogether. VSNL, the recently privatised long-distance carrier, is reportedly owed between Rs. 350 and Rs. 400 crores by WorldCom. The two companies have had, so far, a mutually satisfying business relationship for carrying each others long distance traffic to and from their respective countries. The danger to VSNL's immediate interests arises out of the fact that WorldCom may be heading towards bankruptcy in the aftermath of the alleged fraud in its accounts and would therefore be unable to settle its dues.

Besides, WorldCom and VSNL have signed an MoU for what is called a frame relay service. WorldCom also had plans to locate a manufacturing base in India and a group company UUNET, said to be the world's largest Internet backbone provider, has entered into a strategic alliance with a Delhi based company.

The genesis of WorldCom's troubles lies in an accounting gimmick it has been carrying on for at least two years in a row beginning 2001. WorldCom wrongly booked ordinary expenses — some $3.8 billion — as capital expenses. That piece of jugglery was intended to allow it a much longer timeframe to run them down. The correct course would have been to charge the expenses against current revenue. The obvious motive is to artificially inflate the earnings in a given year. After the accounting gimmick was exposed, after an internal investigation, WorldCom has been forced to restate its earnings. Thus there will be gaping holes in the previously finalised accounts. WorldCom had reported a net profit of $1.5 billion for 2001 and $130 million for the first quarter of 2002.

The sheer size of WorldCom's concealment makes it in financial terms the single biggest fraud of that genre dwarfing even Enron's creative partnerships which were off-balance-sheet items. More importantly, even at a time when disastrous news from the corporate world has become monotonously regular, the fiasco at WorldCom stood out. Share prices throughout the globe fell. The telecom industry worldwide took another massive blow. As it is it is faced with a plethora of problems ranging from excess capacity, low understanding and absorption of new technology and the huge debit burden which some telecom companies, especially in Europe, are saddled with.

The disastrous consequences of WorldCom's financial misadventure go well beyond corporate America or the crucial telecom sector in which the company was an undoubted pioneer in the 1990s. Its fall again mirrors another fast emerging pattern: the speed with which some companies secured iconoclastic status in the boom decade of the 1990s is matched only by the speed of their fall.

In WorldCom and Enron cases there has been a systematic attempt to make the accounts as opaque as possible. Higher earnings were a must, cutting corners, even falsifying accounts acceptable as long as there were both top line and bottom line growths. (The accent on top line growth even to the extent of disowning bottom lines was peculiar to the now failed dotcom phenomena).

In all the cases of accounting frauds the purpose is to inflate share value, the net profit and lower the borrowing costs. Share value in the age of the new economy has acquired a particularly exalted status though not for the right seasons. It has become a "currency'' determining crucial issues such as the pricing of ESOPS and in mergers and acquisitions. WorldCom has grown phenomenally through the M&A route: it made 75 acquisitions during the past 16 years.

The WorldCom disaster once again draws attention to two major failings of the American corporate governance model. The tyranny of the stock market that has forced the companies and the audit profession to bend rules is in evidence. The audit profession has again been tarnished. It will take a long time before investors' confidence is restored. The saving grace is that the problems are being viewed seriously by the regulators, the Government and the companies themselves.

The latest fiasco draws attention to the failure of the once acclaimed American governance model. Unfortunately Indian companies are not above board.

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