In the 1990s, the US economy went through a phase of consolidation, in which many major companies acquired or merged with weaker companies to strengthen their own position in the market (as seen earlier, WorldCom happened to be one of the key acquirers in this phase). The share prices of companies play a vital role during mergers and acquisitions. Therefore companies try to ‘maintain’ the prices of their shares (that is, keep them sufficiently high). If they fail to do so, they can easily become targets for takeover/acquisition. Moreover, if a company wishes to raise capital from the market, its performance on the stock exchange is considered to be very important. The companies are generally valued on the basis of cash flows they could generate in future. As the financial performance of a company is one of the most important (and direct) factors affecting its share price, companies were under constant pressure to show positive revenue streams. However, this was easier said than done. Not only was the US economy facing a slowdown during the late 1990s, industries such as IT and telecommunications were going through one of the worst downturns ever. As a result of the dotcom bust, many big companies lost millions of dollars in a short span of time. The old-economy industries were not faring very well either. In these conditions, many companies resorted to a process called ‘backing in’1 to project increased profits despite low growth rates. WorldCom was also among one of these companies that were trying to take an ‘easy way out’ to project healthy financial growth despite the adverse market conditions. To provide Internet access to customers, the company had built up a huge infrastructure, anticipating that the demand for services on broadband2 networks would grow significantly. However, by 2000, the Internet infrastructure had lost much of its attractiveness and the demand for broadband services was lower than expected. Moreover, the long-distance telecom sector was severely hit by growing competition from local phone companies. Prices fell drastically. With the introduction of mobile telephony, customers were increasingly relying on email and mobile phones for long distance communication. As a result of the above factors, by late 2000, WorldCom was struggling to retain its position in the market. In spite of the tough competition from mobile telephony, WorldCom decided to stick to basic telephony only. WorldCom responded to the changing business conditions and ‘earnings pressure’ by resorting to illegal measures. The objectives behind these adjustments were to illegally inflate the reported earnings and meet the expectations of security analysts, thereby concealing the company’s actual financial position. In a scheme that had reportedly been accepted by its senior management, WorldCom covered its true operating performance through improper accounting that overstated its income during 1999-2002. Ordinary operating costs (telecommunications system maintenance expenses) were characterized as capital expenditure. The company also reclassified certain line cost expenses3 (operational costs) as capital expenditure. As a result of understating the revenue expenditure, the company was able to overstate its operating cash flows and overall profits.4 The amount involved in such reclassification was $ 3.055 billion for 2001 and $ 797 million for the first quarter of 2002.

1. WorldCom has been one of the most successful companies in the recent past. It was considered to be a socially responsible firm. Then why did it choose to be unethical? 2. What did WorldCom do to conceal its actual financial position? Do you think what it did is acceptable in the harsh circumstances it was forced to face.