Corporate governance has been a hot cake particularly due to the high profile crumpling of a large number of firms such as Enron, WorldCom and the recent Satyam debacle. The US federal government passed the Sarbanes-Oxley Act in 2002 to reinforce the confidence of the masses in corporate governance, which had suffered a huge blow due to the accounting and corporate malpractices surrounding Enron Corporation, Tyco International, Adelphia, WorldCom and Peregrine Systems.
Such scams continue to tarnish world business practices and raise questions about the existing corporate governance system. Directors and managers across the globe may want to assess the following “early warning signs” to gauge the overall corporate health and the effectiveness of the management team.
1. High earning expectation is a potential “warning sign” as more often than not it leads to accounting irregularities that may result in “abusive earnings management.” Revenues that consistently match the analysts’ expectations should ring an alarm in the minds of the auditors and stakeholders.
Innovative company
Enron held the reputation of being “America’s most innovative company” for six consecutive years and consistently matched or exceeded analysts’ expectation until it came under the spotlight for carrying out accounting malpractice. The Bernard Madoff scandal illustrates yet another aspect of this where the multi-billion dollar ponzi scheme seemed “too good to be true.” Apparently regulators were alerted many times over the years by several outsiders that Madoff’s ability to deliver steady double-digit returns was Machiavellian.
2. Fraudulent accounting: cash flows that are not aligned with the earnings; receivables that are not parallel with the revenues; superfluous allowances for uncollectible accounts that are not connected with receivables; reserves that stand unparalleled with the balance sheet items; and questionable acquisition reserves should raise eyebrows. WorldCom overstated cash flow by booking $3.8 billion in operating expenses as capital expenses and gave founder Bernard Ebbers $400 million in off-the-books loans. In no time WorldCom surpassed Enron becoming the biggest bankruptcy in history and leading to a domino effect in corporate scandals.
Corporate governance
3. Dormant or non-existence corporate governance committee: Often in an attempt to deceive the financial community, the company either has a dormant corporate governance surveillance committee or does not have one; as such frauds cannot be easily detected by outsiders.
Ethical practices
4. Ethical practices of the company: Many businesses pay lip service to ethics and as a result their practices still fall short relative to its importance. Businesses ought to think deeply about corporate social responsibility and appropriate standards of conduct in society. Milton Friedman’s contention that “the business of business is business,” and the slavish dedication of many businesses to focus on increasing short-term shareholder value and rewarding managers accordingly borders on myopia.
5. The big lie theory: Although related to the ethical practices of a company, according to the proponents of “the big lie theory,” after having established their credibility, firms tend to get involved in “big lies,” that is, they commit frauds of prodigious magnitudes. The infamous Enron-Arthur Andersen-WorldCom and Satyam-Price Waterhouse episodes hold testimony to the theory. Andersen’s motto was “Think straight, talk straight.”
The firm’s culture was believed to be ingrained with honesty and ethics. But this did not last. After having established a reputation for IT consultancy in the 1980’s, the ethical standards of the firm went downhill as the accountancy firms in the US were having a tough time maintaining commitment to the auditing arms.
Commitment and honesty in audits were pitted against the desire to grow the consultancy practices, which were greater revenue generators from the existing audit clientele. Predictably, Andersen gave in to the pressures of the client’s desires to maximise profits and succumbed to fraudulent accounting and auditing practices in order to capitalise on the opportunities to increase consultancy fees.
Hopefully, paying closer attention to Enron-Arthur Andersen-WorldCom-Satyam may help identify lacunas in the corporate governance system. However, some questions remain unanswered: How many WorldComs, Enrons and Satyams is it going to take for us to finally bring the systems in place? Will we keep on ignoring the early warning signs of the corporate governance system? Until when?
Alliance University 
