Big giants lost credibility and some of them filed bankruptcies


July 29 - Aug 04, 2002

The concept of global economy and global village played its role and attracted the attentions of investors towards the accounting scandals in the United States. Overnight investors realized that the corporate culture in the United States needs to be overhauled and even it needs new vision as the top management has failed to set ethics and to show transparency in accounting.

U.S. firms have enjoyed boom for a long time and their operations approached maturity and profits were diminishing. From this point onwards accounting scandals generated, when the firms inflated real profits and even exaggerated projections for the profits only to attract both local and global investors and to support stock prices. But when the reality surfaced, big giants lost credibility and some of them filed bankruptcies. Subsequently, American stock markets were hit hard. The Dow Jones Industrial Average tumbled to 7717.29 almost 23 per cent, NASDAQ to 1272.46 around 34 per cent and S&P to 813.26 almost 28 per cent in this year. In wake both local and global investors pulled out capital from the U.S. assets and invested somewhere else in search of higher returns at low risks.

Enron, few months back, was the favourite stock both for the investors and Wall Street analysts. But later on went under severe selling pressure by Enron's false financial reporting that led the giant firm towards bankruptcy and it filed chapter 11 bankruptcy on December 02, 2001. Enron's collapse devastated its employees' retirement funds. So we simply can say that Enron was really a systemic failure of all the checks and balances on corporate governance, integrity of management, board of directors, audit committee of the board and, outside accounting firm. But, at that time, this bad news failed to get attention of media and regulatory authorities as both of them focused on the war in Afghanistan. The U.S. authorities took, only one step, and stopped Enron's trade in the New York Stock Exchange. And the matter was thrown in cold room that weighed on stocks. Another nose dive was noted in stocks when Nasdaq suspended trading in Adelphia stock that at that time traded at $5.70 per share, down nearly 87 per cent from its 52-week high of $42.97.

After some time World Com crisis globally affected major stock indexes, especially European stock markets. WorldCom Inc. the long-distance telephone and data services company, on Sunday, July 21, 02 filed Chapter 11 bankruptcy protection in the largest U.S. insolvency after buckled under a $3.85 billion accounting scandal. At this occasion WorldCom Chief Executive John Sidgmore said "Because we're going to restructure our balance sheet and reduce our debt, we think we can emerge from the Chapter 11 process as a stronger and healthier company," The seriousness of the matter can be judged from this that WorldCom has 60,000 employees and operations in 65 countries. The bankruptcy would not include its international operations. World Com has portfolio more than 20 million customers and transmits half the world's Internet traffic. The Chapter 11 filing by WorldCom has listed $107 billion in assets and $41 billion in debt. WorldCom last month disclosed it improperly accounted in expenses and fired its former chief financial officer, Scott Sullivan. WorldCom was charged with fraud by the U.S. Securities and Exchange Commission and faced lawsuits from several state pension funds, which alleged that it provided misleading information during a 2001 bond offering.

Investors' concerns about U.S. accounting practices re-ignited after questions about billions of dollars in revenues booked by drug giant Merck & Co. Overnight it was reported U.S. drugs giant Merck had recorded revenue of over $14 billion from its pharmacy-benefits subsidiary. In wake the blue chip Dow Jones industrial average closed down 1.12 per cent while the Nasdaq composite dropped 2.95 per cent. Merck is cleaning up its balance sheet through the Medco deal through a complex series of transactions tied to the Medco Initial Public Offer (IPO). The biggest chunk comes from a debt-for-equity swap involved in the offering among the largest such swaps to date. Under the Medco swap, Goldman Sachs and J.P. Morgan have agreed to swap debt that they hold in Merck for Medco Health shares. The underwriters will then place those swapped shares with investors along with the IPO.

Overnight it was estimated that the failure of the "Kmart" was totally due to conservative approach in the marketing. But consumers' confidence shook at the decision by the 40-year-old discount chain "Kamrt" to file for bankruptcy-court protection on January 22, 02. Kmart says it plans to emerge from Chapter 11 of the U.S. Bankruptcy Code in 2003, but has yet to spell out a reorganization plan. Bankruptcy protection will allow Kmart to save millions by terminating leases on some 350 properties that are closed or sublet. The company can save money by closing stores and cutting its workforce. Kmart also has secured
$2 billion in senior secured debtor-in-possession financing that will be used to supplement cash flow during the reorganization. American business community had enjoyed since long time as the United States has developed itself as the biggest consumer market on the globe. The Americans love to shop that's why nation's net saving is standing in negative territory. Four key factors that spell success or failure for retailers are place, price, product mix and service. Many Kmart stores are older than those of its competitors and located in less-than-attractive urban areas. When it comes to price, Kmart never matched the expertise of Wal-Mart.

Another big giant Tyco also failed to show transparency in its accounting documents. Overnight Tyco's crisis initiated when, the company-completed acquisitions valued at $30.5 billion between
fiscal 1999 and fiscal 2001. Tyco dropped plenty of cash for those acquisitions, some $17.5 billion in all. Where Tyco found all that cash is explained on its balance sheet. Long-term debt in 1998 was $5 billion, or about 26 per cent of its revenues that year. By fiscal 2001, long-term debt was $38 billion, or 6 per cent more than its revenues. Investors were really disturbed as Tyco's stock price lingered down about $16 as compared to its stability in the $50-range for the past two years.

U.S. accounting scandals spread out when the Security Exchange Commission of U.S. fined $10 million to Xerox for overstating profits by $3 billion between 1997 and 2001. In accepting the fine, Xerox neither admitted nor denied any wrongdoing. At the same time Wall Street Journal fanned jitters, as reported gap might be profits by $6 billion. Xerox was already in trouble before this latest blow. The company last October announced that it was cutting up to 1,300 jobs in Britain as part of an overhaul to reduce costs. In the face of falling sales and fierce competition Xerox has been shedding staff and selling off various manufacturing operations to reduce debt.

Reliant Resources also admitted faking transactions. Reliant Resources Inc., one of the U.S.'s biggest electricity traders, informed that it had conducted fake transactions with four power companies that inflated its revenue by 10 per cent over the last three years. At that time the news unsettled the market, already suspicious about the integrity of the power sector.

These accounting scandals raised importance of corporate ethics, as the scandals were much worse in Europe in 1927-30 and in the U.S. in 1932-34 and in 1936-37. The US President George Bush, realizing the seriousness of the matter, addressed to Wall Street demanding "a new era of integrity" in American corporate life following the Enron collapse and WorldCom fraud. He put forward a series of new measures, including a doubling of the maximum jail term for financial fraud to 10 years. He also called for a new ethic of personal responsibility in the business community an ethic that would increase investor confidence, make employees proud of their companies and regain the trust of the American people.

But it seems that all efforts made by President Bush to overcome corporate crisis wasted as the U.S. public is asking about the accusations that have been levelled at the president over his business dealings. Now Democrats think they have found powerful issue with anxious voters. They have unearthed an investigation into Mr Bush by financial watchdogs a decade ago while he was a director of the oil company Harken Energy, and are calling for details of the inquiry to be published in full. Meanwhile, the U.S. vice President Dick Cheney was sued for alleged accounting fraud while he was a director of the oil firm Halliburton that further undermined the Bush administration's attempt to take a firm grip on the scandals. Overnight, Judicial Watch filed the lawsuit against Dick Cheney, a self-appointed public interest law firm that monitors corruption in government and often challenged former president Bill Clinton. Halliburton said that the US financial watchdog, the Securities and Exchange Commission (SEC), had opened an investigation into the firm's accounting. The civil suit claims that Halliburton overstated earnings by $445 million over a period of three years. The accounting policies under investigation at Halliburton were adopted by the oilfield services and construction company in 1998. Under the change in policy, the company booked as revenue disputed claims when construction projects ran over budget. The effect was to increase revenues at a time when the company was actually suffering big losses on a number of long-term contracts. Judicial Watch is suing on behalf of two shareholders in Halliburton who, it said, were deceived by fraudulent accounting that caused the shares to be overvalued. Mr Cheney was chairman and chief executive of the company from 1995 to 2000. The SEC has not yet filed any charges against Halliburton but last month said the investigation would continue regardless of where it leads.

Federal Reserve Chairman Alan Greenspan also felt the gravity of the matter and urged lawmakers to be cautious in any move to overhaul the nation's system of corporate governance. "The system is frayed but it is not broken," Greenspan said during an appearance before the Senate Banking Committee. "If we endeavour to try to change the system in a fundamental way, we may end up doing more damage than help," he warned. "I suspect, that if the CEO issue were fully and completely resolved, which it never will be because we're dealing with human beings, I think all the rest of the problems would just disappear," Greenspan also said.

U.S. accounting scandals also mounted jitters in other countries of the world as German Chancellor Gerhard Schroeder blamed U.S. corporate culture for recent accounting scandals and lauded Europe's model on as President Bush launched new penalties for such abuses. So, now, any more corporate scandal and further deterioration in the U.S. stock markets can wobble investors' confidence, global economy and even challenge Bush's triumph in coming election.

How the Dow reacts

Reaction period

Percent change in the DJIA (%)

Percent change after six months (%)

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World Com filed bankruptcy

July 21, 2002 -