Agency theory was developed by Jensen and Meckling in 1976. Solomon ( 2004 ) explains bureau theory in visible radiation of directors and board of managers as the agents and the investors and stockholders as the rules. The rules invest in the company and establish their religion and trust on the agents to carry on concern operations ethically and maximise stockholder value. Any determination made by the agents should be in the best involvement of the organisation. On the contrary, corporate prostrations portray a different image of the motivations and involvements of the corporate leaders.
There exists a cardinal job in the with respects to stockholders ‘ involvements in a public corporation, that is, top direction do non ever move towards maximising stockholders ‘ return on investing ( Kulik, 2005 ) . This divergency of involvement airss risk to the corporation every bit good as its investors.
Sherman and Chambers ( 2009 ) citation Waddock ‘s ( 2005 ) work in observing that the corporate leaders and fiscal adviser in the modern-day yearss lack “ cardinal unity. ” These defects of the directors were apparent in the much published corporate dirts at WorldCom and Enron. Canary and Jennings ( 2007 ) postulate that prostration of Enron and WorldCom was a consequence of unethical behavior. Such dirts result in immense losingss which range from fiscal loss to loss of investor assurance.
This paper is divided into four subdivisions. The first subdivision takes a brief expression at the history of Enron Corp. and the fiscal issues which led to its dramatic prostration. The 2nd subdivision highlighst the grounds behind the passage of the Sarbanes-Oxley Act ( SOX ) and outlines its contents and authorizations. This follows a brief expression at the pros and cons of Act. The 3rd subdivision discusses the ability of SOX to forestall future corporate prostrations such as Enron. The last subdivision concludes the paper.
Impact of Corporate Collapses
Mckay ( 2007 ) dubbed twelvemonth 2002 which saw the concern universe taking a extremist alteration. Corporate dirts non merely ensue in loss of one million millions of dollars but besides cause occupation losingss and loss of valuable credibleness. The Enron and Worldcom saga brought great discredit to the accounting profession. Investors lost assurance in the market as they suffered drastic losingss to their investings.
Background of Enron Corp
Enron Corp. ( referred to as Enron afterlife ) was formed in 1985 from a amalgamation of the Houstan Natural Gas and Internorth. Enron was the first countrywide natural gas grapevine web ( Jickling, 2002 ) . It so diversifies to supplying merchandises and services related to natural gas, electricity and communications ( Tonge et al, 2003 ) .
Enron became the 7th largest listed company in the United States by using questionable accounting methods and techniques ( Bryce, 2002 ) . Perceivers and analysts from the Wall Street dubbed Enron ‘s transmutation as an outstanding success ( Jickling, 2002 ) .
On 16th October, 2001 Enron reduced its after revenue enhancement net income by $ 544 million and its stockholders ‘ equity by $ 1.2 billion. It so restated its net income for the old ages 1997 – 2000 following accounting mistakes ( Benston and Hartgraves, 2002 ) . Enron finally filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code ( Tonge et al, 2003 ) .
This was the largest corporate bankruptcy in the history of United States. Enron ‘s stock monetary value which had increased enormously from the 1990s to early 2000 ( from $ 7 to $ 90 ) fell to under $ 1 towards the terminal of 2001. Following Enron ‘s bankruptcy, their hearers, Arthur Andersen which was one of the Big 5 CPA houses back so, was charged with neglecting to make their occupation right. Arthur Anderson was fined and it finally went out of concern ( Benston and Hartgraves, 2002 ) .
Fiscal Practices at Enron Corp
Enron used complex finance constructions and accounting patterns to achieve assorted advantages including funding, revenue enhancement and accounting advantages ( Benston and Hartgraves, 2002 ) .
Enron used assorted accounting techniques and scrutinizing issues to pull strings the figure it reported. The six extensively pattern is of primary importance. These are discussed at length below ( Benston and Hartgraves ( 2002 ) .
Enron ‘s accounting policy was non to consolidate its special-purpose entities ( SPEs ) .
Enron funded legion SPEs and did concern with it. It used some of these to hedge US revenue enhancements for its foreign income. Other major SPEs were used to make concern with Enron domestically. GAAP regulations prevalent in those yearss did non necessitate Enron to consolidate its SPEs with its fiscal statements if independent 3rd parties had a controlling and significant ( 3 % of the SPEs assets ) equity involvement in the SPE. Enron guaranteed most of these SPEs bank debts and had to presume these debts when the SPEs assets were deficient to cover its debts. Enron nevertheless, did non consolidate these SPEs into its financials hence was minimizing its existent debts from its investors.
Enron ‘s handling sale of merchandiser investings to unconsolidated SPEs and entering it in its accounting books as they were arm ‘s length dealing.
If there is a forward contract with fixed monetary value, GAAP does non let additions in the value of the stock as income because the addition was simply a consequence of addition in the companies own stick. Enron nevertheless, used additions from such forward contracts to patronize legion SPEs it funded.
Enron recorded fees for services rendered in future periods as current income as portion of its income acknowledgment pattern.
The fiting construct of GAAP requires that the gross be recognized and lucifer with the disbursals in the period in which it is earned. Enron nevertheless recorded upfront income for fees received from SPEs as loan warrants. Although Enron ‘s income acknowledgment standards violated GAAP, it is questionable why their hearers accepted these accounting policies.
Enron restated its merchandiser investings at its just value but the restatements were non grounded with dependable and trusty figures.
Fair value requires that minutess be recorded at market monetary values derived from arm ‘s length dealing. GAAP requires investing financess to be revalued to their just values. Enron had many fiscal assets ( merchandiser investings ) which did non hold dependable market monetary values. This gave them an chance to delegate values to these fiscal assets and record earned gross.
Enron issued stock to its SPEs which were held by them. The accounting of this stock traveling dealing was questionable.
GAAP does non let companies to enter increased in the value of its ain stock as income. None the lupus erythematosus, Enron employed this technique. It recorded investing in one of its SPE ( JEDI ) utilizing the equity based method and when the accounting for the additions in the market value of its ain stock, Enron recorded this grasp as income. When the Enron ‘s stock held by JEDI declined, it did non record loss in its books. Both these events were identified by Enron ‘s hearers ( Arthur Andersen ) but non rectification was made to Enron ‘s histories.
GAAP besides disallows entering companies from entering exchanges of their stock for notes receivable as addition in equity. The sum receivable should be deducted from equity. Enron, nevertheless, recorded such dealing as assets which increased its shareholders equity.
Enron inadequately disclosed related party minutess and struggles of involvement and their cost to shareholders.
Enron failed to adequately unwrap minutess associating to its executive officer in which he had material involvement. Enron ‘s Executive Vice-President and Chief fiscal Officer, Andrew Fastow, had several linkages with its SPEs and had his compensation bundle with the profitableness of the SPE. These nevertheless, were non disclosed wholly and clearly by Enron. It is clear that Fastow had a struggle of involvement and it is seems that the minutess between Enron and its SPEs were non made at weaponries length.
Enron revealed accounting abnormalities in the 3rd one-fourth of 2001 and this brought their external hearers into the calcium hydroxide visible radiation ( Nelson et al, 2008 ) . Arthur Andersen were cognizant of the accounting mistakes, misstatements, and the consolidation issues of the SPEs. However, they turned a unsighted oculus of these terrible divergences from the GAAP. They non merely compromised their professional responsibility but jeopotised the full auditing profession and led the investors of Enron into fiscal convulsion.
Arthur Andersen was fined $ 500,000 and given five old ages probation after the Enron saga. The one time ranked top five accounting house so lost 1000s of employees and subsequently ran out of concern as they no longer audited corporations ( McKay, 2007 ) .
In add-on, the larger corporate cozenage revealed in 2002, that of Worldcom infuriated the investors more as it was revealed that Arthur Andersen was their hearers as good. This goes on to demo that collusion between the hearers, who are supposed to be the watch Canis familiariss for corporation, and the corporation consequences in misdemeanor of accounting rules, unethical behavior, misdirecting and misleading investors and at the terminal of the twenty-four hours, taking to corporate prostrations and one million millions of dollars of losingss.
Background of WorldCom
Worldcom was founded in 1983 as LDDS Communnications, was the 2nd largest long distance telecom company in the United States. It was announced on the 25th of June, 2002 that Worldcom was portion of the largest corporate fraud in the history of the United Stated. The bets reached up to $ 3.8 billion ( Snee, 2007 )
Fiscal Practices at WorldCom
Worldcom had overstated its grosss and net incomes. This it did by playing with its balance sheet to blow up grosss and net incomes while befoging disbursals. Worldcom classified its day-to-day outgo as investings and long-run outgos associated with capital assets. It was able to conceal disbursals intensifying to $ 3.8 billion and portrayed this as net income ( Shridhar, 2002 )
Background of Sarbanes-Oxley Act ( SOX )
Dey ( 2010 ) dubs the Sarbanes-Oxley Act ( SOX ) as a “ extremely controversial ordinance. ”
Cullinan et Al. ( 2006 ) notes the aim of the Sarbanes-Oxley Act ( SOX ) as to “ aˆ¦improve the truth and dependability of corporate revelations. ”
Content of Sarbanes-Oxley Act ( SOX )
The Sarbanes-Oxley Act ( SOX ) comprises 11 ( 11 ) rubrics. Each of these rubrics contains several subdivisions which encompasses specific authorizations and demands for fiscal coverage. The content of SOX is briefly discussed below.
Title I – Public Company Accounting Oversight Board ( PCAOB )
The first rubric of the Act comprises of nine subdivisions. Through this rubric, the Act establishes an inadvertence board responsible for supplying independent supervising of hearers ( public accounting houses supplying audit services ) . This Board called the Public Company Accounting Oversight Board or PCAOB in short, has the undertaking of registering hearers and sketching certain procedures and processs for conformity audits along with inspecting and patroling behavior and quality control and enforcing conformity with SOX.
Title II – Hearer Independence
The 2nd rubric of the Act besides contains nine subdivisions which set out to restrict struggle of involvement between hearers and houses which the audit by set uping criterions for external hearer independency. This rubric besides encompasses issues of new hearer blessing demands, rotary motion of audit spouse, and describing demands of hearers. Via this rubric, the SOX provide limitations on the extent of non-audit services provided by scrutinizing companies to the clients which it audits.
Title III – Corporate Duty
The 3rd rubric mandates the senior executives are required to take independent duty to guarantee that the corporate fiscal statements are valid, complete and accurate. It besides highlights the interaction demands between audit commissions and external hearers.
Title IV – Enhanced Financial Disclosures
The 4th rubric requires enhanced coverage demands for fiscal minutess including off-balance sheet points such as corporate officers ‘ minutess with the company. The nine subdivisions under this rubric require internal control to guarantee truth of fiscal studies and revelations. It mandates that these controls be audited by external hearers and be reported upon.
Title V – Analyst Conflict of Interest
The 5th rubric contains merely one subdivision aimed at the securities analysts. This is designed to reconstruct investor assurance in these analysts describing. Under this rubric there is a codification of behavior for the analysts which require them to unwrap any struggle of involvement.
Title VI – Commission Resources and Authority
The 6th rubric besides aims to reconstruct investor assurance in securities analysts. The four subdivisions under this rubric outline SEC ‘s authorization to ban or exclude securities professionals from pattern and the conditions in which this can be done.
Title VII – Surveies and Reports
The 7th rubric is aimed at the Comptroller General and the SEC. Through this rubric, the Act requires them to execute a scope of surveies and describe their findings. These include and are non limited to the impact of consolidating public accounting houses, securities misdemeanor and enforcement actions and Global Crossing.
Title VII – Corporate and Criminal Fraud Accountability
The eight rubric introduces condemnable punishments for use, devastation or change of fiscal records or other intervention with probes. It besides provides protection to whistle blowers. The seven subdivisions jointly are besides referred to as “ Corporate and Criminal Fraud Act of 2002 ” .
Title IX – White Collar Crime Penalty Enhancement
The 9th rubric, besides known as the “ Whit Collar Crime Accountability Act of 2002 ” has six subdivisions. The aim of this rubric is to turn to condemnable punishments associated with white collar offenses and confederacies. It has rigorous condemning guidelines and high spots that failure to subscribe corporate fiscal study is a condemnable discourtesy.
Title X – Corporate Tax Tax returns
The individual subdivision of the 10th rubric requires the Chief Executive Officer to subscribe the company revenue enhancement return.
Title XI – Corporate Fraud Accountability
The 11th rubric consists on seven subdivisions and is besides called the “ Corporate Fraud Accountability Act of 2002 ” . This subdivision links discourtesies to specific punishments and makes corporate fraud and record use a condemnable discourtesy.
Advantages of Sarbanes-Oxley Act ( SOX )
Disadvantages of Sarbanes-Oxley Act ( SOX )
Sarbanes-Oxley Act ( SOX ) in the South Pacific
Can Sarbanes-Oxley Act ( SOX ) avoid future corporate prostrations and frauds?
The issue with corporate failure is more an ethical failure instead than a system failure. The Sarbanes-Oxley Act ( SOX ) addresses both the ethical and the system failure. A system can be corrected through implementing ordinances and qualifying regulations. However, ethical failure is one which is borne with persons. The degree of morality and moralss that a individual has will impact on his function in the organisation. Regulation can forbid people from set abouting certain classs of action but this does non halt them from besieging or flexing the regulations.
Sarbanes-Oxley Act ( SOX ) is like a well and the directors are like a Equus caballus. And as the celebrated expression goes – you can take the Equus caballus to the well but you can non do him imbibe. If the directors are unethical and want to work in their ego involvement, they will by all agencies attempt to make so. Laws act as a hindrance but directors who are willing to take the hazard will further to happen possible loopholes to gain from the organisation at the cost of the investors.
SOX has closed many doors for directors to indulge in deceitful activities but research has shown that despite the debut of SOX, corporate fraud is on the rise.
The issue of bureau job discussed earlier could be seen as the footing for these possible corporate failures. The investors put their money into organisations trusting to acquire returns and they base their religion in the direction that runs the companies. The board and direction nevertheless, do non hold the same motivations and ends as the investors. They tend to work in self involvement and every bit long as this occurs, no ordinance would be able to wholly battle corporate frauds.