Worldcom Agency Theory

1.AGENCY THEORY

Agency theory is directed at the agency relationship, a contract involving the delegation of decision-making authority from one party (the principal) to another party (the agent) to work on their behalf (Jensen and Meckling,1976). Stemming from the assumption that people are self-interested, the theory concerns the most efficient contract governing the principal-agent relationship(Mitchell and Meacheam, 2011).

Agency relationship is derived from the separation of ownership and control. Typically, it refers to the relationship between the shareholders and managers of a corporation with diffused ownership (He and Sommer,2006). A contractual relationship is created when the principal(shareholder) hires an agent(manager) to manage

The managers deliberately deceive the investors to pursue their own interest.

2.2WORLDCOM

In corporations, managers with formal control power may go against shareholders’ interests by taking advantage of the company’s resources to fulfill their personal needs (Kim,Nofsinger and Mohr,2010). In WorldCom’s case, the CEO Bernard Ebbers had underwritten $400 million of personal loans at a favorable interest rate through the use of company assets. However, this was not disclosed as executive compensation. Along with the CFOs, they committed accounting fraud through overstating their revenue to inflate the stock price (Bebchuk and Fried,2013).

Eventually, WorldCom entered bankruptcy in 2002. Even though WorldCom’s Board were aware of the firm’s financial situation, they failed to safeguard the shareholders’ interest. The management unduly influenced the compensation and appointment of board members, leading to an alignment of their interests(Maskara,Eser, and

Other than internal control, effective external control is of great importance to curb agency problem, particularly with the external auditor’s involvement. In this context, the external auditor would periodically examine the authenticity and objectivity of the company’s financial reports(Boshkoska,2014). Precise financial reporting is critical to ensure the truthfulness of the results and management has not manipulated results for personal gain(Larcker and Tayan, 2011).

By employing appropriate accounting policies, the external auditor could help facilitate a position whereby aggressive accounting practices and exaggeration of figures are discouraged(Ojo,2009). Penalties could be imposed on managers and directors who intentionally inflate or manipulate reporting figures. These penalties could be in the form of a reduction of annual bonuses, remuneration or even pensions(Ojo,2009). Financial audit is significant in making management accountable to shareholders for its stewardship of a company(Fearnley and Beattie,2002).