Corporate Governance and the Tyco Scandal

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Introducing Corporate Governance

The Cadbury Report 1992 defined Corporate Governance as the system by which organisations are directed and controlled (ACCA, 2011).

There are many different definitions of Corporate Governance, some have a narrow point of view (focusing on management and shareholders) , while others are more inclusive of society (stakeholders).

Parkinson, in 1994, defined it as “the process of supervision and control intended to ensure that the company’s management acts in accordance with the interests of the shareholders.”

Tricker (1994), defined it as both the running of the business as well as the supervision and control of management in order to comply with legistaion and regulation.

Cannon (1994), stated that “ the governance of an enterprise is the sum of those activites that make up the internal regulation of the business in compliance with the obligations placed on the firm by legislation, ownership, and control.” (Feizizadeh, 2012)

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In 1999, Sir Adrian Cadbury redefined Corporate Governance as being “concerned with holding the balance between economic and social goals and between individual and communal goals…the aim is to align as nearly as possible the interests of individuals, corporations and society.” (Heritage Institute, n.d.)

The organisation for Economic Co-Operation and Development (OECD) stated in 1999 that “Corporate Governance is a set of relationships between a company’s directors, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set and the means of achieving those objectives and monitoring performance are determined.” (OECD). The OECD established a number of Principles of Corporate Governance which act as a guide for countries and companies. It sets out the rights of shareholders, the importance of disclosure and transparency and the responsibilities of the board of directors. (ACCA, 2011)

Corporate Governance is the structure is in place to ensure that the right questions will be asked and that checks and balances are in place to make sure those answers reflect what is best for the creation of long term sustainable value. (Minow, 2004)

No matter who defines Corporate Governance, there is a common theme among them:

  • It is based on a number of concepts including transparency, independence, accountability, integrity, fairness, probity / honesty and reputation.
  • The management, awareness, evaluation and mitigation of risks are fundamental to good governance.
  • Overall performance is enhanced by good supervision and management within set best practice guidelines.

Corporate Governance is important as in many cases those that manage the company are employed to run the business and therefore structures must be in place to ensure that management will not take advantage of the stakeholders of the company. (ACCA, 2011)

It also provides confidence for current and potential investors

According to Minow (2004), the importance of Corporate Governance became dramatically clear in 2002 as a number of corporate disasters that led to the loss of billions of dollars of shareholder wealth, thousands of jobs as well as massive bankruptcy filings.

Tyco

Introduction:

Prior to the scandal Tyco was one of a number of large conglomerates in America. It boasted an annual revenue of $40 billion and 250,000 employees and over 100 companies across the globe (Neal, 2013) . Arthur J. Rosenburg founded Tyco in 1960 as an investment and holding company concentrating on laboratory research for the government relating to energy conversion and solid-state science. He moved into the commercial sector and became a publicly traded company by 1964. The 1970’s saw the company grow through acquisitions and continued this through the 1980’s where it reorganised the group into four business segments: Electrical and Electronic Components; Health-care and Speciality Products; Fire and Security Services and Flow Control. This structure remained up until after the scandal (TYCO , n.d.).

"http://img.docstoccdn.com/thumb/orig/107839569.png"Denis Kozlowski started employment with Tyco in 1976 in the accounts section and rose through the ranks. He was observed by John F. Fort III, CEO at the time for concentrating on fulfilling Fort’s vision and was promoted to Tyco’s largest division. There he made a name for himself by cutting costs and worked hard to buy out competitors but also acknowledging both high and low achievers within the division. Within a few years he became CFO and by 1992 was made CEO. With power came a lavish lifestyle, he was earning over $100 million a year and frequently splashed out on items such parties, numerous homes, the $6000 shower curtain and the $2 million party held for his wife (Boostrom, 2011). This is a far cry from what he was quoted saying “We don't believe in perks, not even executive parking spots” (Symonds, 2002). He also liked to purchase priceless art and it was this that led to the revelation of the scandal. At the time the New York district attorney was investigating high end art purchases in as it was a route used by many who wished to evade tax when they came upon Kozlowski’s name. He owed approximately $1 million in taxes based on purchases of fine art for Tyco. Tyco then decided to investigate and uncovered numerous indulgences by Kozlowski. Kozlowski resigned from Tyco due to charges of theft and the unauthorised disposal of company shares the SEC brought against him (Hartley, 2008).

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"ImageIssues with the Financial Statements

The CEO, CFO and CLO during the period in question were Denis Kozlowski, Mark Swartz and Mark Belnick respectively. According to the SEC, they were the masterminds behind the fraud. Between the years 1996 to June 2002, they stole hundreds of millions of dollars without the knowledge or approval of the shareholders through low interest or interest-free loans ($170 million), rewarded themselves with high figure bonuses for undisclosed transactions worth approximately $340 million and pocketed the money from the loans due to the company forgiving the repayment while assuring the shareholders and investors that all was fine and that there were no skeletons hiding. Kozlowski and Swartz also concealed the fact they sold seven and a half million shares. According to Friestad, Associate SEC Enforcement Director, “The Tyco accounting fraud was orchestrated at the highest levels of the company, but carried out at numerous operating units and management levels of the company” (SEC, 2002). In January 2002, the SEC began inquiring into the top executives.

Examples of issues within the financial statements per the SEC were as follows:

  • Inflating the Operating Income due to the undervaluation of acquired assets and overvaluation of acquired liabilities.
  • The establishment and use of a variety of reserves to adjust financial statements to dress up its results and meet forecasted earnings.
  • Overstating Operating Income and cash flow concerning “connection fees” by approximately $567 million and $719 million respectively which lacked any kind of substance economically.
  • Failure to disclose certain executive compensation, indebtedness and related party transactions.
  • Exclusion of bonuses from its operating expenses and any costs associated with it.
  • Non-disclosure of stock sales which was pocketed by Kozlowski and Swartz

Due to all of the above as well as bribing Brazilian officials to retain or gain business, they violated federal laws that prohibit fraud. The also failed to maintain accurate accounts and provided inadequate internal control systems. According to Maremont and Cohen (2002), the reason behind all this corruption was greed in order to fund their extravagant lifestyle.