Agency problem of a company PDF

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Agency problem is a main concern in every company between the stakeholders and managers....

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Introduction This document shall take a close look at the agency problem’s concept and its consequences in corporate governance. The paper focuses on a major accounting scam in Adelphia, a cable company run by a family in America. The fraud continued for many years before it was identified, and the executives of Adelphia stole money from the company for their benefits. The CEO of Adelphia, John Rigas, with the support of other family members, who also were executives in the company, carried out the scandal. The paper will discuss the scam in detail and give the learnings and conclusion. Adelphia scam hit the news in 2002, just after Enron’s collapse. John Rigas and his brother Gus found Adelphia Communications Company in 1972 in Coudersport, Pennsylvania. In 2002, Aldephia had reached the sixth-largest cable company position in the USA. Family members of John Rigas held the company’s top posts. John Rigas himself being the founder and chairman of Adelphia. 

Timothy Rigas, CFO, and Board member, Between December 1992 and June 2001, he was chairman of the Audit Committee of Adelphia’s Board of Directors,son of John Rigas

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Michael Rigas, Executive vice president and Board member,son of John Rigas

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James Rigas, Executive vice president and Board member,son of John Rigas

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Peter Venetis, Board member,son-in-law of John Rigas

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James R. Brown Adelphia’s Vice President of Finance

Rigas family occupied five out of nine board seats and owned 100% of class B voting shares,giving them control over the company even when it went public. Agency Problem Rigas family used Adelphia as their personal ATM and lived a luxurious life by deriving cash from the company. They continuously manipulated the financial statements by overstating the income and hiding the debt from the balance sheet. This action kept shareholders and stakeholders deprived of the essential information. In Adelphia, a conflict of interests between shareholders and management and also a conflict between management and debtholders can be seen. As a consequence, the Rigas family did steal

from the company and employed family members instead of well-deserving managers to fulfill their interests. Hiring family members was a good thing for the CEO but not for shareholders. Rigas family used money from Adelphia to live a life of luxury and resulted in overspending. Being a family firm, where the CEO is also the company’s founder, conflicts may arise between controlling and non-controlling shareholders. Controlling Adelphia shareholders is the Rigas family members who wanted extra benefits and looted the company, and only focused on maximizing their empire. Major manipulation of financial statements was done to prevent adverse effects and help family members derive benefits from the company. Explanation of Case John Rigas and his family used the company’s money to serve their luxurious lifestyle where they owned private jets, a golf course, a hockey team, and apartments in Manhattan. Company funds had been used to purchase back Adelphia’s stocks and finance other family companies,a car fleet, and John’s daughter used money from the company to produce a movie. All of it was off the books. If not for one single person, the fraudulent brotherly conduct may have continued forever. Merrill Lynch analyst Oren Cohen wanted to know how the family could afford to purchase over one billion dollars of the stock during an earnings conference call. CFO, Tim, could not come up with a decent explanation. As it was the Enron scam period, investigators got interested in the company and started digging up things. The Rigas family resigned in two months and abandoned control of the company. Adelphia officials reported that the corporation had been responsible for an enormous family debt of $3.1 billion, which was sufficient to render the business bankrupt. The securities and exchange commission has divided Adelphia fraud into three components : 1. 1999(Mid) – 2001(end): By systematically registering such debts on unconsolidated affiliates’ books, Adelphia has fraudulently omitted over 2.3 billion dollars from the annual and quarterly consolidated financial statements. 2. During the same period, earnings reports and commission filings were misstated. 3. Rampant self-dealing by the Rigas family was omitted and misrepresented. From owning a golf course to buying back Adelphia shares, the public company had to pay for that.

Detailed analysis Using journal entries, fund transfers were created, and Rigas were given millions of dollars for nothing by adelphia. They covered the loans taken previously by manipulating the books and made an exaugurated inflation of the companies’ financial condition. Further, they have created fack transactions to boost their earnings and cover the companies debt with others. People have started to become suspicious; thus, the financial analyst did research and identified that $1 billion worth of off-the-book dealings of Adelphia funds to entities owned by the Rigas family. This caused the U.S. Securities and Exchange Commission to investigate Adelphia further. Adelphia had to delay filing the annual report in 2001 and re-report financial statements for the three previous years to properly account for the debt. In Adelphia, we have seen two kinds of fraud. Fraud committed by management on behalf of the company and fraud committed by management for their self-benefit. Fraud committed on behalf of the company: The management committed the fraud under pressure. In the late 1990s, industry pressure was high on adelphia and its management. The company could not meet outsiders’ expectations, i.e., the shareholders and the bankers who have given loans. Since the outsiders rely on the company’s financial statements, they have window dressed the financial statements and projected wrong amounts. Fraud committed for self-benefit: the Rigas used the companies’ money to enjoy their luxuries and paid all the bills out of its profit. It is stated that the Rigas used the company as their “personal ATM.” They bought luxurious condominiums. Issued over $722 million of Adlphias common stock apart from these, they also had more than $563 notes were present only for the Rigas family’s benefits. Auditors of the company had the responsibility to show the stakeholders the real face of the financial statements. Deloitte and Touche was the auditor of adelphia in the year 2000. They were responsible for following the generally accepted accounting standards and performing the audit. If any fraud or misrepresentation was found, they had to seek details from the management

regarding the same. If not satisfied with the reasoning, they had to report to the concerned authorities to take appropriate action, which was not done in the required manner. Aftermath After disclosing the fraud committed by Rigas in the company, they were under criminal and regulatory investigation. Efforts were made to save the company. A committee of creditors and bord forced Rigas to capitulate the company, and attempts were made to renegotiate loans and sell the assets to decrease the debt. The share price had seen a drastic fall from $20.39 to $.70; consequently, the investors faced a loss. On 3rd June, the company got officially delisted for the. In 2005 Touche LLP and Deloitte had to pay $50 million as a penalty due to their improper conduct since they were Adelphia’s auditors. Further, the amount received from them was used to pay for those who suffered from the scandal. Civil penalty on Rigas was charged at $2.18 billion out of this 95% consisted the assets like securities and the real state of adelphia. Along with Timoty, John Rigas and his sons were sentenced to imprisonment for 15 and 20 years, respectively. Later on, in the same year, Time, Warner, and Comcast have taken Adelphia, concluding the scandal. Learnings 1. As failure happens in the company because of the so many corporate governance aspects, including all top management, the board of directors, auditors, etc. 2. This case is an opportunity to learn about how management and conflict of interest takes place, which possible result in bankruptcy 3. Window dressing was done by overstated earnings by using creative accounting behavior, including net income, earnings before taxes, depreciation, and amortization. They also overstated the extent of the cable park and the extent of the cable. 4. Importance of transparency pays in business. lines This case fetch the cost of a family business 5. If auditors had done their duty correctly by following GAAS, then the loss that the stakeholders and the creditors have incurred would be comparatively less. Proper actions would

be taken within time to protect the company. Instead, Deloitte and touch could not perform their respective functions ineffectively. The risk procedure followed was not appropriate. International auditing standards were not followed rightly. 6. One of the significant learning is how accounting frauds can happen from top management and who can prevent it. 7. Frauds in Adelphia would have happened no matter what rules had been in place at the time since the highest authorities in the company performed the scams. 8. The possibility of committing fraud does not necessarily get more difficult because of the rules themselves, but because the framework focuses on fraud. Conclusion From a detailed study of the Adelphia Scandle, we could infer that the company has achieved greater heights, but later on, it down due to owners’ hankering. The scandal happened that it excluded billion dollars in liabilities and didn’t consolidate in books, and they hide them in books of accounting balance sheets. The company tried to misrepresent the earnings to meet the expectations of stakeholders. Even the Rigas family has used corporate funds for personal usages. The company has done accounting fraud. The case presents the greed and falsehood of misconduct of management at large. Internal control is quickly developed to prevent fraud from happening among the employees, but internal control can often be overridden when facing management. A question arises while studying this case, what were the internal controls doing when all this was happening? We could clearly understand that the Internal control only works if people monitor and ensure they are followed. It is hard to detect fraud committed by the people on top and even more complicated when all the people on top are on the scam. Auditors of the company had the opportunity to rectify the top-level management’s misstatements or mistakes, which were not done....