Category: Analysis

Introduction

Nortel Networks Corporation is one of the companies from Canada that played a major role in the telecommunication boom in 1990 (Nortel, 2012). Even though it still boasts of having been one of the largest telecommunication equipment makers in North America, Nortel is currently in the process of liquidating its assets due to its dramatic rise and fall in the early years of the XXI century. The root cause of this dramatic rise and fall is a subject of discussion in this paper.

Contributing Factors

Several factors might have contributed to Nortel’s sudden rise and fall. However, an ethical view reveals some factors that are being discussed below as the major players.

Equity Overvaluation

Baker & Powell (2005) defines overvaluation as the existence of large deviation in the company’s share price and its underlying value in the environment that suggests high chances of not achieving its stakeholders’ expectations. This was a genesis of Nortel’s steep rise and abrupt fall. The exaggerated pricing of the company’s share for $ 2000 created the biggest deviation compared to its underlying value. As a result, the management found itself in a risky business in order to cover up the looming disasters.

Opportunistic Marketing

Nortel seized all the opportunities that came on its way, ranging from internet technologies to international deregulations in the telecommunication industry. It benefited from the favorable market and regulatory conditions to gain temporary market dominance. In order to achieve this, Nortel management dishonestly used media to influence on its investors. As a result, the media gave investors a great deal of unfounded confidence in the company’s management and business strategies. It is this unfounded consumers’ confidence that saw Nortel’s steep growth in the late 1990s (Fogarty, Magnan & Markarian, 2007).

Government regulators further increased other Nortel stakeholders’ confidence by making it a Canadian national economic icon. They branded Nortel with the Canadian flag to symbolize the country’s flying economy. As such, everyone came to a belief that Nortel had been the company to identify with. More blindly, several analysts continued to applaud the performance of this company, while it increased its institutional investor ownership ((Fogarty, Magnan & Markarian, 2007).

Dishonest Accounting Practices

Analysts as well failed to recognize some of disastrous decisions made by the company’s management. For instance, a highly priced acquisition of such firm like Qtera, at the cost of $ 3 billion, was blindly justified by analysts despite the fact that it had no sales that could explain this suicidal investment (Fogarty, Magnan & Markarian, 2007). Instead of undertaking a critical analysis of accounting changes that would later pose some revenue impacts on the company, analysts continuously applauded even the questionable developments in Nortel Corporation.

Unfortunately, the management and the Board of Directors could not monitor and account for its revenues. This resulted into some financial accounting irregularitiesthat led the company to face several lawsuits. The charges against Frank Dunn, filed by the Securities and Exchange Commission, were just a manifestation of the executives’ manipulation of their earnings and financial improprieties in a revenue recognition throughout the company (Romajas, 2005).

Selfish and Unreliable Management

Some unrealistic promises to investors gave them a false hope about the company’s future. This killed the investors’ trust in the company and its management. Even after the company had lost its market share and competition in the stock market, Nortel’s management continued to give its excessively optimistic projections.Hence, the investors felt betrayed by the management that continued to selfishly reward itself against the backdrop of the falling share prices (Baker & Powell, 2005).

Aligning Managers with the Interests of Shareholders

Retrospectively, the alignment of managers with the shareholders’ interest would have greatly solved the investors’ problems in Nortel Corporation. However, the mechanisms to do this alignment remained to be a challenge. Several scholars in the Corporate Management have proposed some strategies discussed below.

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The first strategy would be making the top managers as a part of shareholders by giving them some shares at the beginning of their tenure. In order to make this offer appealing and binding, Baker & Powell (2005) suggested that the shares had passed to managers and had to be deposited in some trusts where they would not sell them at least for ten years. As such, any business minded manager would work extra hours hard and with a good will in order to receive a better dividend.

According to Baker & Powell (2005), the tying managers’ compensation to the company’s performance can be another mechanism of aligning managers with the interest of shareholders. While advocating for the Agency Theory, Fogarty and his colleagues emphasized that aligning the managers’ remuneration with the well spelt-out measures of a corporate success is a sure way of reducing some unjustifiable managerial costs. They defined the Agency Theory as a contract wherein a principal retains his agent to accept the delegation of his (principal’s) authority in order to accomplish a given purpose (Fogarty, Magnan & Markarian, 2007).

In the light of the above definition, shareholders play a principal role, while managers become an agent. The strength of this theory lies in the nature of contract between the managers and the firm owners or shareholders. As much as managers are given the authority to oversee the firm’s operations, the contract aligns them to the interests of shareholders, since shareholders become the party to determine the principal purpose, which should be accomplished by managers. The knowledge of the managers’ varying degree of moral hazard makes it paramount for contracting efforts to be made on imposing some costs upon managers with the unpredictable fiduciary adherence (Fogarty, Magnan & Markarian, 2007).

Nortel’s Meltdown as a Failure of People, not Capital Market Processes

From the analysis of Nortel’s history, it is more accurate to describe its meltdown as the people’s failure rather than being the failure of the capital market process. Fogarty and his colleagues also noted that Nortel’s top managers’ ensuing actions from various motivations and incentives had to be blamed for the company’s meltdown (Fogarty, Magnan & Markarian, 2007).

The lack of strong internal control mechanisms witnessed in Nortel can be attributed to the dysfunctional Board of Directors. The composition of this independent board is highly questionable in terms of its size and the financial expertise involved. While the corporate management experts advocate for a threshold of nine (9) directors per firm, Nortel’s Board of Directors had twelve (12) members (Fogarty, Magnan & Markarian, 2007). Such a large board gave a room for some free-rider problems among directors, resulting into the ineffective monitoring of the company’s finances. This trend allowed the blind and dangerous acquisitions by John Roth to get away unnoticed. Consequently, its internal control system had been overwhelmed and replaced by the deceptive praises from media and external spectators such as government regulators. Most probably, the large size of this board could have increased its decision making time.

In the properly equipped Board of Directors, there should be at least one independent director being skilled and experienced in accounting, audit and other financial matters (Baker & Powell, 2005). However, the advocates of Nortel’s board revealed that the board entirely relied on the management office for the verification and communication of the company’s financial results. The point is that the board lacked a financial expertise to be carried out for the independent monitoring of the company’s financial progress. As such, the board could not even detect the financial irregularities that had brought the company down. Numerous accounting restatements happening in the life of this company were the symptoms of the board’s expert deficiency. 

On the rational grounds, Nortel’s failure cannot be pegged on the capital market conditions. Instead, the executives’ and the Board of Directors’ complacency had all to do with its sudden and massive fall. The binding legal fiduciary duty of board members for preserving the stakeholders’ interest was unceremoniously forgotten, as the board failed to reduce Nortel’s agency costs. In addition to their membership in the board, these directors had some multiple obligations and duties that could not allow them to perform properly (Fogarty, Magnan & Markarian, 2007).

As much as the increased number of transient institutional investors could be cited as a contributing factor in the sudden fall of Nortel, the lack of the effective market monitoring body could have been another cause. If the company’s market analysts and the Board of Directors were awake to this unhealthy trend of ownership, they could have come up with a better marketing strategy that would count the challenges of a short-term trading and a consequent high portfolio turnover.

Unfortunately, the management was easily influenced by the short-term trading of transient institutional investors, thereby robbing the company of its long term business strategies. Some income manipulations and fraud that had been done by John Roth and his managerial counterparts were a manifestation of their unprofessional and unethical response to the pressure to meet the unrealistic expectations coming from the Wall Street (Fogarty, Magnan & Markarian, 2007).

Instead of laying down some sound foundations for the company’s long term business, the managers settled the short-term business strategies triggering an instance growth and abrupt failure of the entire company. Dunn, the further CFO, publicly disregarded Nortel’s control organization and suggested that it could have been the company’s barrier to making its quick business (Romajas, 2005). These quick fixing strategies led to the hurried acquisitions of Nortel’s assets, which were later pronounced as worthless. In his Fast Finance Initiative, Dunn down played the company’s control function by primarily focusing on the sales and customer service. In fact, he is quoted as having directed all Nortel’s employees to disregard the company’s business logics and consequently make them free from what he had termed as the tyranny of unimportant managerial details (Romajas, 2005). This approach advocated for the abandonment of all activities, i.e. the accounts’ reconciliation, as they were not generating the direct revenue for the company.

Why Businesspeople Make the Same Mistake

A keen analysis of the failures by different businesses reveals that such businesses are making the same mistakes for many years (Baker & Powell, 2005). The case of Nortel, for instance, is a replica of what had happened in such companies as Citigroup, Enron and WorldCom. The discussions followed suggest some reasons for this vicious cycle.

Lack of Commitment and Proper Leadership

At the start of every business venture, all businesspeople have a plan for their business and for overcoming future challenges. However, most of these plans never last till the business’ first challenge. Just like Nortel Corporation, very few businesspersons are committed to their initial plans and easily swayed to the same paths taken by failed businesses. This was the case with Nortel Corporation. John Roth’s desire to succeed had pushed him beyond learning. Even though other companies had failed in their blind move to new markets, he persistently saw the internet technology as Nortel’s only way to go ahead. Consequently, he ignored all the pieces of advice from the media, the Wall Street and the company’s employees (Fogarty, Magnan & Markarian, 2007).

It is surprising to compare the company’s mission or vision statements and its actual work procedures. Leaders being not committed to the business’ blue print usually find themselves in the same mess as those that had failed in the past. Frank Dunn, later Nortel’s CFO, is a typical example of leaders that disregard the company’s operational procedures. He strongly rejected Nortel’s business logics, which he termed as the useless managerial details with no direct financial benefits (Romajas, 2005). Even though false accounting practices brought down from such big companies like Citigroup, Enron and WorldCom, Dunn regarded the accounts reconciliation as an unnecessary and tyrannical procedure that could be done away with.

Failure to Transfer Lessons from the Past

Most businesspersons believe that they are right and assume that the past failures in other businesses might have been caused by other weaknesses being only unique to those which had failed. In cases of corporate ventures, the leaders are supposed to be the ready and willing learners. Being reluctant to listen is a sure path to past failures. However, just few CEOs are humble enough to take any advice being contrary to their views (Baker & Powell, 2005).

Lack of Critical Analysis of Business Conditions

Additionally, some businesspersons do not even think about what they are going through and what they must do differently (Baker & Powell, 2005). As such, they become more reactive than proactive. The ill preparedness for the crisis in most firms make leaders in those firms adopt quick-fix techniques that have been used over many years. The overvaluation problem that had been witnessed in Nortel exerted its usual pressure that would be expected in such situation. However, the reaction from Nortel’s management caused the harm. Their borrowing from the company’s future revenues in order to actualize the management’s dishonest earnings was just a replication of what had happened in the past failed businesses.

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Prioritizing Remedies

In order to avoid the recurrence of Nortel’s strategy in other companies, some priorities should be given to regulate a financial accounting. As discussed above, Nortel’s failure is largely attributed to some accounting discrepancies, where the management unethically had been manipulating the financial statements with no regard to the standard accounting requirements. The accounting problemsrevealed through numerous accounting restatements call for the proper regulations of accounting (Baker & Powell, 2005).

The success in the winning shareholders’ trust and keeping the company’s market share requires the company to comply with the standard financial accounting standards. This regulation will not only help the company to comply with the financial requirements but it will also help in streamlining its operations. The optimization of the company’s resources and proper management of its expenditure is an invaluable feature of some standardized financial accounting practices (Baker & Powell, 2005).

Secondly, the business education should be the culture of any company that seeks to prosper. Most of unethical practices encountered in Nortel can be linked to the insufficient business knowledge. All business stakeholders should be knowledgeable in the major aspects of company’s operations. It was the shame to realize that Nortel’s Board of Directors could not verify the firm’s accounting statements (Fogarty, Magnan & Markarian, 2007). Moreover, shareholders should be made to understand the nature of the firm’s operations and the environment, in which it is operating. Most importantly, the research and innovation should be a part of the company’s norms.

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