Question

Forms of business organization and ethics in financial decisions

Part I Historically, forms of business organization have been classified into three general categories: (1) sole proprietorships ; (2) partnerships and (3) corporations (public and private). However, with the evolution of markets, many hybrid ways of organizing business have developed in our economy, combining benefits from the original three categories of business organization. Instructions: Do a search and explain at least three (3) of these new hybrid ways of organizing business. Identify what are the advantages that they offer their owners compared to the original forms of business organization. Part II The beginning of the first decade of the 2000s was characterized by the rise of the great corporate fraud scandals. Many high-profile, large-cap companies were prosecuted, and their top executives and employees had to pay large sums of money and even serve in prison. One of the first scandals to come to light was the Enron Corporation case. Other companies were also prosecuted and some were directly related to the Enron case. Conduct a search on the companies Enron Corporation, Arthur Andersen, Merrill Lynch, and WorldCom and develop an analysis that includes what corporate fraud consisted of for each of them. Explain what was the impact it had on the company, on the industry in which the company operated and on the socio-economic environment. Argue what element or elements do you understand that the authors who originated these corporate fraud schemes had in common that led the economy to one of its worst moments in the economic history of the United States.

Answer 1

1) S corporation-

Following S-corporation eligibility criteria:

The company has no more than 100 shareholders

All shareholders are individuals, estates, or certain nonprofits or trusts

All shareholders are U.S. citizens and permanent residents of the U.S.

The business is not a bank or insurance company

All shareholders concur with the decision to form an S-corporation

2) Limited Liability Company

a limited-liability company looks a lot like an S-corporation. Its owners (called members rather than shareholders) are not personally liable for debts of the company, and its earnings are taxed only once, at the personal level (thereby eliminating double taxation). But there are important differences between the two forms of organizations.

1. Has fewer ownership restrictions. It can have as many members as it wants—it is not restricted to a maximum of 100 shareholders.

2. Its members don’t have to be U.S. residents or citizens.

3. Profits do not have to be allocated to owners based on percentage ownership. Members can distribute profits in any way they want.

4. Is easier to operate because it doesn’t have as many rules and restrictions as does an S-corporation. It doesn’t have to elect a board of directors, hold annual meetings, or contend with a heavy record-keeping burden.

Advantages in two above hybird organisation as compared to original forms of organisation

1) No double taxation

2) Limited Liability

3) Ease of operstion

Not-for-Profit Corporations

A not-for-profit corporation (sometimes called a nonprofit) is an organization formed to serve some public purpose rather than for financial gain. As long as the organization’s activity is for charitable, religious, educational, scientific, or literary purposes, it should be exempt from paying income taxes. Additionally, individuals and other organizations that contribute to the not-for-profit corporation can take a tax deduction for those contributions. The types of groups that normally apply for nonprofit status vary widely and include churches, synagogues, mosques, and other places of worship; museums; schools; and conservation groups.

It enjoys favourable Tax benefits as compared to Orginal forms of organisation

Financial Statement Fraud in Enron, WorldCom Scandals,Arthur Andersen and Merrill Lynch

Impact of Scandals

4500 employees lost their jobs.

• Investors lost some 60 billion dollars within a few days; for many it meant losing their old-age security.

• The pension fund for the company's employees was obliterated.

• Citizen’s trust in the American economic system was destroyed.

• Losses on the financial market amounted to the worst stock value loss in peaceful times.

• Banks were suspected of collusion.

• The auditing firm Arthur Anderson lost its accreditation.

The effects include, loss of trust, increased cost of capital, the slowing of deregulation, more demanding and comprehensive accounting procedures, to name a few. These constraints could not only impede the growth of the industry, but could paralyze it. This paralysis will occur at a time when the energy industry needs to build investor confidence, build consumer confidence and regulatory confidence, and not bombard it with fears and doubts. The energy industry has for a very long time had the reputation of being greedy, greasy and underhanded. This comes from the “boom and bust” cyclical nature of the oil and gas industry. Typically, the cycle starts with a spike in demand, or a supply shortfall, which triggers high spot market prices. High prices spur capital expenditures, which in turn create excess supply, which ultimately deflates prices, resulting in a cutback in expenditures. This cycle is an energy market reality and will no doubt continue for the foreseeable future certainty. The only question is the timing, amplitude and duration.

element or elements that the authors who originated these corporate fraud schemes had in common that led the economy to one of its worst moments in the economic history of the United State

1) Ethical Assessement

Enron didn’t start out as an unethical business. As we have seen in this case study, what introduced the virus was the pursuit of personal wealth via very rapid growth. This led to the introduction of quite extreme incentive schemes to attract and motivate very bright and driven people, which, in turn, led to an unhealthy focus on short term earnings. The next step was, naturally, to look at how earnings could be massaged to achieve the aggressive revenue and earnings targets. Since the massaged figures for growth in earnings still left a shortfall in cash, Enron quickly maxed out on its borrowing abilities. But issuing more equity would have hurt the share price, on which most of the incentives were based. So, schemes had to be created to produce funding secretly and this funding had to be hidden. In this way, an amoral and unethical culture developed in Enron in which customers, suppliers and even colleagues were misled and exploited to achieve targets. And the top management, who were rewarding themselves with these same incentive schemes, boasted that a pure, market-driven ethos was propelling Enron to greatness and deluded themselves that this equated to ethical behavior. Lay even lectured the California authorities, whom Enron was cheating, that Enron was a model of business ethics. Finally, the respected Arthur Andersen allowed greed for fees to over-rule the strong business ethics tradition of its founder and caused it to succumb to bending and suspending its professional standards, with fatal results.

2) Impact on Corporate Governance

Our five Rules of Good Corporate Governance start with the need for an ethical culture. Having established that Enron’s culture became progressively more deficient in this regard, let’s consider briefly the impact of this failure in business ethics on the other Rules

3) Clear goal shared by all key Stakeholders

Lay and, particularly Skilling, engendered in all the staff of Enron the goal of driving up the share price to the virtual exclusion of all else. The goal of achieving a long-term satisfaction from a stable customer base took a distant second place to signing up deals. In California, the customers were deliberately exploited by the traders to the maximum extent their ingenuity could achieve. Even internally, the Chief Finance Officer’s funding scheme was designed to make him rich at his employer’s expense

4) Strategic Management

As a McKinsey consultant specializing in strategy, Skilling had a very clear vision, at least initially, of what he wanted Enron to achieve. However, he wasn’t interested in management per se and allowed operational management to wither. But his vision of a huge trading enterprise wasn’t carried down to the next level of developing and implementing practical business plans, as evidenced by his crazy launch into broadband, a field in which he had no personal knowledge or experience and in which Enron had almost no capability or likelihood of raising the funds required to implement the project

5) Organizational failure at Delivery

Skilling became COO on the departure of a very tough and experienced predecessor. Even at that point, Enron had been expanding at a rate which outran its ability to set up appropriate and adequate administrative systems and controls. Added to which it had always been short of funds. Skilling’s lack of interest in operational management meant that on his appointment at COO, he made a poor situation much worse by making bad managerial appointments. His focus on rapid growth incentivized by very generous compensation schemes, and with inadequate spending controls, created a totally dysfunctional organization.

6) Transparency and Accountability

From the early stages, Enron’s focus on earnings and share price growth and the related financial incentives led to a necessary lack of transparency as the figures were fiddled. One could argue that Enron felt very much accountable to their shareholders for delivering consistent above average growth in Enron’s market capitalization. However, this growth was achieved by subterfuge and deception. Certainly, the dealings in California were as far from transparent as it was possible to be