Nortel case study analysis

Nortel Case Study

Nortel Networks Corporation, more commonly referred to as Nortel, was a global company of Canadian origin that at its peak in the early 2000's had comprised of one-third of the total valuation of the companies listed on the Toronto Stock Exchange (TSX). Nortel was founded in 1895 in Montreal, Quebec, with its manufacturing headquarters currently located in Mississauga, Ontario. The company manufactured data networking equipment along with offering telecommunication services. It employed over 94,500 employees worldwide.

Nortel's troubles began in the 1990's when under CEO John Roth, the company expanded into the internet technology market. Roth used media to alter public perception of the company. The sale of the optic fibre networking gear by the company from then on was hyped up by the speculators in the market, driving the share price of the company up, even though the company failed to produce overall annual profits. This is due to the market saturation that was soon resulted. However, due to the perception created by Roth supported by acquisitions of web-tech companies such as Bay Networks, and further investment in optical fibre technology, supported by press releases and praises from the media, analysts judged stock price of the company to grow exponentially, and anything less than that would harm the stock price.

The downfall of the company began when the company did not live up to the investor expectations. The financial results of the company did not support the statements dished out by its management and the CEO. As a consequence, the stock price took a nose dive. This led to the investors in the company to lose huge amounts of money. Most investors divested their funds from the company and thus, Nortel was left on the verge of bankruptcy. The company continued to exist by means of debt financing but the damage had already been done and the company finally went into liquidation in 2009. In carrying out the analysis, I would be using some topics such as the 'Unethical Behaviors in Organizations and Human Nature' to explain the manner in which ethics is important and how the human nature of managers acts whilst conducting their business. Chapters 'Codes of Ethics and Codes of Conduct' and 'Ethical Decision Making' would aid in explaining the manner in which decision making processes in the companies should operate while also emphasizing on the need to display ethical traits in business dealings.

From an ethical perspective, describe the factors that contributed to the rise and fall of Nortel.

The rise of Nortel was as quick and rapid as was the downfall. Although the company existed way before John Roth became the CEO of the company, the era of Roth at the top most position of Nortel had brought dramatic changes to the fortunes of the company. From an ethical perspective, one can observe that there were several reasons due to which the company shot up and spiraled down. The first task that John Roth took upon becoming the CEO was to grow the business by expanding it into the internet business line. Nortel began the acquisition of networking and internet companies across Canada and the U.S., and by 2000, Nortel had acquired 17 different companies. During this period, Roth greatly used the power of press and media to his own advantage, mostly unethically. Even though the company was still growing at a slow pace, Roth took advantage of the channel of media to spread out falsified or exaggerated financial projections and reports. This attracted huge investment in the company, and thus, the growth of Nortel paced up and led to the rapid rise of the company.

Once the company had began attracting investors and increased funds, Roth and his team decided to ensure that these investors did not sell off their shares in pursuit of higher returns elsewhere, and chose to hold the stock of Nortel. For this the management acted quite unethically and began to report over optimistic financial performance of the company that indicated very high earnings per share. The investors fell for this bait, and continued to not only hold their current holdings, but also acquire more shares. This can be understood as intentional misleading by the management but this helped the company rise and progress to become one of the most powerful entities in Canada, with shareholding base expanding to other countries as well.

Another issue that arises from an ethical perspective related to the fall of the company was the compensations that the executive directors of Nortel were entitled to even when the share price was declining and there was a funding problem beginning to grow. Ethically, it would be required by the directors of an entity to avoid accepting very high bonuses and other incentives when the company was losing its market credibility, the share price was falling down, and the operational side of the business was facing debt crunches. This was not the case in terms of the management of Nortel. John Roth himself was earning extremely high bonuses, which were way greater than the industry norm. The management continued to carry on its unethical behavior and thus, this became one of the crucial factors for the downfall of Nortel.

The management of the company had decided to showcase its financial performance using 'pro forma' earnings per share so that the investors could grow the hope of receiving a higher return. In terms of ethics, the management should have followed the GAAP principles in stating the earnings per share, rather than misleading the owners and other stakeholders with the use of 'pro forma' earnings, or better known as 'street earnings'. In terms of good governance and ethics, the management should have followed the GAAP principles in preparation and presenting the financials. But the management acted to benefit itself by unfair and unethical means which eventually led to the fall of the communications giant Nortel.

What mechanisms should be put in place to better align managers with the interests of shareholders?

One of the mechanisms as such would be the decision of the organization to emphasize on ethical practices in all dealings of the company. Keeping ethics a vital guideline in the running of the business can prove to lead the business of the company to growth and sustainability. Many theorists have suggested that the application of ethical practices amongst the management of the company creates a strong sense of responsibility towards the shareholders of the company. If ethical practices would have been present in Nortel from the beginning, the management might not have acted in the manner it did, and the company could have grown and remained healthy till today. Another mechanism that can be used is to set the limit of the executive earnings equivalent to the industry norms, and offering the executives better share option schemes that would not require the higher management to indulge in manipulation of the accounts and operations to earn higher from their holdings. The financial records of the company and its accounts can be brought to be prepared and treated using the GAAP principles. This will allow creating more transparency and proper financial records, allowing correct reporting to be done. The managers would have less incentive and margin to be able to manipulate accounts that are already prepared according to set standards. Once such mechanisms are placed properly, the interests of the managers would be better aligned with those of the shareholders.

Would you describe the meltdown of Nortel more as a failure of 'people' or of 'capital market processes'?

The collapse of Nortel has been linked to many reasons. Most of these reasons fall in the broad category of mismanagement and inappropriate actions taken by the company executives in the running of the company. Partially, the blame of the fall of Nortel lies completely with the actions of the people in control of the company's operations and management. However, the 'people' factor would not be the only category to be charged with the failing of Nortel. The existing capital market processes played their parts silently, mostly aiding the management towards the faulty running of the company. To understand the manner in which the failure of the 'people' factor can be taken as the primary reason for the meltdown of Nortel, an elaborate discussion has to be made which outlines and explains the many instances of mismanagement.

One of the foremost factors relating to the management's failure to act appropriately was due to the fact that executives were entitled a certain shareholding upon taking up a certain position in order to uphold the agency theory's success. This made the executive management a huge stakeholder, as they had the incentive to earn more by ensuring the share price increased so that they could avail a significantly higher return on the sale of their holdings. Thus, the conscience and the human nature of the directors impaired their judgment and made them act against the ethics in the pursuit of increasing the stock price of the company, which was evident from the fact that share price reached over $200 per share during the early 2000s, even though the operations of the company were not booming accordingly.

When the board of directors of the company is scrutinized, one can observe that the board of Nortel was not properly equipped with the financial knowledge and expertise that was required in a typical boardroom. This raised several issues for the proper management and monitoring of the company's financial outlook. The independent directors on the board of Nortel had the fiduciary task of keeping a check on the manner Roth and his management team of executive directors handled the company's finances and how they presented the information to the shareholders. Moreover, the board was also over numbered as the fewer the directors, the less the free rider problems. The board room of Nortel comprised 12 directors, which was already over the ideal limit of 9 board members for the smooth running of a company. Another issue regarding the board was that the non-executive directors on the board were over worked and were responsible for almost an average of 4-5 directorships. Some of these independent directors were CEOs of other companies as well. All these resulted in the inadequate functioning of the independent directors' panel on the board of directors, thus allowing Roth to pursue the manipulation of accounts and financial performance indicators of the company.

Since the ascending of John Roth to the position of the CEO of Nortel, the company expanded and entered other capital markets. One of these markets was the investor mine in the United States of America. The investors in the U.S.A. mostly followed the principle of short-term investing as this allowed them to benefit from the short-term increase in prices of stock of a company. Whenever they analyzed based on the financial performance and the announcement made by the press releases of the company that an entity was about to lose its stock price, they cashed in on their stock. This created an incentive for the management of Nortel to continually display growing and progressing financial performances and earnings so that these short-term investors continued to purchase and hold the shares of Nortel. The reporting criteria of the company management became clouded by such incentives. The altruistic behavior within the management ranks of Nortel became completely lost as the company began to report 'pro forma' earnings per share, which excluded items such as depreciation, unusual items, extraordinary charges, etc. from the face of the accounts and reported the financial figures based on the continued operations of the company. This was made possible by departing from the GAAP requirements by Nortel, allowing the executives to post more optimistic and inflated results, where taking the advantage of the capital market regarding the implementation of GAAP. Although the failure of the capital market processes did aid in the collapse of Nortel, it was the failure of the 'people' factor that primarily must be blamed for the downfall of Nortel as the management did not pay heed to the moral imperative of being honest and reporting properly to the shareholders of the company.

What happened to Nortel is similar to what happened to WorldCom and Enron in the early 2000s, and to Lehman Brothers, Citigroup, and many other banks during the 2008 financial crisis. Why do business people keep making the same mistake?

The notion that businesses keep making the same mistakes over and over again is based on only one common element. This common element is the pursuance of the management to earn more for them, arising from the greediness factor, rather than properly following their roles as the agents of the shareholders. In most of the cases, the judgment of the higher management of these companies became clouded by the urge to benefit themselves from the possible excellent operational opportunities, higher sales and relaxed regulations or able to utilize a loop hole in the legal and financial regulatory system.

However, this is not common amongst all the companies, but only amongst those whose management can be deemed corrupt and fraud. These mistakes can also be attributed towards the inability of the managers of these companies to be able to handle the financial records according to the set out standards. The incompetency of the executive management to cope up with the changing and developing financial recording and reporting system can also be attributed towards these companies making mistakes similar to the one made by the failed companies in the past.