Question

What were the problems at Tyco- Exhibit 12-1 page 426?

Executive Compensation Abuses at Tyco EXHIBIT 12-1 Tyco International Ltd.'s Dennis Kozlowski looms large as a rogue CEO for the ages. His $6,000 shower curtain and vodka-spewing, full-size ice replica of Michelangelo's David were symbols of excess and greed. In essence, prosecutors accused Kozlowski and former Chief Financial Officer Mark Swartz of running a criminal enterprise within Tyco's executive suite. The two were hit with 38 felony counts for pilfering $170 million directly from the company and for pocketing an additional $430 million through tainted sales of stock. Ironically, both Kozlowski and Swartz were former auditors; Kozlowski has become the personification of the widespread irrational exuberance of the late 1990s. Kozlowski handpicked some of the members of the compensation committee, and the changes worked to his benefit as his total compensation rose from $8.8 million in 1995 to $67 million in 1998 to $170 million in 1999. The more he was paid as a reward for Tyco's soaring stock price, the more he spent on luxuries -and the more he stole. Kozlowski also ran up a $242 million tab at Tyco under a loan program designed to finance the purchase of company stock. Rather than use the money to buy Tyco stock, he used it to purchase fine art and antiques, a yacht, and a Nantucket estate. The loans were forms of compensation, but characterizing the compensation as a loan provided significant tax and accounting benefits to the executive and the corporation. Tyco's board approved some, but not all of the forms of compensation Kozlowski had tapped into. When Congress learned of the level of abuse in corporate loans, it was shocked. In the Sarbanes-Oxley Act of 2002, Congress forbids public companies to make or even arrange new loans to executives or to modify or renew old ones. The penalties for a violation are up to 20 years in jail and fines reaching $5 million for executives and $25 million for companies. In June 2005, Kozlowski and Swartz were each convicted on 22 criminal charges relating to their misdeeds at Tyco. Both were sentenced to serve up to 25 years in prison and pay fines and restitution totaling $240 million. Kozlowski served over 6 years in prison and 3 years in work release on parole. After serving his time Kozlowski said, "I was piggy, but I'm not that person anymore." As a result of abuses, public companies are now required to provide a "readable" explanation of how executive compensation was determined in the "Executive Compensation Discussion & Analysis" section in SEC filings. There are also tools online that pull executive compensation numbers from SEC filings in order for investors to make comparisons between companies.

Answer 1

The problems at Tyco can be identified as follows:

1. Management override of controls since the CEO it self was directly involved in mismanagement of funds and resorted to accounting tricks which spiraled his compensation into millions. He was an auditor himself and hence knew the accounting procedures and loopholes well.

2. The other board members approved of his compensation without getting in to the details and did not doubt until something concrete emerged. Lack of due diligence led to payment of unwarranted compensation.

3. The company also allowed the CEO to pick the compensation member committee when it has to be unanimous decision to be taken by all the board of directors which led to getting his self interests treated well.