Sunbeam gets toasted

Accounting fraud, business failure and creative auditing: A micro-analysis of the strange case of Sunbeam Corp.

Marisa Agostini (marisa.agostini@unive.it) and Giovanni Favero (gfavero@unive.it)
(Both at Department of Management, Università Ca’ Foscari Venezia, Italy)

Abstract
This paper puts under the magnifying glass the path to failure of Sunbeam Corp. and emphasizes the reasons of its singularity and exceptionality. This corporate case emerges as an outlier from the analysis of the US fraud cases mentioned by WebBRD: the consideration of the time between fraud disclosure and the final bankruptcy reveals the presence of an exceptional sampled case. In fact, the maximum value of this temporal variable is estimated equal to 840 days: it is really far from the range estimated by the survival function for the entire sample and it refers to Sunbeam Corp. Different hypotheses are evaluated in the paper, starting from the consideration of Sunbeam’s history peculiarities: fraud duration, scapegoating and creative auditing represent the three main points of analysis. Starting from a micro-analysis of this case that the SEC investigated in depth and this work describes in detail, inputs for future research are then provided about more general problems concerning auditing and accounting fraud.

URL http://econpapers.repec.org/paper/vnmwpdman/25.htm

Review by Masayoshi Noguchi

This paper was distributed by NEP-HIS on 30 September 2012. It was also distributed by other NEP reports, namely Accounting (nep-acc), Heterodox Microeconomics (nep-hme) and Informal & Underground Economics (nep-iue).

Agostini and Favero use the case study method to raise questions and considerations concerning the accounting of fraud. Their analytical focus is the company now named Sunbeam Products Inc. It was established in 1897 as the Chicago Flexible Shaft Company by John K. Stewart and Thomas Clark. Its first ‘Sunbeam’ branded household appliance, the Princess Electric Iron, was launched in 1910 and following the success of this line of products the company officially change its name to ‘Sunbeam’ in 1946.

Wikipedia informs us that ‘in 1996, Albert J. Dunlap was recruited to be CEO and Chairman of what was then called Sunbeam-Oster. In 1997, Sunbeam reported massive increases in sales for its various backyard and kitchen items. Dunlap purchased controlling interest in Coleman and Signature Brands (acquiring Mr. Coffee and First Alert) during this time. Stock soared to $52 a share. However, industry insiders were suspicious. The sudden surge in demand for barbecues did not hold up under scrutiny. An internal investigation revealed that Sunbeam was in severe crisis, and that Dunlap had encouraged violations of accepted accounting rules. Dunlap was fired, and under a new CEO, Jerry W. Levin, the company filed for Chapter 11 bankruptcy protection in 2001. In 2002, Sunbeam emerged from bankruptcy as American Household, Inc. (AHI), a privately held company. Its former household products division became the subsidiary Sunbeam Products, Inc. Then AHI was purchased in September 2004 by the Jarden Corporation, of which it is now a subsidiary.’

Al ‘Chainsaw’ Dunlap

Agostini and Favero look at this situation in detail while aiming to show ‘how the specific fraudulent strategy of performance overstatement adopted in the Sunbeam case can be connected to the peculiar modality of its disclosure, allowing to scapegoat the CEO, to (temporarily) discharge the board and the company of any responsibility, and to pursue a business recovery’ (p. 4).

By examining what they consider an exceptional case, Agostini and Favero aim to avoid over simplification and ‘not to sacrifice knowledge of individual elements to wider generalization’, but to be coupled with the informed use of ‘all forms of abstraction since minimal facts and individual cases can serve to reveal more general phenomena’ (p.4). The reason for examining this single outlier case is that, in their view, ‘“deviant cases” follow a peculiar path-dependent logic where early contingent events set cases on an historical trajectory of change that diverges from theoretical expectations’ (p. 2). By so doing, Agostini and Favero aim to ‘enlighten causal mechanisms which are too complex to emerge from standard empirical studies based on statistical approaches’ (p. 4).

The case documents the very aggressive management strategies of Dunlap. As mentioned, these led to fraudulent financial reporting through the misstatement of significant amounts in the financial accounts. In other words, Dunlap was found to have manipulated accounting numbers in numerous ways, skilfully covering these up through the acquisitions of new subsidiaries. Measures were also taken to assure the survival of the company after revelations of the fraud emerged. But in spite of scapegoating, rather tyranic management and the extremely long duration of the fraud the company final reached bankruptcy.

Normally auditors are integral (either by action or omission) to the process leading to accounting fraud (see for instance my work with Bernardo on the auditing of building societies here). But the case of Sunbeam was exceptional in the sense that its auditor, Arthur Andersen, avoided being involved in the crisis (but shortly after were intimate involved in the infamous Enron case). Agostini and Favero point out that ‘[t]his represents another item of exceptionality in Sunbeam Corp. case where there is a shift from the auditors to the CEO of the scapegoat function’ (p. 9). They further add that it was indeed the ‘auditors’ peculiar behaviour that which led to Dunlap being ‘the scapegoat’ (p. 9).

From the late 1940′s to 1997, the upscale toaster market was dominated by the ‘Radiant Control Toaster’ from Sunbeam.

To explore the point above the authors propose the concept of ‘creative auditing’ in comparison with the counterpart of ‘creative accounting’ or ‘earnings management’. According to Agostini and Favero, ‘auditors (agents) may use their professional knowledge, the asymmetrical information and the flexibility inside auditing rules to distract the principals’ attention (owners, shareholders, investors, etc.) from news which will not be welcome’ (p. 14). Agostini and Favero argue that ‘auditors working with management of the company are privy to essential information that can be used in a legal, but not proper way, to maximize their own interests at the expense of the principal’ (p. 14) by citing that ‘Prior to scandal, many assumed that either legal liability or reputational concerns would prevent the large audit firms from engaging in collusion with their clients. Enron and the many frauds that followed have undermined these assumptions’ (p. 14) from Brown (2007, p. 178)

In spite of having effectively discovered the accounting fraud at Sunbeam, the partner in charge of Arthur Andersen, Phillip E. Harlow, signed clean audit report on the ground that ‘the part, which was not presented fairly, was not material, so it did not matter’(p. 22). Agostini and Favero further claim:

After Sunbeam fraud disclosure, Mr. Harlow was supported by its partners at Arthur Andersen, which stated that this case involved not fraud, but “professional disagreements about the application of sophisticated accounting standards.” As emphasized by The New York Times (May 18, 2001), “in the typical accounting fraud case, the auditors say they were fooled. Here, at least according to the S.E.C., the auditors discovered a substantial part of what the commission calls sham profits”. Moreover, stating the immateriality of a part of improper profits, they used their professional knowledge, the asymmetrical information and the flexibility inside auditing rules to distract other stakeholders’ attention from news which will not be welcome.

However, the above indication only refers to the technical nature of the accounting fraud committed and the professional judgment exercised for the degree of materiality. In order to consider the case of Sunbeam as an incident of creative auditing (as Agostini and Favero claim it is), elucidations as to the supposed for Arthur Andersen participating in the fraudulent scheme are insufficient. An improvement on this point would be desirable. Although one can fully agree with their view that the role of auditors for the financial reporting of business enterprises should be reexamined. This paper is thought provoking in this sense.

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3 thoughts on “Sunbeam gets toasted

  1. Marisa Agostini

    REPLY TO MASAYOSHI NOGUCHI’S LAST COMMENT. Thanks a lot for your review. We’d like to just precise the following. The above indication does NOT only refer to the technical nature of the accounting fraud committed and the professional judgment exercised for the degree of materiality: it refers to auditors’ professional judgment about the fraud of Sunbeam. The paper emphasizes the differentiation between auditors’ involvement in the fraud and creative auditing: it does NOT assert that Arthur Andersen participated in the fraudulent scheme (so it does NOT need to give elucidations about this point) because Sunbeam represents a case of creative auditing (as deeply discussed in the paper). Both these types of auditing (i.e. involvement in the fraud and creative auditing) have emphasized that there is a gap between the beliefs and the preferences of the auditors with respect to those of the users of accounting reports: the latter assign to auditors a greater responsibility in discovering accounting manipulation and illegal acts than the extent to which auditors feel themselves responsible for such a task. As highlighted in the paper, recent regulations have tried to reduce both this gap and the second emphasized cause of audit failure, that is the lack of independence, by introducing some restrictions affecting the decision to outsource the internal audit function (such as the Sarbanes–Oxley Act in the USA) to external audit firms: after the notorious scandals, a fundamental change in the way audits are performed was then needed to win back the public’s trust. However, some inquiries on the quality of auditing during the recent financial crisis show that problems are far from being solved, and other studies cast doubt on the likelihood that the stricter internal controls imposed by recent regulations will be effective, if the “dramaturgical exchanges between the SEC and corporate regulatees” will go on as they did in the past (Shapiro & Matson, 2008, p. 224). Therefore, there should be more emphasis on past mistakes, as we have already highlighted in the introduction of the paper.

    Reply
    1. bbatiz Post author

      I think the author’s indication is right. Our use of the expression ‘fraudulent scheme’ was, on hind sight, a mistake. Please accept our apologies on this matter.
      Yours sincerely
      Masayoshi Noguchi

      Reply
      1. Marisa Agostini

        There is no need to apologize: the review was very useful because it pushed us to reflect on the issues it raised and to clarify better the point in question. So, thank you again for your precious comment.
        With my best regards,
        Marisa Agostini

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