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.

Must we question corporate rule?

Financialization of the U.S. corporation: what has been lost, and how it can be regained

William Lazonick (University of Massachusetts-Lowell)

Abstract
The employment problems that the United States now faces are largely structural. The structural problem is not, however, as many economists have argued, a labor-market mismatch between the skills that prospective employers want and the skills that potential workers have. Rather the employment problem is rooted in changes in the ways that U.S. corporations employ workers as a result of “rationalization”, “marketization”, and “globalization”. From the early 1980s rationalization, characterized by plant closings, eliminated the jobs of unionized blue-collar workers. From the early 1990s marketization, characterized by the end of a career with one company as an employment norm, placed the job security of middle-aged and older white-collar workers in jeopardy. From the early 2000s globalization, characterized by the movement of employment offshore, left all members of the U.S. labor force, even those with advanced educational credentials and substantial work experience, vulnerable to displacement. Nevertheless, the disappearance of these existing middle-class jobs does not explain why, in a world of technological change, U.S. business corporations have failed to use their substantial profits to invest in new rounds of innovation that can create enough new high value-added jobs to replace those that have been lost. I attribute that organizational failure to the financialization of the U.S. corporation. The most obvious manifestation of financialization is the phenomenon of the stock buyback, with which major U.S. corporations seek to manipulate the market prices of their own shares. For the decade 2001-2010 the companies in the S&P 500 Index expended about $3 trillion on stock repurchases. The prime motivation for stock buybacks is the stock-based pay of the corporate executives who make these allocation decisions. The justification for stock buybacks is the erroneous ideology, inherited from the conventional theory of the market economy, that, for superior economic performance, companies should be run to “maximize shareholder value”. In this essay I summarize the damage that this ideology is doing to the U.S. economy, and I lay out a policy agenda for restoring equitable and stable economic growth.

URL http://econpapers.repec.org/paper/pramprapa/42307.htm.

Review by Bernardo Bátiz-Lazo

As I have noted before (see Bátiz-Lazo and Reese, 2010), financialisation has been coined to encompass greater involvement of countries, business and people with financial markets and in particular increasing levels of debt (i.e. leverage). For instance, Manning (2000) has used the term to describe micro-phenomena such as the growth of personal leverage amongst US consumers.

In their path breaking study, Froud et al. (2006) use the term to describe how large, non-financial, multinational organisations come to rely on financial services rather than their core business for sustained profitability. They document a pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production.

Instead, in the preface to his edited book, Epstein (2005) notes the use of the term as the ascendancy of “shareholder value” as a mode of corporate governance; or the growing dominance of capital market financial systems over bank-based financial systems.

Alternative view is offered by American writer and commentator Kevin Phillips, who coined a sociological and political interpretation of financialisation as “a process whereby financial services, broadly construed, take over the dominant economic, cultural, and political role in a national economy.” (Phillips 2006, 268). The rather narrow point I am making here and which I fail to elaborate for space concerns, is that ascertaining the essential nature of financialisation is highly contested and is in need of attention.

Sidestepping conceptual issues (and indeed ignoring a large number of contributors to the area), in this paper William Lazonick adopts a view of financialization cum corporate governance and offers broad-base arguments (many based on his own previous research) to explore a relatively recent phenomenon: the demise of the middle class in the US in the late 20th century. In this sense, the abstract is spot on and the paper “does what it says on the can”. Yet purist would consider this too recent to be history. Indeed, the paper was distributed by nep-hme (heterodox microeconomics) on 2012-11-11 rather than NEP-HIS. This out of neglect rather than design but goes on to show that the keywords and abstract were initially not on my radar.

William Lazonick

Others may find easy to poke the broad-stroke arguments that support Lazonick’s argument. Yet the article was honoured with the 2010 Henrietta Larson Article Award for the best paper in the Business History Review and was part of a conference organised by Lazonick at the Ford Foundation in New York City on December 6-7, 2012 (see program at the Financial Institutions for Innovation and Development website).

Lazonick points to the erotion of middle class jobs in a period of rapid technological change. This at a time when others question whether the rate of innovation can continue (see for instance The great innovation debate). Lazonick implicitly considers our age as the most innovative ever. But his argument is that the way in which the latest wave of innovation was financed is at the hear of the accompanying ever-growing economic inequality.

So for all its short comings, Lazonick offers a though provoking paper. One that challenges business historians to link with discussions elsewhere and in particular corporate governance, political economy and the sociology of finance. It can, potentially, launch a more critical stream of literature in business history.

References

Bátiz-Lazo, B. and Reese, C. (2010) ‘Is the future of the ATM past?’ in Alexandros-Andreas Kyrtsis (ed.) Financial Markets and Organizational Technologies: System Architectures, Practices and Risks in the Era of Deregulation, Basignstoke: Palgrave-Macmillan, pp. 137-65.

Epstein, G. A. (2005). Financialization and The World Economy. Cheltenham, Edward Elgar Publishing.

Froud, J., S. Johal, A. Leaver and K. Williams (2006). Financialization and Strategy: Narrative and Numbers. London, Routledge.

Manning, R. D. (2000). Credit Card Nation. New York, Basic Books.

Phillips, K. (2006). American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century. London, Penguin.