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Parmalat Post Fall Analysis

Analyse the fall of Parmalat in 2003 using the four-stage fundamental analysis (1.Business strategy analysis, 2.Accounting analysis, 3.Financial analysis, 4.Prospective analysis) and support your analysis from your reading of the literature. In particular:

Explain the strategies and practices that exposed Parmalat to major risks.
Explain the accounting and corporate governance issues that led to the fall of Parmalat.
Discuss the role of the auditor in this case.
Discuss the broader lessons for international business that can be gained from this case.

Parmalat Post Fall Analysis

Parmalat was one of the leading food-based companies in Italy and globally too. In the year 2003, Paramalat unearthed a financial scandal that left the company bankrupt at £14bn ($20bn). It was revealed that certain fraudulent transactions and corruption from the top management had been practiced ever since 1980. Recipients were proved to be overseas companies and other subsidiaries who led to continued financial drainage referred as ‘Europe’s Enron’ since it happened to be the biggest financial crisis in European corporate history (Segato 2006). Moreover, other transactions made in Parmalat were to non-existing (delusion) companies as revealed in 2003. In efforts to analyze Parmalat Post fall, this paper seeks to utilize four economic concepts including; business strategy analysis, accounting analysis, financial analysis and prospective analysis. A conclusion will therefore be drawn on the case application to other international businesses. That is, Parmalat fall case cautions international businesses on fallacious business strategies and management, which probably leads to future business downfalls.

  1. Business strategy analysis

In elucidating the cause of Parmalat’s bankruptcy, business strategies and practices which were in place before and in 2003 will be analyzed.

Strengths

Before being announced bankrupt, Parmalat was the leading food-company in Italy, an implication that the company had gained recognizable popularity. The company had also expanded its businesses to international countries such as Europe, Latin America, North America, Australia, China and South Africa among other as noted in 2003 Parmalat report. Additionally, Parmalaty had about 100 production centers and over 26,000 employees while an estimate of 4,000 dairy farmers in Italy were depend on Parmalat. Leading to the company’s down fall, fraud and corruption in the highest level of management happened to surpass the company’s business strengths as expected in any business (Hess 2010).

Weaknesses and Threats

Fraud and corruption were the major drawback aspects practiced in Parmalat. This two aspects were responsible for the diverse fraud transactions and their respective forged reports and financial statements. Parmalat depended on massive borrowing from diverse financial institutions, an aspect which translated to increased credits and growing interests respectively as proposed by Ehrhardt and Brigham (2008). As fraud and corruption unearthed, most of Parmalts funds went to paying off the accumulated loans and corresponding interests.

Parmalat made fraud transactions indicating $3.6 billion to have been spent on purchasing corporate debt securities. Additionally, Parmalat had made another fraud transaction of the $100 million to acquire Senior Guaranteed Notes. Such transactions happened to be void since no such transaction had ever taken place. From too much exposure to such fake transactions, Parmalat faced continued financial drainage leading to it bankruptcy.

Operation of fantasy accounts was another weakness posed by Parmalat’s CFO Mr. Tonna to the company. Parmalats 2003 financial statements indicated existence of ‘Bonlat Financing Corporation’ account worth $4.9 billion in both cash and marketing securities in Bank of America. Additionally, a Bank of America employee confirmed existence of such accounts when U.S investors enquired. Existence of such accounts happened to be fallacy, though such justification was previously used to advance massive cover up until 2003 declaration of Parmalat’s bankruptcy. Such illusion accounts weakened Parmalat by covering fraud and corruption in the company’s transactions until intensive losses accumulated (Business week 2004).

Operating with uninformed auditors was another Parmalat’s weakness. The company continuously made fraud and corrupted transactions which happened to have never even existed. In cases where $3.6 billion was spent on purchasing corporate debt securities, $4.9 billion in both cash and marketing securities in Bank of America, and the $5.2 billion claimed to be in cash were not noticed by the company’s auditors. However, the fraud involving $100 million to acquire Senior Guaranteed Notes was questioned by the auditors. If Parmalat’s auditors were well informed, they would have noticed the accumulated fraud early in advance, an aspect which posed Parmalat’s weakness.

  1. Accounting analysis

From the report presented by Kieso et al (2007), Parmalat had made massive borrowing from financial institutions between the years 1990 to 2003.  Financial institutions which took part in financing Parmalat included; Bank of America, Credit Suisse First Boston, Morgan Stanley, Citigroup, Deutsche Bank, J. P. Morgan Chase and Merrill Lynch as reported in the ‘Accounting and Auditing Enforcement’ by U.S. Securities and Exchange Commission (2003). Specifically, Parmalat borrowed an estimate of between $600 million and $4billion in every bank mentioned above.

Additionally, Parmalat borrowed funding from foreign and Italian banking institutions an estimate of $6 billion through its CFO Mr. Tonna, who happened to be behind all Parmalat’s frauds. In ensuring that borrowing transactions went through, Mr. Tonna made fraud reports implicating the company to have $4.9 billion in Bank of America account. Such strategy tricked market capitalization into funding on biased reports (Dias 2013). The fraud was unearthed when the company was unable to pay off a bond of $ 190 million, though also claiming to have $5.2 billion in cash as reported in reported in litigation release by U.S. Securities and Exchange Commission (2003).

Between August and November 2003, the company made fraud transactions of $ 100 million to unsecured Senior Guaranteed Notes. This was achieved through overstating the total assets by about $4.9 billion, while understating the total liabilities respectively as noted in the wall street journal (2004). These statements were confirmed to be false, similar to claims made to US investors that the company had purchased corporate debt securities of $3.6 million. Specifically, the corporate debt securities were fraud claims since no such securities were purchased in deed (Kieso et al 2007).

Fraud and Corrupt transactions by 2003

Transaction Amount Comment
Bank of America, Credit Suisse First Boston, Morgan Stanley, Citigroup, Deutsche Bank, J. P. Morgan Chase and Merrill Lynch $600 million to $4billion per Bank Acquired from fraud transactions cover up like fraud of $ 4.9 billion in Bank of America and $ 5.2 billion in cash
Foreign and Italian banking institutions $6 billion Acquired from fraud transactions cover up
Bonlat’ account $4.9 billion Fraud, never existed
Purchasing unsecured Senior Guaranteed Notes $100 million Fraud, never existed
Purchasing of corporate debt securities $3.6 billion Fraud, never existed
Liabilities $16 billion ($16 billion real liabilities) understated liabilities were $2 billion
Assets $4.9 billion Amount overstated on Assets
Tanzi transactions $ 600 million Tanzi confessed the fraud to family-run companies
Cash available $ 5.2 billion Fraud – available cash was $ 500 million

 

  1. Financial analysis

In ensuring successive fraud transaction in all years between 1987 and 2003, Parmalat CFO Mr. Tunna was behind all adjustments and cover-ups as evident in the case between the company and U.S. (SEC) referred as, ‘Securities and Exchange Commission v. Parmalat Finanziaria’ case. Following series of corrupted and fraud transactions, Parmalat was at last announced bankrupt in 2003 (Fast Company 2004). Bank of America auditors happened to be part of the fraud by confirming existence of Parmalats’ account by the name ‘Bonlat Financing Corporation’. Parmalat’s auditors on the other hand played a vital role in questioning diverse Parmalats’ accounts as the fraud incidents unearthed.

Mr. Tunna directed continued adjustments in positioning the company as one of the best in Italy. At this, Mr. Tunna had directed his editors to overstate assets while understating liabilities to balance the $100 million fraud transaction to the unsecured Senior Guaranteed Notes. Additionally, Tunna editors had indicated $3.6 billion transactions in purchasing of corporate debt securities, which happened to be a false transaction. Even though the $ 3.6 billion fraud was unearthed later, Parmalat editors noted the fraud and corruption in the $ 100 million transaction on Senior Guaranteed Notes.

Bank of America employee on the other hand made a fraud confirmation to US investors and Parmalat’s auditor claiming that Parmalat had ‘Bonlat’ account with a total of $4.9 billion in both cash and marketing securities. This happened to be high level of fraud where the Bank of America itself claimed to be a victim of the planned fraud. Both Bonlat account and Senior Guaranteed Notes transactions were fraud statements directed by Mr. Tonna to his personal editing team including the Bank of America employee who made malicious confirmations. Notably, Parmalat auditors were not involved in this fraud but happened to be victims, since the edited statements and reports which were already altered with Parmalat CFO (Mr. Tunna) consent.

The unearthed corruption and fraud in 2004 implicated the company to have owed $16 billion in liabilities, contrasting an earlier report of $2 billion. Tanzi himself also claimed to have transacted about $600 millions to boost other family-run companies as reported in Securities and Exchange Commission verses Parmalat Finanziaria case. Generally, most of Parmalat’s funds were maliciously used to pay the company’s debts and their respective interests, illusional financial acquisitions as well as paying off private editors who covered the fraud and corruption through forged financial statements (Rebonato 2010).

  1. Prospective analysis

From considering Parmalat’s case as one of the biggest financial crisis in European corporate history, international businesses can learn much from the case. This would include; analysis of the leadership styles which can lead to an overall fraud as in Parmalat, identification of crucial auditors who can drain business fund, identification of government role in ensuring full implementation of the Law such as Security Act in international (Cheese et al 2008 and Weybrecht 2010). For instance, Paramalat was charged with violation of Section 17(a) of the Securities Act of 1933 as noted in Securities and Exchange Commission verses Parmalat Finanziaria case.

From Fausto Tonna leadership style, international businesses can clearly understand the negative effects of autocratic leadership as practiced by Parmalat CFO. Through dictation, fraud and corruption, any company can perceive financial drainage (Cameron 2008, Hackman & Johnson 2000, Martindale 2011, Graeff, 1983 and Greenberg & Robert 2000). Specifically, transformation leadership would be the most appropriate leadership style for international business. This would follow involvement of other management team in the leadership and financial accounting as supported by Schultz J and Schultz D (2010), an aspect which could unearth fraud and corruption before mounting to big crisis like in Parmalat case (Fast Company 2004).

Through identification of crucial auditors, international companies would ensure close monitoring of all auditors’ report as a step by step procedure (Andriosopoulos & Nomikos 2012, Eilifsen et al 2001, Franzetti 2011 and Cudworth & Hobden 2011). As noted in Parmalat case, independent auditors play a crucial in confirming statements presented by a company, however, they never have role in credibility of the information provided to them. Additionally, financial institutions might have incredible employees and therefore, all transactions should have a follow up from both bank and company in consideration (Mainelli 2013). Following clear analysis of involved auditors, international companies should learn a lesson to ensuring involvement of the overall management team (Koijen 2014, Weldy 2009, and Grant 2013). This would ensure credible follow up of each audited report until a final draft is acquired, an aspect which would reduce chances of fraud and corruption in auditing (Uryasev et al 2010, Wang & Yang 2013, and Schneider 2012).

Governments’ roles and policies in implementation of business Laws such as Securities Act can also be analyzed from Parmalat’s case. The Italian government seemed to be too loose in facilitation of Security Act (Wall street Journal 2004). For instance, the Italian government failed in monitoring international businesses, an aspect which led Parmalat to continuously violate Section 17(a) of the Securities Act of 1933. International businesses should therefore analyze the different policies used by different governments before venturing into business (Cleary & Malleret 2007 and Gruber & Koutroumpis 2013). This would reduce cases of less stakeholder protection as presented in Parmalat fall case hence enabling them to invest on more responsible countries where cooperates responsibilities are upheld and monitored appropriately (Verbeke, 2009, Kaplanski & Levy 2013, Eweje 2011, and Shawky et al 2011). For instance, U.S policies are far tough compared to Italy policies, an aspect which has motivated revision and amendment of the current Italian government policies.

Conclusion

From the lessons learned from Parmalat fall case, international businesses can be able to clearly analyze business and government policies of a country they which to invest. Also, the innocence of auditing companies is noted such that they only edit reports as presented, implicating that any mistake in the final statement is blamed on client Company. The Italy government should introduce policies similar to U.S policies where cases of fraud and corruption would see shareholders recover their shares upon bankruptcy. Additionally, involvement of the whole management team in crucial sectors like finance auditing and accounting is advisable to international businesses. This would aid in unveiling underneath financial corruption and fraud with respect to time, translating to early identification of such cases before they get out of hand.

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