Sunbeam: Too Shareholder Focused?


For this paper I wanted to focus on the company Sunbeam, who in 2001 filed for bankruptcy after fraud was committed at the company. In 1996 Sunbeam was encountering financial difficulties and brought in Al Dunlap to become CEO and Chairman. He went on to commit several serious accounting violations leaving Sunbeam in a severe financial crisis. Charges were eventually filed against Dunlap, and he was banned from ever serving as a director or officer of a publically held company. When Dunlap took over Sunbeam he orchestrated the appearance of massive losses in the prior year so that his takeover and performance could seem more profitable. In total, after their investigation was concluded the SEC said that almost $60 million of Sunbeams record setting profit of $189 million in 1997 was the result of fraudulent accounting. The Sunbeam fraud case remains in accounting curriculum as an example of how management is in an easy position to manipulate financial statements causing fraud. Like Enron, these loopholes have now been closed but the possibility of fraud within any company still remains.

Founded in 1897 Sunbeam has had a long history of producing consumer appliances, starting first by producing horse trimming and sheep shearing appliances. Soon after in 1921 Sunbeam began to produce a line of consumer products, starting with an electric iron and expanding to a wide range of products such as mixers, toasters, and coffee makers. As their range of consumer products grew, Sunbeam purchased and acquired an ever-increasing amount of subsidiaries. Through much of the 1980’s Sunbeam grew under new ownership after a takeover by Alleghany International to be the world’s largest maker of small appliances.

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In 1996 Sunbeam encountered financial difficulties and brought in Al Dunlap to become CEO and Chairman. During his tenure in 1997 Sunbeam reported a massive increase in sales for its consumer line of products, such as backyard items like grills and kitchen items like blenders. Dunlap was brought in due to his reputation in the business world as a “turn-around” artist, someone who could flip failing companies into profitable ones. Sunbeam saw an immediate jump in its share price once investors noted that Dunlap was taking over, as he had such a proven track record within the industry. One of the first things that Dunlap did was cut over 6,000 jobs in an effort to streamline the company. In addition, “Sunbeam [took] a $300 million pretax charge to cover severance and other costs, [sold] four major product lines and [reduced] to 13 from 43 the number of cities globally where its plants and warehouses are situated.” (Collins) The drastic measures taken by Dunlap were nothing out of the ordinary, as he developed the name “Chainsaw Al” for his frequent cuts in personnel at the companies he turned around. Through his use of layoffs and consolidations, Dunlap caused stock prices to soar and he began to look at selling the company. In early 1998 no investor wanted to purchase Sunbeam at its market cap price of around $4 billion, with such little revenue on the books of only around $1.2 billion. Dunlap never the less pushed on, acquiring three more companies in an effort to expand Sunbeam’s portfolio of companies. A few days after these acquisitions took place, Sunbeam’s stock price rose to an all time high. With all of Dunlap’s success, the SEC began to investigate Sunbeam’s accounting practices. To say that this investigation has one root cause would be difficult, but the acquisition of these three companies seems to be what sparked the investigation to occur.

Problems began to emerge as the SEC investigated Dunlap and Sunbeam. “’This case is the latest in our ongoing fight against fraudulent earnings-management practices.’ that have cost investors billions of dollars, said Richard H. Walker, the commission’s director of enforcement.” (Norris) The three acquisitions that Sunbeam purchased were paid for mostly in Sunbeam stock, as the investors were confident that share price would continue to risk giving them more money for the exchange. In 1998 rumors began to emerge that shady and questionable accounting tricks were the cause of the majority of Sunbeam’s financial success. As Sunbeam’s revenue growth began to slow as management ran out of accounting loopholes to exploit, investors became worried. After Sunbeam declared a loss in the first quarter of 1998, share price fell almost 25%. (Canedy) Revelations were made that caused Sunbeam to have to restate its financial statements, with each subsequent restatement causing more distress for investors and the public. (See Figure 1 at end) Claims regarding fraudulent accounting practices were ultimately investigated internally, and Dunlap was forced to resign amongst pressure from Sunbeam’s board of directors. After a full investigation it became apparent that Dunlap manipulated several aspects of Sunbeam’s financial statements to make it appear that prior management did a worse job than they actually did, so that when he moved forward as CEO it would appear that he was making a massive turnaround for the company. Dunlap was barred from ever serving as a director or officer of a publically held company.

Why did things go wrong? Dunlap was a large proponent of the shareholder theory, which states that a business should always seek to maximize shareholder value. In his quest for a higher share price and happier shareholders, Dunlap and other top executives at Sunbeam ignored accounting rules and sought out loopholes that would allow them to boast massive profits. In auditing there is something that exists called the fraud triangle. The triangle is made up of three parts: Opportunity, Rationalization, and Incentive. Opportunity is the ability to carry out the fraud, this could be due to either a lack of internal controls or other factors that allows the fraud to happen. Rationalization deals with the justification of one’s actions, such as saying “No one will miss this money.” Incentive deals with the motivation to commit the fraud, such as financial pressures at home. The combination of these three elements is present within Dunlap’s time at Sunbeam. Opportunity to commit fraud was rampant at Sunbeam, as the company had various internal control issues and accounting loopholes at their disposal. While there is no way of knowing exactly what Dunlap and other executives at Sunbeam felt for their rationalization, the rationalization seems to be the pursuit of shareholder value. Because their actions benefited shareholders in the short run, they may have thought that they were doing something positive. Dunlap’s incentive to commit this fraud largely came from pressure from the board of directors to achieve profitable results as well as pressure from shareholders that he would live up to their expectations. Overall Dunlap and other executives’ decision to engage in fraudulent activities negatively impacted shareholder by giving them a false sense of security in the value of their stock holdings.

During the second half of this paper I will delve more deeply into the ethical issues that are at hand in this case, as well as discussing how in the pursuit of shareholder value Dunlap went against tenants of the Shareholder value theory. The ethical school of thought that relates best to the case of Sunbeam is Deontology. Deontology focuses on following professional ethics and/or an ethical code, both of which are present within the business and accounting fields. In their book Accounting Ethics Duska et al. discuss how accounting itself leads to many different ethical dilemmas. They state “Accounting is developing information that is going to be used. If the use of the information is benign and the information is truthful, no ethical problems arise.” (Duska 14) This however is not always the case, such as with Sunbeam. Duska et al discuss how in an ideal market transaction two people decide to exchange goods because they each believe that the trade will leave them both better off. If one person however is misled into believing that a product is something that it is not, the quality is undermined. In this case Sunbeam’s stock would not have been as successful if investors really knew what was going on. Something else which Duska et al. discuss is does failing to disclose pertinent information equivalent to lying? They argue that withholding information that would allow others to “…act contrary to the way they would if they had true information, has the same deceptive structure and consequence as an overt lie.” (Duska 16) As the accounting profession is rooted heavily in decisions that are both complex and ethical in nature, it is important that there are rules of conduct that govern decisions. The certification of “Certified Public Accountant” (CPA) carries with it the expectation that one will follow the ethical code of conduct as outlined by its governing organization the American Institute for Public Accountants. Deontology focuses on the teaching of Kant, who stresses three formulations of a categorical imperative with which one can judge ethical decisions.

Kant’s first formulation of the categorical imperative states “Act only on maxims which you can will to be universal laws of nature.” As David Bowie suggests this phrasing is awkward, but it simply means that there is a test to see if every action, including those in business is moral. Applying the first formulation of the categorical imperative to Sunbeam, it seems that the company already fails. The example that Bowie gives ties perfectly to Dunlap and Sunbeam’s situation. “Suppose you desperately needed money. Should you ask someone to lend you money with a promise to pay the money back but with no intention of paying it back?” (Bowie 4) Through acts of deception by upper management, Sunbeam effectively lied to investors about the value of its share price. During the acquisition of three business segments as discussed above, Dunlap largely used shares of stock to pay for the transaction. Knowing that the company was not in a good financial position, he effectively lied. Through the eyes of deontology, Kant would argue that a universalized maxim such as the one discussed above would not be logically coherent.

The second formulation of the categorical imperative states “Always treat the humanity in a person as an end and never as a means merely.” This formulation puts some constraints on the nature of economic transactions. Through its deceptive acts Sunbeam let investors have a false sense of confidence in the value of their stock holdings. Bowie discusses how simply refraining from a coercive or deceptive act is not sufficient for respecting the humanity in a person. Another place where the second formulation of the categorical imperative fits Sunbeam’s actions is with the mass layoff that occurred when Dunlap took over Sunbeam. A Kantian response to a mass layoff such as this would be to immediately label it as immoral, because the employees are only a means to enhance shareholder wealth. A closer look however would need to take into account the contract between Sunbeam and its workers. As long as the firm was not negligent or acted illegally in dismissing its employees the layoff would not be immoral. The actions of Sunbeam and these large layoffs were scrutinized more heavily because the firm eventually ended up declaring bankruptcy. Many people wondered if there had been a CEO other than Dunlap that so many people would have lost their jobs.

The last formulation of the categorical imperative states that you should act as if you were a member of an ideal kingdom of ends in which you were both the subject and sovereign at the same time. Bowie believes that in order to abide by Kantian ethics (Deontology) a firm should consider the interests of all the affected stakeholders in any decision that it makes. (Bowie 10) Sunbeam failed to consider, or simply didn’t care, about the shareholder that lost money off of the valuation of the stock. Bowie also suggests that at no point should the interest of one set of stakeholders take priority, which was another issue that Sunbeam had. Dunlap and the team of executives knew that the fraudulent accounting that they were using was unethical, they were just trying to turn a profit long enough to sell their shares of stock in the company to make some money. In addition, no business rule or practice should be enacted that violates one or both of the first two categorical imperatives.

Overall Al Dunlap and Sunbeam acted unethically in their pursuit for higher profits. Dunlap embodied the philosophy of maximizing shareholder value, but took his quest for shareholder value too far by acting unethically. This is not to say that a shareholder approach is not a valid way of conducting business or running a company, but in Sunbeam’s case ethics took a back seat. So long as ethical decisions are made while using a shareholder approach it is entirely possible for a company to succeed. The case of Sunbeam provides a stark example of exactly what can go wrong when there is a lapse in ethical judgment while using a shareholder approach to business.

Works Cited:

Bowie, Norman E. (1999). “A Kantian Approach to Business Ethics.” A Companion to Business Ethics, Blackwell Publishers Inc., Print.

Canedy, Dana. “A Warning By Sunbeam Stuns Wall St.” The New York Times. The New York Times, 1998. Web. 14 Apr. 2016.

Collins, Glenn. “Sunbeam to Halve Work Force Of 12,000 and Sell Some Units.” The New York Times. The New York Times, 1996. Web. 14 Apr. 2016.

Duska, Ronald F, Brenda S. Duska, and Julie A. Ragatz. Accounting Ethics. Hoboken: John Wiley & Sons, 2011. Internet resource.

Norris, Floyd. “S.E.C. Accuses Former Sunbeam Official of Fraud.” The New York Times. The New York Times, 2001. Web. 14 Apr. 2016.

“The Fraud Triangle” Association of Certified Fraud Examiners. Web. 14 Apr. 2016.

Figure 1:

sunbeam-1997-financials-comparison1

 

 

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