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A Letter from Prison

Written Analysis of the Case


I.

Summary of the Case


A student of the University of Chicago, Booth School of Business, Eugene Soltes, made a

list of questions to Stephen Richards, a former global head of sales at Computer Associates,
about his opinion on the allegations against Computer Associates that happened during the year
2000s. Computer Associates International, Inc. (CA) began in 1976, and was established by
Charles Wang, who wanted to feel a growing need for mainframe computing software for IBM
computers. CA offered variety of products that includes database, application, and financial
management software. Most of the software products are sold by the sales team to clients who
purchase a license to use the product for a period between three to ten years. CA also provides
software updates and technical support to its clients during the period of licensing. The fee of
licensing charged by the CA to the clients increases with the length of the contract, as well as
each additional licensing year was priced lower as compared to the previous year in order to
reflect software obsolesces. The CA distributes the revenues obtained from the clients to
licensing fees as well as to usage and maintenance fees once the contract of the license between
the company and the client is finalized. At least 80% of the revenue is allocated to the licensing
fee. Generally, under GAAP, revenues from software licensing were recognized once a contract
was signed, the software was delivered, and payment was reasonably assured. Once all of the
three conditions are met, a software firm could recognize the entire value of the licensing fee as
revenue. In accordance with GAAP, CA recorded the entire present value of the licensing
contract in the quarter when the revenue recognition criteria were met. CA has a sales-driven
culture that sales associates were under immense pressure to meet the sales targets. Each
quarter, management sets internal sales targets for the sales team. Sales associates who met or
exceeded their sales targets were handsomely rewarded with the sales incentives are given to the
immune pressure to meet these targets. In the early 2000s, the management found it hard to
accurately forecast revenues and earnings for each quarter in the year, and found that they are
unable to warn the analysts about the unexpected shortfalls in revenue. There is allegation about
fraud within the company by few executives of the CA. The CA had greatly implemented the
approach of aggressive accounting practices in order to boost the earnings. But evidences proved
that the company is applying all the accounting practices in accordance with GAAP. This

allegation got the attention of the federal investigators at the DOJ and SEC who showed
dissatisfaction with the internal investigation of the company. The company faced much criticism
that deeply affected their status. So, the company hired a prestigious law firm in order to
investigate more aggressively. It is determined from the investigation that the few employees of
the CA, Ira Zar who is the CFO and his subordinates, had backdated some of the contracts. in
addition It also appeared that the revenues related to such contracts had been recognized after the
end of the quarter which must be recognized in the quarter in which the contract has been signed.
The investigators redoubled their efforts in investigating focusing on President Sanjay Kumar
and other senior management. In the complaint, the prosecutors alleged that Richards smoothed
the progress of the extension of the fiscal quarter, allowed subordinates to obtain contracts after
the quarter end, and failed to inform the finance and accounting department about the backdated
contracts. The complaint also contains how misreporting affected revenues and earnings. On
April 2006, Richards pleaded guilty and was sentenced to seven years in the Taft Federal
Correctional Institution in California.
II.

Statement of the Problem


The pressure being imposed by the executives of Computer Associates, Inc. to meet

market expectations has led the employees of the entity to rely more on aggressive means of
accounting for revenues. Although the entity has initially regarded such reporting as a strategy to
improve performance (at least in the financial statement level), in the long run, the line between
legal and illegal reporting has become blurry. Such circumstance has later resulted to legal cases
and suits for the entity.
Considering the above factors, what change in policy could facilitate reporting of true
performance (earnings) while mitigating the probable losses involving stakeholders (investors,
shareholders, creditors, and employees) interests in the long run?
III.
1.)
2.)
3.)
4.)

Objectives:
To be able to amend existing policies ( e.g. compensation and accounting practices)
To reduce pressure for committing fraudulent activities
To report true earnings
To be able to maintain stakeholder (investors, shareholders, creditors, and employees)
relationships

5.) Improve entity performance despite the possible losses involved with the chosen
alternative.
IV.
Areas for Consideration
A. SWOT Matrix
STRENGHTS

INTERNAL

1. Competitive employees
2. Established and known company
3. Right compensation (employees are
motivated to work harder)
4. Goal-oriented
5. Sales driven culture

EXTERNAL

OPPORTUNITIES
1. Many subsidiaries
2. Market for products
3. Product development

WEAKNESSES
1. Most boards have no enough
involvement
2. Most boards lack a strong
background
3. Fraud vulnerability
4. Sales driven culture

THREATS
1. Investors reliance on analysts
estimates
2. Competitors
3. Stakeholder relationship

B. Analysis of SWOT
Computer Associates was among the most aggressive company when it comes to its
pursuit of goals. Because of its considerable success, CA became a well established and known
company and was even featured in Fortune magazine and described as one of Americas most
admired companies. With a sales- driven culture, sales associates were under immense
pressure to hit these sales targets. This kind of culture has both advantage and disadvantage. The
employees are very competitive in this kind of environment but due to the immense pressure,
which is one of the legs of a fraud triangle, the company is very vulnerable to fraud.

Most Boards lack a strong background in the market place they represent and since they
are too far removed from the day to day aspects of the business they struggle to add value on the
strategic aspects of the business.
Given that CA is a very big company that has a lot of subsidiaries in nearly 100 countries,
it has a lot of opportunities in which the company can enjoy like a larger share in the market, and
a lot of resources that can be used to make a research and development for the new and existing
products. In this line of business competition is very intense because of many complementary
products available in the market and because of the demand for products is very elastic and
dynamic.
A possible threat in the company is the investors reliance on analysts estimates rather
than the direct communication with the company. Relying solely on information that the analyst
provided can be detrimental to the company, especially when market expectations set by the
outside parties are not met by the company. Existing and potential investors may pull- out/ backout their investments when such situation will occur.
V.

Alternative courses of Action

1.) Reduce pressure for fraud and decrease compensation expense


This change in policy would include the re-establishment of the commission policy in the
entity. Instead of having a sales basis compensation plan (which is limitless), the entity would
instead set a limit to the compensation to be received. Compensation would then be set to not
exceed the basic salary of employees.
If Computer Associates, Inc. will decrease the compensation expense then the objectives
previously identified will be met. First, the group has made it a point to reduce the pressure (both
internal and external) existing in the company. It is to be emphasized that backdating of revenues
would be eliminated and the pressure concerning the meeting of analysts forecasts would be
reduced. Not that the entity would completely ignore the market forecast but instead would use it
as a guide to improve entity performance. Second, true earnings would be reported and
stakeholder relationship would be maintained. Even if market expectations are not met, the entity
would prioritize true financial reporting than stakeholders interest. This may seem unethical at

first but, in the long run reporting manipulated earnings would mislead investors and eventually
affect their future decisions. Third, this alternative poses an opportunity to eventually increase
revenue in the long run. The market expectation would still be critical in this circumstance not
that it would set the actual goal that should be met but rather it would be the goal that would help
the entity assess whether its performance is consistent and improving.
2.) Reduce pressure for fraud and utilize entity resources
Computer Associates operations currently offer a range of products, including database,
application, and financial management software, to fulfill the computing needs of businesses. It
is evident in exhibit 4 that without earnings management, the earning of the company is
fluctuating. However, they should take note that the entity is still earning. Therefore, the entity
could use this established market of their current products as basis for improving future
performance.
The objectives identified are also met using this alternative. However, instead of reducing
the compensation expense, we direct the entitys effort to utilizing the entitys current resources.
First, in this alternative, fraud is also reduced. It is to be emphasized that backdating of revenues
would be eliminated and the pressure concerning the meeting of analysts forecasts would be
reduced. As with the first alternative, the forecasted market expectation will only serve as a
guide. Second, true earnings would also be reported and stakeholder relationship would be
maintained. Third, this alternative poses an opportunity to eventually increase sales in the long
run. In this alternative, the entity will develop the current products and possibly market them to
new classes of customers. In this way, the entity could show that theres still an intention to
improve performance so as to meet the target, but not actually to the point of manipulating
earnings to achieve the expectations of third parties.
3.) Reduce pressure for fraud and offer IT services
This alternative has met the objectives just like the other alternatives. There is a need to
reduce pressure for fraud so that the management wont resort to fraudulent means like
backdating just so they can meet market expectation. Not that the entity would completely ignore
the market forecast but instead would use it as a guide to improve entity performance. True
earnings would be reported and stakeholder relationship would be maintained. The third

alternative also suggests CA to offer IT Service Management. . Offering this kind of service will
increase CAs revenue, as well as increasing its versatility as a software business.
VI. Recommendation
Through weighing the advantages and disadvantages of each alternative, we therefore
recommend alternative 3, which is to reduce pressure for fraud and offer IT Service
Management. Before giving the specifics of the chosen alternative, we present the following
reasons why the other alternatives were not chosen:
The first alternative is not chosen because decreasing compensation expense, meaning,
decreasing or limiting the compensation (such as bonus) to be received by employees can
actually lead to employees being less motivated to reach sales target. Even though reducing
compensation expense leads to greater profit, this can be offset by the decreasing sales caused by
employees who are less motivated to meet sales target. Employees will become less concerned
about meeting the needed sales, it will eventually lead to decreased/decreasing sales.
On the other hand, though alternative 2 addresses the former problem identified in the 1st
ACA, this alternative also involves some other areas of concern. As a software company, the risk
of developing new software products, considering their nature, is risky. The market for these
products is limited and is threatened by the existence of bigger competitors. (Microsoft and
Oracle). Furthermore, we can't deny the fact that technology comes in many similar forms. A lot
of companies sell the same software with just small differences in components or processes. If
the goal is to improve performance though an increase in revenues, then selling or developing
products which are not unique rom other sellers, will prove to be ineffective in reaching the said
objective in the long run.
The following are the details of the chosen alternative: It is to be noted that each
alternative has something in common and that is to reduce pressure for fraud. There is a need to
reduce pressure for fraud so that the management wont resort to fraudulent means like
backdating just so they can meet market expectation. Means such as backdating do not reflect
true earnings of the entity, can give the wrong impression about the entity and misinform the
current clients and investors, and potential clients and investors about the true performance of
CA. How do we reduce pressure for fraud?

Instead of using market expectation as their basis for its performance, the entity should
just focus on using market expectation as their guide to improve their performance. Thus, even if
market expectations are not met, the entity should still prioritize true financial reporting so that
investors are not misled. If they do not meet market expectation, they should use it as their drive
to do better and improve their performance. Another way to reduce pressure for fraud is to
reduce opportunity for fraud. How to reduce opportunity for fraud? The most effective way is to
amend their existing fraud policies by implementing effective means of preventing and detecting
fraud. One way is to set up punishment for people who commit fraud, no matter their position in
the company. Those people who will be proven to commit fraud can be suspended or terminated.
They can also establish a hotline which can be used for anonymous tips regarding any fraudulent
activity. This will make employees deter from committing fraud, thus reducing opportunity for
fraud.
The third alternative also suggests CA to offer IT Service Management. IT Service
Management is, by definition, a strategic approach to designing, delivering, managing and
improving the way information technology is used within an organization. The goal of IT Service
Management is to ensure that the right processes, people and technology are in place so that the
organization can meet its business goals. Offering this kind of service will increase CAs
revenue, as well as increasing its versatility as a software business. Since CA is in the business of
creating software, it can be assumed that offering IT service management will not be so much of
a problem for them since it is within their expertise. Another advantage of this is, when
customers will purchase in the future, it is highly probable that they will also choose CA for IT
service management. This can lead to stronger customer relationship and loyalty. Their current
and potential customers will not feel the need to look for another company who offers IT service
management because CA will already offer it. Furthermore, the new market of customers may
compensate for the risks involved in the production of software alone. Through implementing
this alternative, the entity will be able to expand and attract new customers and eventually earn
revenue that may increase performance in the long run.