UC failed to recognize companies’ risky tactics

By Theodore Andersen

The collapse, first of Enron in which the University of
California pension fund lost $150 million, and then of Worldcom in
which the UC lost another $350 million, calls into question the
investment policies of the UC pension fund management. The price of
Enron stocks fell from $90 to under $2 and Worldcom stock dropped
from a high of $62 to a low of 6 cents.

Both companies long pursued especially aggressive growth
policies that were highly risky, which eventually proved to be
disastrous. The UC pension fund manager, however, failed to avoid
large investments in such high-risk stocks. Management theory
recognizes that the span of management is limited. This is
especially true where the economic activity is highly complex,
where change comes at a rapid rate, and where competition is quite
intense. Failing to respect this principle, the two companies
greatly expanded the line of products they were producing and then
moved into many new types of markets. Worldcom acquired 70
companies and increased its debt level to $30 billion. Enron added
1,700 products to its overall line and expanded to 30 nations
spread over six continents.

Multi-billion dollar companies usually cannot grow at a rate
faster than 20 percent and still maintain adequate control over the
quality of their investments and costs. Enron, however, expanded
its revenues at an average of 58 percent annual rate during the
1995-2000 period. It is not surprising therefore that it suffered
large financial losses, was unable to pay its debts, and went into
bankruptcy on December 2, 2001.

In regard to its accounting practices, Worldcom reported $1.6
billion of profits for the 15-month period covering 2001 and the
first three months of 2002. If the company had properly taken into
account all of its operating costs, it would have reported a loss
of $1.2 billion for the period. For the 1999-2001 period, the
company overstated its profits by $3.8 billion.

In another questionable activity, Worldcom made a loan of $408
million dollars to its CEO Bernard Ebbers. This loan helped
contribute to the company’s inability to pay interest on some
of its debts when they became due. Additionally, when Ebbers was
forced to resign, the company directors awarded him a lifetime
pension of $1.5 million per year.

On the balance sheet, Worldcom reported that it owned $103
billion in assets. However, because these assets, for the most
part, are unable to produce profits, their estimated market value
ranges from only $3 billion to $8 billion. This means that if
Worldcom goes into bankruptcy and has to liquidate its assets to
make payments to its creditors and stockholders, the UC pension
fund cannot expect to receive very much, if anything, for its large
investment in Worldcom stock.

Pension funds should be invested only in relatively low-risk
stocks and bonds. Accordingly, in the future it is hoped that the
UC pension fund managers will avoid investing in companies that
engage in especially high-risk financial policies, such as
companies like Enron and Worldcom.