The Rise and Fall of Nortel

The Rise and Fall of Nortel

The Rise and Fall of Nortel
At the peak, Nortel was a giant diversified Canadian corporation focused primarily on
telecommunications. In July 2000, Nortel’s market capitalization peaked at more than $350 billion.
Ranking among the largest companies in the world, Nortel accounted for just over 37 percent of the
total value of Toronto Stock Exchange Composite Index.
Nortel’s expertise in wireless and broadband communications allowed it to achieve unparalleled
revenue gains in the rapidly growing telecommunications sector. Nortel was intent on exploiting this
rapid growth based on the international trend towards deregulation in the telecommunications
industry. Using an aggressive acquisition strategy, Nortel quickly established itself as a global
corporation. Its share price tripled in four years, reaching a peak of just over $200 per share by the
middle of 2000.
Nortel’s CEO compensation strategy was heavily based on option compensation. The fixed salary
awarded to the CEO each year amounted to slightly less than $ 1 million, while short-term bonuses
reached $1.3 million in 1998, $4.2 million in 1999, and $5.6 million in 2000. Nortel’s 2000 and 2001
statements indicated that most heavily weighted driver for bonus compensation was revenue, followed
by operating earnings per share. As such there was significant incentive for Nortel’s CEO to pursue an
aggressive strategy of growth through acquisitions.
Although John Roth, CEO of Nortel between 1996 and 2001, was well compensated in terms of salary
and bonus, this compensation appeared meagre relative to the value of options awarded to him: $5
million in 1998, $18 million in 1999, and $33 million in 2000. It was shortly after the last that the bottom
fell out.
Nortel’s decline was rapid and multi-faceted. The apparently accelerating levels of growth and earnings

were largely informed by massive accounting and financial irregularities that supported the
manipulation of earnings over a multi-year period. Nortel was forced to restate its financial statements
several times, one of these restatements involving the largest changes in a restatement in Canadian
history. Further investigation showed that many of Nortel’s aggressively pursued acquisitions were
overvalued and ill-advised. Nortel’s stock went into a free fall – from a share price of more than $200
down to $0.67. Two-thirds of Nortel’s workforce were let go, and the CEO and several other high-level
corporate executives resigned. Shareholders and institutional investors complained that these
executives continued to receive bonuses even as the company slid towards insolvency.

There was much speculation that the excessively generous incentive-based executive compensation led
to the culture of high risk-taking, aggressive, and unsustainable growth strategies, and the fraudulent
manipulation of financial information that ultimately let to the collapse of Canada’s largest corporation.
Questions:

  1. A former employee of Nortel made the statement that, for the most part, the Nortel executives
    consisted of a group of “good people” caught up in a “bad culture.” Do you believe there is any
    merit to this statement, particularly concerning senior management knowingly engaged in
    misstating financial performance? (5%)
  2. Should stakeholders such as employees and pensioners have any recourse against management
    in leadership position who play a significant role in the decision-making that ultimately leads to
    the collapse of an organization? (5%)
  3. Would a different executive compensation strategy have minimized the probability of excessive
    risk-taking by senior management? (3%)
  4. What role should the Board of Directors have played in managing compensation strategies?
    (2%)

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