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Nortel: a Case Study of Human Fallibility
By Timothy Fogarty, Michel L. Magnan, and Garen Markarian
Timothy Fogarty, JD, PhD, CPA, is a Professor of Taxation and Business Law at the
Weatherhead School of Management, Case Western University; Michel L. Magnan, PhD,
CA, is a Professor of Accountancy at the John Molson School of Business, Concordia
University, Montreal, Canada; and Garen Markarian, PhD, is an Assistant Professor of
Accounting at IE Business School, IE University, Madrid, Spain.
1. Introduction and Overview
This case provides an in-depth anatomy of a company that failed because of greed
and excess. Guided by an ambitious CEO set to conquer the world, students go through the
step-by-step processes that drove the once stellar flagship of Canadian industry, Nortel, to
public humiliation and eventual liquidation. The actors examined, and the contextual
analysis that accompanies, can easily be applied to any company other than Nortel. The
main issues examined are that governance structures were none functioning, and that
incentivization and compensation of the CEO were based on stock options that heavily
depended on firm performance. The owners of Nortel were short-term oriented without any
patience for a stable and long-run growth. Throw into the mix the fact that the CEO, John
Roth, was a darling (and pride) of the Canadian media and a household name, with a lot of
stake to keep his star high, and rising. The consequence of these factors include poor
investments made, fraud undertaken, and stakeholders realized (or reacted) only when too
late.
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This case study is wide in scope, hence an instructor can focus on any of its four
elements, choosing among corporate governance, executive compensation, ownership
structure, and earnings management/fraud. Moreover, it offers students an opportunity to
learn two further aspects of business life: a better understanding of the telecommunications
industry, and the anatomy of fraud. Depending on the interests of the students, or the
requirements of the degree program, one or more aspects can be the highlight of a session.
Consequently, this case can easily fit a two session class period. Below, a number of
detailed questions are provided that could be the topic of class discussions. The questions
are organized into multiple sub-topics, each with detailed questions, enough to easily fill a
full session.
2. Suggested Questions
2.1 Theory Questions: Corporate Governance
1. What was the role of governance structures in Nortel’s failure?
a. Is the success of the firm the responsibility of the board, or the CEO? What
about the monitoring of the firm: who monitors, the CEO, or the board?
b. Nortel mainly failed because it made poor business decisions, and such poor
business decisions led to eventual fraud. Who is responsible for these poor
decisions, the board or the CEO? Keep in mind that the board can replace
the CEO anytime it wants.
c. Some currents in modern corporate governance philosophy advocate that the
CEO should be fully empowered to lead the company, and the board should
be fully empowered, and ready, to monitor. Is this view contradictory?
Would things have been different in Nortel if this had been the case?
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d. Is financial expertise on the board important? Given that we need to have
small boards for efficient decision making (10 or less), what are the pros and
cons of having financial monitors, versus general business experts?
e. What recommendations you have regarding corporate governance reform,
pertaining Nortel, or industry at large.
2.2 Theory Questions: Executive Compensation
2. What was the role of executive compensation in the failure of Nortel?
a. Discuss the culture of greed in modern corporations.
b. Discuss from a moral point of the view, the fact that CEOs now are paid
about 450 times more than the lowest paid employees within the same
organization.
c. Given that CEOs need to be compensated, what structure do you
recommend vis-à-vis shares, options, cash, bonus, and deferred
compensation?
d. If John Roth was paid in cash, would Nortel have crashed? Alternatively,
would Nortel have grown?
2.3 Theory Questions: Ownership Structure
3. What was the role of Nortel’s ownership structure in the meltdown?
a. Given that the owners of the firm are of different types: pension funds,
family owners, banks and insurance companies, mutual funds, hedge funds,
private equity funds, individual private investors. Some long term, some
very short term – often with very different interests: with whom does the
interest of the CEO lie? To which category should the CEO cater the most?
b. Discuss the pros vs. cons of short term oriented vs. long term oriented
investors.
c. What is the role of owners in the monitoring process?
d. What is the optimal “shareholder” composition of the firm?
2.4 Theory Questions: Earnings Management and Fraud
4. What was the role of earnings management in Nortel’s fall?
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a. Accounting rules involve flexibilities and many grey areas, discuss the role
of morality in accepting what is “correct.”
b. Accounting transactions often involve “ranges.” Such acceptable ranges and
estimates can sometimes be quite disperse. What should managers do in
such cases?
c. If earnings management and fraud, in specific instances, are pareto optimal
from a social welfare perspective, should they be undertaken?
2.5 General Questions
5. What is the main reason, according to you, as to why Nortel failed?
a. Could the fall of Nortel been prevented? How?
b. Discuss the role of the media in Nortel’s rise and fall? Discuss the role
before the crash, and after the crash.
c. Nortel accompanied another well documented disaster, MCI. Discuss the
role of industrial characteristics in the anatomy of a failure. Focus particular
attention to the type of industry, the tremendous growth opportunities, the
competitive pressures, and the glamour attached by the media.
d. Was the Nortel failure due to luck? Discuss Nortel’s situation w.r.t. general
industrial conditions at the time (hard to predict outcomes, uncertain and
volatile environment, the necessity of quick and fast moving action and
growth).
3. Analysis
Given that this is a university level class, and we want to be free of dogma (if such a
thing is possible), and approach this with a broad horizon. Most importantly, students need
to see all sides of the argument. As such, the (more important) general questions come at
the end, discussed once all the technical issues are fully covered and understood
beforehand.
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3.1 Governance
The most abject failure in Nortel was the failure in governance, hence, we start our
questions with this point, taking a bulk of the discussion. This is especially relevant given
that just 10 years after, we had another governance related crisis (the banking crisis), with
similar everywhere.
Certainly, Nortel’s failure started a broad ranging discussion about governance in
Canada, and in the US. The shock of Nortel was felt throughout the world, especially in the
Telecom sector. The issue with governance is that given dispersed ownership, the
representation,? Is the firm a young firm? What is the media interest? Who are the sell-side
analysts covering the firm? How opaque are firm operations? From a multitude of such
As such, at any point in time, who is in control is anyone’s guess.
Nevertheless, the identity of who is in control is not the primary point of interest,
but the capabilities are what matter. In other words, “fit” is very much what optimizes firm
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resources to function. A CEO who informs the board of firm operations, seeks their advice,
and discusses challenges and opportunities. On the other hand, a board that provides
expertise, connections, know-how, and guidance.
What determines this fit is a matter of good judgment, but unfortunately, also of
luck. We do not want an overpowering board who constrains the decisions of the future
Jack Welchs, nor do we want a board who does not believe in the vision of the Bill Gates
Add to the mix that decisions are made under uncertainty. There is no perfect
information, and no clear expectations regarding future trends, costs, revenues, competitive
From this perspective, it certainly is the responsibility of the CEO to guide the
company in uncharted competitive waters. At the same time, it is the role of the board to
But we all recognize that this is no easy matter. Were the acquisitions of Nortel, at
the time, well justified? We are now sure, only with hindsight, and only with the
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fixture in Canadian society, more conservative investment strategies should have been
followed.
Certainly, when it comes to board monitoring, financial expertise is important, and
understanding the numbers and providing a layer of control over the CEO is paramount.
This has to be in tandem with the external auditors, and the audit committee within the firm
3.2 Compensation
The issue of executive compensation is also a recurring issue when it comes to
booms, busts, fraud, and failures, the most recent banking crisis being the prime example.
At the heart of the matter is that humans prefer more money to less money, and prefer
epic proportions (more than $5 million a year, on average).
But, the other side of the argument clearly also exists. Some CEOs have stressful 18
hour days, 7 days a week. CEOs have an average tenure on the job between 12-36 months,
Current compensation structures have a number of facets: a standard cash pay that is
independent of performance (minimum retention fee); a bonus that is a reward for short
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term performance (usually based on accounting profits); options that are incentive based,
There is a lot of conflict regarding what compensation to utilize. Options are the
most incentivized in the sense that CEOs do not get rich, unless stock price appreciates.
This, of course, is a great incentivization tool, except, that it also leads to hubris. A CEO
3.3 Ownership Structure
The structure of “optimal” ownership composition is a controversial matter. In the
late eighties and early nineties, the trend was strong close knit ownership by families,
Is there a superior system? It is too early to tell. Capital markets, and corporations,
have been in existence for such a short time that it is hard to make definitive conclusions.
At the heart of the matter lies a simple conflict: what is the time horizon of the
owner. Is it short term or long term? Mutual funds typically have a short term horizon,
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sometimes in hours or days. On the other hand, families are in it for the long term. The rest
lie in-between. All perform benefits to society – mutual funds with short horizons often are
All investors “monitor” the CEO, irrespective of their time horizons. A long term
horizon investor could put pressure on a CEO who does not properly invest for long term
projects, or alternatively, supports a CEO when they undertake such investments at the
markets and other shareholders, of the repercussions of managerial actions.
Having discussed the pros and cons of each shareholder class, it is obvious that in
the case of Nortel, short term investors where dominant, and led the show. As such, long
3.4 Earnings Management and Fraud
The issues of earnings management and fraud have been in existence since the dawn
of modern times. Questionable auditing practices have been documented in the era of the
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Once earnings management and fraud is uncovered, it is normally accompanied by
massive share price drops, as shareholders lose complete faith in a company. But earnings
management is not a cause in itself – it is often the result of a mixture of factors that
co-exist. In the case of Nortel, the high expectations by all stakeholders (especially the
Nevertheless, issues are not always black and white. Accounting rules involve
flexibilities and many grey areas. For example, when a company sells 100 TVs, it also
needs to make an “allowance” for returns. As such, if the company expects 3 of these to be
This represents a clear grey area that is subject to judgments and flexibilities. Some
people conclude that a CEO should report the 95 (although he would prefer to report 98,
possibly because he would receive a higher bonus), which is the more conservative number.
Earnings management and fraud are not easy matters to resolve or to think clearly
and objectively about detached from their contextual occurrence. Numbers reported in the
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accounting system affect the welfare of society. They affect employee hiring and firing
decisions, the closure of plants, and the growth into markets and products, as such. They
3.5 Why did Nortel fail?
Nortel witnessed the most spectacular rise and fall of any public corporation. Apart
from its disastrous failure, Nortel’s rise from a small regional player to the global name in
telecommunications was like no other. Nortel failed because the perfect ingredients existed
simultaneously: the ambitious CEO who was the darling of Canadian society, a
cheerleading media, an overpowered board who did not monitor, impatient shareholders
The Fall of Nortel could have been prevented if the board had monitored and
approved less risky decisions – especially with so much at stake. The disaster could have
been prevented if compensation was not so incentivized for performance. The fall could
have been averted if the media and financial press had scrutinized Nortel’s decisions a bit
4. Teaching Suggestions and Conclusion
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Ideally, students would read the case in advance and prepare answers to some
of the questions provided by the instructor (questions can be chosen based on the
plan of study for the students, and in conjunction with the other material provided).
The unfortunate outcomes of this case include the liquidation of Nortel in 2009
and 60,000 employees lost their jobs. Retirements and savings were totally lost.
In terms of the main power brokers:
John Roth: He personally cashed in on $135 million of stock options and retired in
2001. Several lawsuits are still pending against him – but with no resolution in
sight.
Frank Dunn: CEO who replaced John Roth and was previously the CFO. He was
5. References and Resources
Selected Newspaper and News Articles
Anonymous, “Canada’s Technology Star Becomes Financial Black Hole,” CBC News,
September 16, 2009, available at
http://www.cbc.ca/money/story/2009/01/14/f-nortel-backgrounder-january09.html,
and has many other links about Nortel
Anonymous, “Nortel sell-off brings TSE way down,” CBC News, October 25, 2000,
available at http://www.cbc.ca/news/story/2000/10/25/ott_nortel001025.html
James Bagnall, “Who Killed Nortel,” Canwest News Service, October 30, 2009,
available at http://www.nationalpost.com/rss/story.html?id=2164470
David Einstein, “Top Tech Execs: John Roth,” Forbes, December 13, 2000
Theresa Tedesco, “Nortel to Overhaul Board,” Financial Post, September 29, 2004.
Company Website Information
Nortel website, http://www.nortel.com/
Nortel historical timeline, beginning 1874,
http://www.nortel.com/corporate/corptime/1874.html
Nortel, “2000 Third Quarter Report to Shareholders,”
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http://www.nortel.com/corporate/investor/reports/collateral/eng_q3_2000.pdf
Nortel Business and Financial Restructuring,
http://www.nortel.com/corporate/restructuring.html
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