Abstract
This paper investigates the causes and implications of Wirecard AG’s collapse in June 2020, the “German Enron.” Wirecard’s poor corporate governance under the German financial regulatory framework fails to serve stakeholders. Its management’s unethical activity of earnings manipulation contributes to the company’s financial collapse and loss of shareholder value. An analysis of how internal and external governance and monitoring failed to identify massive fraud in the German payments business. We also find evidence that the constant pressure of reaching or surpassing consensus profit predictions, management performance rewards based on the increase, and the absence of sufficient monitoring from the Ultimately, the board allows management to enable manipulated profits without detection for years. Such action has resulted in massive financial corporate malfeasance. Wirecard destroyed strong value (Jo et al., 2021, pp. 96-106).
Introduction
When Wirecard AG, one of Germany’s foremost financial technology corporations, announced that 1.9 billion euros had disappeared from its balance sheet and that its CEO had been detained on charges of market manipulation and fabricated accounting, the company filed for insolvency June 2020. Wirecard, Germany’s fastest-developing fintech business was listed on the German standard market in September 2018 and defeated Commerzbank AG, Germany’s second-largest moneylender. In 2020, Wirecard became the first DAX index member to appeal for judicial defense from creditors in Munich. On June 17, 2020, the company’s share price was 104.50 euros; on June 26, 2020, it fell to 1.28 euros (Davies, 2020).
This study examines Wirecard’s corporate governance (CG) and how it was unsuccessful in preventing financial crime. It explores Wirecard’s financial misbehavior, which negatively damaged shareholder value and caused considerable financial losses beginning with a summary of the company’s monetary humiliation. Then it looks at the reasons for the Wirecard financial crisis to learn more about worldwide business problems. As a result of management’s evil actions to manipulate results, Wirecard’s Corporate Governance structure failed to serve its shareholders. Finally, this study assesses the impact of fintech on German financial regulation and assesses the necessity for change to eliminate accounting fraud, strengthen the CG system, and improve Germany’s economy (Jo et al., 2021, pp. 96-106).
In addition to exposing regulatory problems in Germany’s financial system, this corporate scandal has raised significant issues for the European fintech sector. As a result of the collapse of Wirecard, the German Parliament has opened an inquiry into the company and its financial system. A probe of Germany’s financial regulator, BaFin, has also been requested by the European Commission’s market watchdog (Fairless et al., 2020).
Wirecard AG corporate scandal and how it went Viral
Many people, including investors and financial authorities, were shocked when Wirecard collapsed, and its CEO declared that the cashless conversion would happen smoothly after verifying Wirecard’s corporate accounts. For seven Wirecard subsidiaries, the Munich insolvency court began the process on August 25, 2020. Wirecard offers a wide range of electronic payment and transaction services. The corporation had a market capitalization of $30 billion, and it was listed on the DAX, Germany’s top 30 stock exchange. When it failed on June 25, it owed $4 billion in debts to its creditors and revealed a gap in its records, which its auditor EY said led to a complicated worldwide swindle (Stadtmann & Croonenbroeck, 2019, pp.414). The Volkswagen Diesel gate affair in 2015 was perhaps Germany’s biggest scandal since then. Wirecard was accused of accounting errors, and a hearing took place in 2019. Reports in the media claim that the corporation misrepresented its sales volume to boost earnings. Later that year, KPMG (Klynveld Peat Marwick Goerdeler) recruited a third-party auditor to investigate the matter. In April 2020, KPMG revealed that Wirecard could not authenticate its cash balance of one billion euros, prohibiting them from making big loans to its dealers (Engelen, 2021, pp.9-12).
Although the two Philippine banks first admitted receiving the missing monies, their central bank has since determined that they never made it into the country’s monetary system. Their CEO unexpectedly quit on June 19, and three days later, the business acknowledged the likelihood of siphoning $4 billion that was not there. After creditors refused to pay, Wirecard filed for bankruptcy on June 25, and on June 23, German authorities arrested the company’s CEO. Regulatory adjustments are needed in the wake of the scandal, which had aroused enormous public outrage. There is a chance to enhance and execute any necessary legal, legislative, or regulatory activities. German financial regulator, BaFin’s head, has called the Wirecard issue a total catastrophe, and authorities criticized them for handling the problem (Jakubeit 2021, pp.14-19).
Consequences of the firm Wirecard scandal
Following the bankruptcy of Wirecard due to payment hit fraud, auditing firm EY (Ernst & Young) announced the replacement of its head of the German branch. Europe’s largest accounting company, EY (Ernst & Young), said the restructure was part of Europe’s organizational culture, despite considerable criticism of their viewpoint and the collapse of disgraced corporation Wirecard. Because they were in charge of resolving the Wirecard issue and reestablishing confidence, EY was held responsible. Because they signed off on the company’s finances for years while media reports raised red flags about Wirecard’s issue, EY was the target of criticism as the Wirecard auditor for nearly a decade (Teixeira, 2021).
Even though Wirecard was monitored and Wirecard’s home state of Bavaria had indicated that they were not to blame since Wirecard did not operate as a financial corporation, BaFin, Germany’s financial regulator, hastened to condemn the central bank. BaFin ordered a private financial reporting enforcement panel to examine Wirecard’s books of accounts when the business that prepared the report went bankrupt (Fairless et al., 2020).
European Union watchdog later criticized Germany for failing to reduce the fraud investigated by legislators, specifically German Chancellor Angela Merkel’s participation in it. Even after so many changes were made and they discovered no money in the accounts, Bafin’s image was further damaged, creating concerns about their investments being controlled by Bafin as they were not transparent to investors and the broader public. A few months ago, BaFin, the regulator, issued a statement urging the implementation of stricter rules and regulations to protect the public’s trust and national security (Fairless et al., 2020).
Wirecard’s AG corporate governance Prevention Measures
The Financial Conduct Authority oversees United Kingdom financial services. Customers’ interests are protected, industry growth is maintained, and healthy competition is encouraged. Internal or third-party audits may be used to conduct an assessment, which is the first step in reducing fraud risk. According to U.S. federal law, which specifies certain procedures in financial transactions, record-keeping, and accurate outcomes for organizations, the Sarbanes-Oxley Act is applied in the same manner. Additionally, OFAC (Office of Foreign Assets Control) checks on potential customers may be made to confirm their validity. Still, these must be completed regularly using an up-to-date database (Pickett, 2011).
It does not matter how big or small a financial institution is; all workers should know the ramifications of fraud and the need to adhere to a code of ethics. Accounting standards or enhanced cyber security will help to smoothen the way for employees to operate on the cloud. In addition to standard tactics, companies may utilize a variety of approaches to improve cyber security. Internal misbehavior should be brought to the notice of management and preserve ethical standards since this will harm the stability of the organization, its productivity, and its reputation (Pickett, 2011).
Europe market regulation and developing a European market monitoring system require knowledge of national markets’ corporate law, bankruptcy legislation, and other characteristics. We plan to use current national oversight agencies as an integrated European supervisory network. As the network’s apex layer, the ESCMS (Executive Software Configuration Management System) receives reports from all national agencies. Additionally, a hub-and-spoke design will allow national agencies to retain autonomy (Véron & Wolff, 2016, pp.130-153).
Oversight of the whole market, Baffin’s failure to uphold its broad responsibility to safeguard investors and market integrity are shown more widely in the Wirecard case. Additionally, we recommend establishing the supervisory agency’s responsibility for carrying out this broad monitoring mission in substance and giving it more authority. For this accountability to be effective, it must have the right amount of institutional independence and the necessary resources (Azim & Sharif, 2021, pp.37-49).
Compliance with financial reporting regulations, however, the legal basis for enforcement is based on EU legislation, with a few minor exceptions. German financial regulator BaFin is responsible for comprehensive market monitoring, but its investigation powers are too restricted for financial reporting scrutiny, as shown by the Wirecard case. As a result, the German-specific two-step enforcement structure has rendered the system susceptible to delay and produced ambiguous culpability in accounting fraud instances. We propose that the two-step enforcement process be reformed such that BaFin is the only entity with jurisdiction over the matter. While the Financial Reporting Enforcement Panel (FREP) may assist BaFin in enforcing financial reporting, BaFin retains all authority and responsibility. In terms of the European framework, we recommend that the Transparency Directive improve the necessary capabilities assigned to supervisory bodies. Market Abuse Regulation should provide them with the investigation and enforcement authority they need (Langenbucher et al., 2020, pp.74).
In corporating internal controls and a supervisory board, the Wirecard case implies that corporate internal controls and the responsibility of supervisory boards need to be strengthened. Publicly traded companies should be required to have an adequate and effective internal control system, at the very least. This system’s internal controls should be subjected to an external audit. A mandate would bolster my suggestion since it would define auditors’ responsibility in preventing accounting fraud. Independent of management, the boards of directors of corporations must have access to vital information to carry out their duties. Therefore, the head of the internal control function should report to the board of supervisors. They should compel publicly traded firms to maintain a separate audit committee to increase the control of external audits by the supervisory board. The committee’s chairperson must be impartial and knowledgeable about finances to be effective. A significant majority of the audit committee must also comprise non-affiliated individuals (Navaretti et al., 2020).
The company should reform the use of external audits to improve auditor accountability. It is not that Wirecard is a unique situation, but rather that accounting crises have a common pattern. That is why it is essential that professional standards and the law explicitly specify that an external audit includes checks and balances to discover accounting manipulations and fraud. Auditors who verify financial statements for accuracy and fairness need to know what the market regulator and audit oversight body expect of them. Raising the level of responsibility for auditors is an effective way to improve both the incentives for and consequences of doing subpar audits. Finally, I suggest that the efficacy of the current public audit monitoring organizations be examined further. They should at the very least provide summary metrics for each audit firm’s inspection results publicly, which would give vital information to customers and investors (Jo et al., 2021, pp. 96-106).
Short selling enhances the exchange of information. A short sale ban is an asymmetric action that prevents important information from being reflected in the market price. For market players, managers, and supervisors, pricing information is essential. As a result, we urge supervisors to be far more restricted in their ability to impose short-sale bans (Navaretti et al., 2020).
Impact of corporate governance scandals on firms’ performance
A company’s profitability and reputation are directly influenced by its corporate governance practices, which may result in penalties, reputational harm and the loss of capital investment (Jo & Harjoto, 2011, pp.351-383). Wirecard’s corporate governance has been ineffectual in preventing accounting malpractices from occurring. As a part of corporate governance, the Supervisory Board is tasked with ensuring that management acts in the long-term interest of shareholders. At Wirecard, the round-tripping and phony third-party acquisition schemes have been utilized since 2015 by numerous company executives to inflate profits artificially. At this time, Wirecard went from being just one of several specialist payment services to becoming one of Germany’s most valuable publicly listed companies. Journalists and short-sellers have questioned Wirecard’s accounting methods on four separate occasions since 2008. Though concerns about Wirecard’s accounting methods had grown steadily, the Supervisory Board had violated its duty of care by failing to carry out its independent internal investigation into the claims and failing to prohibit management from misbehaving over this period. It is in the long-term interests of shareholders and management to maximize an organization’s inherent worth; nevertheless, short-term investors prefer that an organization’s management concentrate on measures that increase the current stock price (Hussain, 2020).
Effects of Corporate Scandals on Share Prices
Shocking as it may be to investors, the immediate expenses of company financial wrongdoing maybe just a small part of the total bad economic implications. Corporate scandals can reduce stock market participation, which might increase the cost of capital for all businesses. Wang (2014) observed that the cost of corporate financial misconduct is generally quantified using the losses that accrue to the shareholders of fraudulent businesses. According to most estimates, investing in a company might lose up to 22% of its value due to corporate fraud.
In addition, companies reduce their equity interests in dishonest and fraudulent enterprises. The equity holdings of all households, not just those who own shares in fraudulent companies, decline. If, for example, corporate scandals are revealed at the beginning of a recession, corporations may lower their shareholdings on their own. At any one moment, even within the same sector, businesses might go through various corporate scandals, which can negatively affect their stock market participation. When a corporate scandal is exposed, the economy suffers because these changes influence everyone in the economy, regardless of their previous experiences. Investors seem to be selling out of the company’s stock due to a corporate scandal, consistent with this conclusion.
Additionally, the impact of the corporate controversy on stock marketplace contribution seems to be disconnected to investors’ risk aversion since it does not change with investors’ risk acceptance, and households do not enhance their selection variation or require more insurance. In addition, there is a reduction in the percentage of people who have a high level of trust in financial markets, as measured by variations in assurance in major businesses and banks. Furthermore, stakeholders now have more faith in the media, which they say is doing a better job reporting corporate financial malfeasance and even helping to uncover it (Beatty et al., 2013, pp. 183-205).
Effects of Corporate Scandals on Profitability
When a business loses money, it is more likely to be a corporate scandal. According to Armour et al., (2017, pp.1429-1448.), frauds are more likely to occur in companies with a greater demand for financing. Wanting more money may be a motivation to perpetrate fraud. When fraud is discovered, the cost of capital considerably rises because managers are trying to grow capital at a cheaper cost. Kumar and Langberg (2009, pp.144-172) and Wang (2014) conducted similar research. They demonstrated that the availability of external finance might encourage dishonesty. Wang also noted long-term success and high profitability as contributing factors to fraud.
Several research studies have shown further proof that legal consequences do not entirely explain the company’s losses implicated in wrongdoing. The damage to the company’s reputation has been proved to be a significant factor in its punishment and the imposition of monetary penalties. The fines, levies, or penalties that a firm must pay due to a legal violation are known as legal sanctions. The company may use partners’ expectations of the advantages of trading with it in the future to describe its reputation. The market may be penalizing the company because it may be unreliable in the future. Future trade conditions and costs will be affected by such changes in expectations. When input and output prices go down, profits go down, and the firm’s market value decreases. Implicit contracts have an impact on a company’s reputation. As a result of this conclusion, firms that invest heavily in R&D and have more room for expansion face more reputational risks than their analog counterparts, who rely on fewer implicit contracts and smaller name recognition (Armour et al., 2011, pp.1429-1448).
According to Armour et al., (2017), rapid expansion may increase fraud activity. Researchers have hypothesized that organizations experiencing rapid expansion are under pressure to maintain their current levels of success and, as a consequence, resort to criminal tactics. In the two years before the crisis, the median firm engaged in the financial scam had its revenues increase by 77%; there is evidence that financial difficulty increases the likelihood of fraud. Leverage ratios are a good indicator of a company’s risk of manipulating its results. Leverage ratios for accused businesses are 23% higher than those for control companies over five years. Of those companies, 51 percent have suffered losses for more than two straight years, whereas just 16 percent of those in the control group have suffered losses for that long. When it comes to corporate fraud, the vast majority of publications focus on the ramifications for the accused company. That research all agree that the first revelation of corporate fraud results in considerable (and negative) abnormal returns for the accused company.
In addition, the scam firm has been embroiled in several controversies. However, in more recent research, Beatty et al. (2013) seek to identify the ramifications of endorsement to the whole sector. However, this sensation is not widely investigated in cases of commercial fraud. A company’s competitors feel the impact of a fraud revelation in a spillover effect or a contagion effect. There are possibilities where competitors suffer as a consequence of industry fraud since it is assumed that the material given by the firms is no longer accurate or the competitor companies profit from consumer exodus from the faulted corporation and diminished competitiveness. Those impacts are the information spillover effect and the industry competitiveness effect. The overall impact of fraud on competing enterprises relies on the degree of these two factors.
Conclusion
Wirecard’s demise was conveyed about by a scam operation that became so enormous that they could not stop it. Several variables influenced the birth, growth, and evolution of this scam. As a result of these reasons, we think that management was under substantial pressure to fulfill the expectations of the stock market and a firm that was developing organically below expectations. Because of this, management proceeded to exaggerate profits and create fake revenue to make up for the shortfall. Managers and stockholders are not aligned in this circumstance.
The Board of Directors and external auditors were responsible for corporate governance, implemented through Committee assemblies with administration, evaluation of large contracts, and monetary information. However, these safeguards failed, allowing management to carry out a fraud scheme for many years. Management’s motive to perpetrate fraud is a bigger problem than rules, even if they apply certain steps to minimize accounting malpractice. Even when implemented, laws and regulations can’t stop dishonest management from behaving badly. We cannot overstate the significance of ethical conduct.
Germany and other European nations will likely have to rethink their present fintech finance laws to improve their corporate governance framework. Wirecard workers, creditors, and stockholders suffer significant losses from the company’s bankruptcy filing, much like past corporate scams (Franklin, 2020).
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