Introduction/Background:
Throughout the late 1990s, Enron was almost universally considered one of the country's most
innovative companies -- a new-economy maverick that forsook musty, old industries with their
cumbersome hard assets in favor of the freewheeling world of e-commerce. The company
continued to build power plants and operate gas lines, but it became better known for its unique
trading businesses. Besides buying and selling gas and electricity futures, it created whole new
markets for such oddball "commodities" as broadcast time for advertisers, weather futures, and
Internet bandwidth. Enron was founded in 1985, and as one of the world's leading electricity,
natural gas, communications and pulp and paper companies. It bought and sold gas and oil
futures, built oil refineries and power plants, and became one of the world's largest pulp and
paper, gas, electricity, and communications companies before it filed for bankruptcy in 2001 as
annual revenues rose from about $9 billion in 1995 to over $100 billion in 2000. At the end of
2001 it was revealed that its reported financial condition was sustained substantially by
institutionalized, systematic, and creatively planned accounting fraud. According to Thomas
(2002), the drop of Enron's stock price from $90 per share in mid-2000 to less than $1 per share
at the end of 2001, caused shareholders to lose nearly $11 billion. And Enron revised its financial
statement for the previous five years and found that there was $586million in losses. Enron fell
to bankruptcy on December 2, 2001.
Several years before Enron’s bankruptcy, the government had deregulated (lifted restrictions) the
oil and gas industry to allow more competition, but deregulation also made it easier for
companies to act fraudulently. Enron, among other companies, took advantage of this situation.
But the Enron debacle is also emblematic of another problem that has become all too evident in
the last few years: Wall Street's loss of objectivity. The various misdeeds and crimes that Enron's
officers and employees committed, were extensive and ongoing. Particularly damaging
misrepresentations produced inflated earnings reports for shareholders, many of whom
eventually suffered devastating losses when the company failed.
The Causes of Enron’s bankruptcy:
Management played the most significant role in the process of fraud. Some managerial
executives were directly or indirectly involved in the process of fraud. The managers
intentionally took some actions to benefit them from the fraud. Moreover there were some
inherent risks of the business to be misstated. Like;
Extremely volatility of the business.
The uniqueness of the business.
The diversification of the business increased the risk of fraud.
Complex accounting system.
Complex business model.
For these inherent risks of the business and some greedy managerial executives the fraud actually
happened with the help of the auditors. The combination of these issue resulted in the bankruptcy
of the company and the majority of them were perpetuated by the indirect knowledge or the
direct actions of Kenneth Lay, Jeffery Skilling, and Andrew Fastow and the other executives.
Lay served as the chairman of the company in its last few years and approved the actions taken
by Skilling and Fastow although he didn’t always inquire about the details. Skilling always
focused on meeting the Wall Street expectations, advocating the use of Mark to Market
accounting (accounting based on the market value, which was then inflated) and pressured Enron
executives to find new ways to hide its debt. Fastow and the other executives created off balance
sheet vehicles, complex financing structures, and deals so bewildering that few people could
understand them.
Some of the management issues in detail are:
Truthfulness:
The lack of truthfulness by management about the health of the company, according to Kirk
Hanson, the executive director of the Markkula Center for Applied Ethics. The senior executives
believed Enron had to be the best at everything it did and that they had to protect their
reputations and their compensation as the most successful executives in the U.S.
The duty that is owed is one of good faith and full disclosure. There is no evidence that when
Enron’s CEO told the employees that the stock would probably rise that he also disclosed that he
was selling stock. Moreover, the employees would not have learned of the stock sale within days
or weeks, as is ordinarily the case. Only the investigation surrounding Enron’s bankruptcy
enabled shareholders to learn of the CEO stock sell-off before February 14, 2002 which is when
the sell-off would otherwise have been disclosed. Why the delay? The stock was sold to the
company to repay money that the CEO owed Enron—and the sale of company stock qualifies as
an exception under the ordinary director and officer disclosure requirement. It does not have to
be reported until 45 days after the end of the company’s fiscal year. (The Conference Board, Inc.,
845)
Unethical Corporate Culture:
The managers were just concerned about their personal benefits; they didn’t have the ethical
sense to be reasonable and accountable to their actions. This toxic corporate culture in Enron is
undoubtedly the major cause for its fall. An environment where there is no trust and openness
between employer and employees results in a workplace filled with secrecy and suspicion that
spurned internal competiveness and negativity. They ignored or fired anyone who challenged
their decisions which in turn made the environment toxic for everyone.
Managerial Dishonest Activities:
Complex accounting system adaption.
Overstatements of revenue and assets.
Understatement of debts and liabilities.
Increase market share price with false information and financial statements.
Collecting funds through selling of share and misdistribution of funds.
Accounting Fraud (using ‘mark to market’ and Special Purpose Entity):
As a public company, Enron was subject to external sources of governance including market
pressures, oversight by government regulators, and oversight by private entities including
auditors, equity analysts, and credit rating agencies. In this section we recap the key external
governance mechanisms, with emphasis on the role of external auditors. This method requires
that once a long-term contract was signed, the amount of which the asset theoretically will sell
on the future market is reported on the current financial statement.
In order to keep appeasing the investors to create a consistent profiting situation in the company,
Enron traders were pressured to forecast high future cash flows and low discount rate on the
long-term contract with Enron.
The difference between the calculated net present value and the originally paid value was
regarded as the profit of Enron. In fact, the net present value reported by Enron might not happen
during the future years of the long-term contract. There is no doubt that the projection of the
long-term income is overly optimistic and inflated.
As far as the SPE is concerned, the Accounting rule allow a company to exclude a SPE from its
own financial statements if an independent party has control of the SPE, and if this independent
party owns at least 3 percent of the SPE. Enron needed to find a way to hide the debt since high
debt levels would lower the investment grade and trigger banks to recall money.
Using the Enron’s stock as collateral, the SPE, which was headed by the Commodities and
Futures Organization (CFO), Fastow, borrowed large sums of money. And this money was used
to balance Enron’s overvalued contracts. Thus, the SPE enable the Enron to convert loans and
assets burdened with debt obligations into income. In addition, the taking over by the SPE made
Enron transferred more stock to SPE. However, the debt and assets purchased by the SPE, which
was actually burdened with large amount of debts, were not reported on Enron’s financial report.
The shareholders were then misled that debt was not increasing and the revenue was even
increasing. In addition, the taking over by the SPE made Enron transferred more stock to SPE.
However, the debt and assets purchased by the SPE, which was actually burdened with large
amount of debts, were not reported on Enron’s financial report. The shareholders were then
misled that debt was not increasing and the revenue was even increasing.
Conclusion:
This scandal is considered to be the most notorious within American history; this summary of
events is considered by many historians and economists to be an unofficial blueprint for a case
study on a White collar crime; a loss of $74 billion by the shareholders; many employees and
investors lost their pension accounts and became unemployed. CEO Jeff Skilling and former
CEO Ken Lay were the main culprits of this historic event.
There should be a healthy corporate culture in a company, Maybe business ethics is the most
thesis point people doing business should focus on, A more complete system is needed for
owners of a company to supervise the executives and operators and then get the idea of the
company’s operating situation (proper financial management and handling of monetary affairs)
are some of the things other aspiring companies shpuld adhere in order to prevent themselves
sharing Enrons’ fate.
References:
https://www.researchgate.net/publication/306091392_The_Lesson_from_Enron_Case__Moral_a
nd_Managerial_Responsibilities
https://www.linkedin.com/pulse/organizational-culture-how-enron-did-wrong-jason-martin-mba/
https://www.slideshare.net/PanthoSarker/accounting-fraud-a-study-on-enron-scandal
"Enron Is Proving Costly to Economy", Los Angeles Times, 2020. [Online]. Available:
https://www.latimes.com/archives/la-xpm-2002-jan-20-mn-23790-story.html#:~:text=The%20very
%20decline%20of%20Enron,at%20Enron%20face%20meager%20retirements. [Accessed: 18- Oct-
2020].
"Consequences of the Enron Scandal", Global-ethic-now.de, 2020. [Online]. Available:
https://www.global-ethic-now.de/gen-eng/0d_weltethos-und-wirtschaft/0d-01-globale-wirtschaft/0d-01-
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