Corporate Greed taken too far: Enron
Case facts
1.Energy corporation (Oil, Gas & Electricity) based off Houston
Texas.
2.Merger: Houston natural gas and InterNorth.
3.Founder: Kenneth Lay in 1985
4.Peak employee count: 29,000 in 2001
5.Revenue: 101 billion reported in 2000
Reasons for success
1.When it was found that some traders were doing false trades
they later found 2 guilty and cut down their losses by around 70
million
2. Knowledge process outsourcing; Ken Lay hired McKinsey
Consulting with Jeffrey Skilling a Harvard graduate of batch 79
as its head who was known as the smartest man in the room.
Jeffrey Skilling was amazed at how backwards the oil and gas
businesses were; he proposed an idea of buying excess gas
when prices were down to create his own reserves and then
selling those reserves when prices were high. Creating his own
gas bank.
When other businesses were struggling (price instability) Ken
Lay decided to give long term fixed prices to both buyers and
sellers as well as a low initial asset requirement (Asset light
strategy) which allowed the firm to grow faster and gain many
more clients than the competition.
“To be a player in this business, you just needed to understand the price
of natural gas and the concept of risk. In the coming years, Wall Street
firms piled into the business, but Enron always had a huge advantage.
Its immense network of physical assets, its ability to tie all the moving
pieces together and provide physical delivery of the gas itself, and its
long history in the gas business gave it insights its Wall Street
competitors could never match. These, alas, were lessons Enron would
one day forget.”
3.Mark to market accounting- A common practice in financial
sector but unheard of in energy industry, MTM allowed Enron to
register sales and dealings today though actual transaction was
still long due. (Noting down returns on mutual fund which’ll
come 15 years down the line) This allowed them to ride through
losses and maintain their share value/ market cap.
“From the very beginning, however, Enron recruited the best
and the brightest. The company quickly gained a reputation as
supporting and rewarding entrepreneurial thinking. In the words
of a former employee, “If you could show that something new
and different could make money, you could do it.” The
company’s loose culture translated into a distaste for
bureaucracy and a corporate belief in free markets.”
4.Enron capital and trade resources- HR only hired the best
MBA’s and based on out of the box thinking ability and
behavior.
5.Anti-Enron Enron culture- Encouraged risk taking and deal
making but did not expect loyalty only performance, Lou Pai
once took employees to a strip club on a workday and wasn’t
scolded but rather compensated.
Enron International
John Wing was largely responsible for Enron’s growth. He is
behind the Teesside power plant in uk in 1993.It was profitable
earlier but later on was reporting loss. Enron had entered long
term agreement for the North Sea gas, to provide adequate
feedstock for Cogen plant.
Both Mark and skilling were pursing booked earnings –
accounting earnings, because that was criteria for success at
Enron.
Mark was more into power projects & skilling was into trading
and power sales. Both were trying to create a greater value for
the company.
After finishing a Master’s degree in international management, again at
Baylor, she took a position with First City National Bank in Houston. In 1982, Rebecca Mark
joined the Treasury group at Continental Resources, a gas company in Houston, which was
in turn acquired by Houston Natural Gas just prior to it becoming a part of the newly created
Enron. Mark went to work for John Wing.
Mark returned to school, earning her Harvard MBA while still working full time for
Enron on Teeside and related deals. Contrary to her expectations, however, when John
Wing left Enron in 1991, Ken Lay broke up Enron International into geographic regions,
giving Mark control over only the emerging markets segment. In 1992, Enron Development
purchased 17.5% of Transportadora del Sur, an Argentine natural gas pipeline. pipeline
projects were underway in China and Colombia, and,
eventually, the ill-fated Dabhol, India, power project. Whereas
others tried to sell themselves as the companies and agents of
technology and low-cost efficiency
Ironically, Rebecca Mark still found herself competing against John Wing in these early
years. Even though Wing had left Enron in 1991, he continued to work as a freelance
originator of international projects on behalf of Ken Lay. Enron International, under first John
Wing and later Rebecca Mark signed and sealed new power and pipeline projects at a
breakneck pace. The difference was that by the time Enron International grew to size and
influence in the mid-1990s under Rebecca Mark, projects recognized earnings upfront using
the same mark-to-market accounting as employed in the trading businesses.
These projects committed Enron’s capital resources for years to come, and, in many cases,
locked in cash-flow shortfalls for as many years as well.
Enron Development would often sign and book deals which
later proved to be dead in the water. Accounting rules required
that projects which were no longer in progress be written down
in current earnings. Enron Development fought these write-offs
at every turn. Rich Kinder had instructed the unit that these
unrecognized losses, called “snowballs” within Enron, be kept
below $90 million in total. In early 1996, however, they soared
to over $200 million
The Dabhol, India, the project was a microcosm of Enron’s
business model. In December 1993, after roughly 18 months of
negotiations, Enron Development signed a long-term power
sales contract with the electricity board of Maharashtra, India.
Enron would build a 2000-megawatt natural gas-fuelled power
plant at an estimated cost of $2.8 billion. Once again, Mark
went into overdrive for months of negotiations and
renegotiations.
Finally, on February 23, 1996, a new contract was signed between Enron and the MSEB. By
December, financing was in place and the project’s construction resumed. The Dabhol
power plant today is considered a failure for everyone involved but Rebecca Mark. In 1996,
Enron International generated 15% of Enron’s total earnings and was expected to grow at
double-digit rates for years to come.
Rebecca Mark was named CEO of Enron International.
Financial Focus
The financial philosophy which emerged at Enron in the 1990s
was one that catered nearly exclusively to Wall Street. Both Ken Lay
and Jeff Skilling believed that the market rewarded earnings growth over all others, including
cash flow and quality of earnings.
In 1990s, when Enron’s business results were still primarily
from gas pipeline operations, earnings and cash flows were
largely aligned. When earnings were recognized (recorded as
occurring), they were realized (showing up as cash flow).
Enron’s net business cash flows remained either slightly
positive or balanced. Earnings were growing throughout this
1991 to 1996 period.
Mark-to-market accounting was employed to a larger and larger
extent to reflect all of the earnings associated with a trade or
deal upfront. As Enron’s business grew into power trading, broadband, and other
market-making activities, the gap between reported earnings and cashflows grew.
The financial schism between earnings and cash flow was not,
however, confined to Jeff Skilling’s trading activities alone, but
also—and possibly, in the end, more significantly—to the
company’s growing international commitments generated by
Rebecca Mark at Enron International.
Once following this path, the company was indeed on dope as a former employee note.
Income from pipelines was recurring; it came regularly and predictably. Earnings from deal-
making and trading were not.
Ken Lay, in the end, came to believe that Jeff Skilling would be
able to deliver on the 15% promise; he had no such confidence
in Rebecca Mark
The Performance Review Committee
To motivate the needed deals at Enron, rewards were based only on what
deals had been signed in the current period. This reflected Jeff Skilling’s belief in the value of
confrontational debate; only through debate would the best ideas rise to the top.
In the words of Jeff Skilling: I’ve thought about this a lot, and all
that matters is money. You buy loyalty with money. This
touchy-feely stuff isn’t as important as cash. That’s what drives
performance
Every employee was the subject of an intense review process
conducted twice a year by the Performance Review Committee
. After the submission of detailed performance reports for each individual, a series of
committee meetings were held, often far into the night, in which a business unit leader
promoted, defended, and negotiated their own peoples’ futures against other business units.
The PRC, in a system affectionately referred to as rank and yank, rated everyone from 1
to 5 . Each employee under review, represented by a name card, was then pushed, thrown,
and prodded up and down the conference room table. Only deals are done this year
mattered; no credit was given for historical performance. A final rating of 1 was considered
premier, and often meant promotion and stock option bonuses. Those with a rating of 4 or 5
were given roughly six months to improve their rating or they were fired.
Leadership Transition
Ken Lay had always led Rich Kinder to believe that he would
eventually assume the role of CEO.
Kinder’s no-nonsense approach to business, concentrating on
management, execution, and control, was thought to be a
valuable counterbalance to Ken Lay’s aggressive grow-the-
business fast, hands-off approach. But lay had always been
somewhat condescending in his attitude towards Kinder, and
Kinder openly resented it. In the following contract negotiation,
Kinder had a clause added to his contract stating that in the
event that he and Enron was unable to agree upon an
acceptable employment position, he could leave the company
with bonuses.
Although Kinder expected Lay to resign and Kinder to be
offered the CEO position, Lay accepted a new five-year contract as Chairman
and CEO. Lay later told Kinder that, although he had supported him for the position, the
Board had refused. 10 Kinder received a parting gift of $2.5 million in cash, forgiveness of
his outstanding Enron loan of $4 million, and an indeterminate number of additional vested
stock options.
Lay had originally intended to leave the long-dead office of
President at Enron vacant, Jeff Skilling moved quickly to fill the
post himself, probably to prevent other suitors such as Rebecca
Mark from filling the slot. On December 10, 1996, Jeff Skilling
was made both President and Chief Operating Officer of Enron
Corporation.
The New Enron
With the ascension of Skilling to the COO position, Skilling’s
ECT subculture moved to the driver’s seat within Enron’s
complex web of business units and corporate cultures
And although both trading and international had increasingly
shared accounting practices, there were still fundamental differences in how
business was done and the personality characteristics of those doing it.
Jeff Skilling often characterized Enron’s corporate culture as
loose-tight. The loose was the no-holds-barred approach to creativity and business
development. All transactions requiring the investment of capital by Enron had to go through
the Risk Assessment and Control Group, an in-house consultancy which evaluated the
expected risks and returns on the proposed investments. The energy trading business,
primarily electrical power in North America, boomed in the 1996 to 2000 period.
Wholesale energy services grew from $12 billion in 1996 to
nearly $95 billion in 2000.
By Ken Lay’s vision, Enron had indeed gotten big fast. In 2000, Enron broke the
$100 billion in revenues mark for the first time. Enron’s perception of its own core
competence was changing.Enron
tried, sometimes failed and
sometimes succeeded, in trading water, weather derivatives,
bandwidth, and coal, to name but a few. As an analyst at Bear
Stearns noted, "Enron aims to commoditize the
uncommodifiable.
Enron’s venture into water was something of a microcosm of
the company’s transition from a bricks-and-mortar business to a
clicks-and-mortar trading house. In July 1998, Enron paid $2.4 billion for
Wessex, a British water utility company. A company, like Portland General Electric before it,
was the first step in acquiring a producing company to provide the backbone to a growth
strategy of ownership, operations, and trading in a new market. Rebecca Mark, hungry to
prove her worth in an organization now under the influence and control of Jeff Skilling,
accepted the Chairman and CEO position of the newly created water business, Azurix.
It was an admission of failure of the utility acquisition strategy,
and, in the eyes of many, an act of desperation. Rebecca Mark resigned as CEO of Azurix.
She then exercised stock options and liquidated shares totalling more than $80 million on
her way out of Enron. A few months later, Enron announced it would buy back all
outstanding shares of Azurix and shut it down.
Many believed the failure of Azurix was proof of the failure of
the old Enron; others, the failure of the new. Regardless, it
sealed the fate of Rebecca Mark and eliminated the last
remaining threat to Jeff Skilling within Enron
