Enron Scandal Analysis Essay Example
Enron Scandal Analysis Essay Example

Enron Scandal Analysis Essay Example

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  • Pages: 5 (1308 words)
  • Published: June 1, 2017
  • Type: Case Study
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Once upon a time, there was a gleaming headquarters office tower in Houston, with a giant Tilted E in front, slowly revolving in the Texas sun. Enron‘s suggested to Chinese feng shui practitioner Meihwa Lin a model of instability, which was perhaps an omen of things to come. The Enron Corporation, once ranked among the top Fortune 500 companies, collapsed in 2001. It collapsed under a mountain of debt that had been concealed through a complex scheme of offbalance –sheet partnership. The collapse forced the company to declare bankruptcy and lay off four thousand employees. In addition to the layoffs, thousands more lost their retirement savings, which had been invested in Enron stock. The stock price plummeted, causing the company‘s shareholders to lose tens of billions of dollars.

The downfall of Enron created a worldwide loss of faith in corporate integrity and still impacts markets today. It also triggere


d a closer examination of financial reporting practices. To understand the reasons behind this failure, we will explore the history, culture, and key individuals involved in the Enron scandal.

Enron Corporation was established in 1985 through the merger of two prominent gas pipeline companies. The company operated using its subsidiaries and various affiliates, providing a wide range of natural gas, electricity, and communication products and services to both wholesale and retail customers. Enron transported natural gas via pipelines across the United States while also generating, transmitting, and distributing electricity primarily in the northwestern region of the country. Additionally, it participated in global markets for natural gas, electricity, and other commodities. Moreover, Enron played a crucial role in developing, constructing, and operating energy-related projects worldwide while managing energy delivery t

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retail customers in industrial and commercial sectors.

Throughout the 1990s, Enron underwent a transformation under the leadership of Chair Ken Lay, CEO Jeffrey Skilling, and CFO Andrew Fastow. The company evolved from a traditional electricity and gas provider into a prominent energy company valued at $150 billion in the investment markets. Enron experienced significant revenue growth during this period, seeing its income rise from approximately $31 billion to over $100 billion from 1998 to 2000. This surge propelled Enron to become the seventh-largest Fortune 500 company.

The majority of Enron's revenues in 2000 were derived from wholesale energy trading, accounting for about 93 percent of total income. An additional 4 percent came from natural gas and electricity sales, while broadband services and exploration contributed the remaining 3 percent. However, an investigation revealed that despite reporting a net income of $979 million for that year, Enron actually earned only $42 million.

Enron's corporate culture focused on maximizing profits for executives rather than generating returns for shareholders. Compensation plans prioritized enriching officer wealth instead of benefiting shareholders. This culture seemingly encouraged bending or even breaking rules to achieve financial gains.

It appears that Skilling was responsible for implementing a system where employees were evaluated every six months based on their performance rankings – potentially incentivizing rule-breaking behavior among staff members.

Within the lower 20 percent, individuals were compelled to leave, fostering a cutthroat atmosphere where employees were pitted against each other both externally and internally. Displaying negative information could have dire consequences, thus issues within the trading department, for instance, were concealed instead of being reported to higher-ups. Several staff members subscribed to the notion that virtually anything had the potential to

be transformed into a profitable financial asset with the assistance of intricate statistical analysis.

Enron's bankruptcy in 2001 was the largest in U.S. corporate history at the time due to being short on assets and heavily reliant on intellectual capital. The corporate culture at Enron rewarded innovation and punished employees considered weak.

Enron declared bankruptcy after it was exposed that the company had used special-purpose entities (SPEs) to conceal losses. In an August 2001 meeting with Enron's lawyers, Andrew Fastow, the former CFO, confessed that SPEs had been established by Enron to shift assets and debts off its balance sheet. This tactic allowed Enron to present inflated cash flow by creating the illusion of funds moving through its records when assets were sold. However, these actions were considered fraudulent financial reporting by external observers as they did not accurately reflect Enron's actual financial state. Many of the SPEs were merely names without substance, and Enron financed them using its own stock while retaining control over them. If any of these partnerships failed to fulfill their obligations, Enron utilized its stock as a means to cover the debt.

Enron encountered a shortage of funds when its stock price decreased, despite a previous arrangement that was effective during high stock prices. The company restated its financial statements for fiscal year 2000 and the first nine months of 2001, revealing a change in cash flow from operations. In 2000, the cash flow was positive at $127 million, but it turned negative in 2001 with -$753 million. As Enron's stock price continued to decline in 2001, the company faced a critical lack of funds. Additionally, Enron had to cover significant shortfalls for

its partnerships in October 2001, resulting in a decrease of $1.2 billion in stockholder equity. The situation worsened due to concerns about inadequate disclosure in Enron's financial statements and reports indicating personal benefits for executives from partnership deals. Consequently, investor confidence declined along with Enron's stock price.

Dynegy initially offered to save Enron by providing $1.5 billion in cash, using Enron's premier pipeline Northern Natural Gas as collateral, and purchasing Enron for approximately $10 billion. However, when Standard ; Poor's lowered Enron's debt rating to below investment grade on November 28, 2001, $4 billion in undisclosed debt became due, and Enron lacked the necessary funds to repay it. Consequently, Dynegy terminated the agreement. Subsequently, Enron filed for bankruptcy on December 2, 2001, leaving it facing 22,000 claims worth around $400 billion.

Sherron Watkins, an eight-year Enron veteran, was assigned to work directly with Andrew Fastow in June 2001. Her task was to find assets to sell off due to the bursting of the high-tech bubble and Enron's slipping stock price. However, she came across unclear off-the-books arrangements that were supported only by Enron's deflating stock. The explanations for these arrangements were not clear to her. Aware of the potential consequences of confronting CEO Jeffrey Skilling, Watkins started looking for another job. Her plan was to confront Skilling just before leaving for her new position.

Skilling, however, abruptly resigned on August 14, citing a desire to prioritize family time. Ken Lay, the chair, reassumed the role of CEO and initiated a process where employees could voice their concerns by placing them in a designated box for later review. Watkins opted to write an anonymous memo and placed it in

the box. Despite this, during a company-wide meeting that CEO Lay held shortly afterwards, he failed to mention her memo. Consequently, she arranged a private meeting with him. On August 22, Watkins delivered a seven-page letter detailing her concerns to Lay.

She warned him that if nothing was done, Enron would collapse due to accounting scandals. Lay arranged for Enron's law firm, Vinson & Elkins, to examine the questionable deals. However, Watkins advised against having a party investigate that could be compromised by its involvement in Enron's scam. In late September, y sold around $1.5 million worth of personal stock options, while assuring Enron employees that the company was in a strong position. By mid-October, Enron reported a third-quarter loss of $618 million and a $1.2 billion write-off related to the partnerships that Watkins had cautioned Lay about.

Watkins faced consequences for her actions, including the confiscation of her computer hard drive. She was also relocated from her luxurious executive office suite on the top floor of the Houston headquarters tower to a less extravagant office on a lower level. Her new metal desk lacked the exciting projects that previously sent her on Enron business trips around the globe. Providing testimony before Congress about Enron's partnerships in February D2, Watkins eventually resigned from Enron in November of the same year.

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