Rise and Fall of Enron Essay Example

that society shows it cares about responsible conduct in business. In the early 1990s the Congress of the United States of America passed legislation deregulating the sale of electricity like natural gas a year earlier. . Enron took advantage of the lack of regulation of its energy trading business to influence government officials and play games with the numbers. Enron rapidly changed its business from a regulated natural gas company into one of the world’s largest energy traders.

The corporation became an unregulated derivative –trading company.It generated funds by entering into extremely volatile, risky, and expensive hedging transactions. The company changed its business focus from primarily delivering and brokering energy domestically to focusing on three new key business areas: water, international energy brokerage, and broadband communications. . As the corporation grew rapidly, the emphasis was more on short-term effects and not on the long-term.

It became all about living up to the expectations of growth. The system of internal control and control by the management could not keep up with the way Enron was growing.No one outside of the company could figure out how Enron was able to generate so much revenue compared to its counterparts. In order to continue to grow, increase its profits and push up its share price, Enron needed additional capital despite its substantial debt load. Therefore, it formed a series of partnerships between various Enron directors and outsiders that appeared to be independent but were effectively controlled by Enron executives.

These were named “Special Purpose Entities” (SPE). These SPEs were of doubtful legality and served a number of purposes. Walsh, 2002) At first Enron apparently set up these SPEs correctly with the help

of its independent auditors, Arthur Anderson. When Enron ran into some difficulties finding replacement for these SPEs, it started using key management personnel for this purpose. What Enron was in fact doing, was using these Special Purpose Entities to move debt off the balance sheet and using the company stock as collateral.

These SPE's are supposed to be isolated from the parent company but in Enron's case this was untrue and the SPE's depended on Enron management and stock capital.When auditors forced Enron to bring these SPE's back into the company the sales from moving the assets into the SPE's was lost and this explains the 1 billion dollar charge. Arthur Andersen, LLP, should have noticed these problems internally and been fixed sooner, but due to very complicated financial maneuvers they were never found.

Andersen did not move to ever investigate Enron, because they were so closely tied with Enron executives and they were making a lot more money serving as a consulting firm to Enron then they were as auditors.When Andersen finally found the problem with the accounting procedures they knew an SEC investigation would take place, therefore they began shredding internal documents that could be used against them in court.

Andersen was correct, although the federal government could not prove that the auditing procedures used by Andersen were illegal, they did charge Andersen with obstructing justice for shredding internal documents. Concerns about Enron’s financial stability were mounting.On August 14, 2001, Jeffrey Skilling, the chief executive of Enron, a former energy consultant at McKinsey & Company who joined Enron in 1990, announced he was resigning from his position. Skilling cited that his reasons for leaving were personal.

The months leading up to his resignation, Skilling had sold at minimum 450,000 shares of Enron at a value of around $33 million.

After Skilling’s departure Lay reassured the concerned public that Enron was not facing any problems and was in a healthy state. Lay reassumed the position of Chief Executive after Skilling left but a lot of attention was now being focused on the company.Meanwhile, Kenneth Lay had cashed in hundreds of millions of dollars of his own shares but failed to warn others of the tidal wave that was heading their way, particularly those employees that had their entire life savings invested in Enron stock. The public was beginning to lose its confidence in Enron and company refused to elaborate on its unusual investment and accounting practices.

By the end of October, 2001, Kenneth Lay removed Andrew Fastow from his position as Chief Financial Officer. At this point in time, Enron stock was trading at $16. 41, having lost half its value in a little over a week.Toward the end of November, Enron stock was trading at $7. In December, 2001, Enron filed for bankruptcy.

At this time, this was the biggest bankruptcy in the United States History and it cost 4,000 employees their jobs. Enron was estimated to have about $23 billion in liabilities, both debt outstanding and guaranteed loans. Arthur Anderson, Enron's accounting firm, turned their heads while Enron's management created "special purpose entities" that kept hundreds of millions of dollars of losses and debt off the balance sheet, which misled individual's investment decisions.

The lack of information led to an overstatement of profits of almost six hundred million dollars and an understatement of debt

of six hundred and thirty million dollars between 1997 and 2000. Arthur Anderson was not the only one releasing misleading information, some of Enron's senior managers also misled investors into thinking the company was in better shape than it was. During this time Kenneth Lay was cashing in his own Enron stock, which sold for thirty seven million dollars.

The GOP also indirectly helped Enron conceal its illegal activities.The company placed more than one-third of its subsidiaries in offshore accounts and slipped its domestic assets in different tax shelters, which helped conceal Enron's financial situation. The main reason that Enron escaped any detection of fraud is that it invested in a particular type of derivatives. This was a complex financial arrangement that escaped all regulatory provisions.

There was no law that required the company to disclose its derivative investments on their balance sheets. Arthur Anderson was one of the "Big Five" large international accounting firms prior to the fall of Enron.In June, 2002, a federal jury convicted Arthur Anderson, Enron’s independent auditor, of obstruction of justice, prohibiting the firm from practicing before the Securities and Exchange Commission and ending its audit practice. Nancy Temple, (Andersen Legal Dept.) and David Duncan, (Lead Partner for the Enron account) were cited as the responsible managers in this scandal as they gave the order to shred relevant documents.

Anderson admitted it had destroyed Enron documents. It says the records included “a significant but undetermined number of electronic and paper documents and correspondence. The United States District Court reasoned that Anderson failed its statutory and professional duty to preserve evidence. Additionally, the absence of any explanation as to why the documents were destroyed

showed that the willfulness element required by the statute had been met. (United States District Court, 2002) The independence of the Anderson auditors was compromised as the auditors were also advising their clients when they set up the Special Purpose Entities.

Therefore, Enron was paying its auditors for audit work as well as consulting work which created a conflict of interest.This issue was later addressed by the Sarbanes-Oxley Act of 2002. The legal and societal implications of the Enron scandal as well as other major corporate scandals are far reaching. Perhaps the most significant change that came about was the establishment of the Sarbanes- Oxley Act of 2002.

The major corporate scandals cost investors billions of dollars when the share price of the affected companies collapsed. This new legislation was established in an attempt to protect innocent investors that were being taken advantage of by powerful corporations, and to make these corporations ore accountable. This law provides stronger penalties for fraud and, among other things, requires public companies to avoid making loans to management, to report more information to the public, to maintain stronger independence from their auditors, and most controversially, to report on and have audited, their financial internal control procedures. The Sarbanes-Oxley Act also created more stringent requirements from the auditors. External auditors are no longer allowed to provide unrelated audit services to their audit clients.The Sarbanes- Oxley Act also provides legal protection for whistleblowers.

Enron’s corporate culture was built upon values of “risk taking, individual creativity, and aggressive growth”. While all of these values can be positive, Enron failed to balance them with values necessary for success in the energy industry – customer service, integrity,

and long-term growth. According to the dimensions defined earlier in this paper, Enron valued short-term growth, creative individualism, and an overarching “take over the world” mentality towards its industry.Additionally and most detrimental to the corporate culture at Enron was it’s vision and corporate priorities. Starting with the vision of Jeff Skilling, Enron’s chief operating officer, Enron valued “asset-light” strategy in which the top priority was put on Enron’s publicly traded stock prices and not on investments in traditional, power generating ventures.

The value on the stock price of the company was the top value in Enron’s corporate culture, over integrity, honesty, and customer satisfaction. This is the point in which the positive values that Enron made integral in their culture became liabilities.Certain arrogance was developed from the top down at Enron and a belief that individual short-term profits in order to boost stock prices became the company’s top priority. It was part of the culture at Enron that success should be achieved no matter what the cost and that the ends of a business venture can justify the means.

While this culture became stronger within the corporation, Enron’s top management gave young, bright employees freedom to pursue the company’s overarching profit goals and only questioned them if their profit targets were not hit.If employees did not conduct their work ethically but did hit their mark, management seemed to look the other way. As the stock prices were inflated, the liquidity of the company was spread very thin. Through the individual business ventures of these highly educated individuals, Enron took out loans and spread their finances thin. Additionally, there was an intense culture of competition within Enron.

Enron sought

out young, ambitious, recent college graduates and placed them in entry-level positions and then gave them the autonomy to make big trade decisions.The few star performers were promoted very quickly. Taking this hiring approach benefited the company because it kept labor costs low due to the employee's inexperience. It also provided increased innovation and creativity because these recent graduates were exposed to cutting-edge techniques and were prone to take more risks, and it helped to socialize workers into Enron's culture and behavioral norms.

The downside to this approach was that these individuals were inexperienced and prone to taking large risks.Enron employees were motivated by vanity and greed. Management used promotions, hefty raises and bonuses to motivate their employees. The focus was placed on meeting financial needs.

It was effective in motivating those who were extremely ambitious and did not have concerns for ethical practices but put their focus on earnings and acquiring wealth. Enron used a 360-degree feedback performance management system (PMS). Performance was directly linked to rewards. The bottom 10% of employees according to this evaluation were often fired or demoted.This created a state of individual paranoia at Enron in which individuals, in order to keep their jobs, were forced into using shady accounting practices and not worrying about the future considerations of a deal as long as it turned a short term profit. Because of this intense culture of internal competition, employees at Enron (even the ones who felt they were using unethical practices) were reluctant to speak up.

The system can be beneficial to managers because it typically gives them a much wider range of performance-related feedback than traditional evaluation provides.The disadvantage to this type

of PMS is that if used inappropriately the focus can be placed on individual biases and politics. That is, if an employees peer dislike them, the PMS can be used as a means to hurt that individual. Enron should have more closely managed their PMS so that its focus remained on constructive rather than destructive criticism. Also, they could have removed the link between the PMS and rewards.

Insider trading is one the indefensible unethical exploitations of the Enron case. Insider trading is the trading of a corporation’s stock or other securities (e. g. onds) by corporate insiders such as officers, key employees, directors, or holders of more than ten percent of the firm’s shares. Key Enron executives who knew the real financial situation of the corporation cashed in their chips before the corporation imploded. This is not fair for the stakeholder of the corporation which included stockholders, employees and creditors.

More than half of the Enron employees had 401(K) plans that consisted primarily of Enron stock. In the fall of 2000, Enron changed administrators for its 401(K) plan, and as is typical, the plan was “closed” while that transfer took place.When a plan is closed, no one can buy, sell, or trade in his or her 401(K) until the standstill is over. In other words, employees did not have access to their 401(K) plans as they watched the Enron stock price plummet. Anyone who watched the news during the Enron bankruptcy empathized with thousands of people that cried on national television as their entire life savings was gone. Conflicts of interest existed in many different forms with the Enron case.

A conflict of interest is a situation

in which someone is in a position of trust and has competing professional and personal interests.Such competing interests make it difficult to fulfill his or her duties impartially. The Special Purpose Entities that were set up to offload debt from the balance sheet were managed by Enron executives who stood to benefit financially from these deals. Arthur Anderson auditors helped Enron to set up these special purpose entities.

Anderson was in effect auditing and advising the client which creates a conflict of interest. A basic key issue in business is truth. Providing honest information to the public is ethical practice. Enron inflated its figures and mislead a lot of people.Providing honest information is an ethical issue because it represents fulfilling your end of the employer/employee contract, and its roots are in fairness and honesty.

Fortunately, today there are grave consequences for those individuals that do not provide accurate financial information. Another ethical issue that arose from the Enron debacle was that of whistleblowers. A whistleblower is an employee, former employee, or member of an organization, especially a business or government agency, who reports misconduct to people or entities that have the power and presumed willingness to take corrective action.Generally the misconduct is a violation of law, rule, regulation and/or a direct threat to public interest, such as fraud or corruption. Sherron Watkins was considered the whistleblower in Enron case.

It is ethical to blow the whistle but may it may also have adverse effects on the whistleblower. At the end of 2002, Watkins left Enron voluntarily to start her own consulting firm. One would expect a whistleblower to be well liked in the community, but Watkins says that

she is hated by many of her colleges and she never received a “thank you” for what she did.Many analyst view the king pin, Kenneth Lay, as having multiple ethical selves. On one hand, Lay was an affable leader who was loved and admired by Enron employees. Even Sherron Watkins, the Enron whistleblower, described Lay as a man of integrity.

At the University of Missouri, Lay was the president of a dry fraternity and went of to earn his Ph. D. in economics. Lay drove an old Cadillac and used rental cars instead of limousines on business trips. On the other side, Lay was described as an arrogant gambler who valued risk taking.Lay was quick to fire people that did not agree to make the numbers.

Early on in his career he fired Enron’s conservative auditors Deloitte Haskins Sells because they were not creative or imaginative. Kenneth Lay was the largest single contributor to George W. Bush’s presidential campaign. Conclusions Business ethics is currently a very ‘hot topic', but even though there is still not enough is done to correct unethical decisions that still occur every day in the business world. There is always more that companies can do in order to protect themselves and their employees from ethical dilemmas.Ethical considerations in business must not be just something that are listed on the company mission statement, or something signed by an employee when he or she is hired.

It must be an ongoing process of re-evaluating the ethical codes and making sure that those codes are up to date and relevant. It is also necessary to make sure that the employees who agreed to support those codes are

continuing to do that. All of the written codes in the world will not make a difference if the management fails to use in practice the things mentioned in them.They must remain sensitive to other employees' racial and cultural differences, and assure employees that there are policies in place to prevent unethical behavior.

Companies should learn how do adopt business practices that will encourage a healthy, rather than unhealthy competition, both internally and externally. The most successful global companies in current marketplace are already learning that truthfulness and honesty in all business transactions gives a very positive result. This is a lesson that Enron executives learned in a hard way.

Works Cited

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