Enron:
Questionable Accounting Leads to Collapse
The
Enron Corporation was established by integrating two major gas pipelines in
1985. The Company provided products and services related to natural gas,
electricity, and communications and it was one of the world’s leading
organizations at these sectors with claimed revenues of nearly $101 billion in
2000. Throughout the 1990s, Chair Ken Lay, chief executive officer Jeffrey
Skilling and chief financial official officer Andrew Fastow transformed Enron
from an old style electricity and Gas company into a $150 billion energy
company. However, after the bankruptcy of Enron, it was revealed that Enron
used accounting loopholes, special purpose entities and poor financial
reporting to hide billions of debts from failed deals and projects. And it was
found that top executives of Enron were involved in this accounting fraud which
led Enron to bankruptcy. In addition, Enron’s corporate culture also
contributed to its demise. The following essay is a study of Enron’s case and
an attempt to find out what went wrong for Enron. This essay would try to analyze
the role of Enron’s culture, the role of its bankers, auditors and the role of
chief financial officer Andrew Fastow to its bankruptcy.
The
Contribution of Enron’s Corporate Culture to Enron’s Bankruptcy:
In
general culture means the sum of social behaviors, beliefs, attitudes, human
thoughts and creations. It affects every aspect of our lives—the way we look at
things, the way we act and react and how we express our feelings (Wong).
Corporate culture also indicates the same thing. Corporate culture or
organizational culture has been defined as “the specific collection of
values and norms that are shared by people and groups in an organization and
that control the way they interact with each other and with
stakeholders outside the organization.” (Charles & Gareth, 2001).
Ethical and healthy competitive corporate culture can take a corporation to the
peak of success; on the other hand, toxic corporate culture can lead a
corporation to bankruptcy. Unfortunate to say that Enron’s corporate was not
ethically healthy enough and it has contributed to push the company to
bankruptcy.
According
to Enron Chairman Ken Lay, Enron’s ethics code was based on respect, integrity,
communication, and excellence in short ‘RICE’. However, history does not say
that moral sentiments like respect, integrity communication and excellence ever
existed in Enron’s corporate culture. By criticizing Enron’s corporate culture Dembinski
et al. defined ‘RICE’ as risk-taking, individualism, contempt and exploitation.
William Thomas describes Enron as characterized by ‘individual and collective
greed born in an atmosphere of market euphoria and arrogance’ (2002, p. 41). People
usually describe Enron’s corporate culture by the word ‘arrogant’. Enron’s
executives loved to believe that there is no competitor for Enron. They
frequently used to quote that Enron’s people could handle increasing risk
without danger. The reason behind the behavior of executives was that they
might want to make their employees confident on their work. However,
‘confidence’ and ‘over confidence’ has very little difference. Overconfidence
makes people to underestimate opponents’ strength. Enron’s executives became
overconfident. According to Sherron Watkins, “Enron’s unspoken message was,
‘Make the numbers, make the numbers, make the numbers—if you steal, if you
cheat, just don’t get caught. If you do, beg for a second chance, and you’ll
get one.’” Enron’s corporate culture did little to promote the values of
respect and integrity.
Enron
employed top MBA graduates from high ranked business schools of USA by offering
rapid promotions and financial incentives. The ultimate goal of the corporation
was made to maximize the stock price and these MBA graduates were very familiar
with this. The ethic of short term stock price maximization was promulgated
ruthlessly and at any cost. Those who contributed to this goal were prized, on
other hand, managers who were unable unwilling to create or fabricated profitable
deals did not last long (Dembinski et al.). Moreover, Enron introduced a
performance monitoring system where employees were rated every six months.
Those who raked in the bottom 20 percent were forced to quit. This ranking
system did not boost up the performance of the employees; rather it created a
fierce environment where employees competed against rivals not only outside the
company but also at the next desk. Delivering bad news could result in the
‘death’ of the messenger, so problems in the trading operation, for example,
were covered up rather than being communicated to management.
Enron’s
corporate culture failed to sustain the organization because it lacked any
method of contractual enforcement. Enron’s ethic gave managers no rational
justification for choosing ‘honor trust’ over ‘abuse trust’.
The
Contribution of Enron’s bankers, auditors, and attorneys to Enron’s demise:
‘High
risk accounting, inappropriate conflicts of interest, extensive undisclosed
off-the-books activity, and excessive compensation’ these are some of the
headings of the report prepared by the U.S. Senate’s Permanent Subcommittee on
Investigations titled “The Role of the Board of Directors in Enron’s
Collapse.” (Permanent Subcommittee on Investigations,2002). Enron
continuously used partnerships, called ‘special-purpose entities’ (SPEs) with
the help of its bankers and auditors to move assets and debts off its balance
sheet and to increase cash flow by showing that funds were flowing through its
books when it sold assets. Most SPEs were fabricated entities. Enron created
them from their own money maintained control over them. If any entity failed to
meet the obligations, Enron covered them from their own stock. So long Enron’s
stock price was high, this accountancy practice worked. However, as the stock
price fell, cash was needed to meet shortfall, and gradually this type of
accountancy directed Enron to bankruptcy (Ferrell et al. pp. 421)
The
US security and Exchange commission found that the bankers of Citigroup and J.P
Morgan helped Enron Corporation to manipulate its financial statements. Each
institution helped Enron mislead its investors by characterizing what were
essentially loan proceeds as cash from operating activities (US Securities and
Exchange Commission). The voluminous third interim bankruptcy report in the
Enron bankruptcy, by court-appointed examiner Neal Batson, is explicit in
detailing the bankers’ role in Enron’s fraud, replete with names, internal
memos, phone conversations, faxes, sworn testimony, and e-mails. In addition,
the final report of Neal Batson revealed that bankers from Barclays, Canadian
Imperial Bank of Commerce, Deutsche Bank, and Merrill Lynch also knew about and
participated in Enron’s schemes. The conclusion of the story is that Enron was
failing terribly. The company needed a path to get cash to maintain its
investment grade credit rating. It owed banks like Citigroup and J.P. Morgan,
billions of dollars. Hence, the banks needed Enron on race. The ultimate result
is ‘Off-balance-sheet special-purpose entities (SPE)’, some masterpieces from
sophisticated financial engineering–and highly aggressive accounting to
understate debt and overstate cash flow (Levinsohn, 2003).
Enron’s
auditor, Arthur Andersen was responsible for ensuring the accuracy of Enron’s
financial statements and internal bookkeeping. Anderson’s reports were used by
potential investors to judge Enron’s financial soundness and future potential
before they decided whether to invest and by current investors to decide if
their funds should remains invested there. These investors would expect that
Anderson’s certification were independent and without any conflict of interest.
However, Anderson was found guilty of obstruction of justice in March 2002 for
destroying Enron-related auditing documents during an SEC investigation of
Enron. The reason behind why Anderson auditors failed to ask Enron to better
explain why its complex partnerships before certifying Enron’s financial
statements was that Anderson was unduly influenced by the large consulting fees
Enron paid it. Enron’s attorneys did a crime by approving illegal transactions.
Kenneth Lay, the Chairman and the CEO of the company said that he believed that
the transactions were legal because they were approved by attorneys and
accounts.
The
role of CFO, Andrew Fastow, in creating Enron’s financial problems:
Enron
practiced controversial accounting to cover losses from appearing on its
statements. And the chief financial officer, Andrew Fastow, was the brain
behind the accounting duplicity. To hide the true financial condition of Enron
Corporation, Andrew Fastow utilized his position in creating unconsolidated
partnerships and ‘special purpose entities’, which later became popularly known
as the LIM partnership. Taking advantage from the SPEs’s main purpose, which
provided the companies with a mechanism to raise money for various needs
without having to report the debt in their balance sheets, Enron’s CFO directly
ran these partnerships and designed them to purchase the underperforming assets
(such as Enron’s poorly performing stocks and stakes). ). Although being
recorded as related third parties, these partnerships were never consolidated
so that debt could be getting off its balance sheet and the company itself
could boost and have not had to show the real numbers to stockholders. Andrew
Fastow was using SPEs to conceal some $1 billion in Enron debt and this led
directly to Enron’s bankruptcy. Overall, according to Enron, Fastow made about
$30 million from LJM by using these partnerships to get kickbacks which were
disguised as gifts from family members who invested in them and enriching
himself. His manipulation of the off-balance-sheet partnerships to take on
debts, hide losses and kick off inflated revenues while banning employees’
stock sales was one of the reasons triggered the collapse of the company and its
bankruptcy.
“Fastow entered his plea in a federal court in
Houston and agreed to serve a 10-year prison sentence and to cooperate with
authorities. He had been facing a 98-count indictment and an April trial date.
He also agreed to surrender $23.8 million as part of the arrangement, most of
which has already been frozen in various accounts.” (CNN
Money). It is also proved in the investigation that Andrew Fastow helped
committing accounting fraud by the use of off the books partnerships to hide
billions of dollars in debt and artificially boost the company’s profits. The
crucial challenge for Enron was to enter burgeoning deregulated energy markets
without sacrificing its credit rating by carrying too much debt on the books. Hence,
Fastow used his creative but conning brain. He increased his staffs to 3 times
by employing many bankers and giving them the task of selling and buying
capital risk. “They were all young kids, 28 to 32, with great pedigrees,
and they started coming up with these fancy derivatives,” says Houston
lawyer Tom Bilek, who interviewed dozens of former Fastow associates before
suing Enron’s management. “But Fastow was the boy genius setting all these
SPEs up.” (Saporito, 2002).
Conclusion:
Enron
is a sad example of how an arrogant culture that rewards high performance and
gets rid of ‘weak links’ can back fire. Enron spread a culture where employees
competed against outside as well as with their colleagues. This created a
culture where ethics and loyalty cast aside in exchange for high performance.The Enron Code of Ethics and its foundational
values of respect, integrity, communication, and excellence obviously did
little to help create an ethical environment at the company.
However, all the explanation of Enron’s ethical collapse is still to have a
concluding opinion as legal proceedings continuing. Fourteen top levelEnron
employees were found guilty
to various charges; 12 of them were awaiting sentencing, while the other two, one of whom is Andrew
Fastow’s spouse, have received prison sentences of at least one
year. In conclusion, it is obviously proved that Enron’s toxic corporate
culture inspire top level executives to practice illegal accountancy to hide
losses of the corporation which eventually led Enron to bankruptcy.
References:
Charles W. L. Hill, and
Gareth R. Jones, (2001) Strategic Management. Houghton
Mifflin.
CNN Money, ‘Fastow and
his wife plead guilty ‘, viewed 23 January, 2012, <.cnn.com/2004/01/14/news/companies/enron_fastows/”>http://money.cnn.com/2004/01/14/news/companies/enron_fastows/>
Dembinski P, Lager C,
Cornford A & Bonvin J, “Enron and World Finance A Case Study in Ethics”,
Palgrave Mcmillan, viewed 21 January, 2012 <.docunator.com/data/1320561739_27b70a45e2/Enron_and_World_Finance_-_A_Case_Study_in_Ethics.pdf”>http://www.docunator.com/data/1320561739_27b70a45e2/Enron_and_World_Finance_-_A_Case_Study_in_Ethics.pdf>
Ferrell O.C., Fraedrich
J, Ferrell L, ‘Business Ethics: Ethical Decision Making and Cases’, 8th
Ed., South Western Cengage Learning, pp. 419-428
Final Interim Report of
Neal Batson, 2003, viewed 22 January, 2012, <.concernedshareholders.com/CCS_ENRON_Report.pdf”>http://www.concernedshareholders.com/CCS_ENRON_Report.pdf>
Levinsohn, 2003,
‘Bankers’ complicity in Enron’s fraud’, Money Library, viewed 23 January, 2012,
<.com/p/articles/mi_hb6421/is_2003_Oct/ai_n29061552/”>http://findarticles.com/p/articles/mi_hb6421/is_2003_Oct/ai_n29061552/>
Saporito B, 2002, ‘How
Fastow Helped Enron Fall’, Time Business, viewed 23 January, 2012, <.time.com/time/business/article/0,8599,201871,00.html”>http://www.time.com/time/business/article/0,8599,201871,00.html>
Third Interim Report of
Neal Batson, 2003, viewed 22 January, 2012
<news.findlaw.com/hdocs/docs/enron/enronbk72803xr3.pdf>
Thomas, W. C. (2002)
‘The Rise and Fall of Enron’, Journal of Accountancy (April), pp. 41–8.
US Securities and
Exchange Commission, ‘SEC Settles Enforcement Proceedings against J.P. Morgan
Chase and Citigroup’, viewed 22 January, 2012 <.sec.gov/news/press/2003-87.htm”>http://www.sec.gov/news/press/2003-87.htm>
Wong, P, “Lessons from
the Enron Debacle: Corporate Culture Matters!”, International Network on
Personal Meaning, viewed 20 January, 2012 <.meaning.ca/archives/archive/art_lessons-from-enron_P_Wong.htm”>http://www.meaning.ca/archives/archive/art_lessons-from-enron_P_Wong.htm>
