case study about enron

Contributors

Twenty Years Later: The Lasting Lessons of Enron

Michael Peregrine is partner at McDermott Will & Emery LLP, and Charles Elson is professor of corporate governance at the University of Delaware Alfred Lerner College of Business and Economics.

This spring marks the 20th anniversary of the beginning of the dramatic and cataclysmic demise of Enron Corp. A scandal of exceptional scope and impact, it was (at the time) the largest bankruptcy in American history. The alleged business practices of its executives led to numerous individual criminal convictions. It was also a principal impetus for the enactment of the Sarbanes-Oxley Act and the evolution of the concept of corporate responsibility. As such, it is one of the most consequential corporate governance developments in history.

Yet a new generation of corporate leaders has assumed their positions since then; for others, their recollection of the colossal scandal may have faded with the years. And a general awareness of corporate responsibility principles is no substitute for familiarity with the governance failings that reenergized, in a lasting manner, the focus on effective and responsible governance. A basic appreciation of the Enron debacle and its governance implications is essential to director engagement.

Enron was formed as a natural gas pipeline company and ultimately transformed itself, through diversification, into a trading enterprise engaged in various forms of highly complex transactions. Among these were a series of unconventional and complicated related-party transactions (remember the strangely named Raptor, Jedi and Chewco ventures) in which members of Enron’s financial leadership held lucrative financial interests. Notably, the management team was experienced, and both its board and its audit committee were composed of a diverse group of seasoned, skilled, and prominent individuals.

The company’s rapid financial growth crested in March 2001, with media reports questioning how it could maintain its high stock value (trading at 55 times its earnings). Famous among these was the Fortune article by Bethany McLean, and its identification of potential financial reporting problems at Enron. [1] In a dizzying series of events over the next few months, the company’s stock price collapsed, its CEO resigned, a bailout merger failed, its credit was downgraded, the SEC began an investigation of its dealings with related parties, and it ultimately declared bankruptcy. Multiple regulatory investigations followed, several criminal convictions were obtained and Sarbanes-Oxley was ultimately enacted to curb the perceived abuses arising from Enron and several similar accounting scandals. [2]

There remain multiple important, stand-alone governance lessons from Enron controversy of which all directors would benefit:

1. The Smartest Guys in the Room . The type of aggressive executive conduct that contributed heavily to the fall of Enron was not unique to the company, the industry or the times. In the absence of an embedded culture of corporate ethics and compliance, there is always the potential for some executives to pursue “edge of the envelope” business practices, especially when those practices produce meaningful near term financial or other operational results. That attitude, combined with weak board oversight practices, can be a disastrous combination for a company.

Even though commerce has made great progress since then on internal controls, corporate responsibility ultimately depends upon the integrity of management, and the skill and persistence of board oversight. [3]

2. The Critical Importance of Board Oversight . As the company began to implode, Enron’s board commissioned a special committee to investigate the implicated transactions, directed by William C. Powers Jr., then dean of the University of Texas School of Law. The Powers Report, as it came to be known, outlined in staggering detail a litany of board oversight failures that contributed to the company’s collapse. [4]

These included inadequate and poorly implemented internal controls; the failure to exercise sufficient vigilance; an additional failure to respond adequately when issues arose that required a prompt and serious response; cursory review of critical matters by the audit and compliance committee; the failure to insist on a proper information flow; and an inability to fully appreciate the significance of some of the information with which the board was provided. [5]

3. Spotting Red Flags . Amongst the most damaging of the governance breakdowns was the failure to question the legitimacy of the related-party transactions for which so many internal controls were required. These deficiencies served to bring a once significant company and its officers to their collective knees and offer many lasting governance lessons. As the Powers Report concluded with brutal clarity, a major portion of the company’s business plan—related-party transactions—was flawed. [6]

These transactions were replete with risky conflicts of interest involving management. There was a significant “forest for the trees” concern—an inability to recognize that conflicts of such magnitude that required so many board-approved internal controls and procedures should never have been authorized in the first place. All this, despite the fact that the individual Enron directors were people of accomplishment and capability who had been recognized by the media as a well-functioning board. [7]

Yet, they lacked the actual necessary independence to recognize the red flags waving before them. Their varied relationships with company leadership made them all-too-comfortable with what they were being told about the company. [8] This connection made it difficult for them to recognize the dangers associated with the warning signals that the conflicted transactions projected. Indeed it was the revelation of these conflicts that attracted media attention and ultimately “brought the house down”. [9]

4. It Can Still Happen . The 2020 scandal encompassing the German financial services company Wirecard offers one of the latest high profile (international) examples of how alleged aggressive business practices, lax internal and auditor oversight, accounting irregularities and limited regulatory supervision can combine into a spectacular corporate collapse that prompted numerous government fraud investigations. It is for no small reason that the Wirecard scandal is referred to as the “German Enron”. [10]

5. A Significant Legacy . Yet the Enron controversy remains fundamentally relevant as the spark behind the corporate responsibility environment that has reshaped attitudes about corporate governance for the last 20 years. It’s where it all began—the seismic recalibration of corporate direction from the executive suite back to the boardroom, where it belongs. It birthed the fiduciary guidelines, principles, and “best practices” that serve as the corridors of modern corporate governance, developed in direct response to the types of conduct so criticized in the Powers Report. [11]

And that’s important for today’s board members to know. [12] Because over the years, the message may have lost its sizzle. The once-key oversight themes incorporated within “plain old” corporate responsibility seem to be yielding the boardroom field to the more politically popular themes of corporate social responsibility. And, while still important, corporate compliance seems to have had its “fifteen years of fame” in the minds of some executives; the organizational initiative has turned elsewhere.

But the pendulum may be swinging back. There is a renewed recognition that compliance programs can atrophy from lack of support. The new regulatory administration in Washington may return to an emphasis on organizational accountability. As Delaware decisions suggest, shareholders may be growing increasingly intolerant of costly corporate compliance and accounting lapses. And there’s a renewed emphasis on the role of the whistleblower, and the board’s role in assuring the support and protection of that role.

So it may be useful on this auspicious anniversary to engage the board on the Enron experience, in a couple of different ways. First, include an overview as part of formal director “onboarding” efforts. Second, have a board level conversation about expectations of oversight, and spotting operational and ethical warning signs. And third, reconsider the Enron board’s critical and self-admitted failures, in the context of today’s boardroom culture. [13]

Such a conversation would be a powerful demonstration of a board’s good-faith commitment to effective governance, corporate responsibility and leadership ethics.

1 Bethany McLean, “Is Enron Overpriced?” Fortune, March 5. 2001. https://archive.fortune.com/magazines/fortune/fortune_archive/2001/03/05/297833/index.htm. (go back)

2 See , Michael W. Peregrine, Corporate BoardMember , Second Quarter 2016 (henceforth “Corporate BoardMember”). (go back)

3 See , e.g., Elson and Gyves, In Re Caremark : Good Intentions, Unintended Consequences, 39 Wake Forest Law Review, 691 (2004). (go back)

4 Report of the Special Investigation Committee of the Board of Directors of Enron Corporation, February 1, 2002. http://i.cnn.net/cnn/2002/LAW/02/02/enron.report/powers.report.pdf. (go back)

5 See , Michael W. Peregrine, “The Corporate Governance Legacy of the Powers Report” Corporate Counsel , January 23, 2012 Monday. (go back)

6 See , Michael W. Peregrine, “Enron Still Matters, 15 Years After Its Collapse”, The New York Times , December 1, 2016. (go back)

7 F.N. 5, supra . (go back)

8 See , Elson and Gyves, “The Enron Failure and Corporate Governance Reform”, 38 Wake Forest Law Review 855 (2003) and Elson, “Enron and the Necessity of the Objective Proximate Monitor”, 89 Cornell Law Review 496 (2004). (go back)

9 John Emshwiller and Rebecca Smith, “Enron Posts Surprise 3rd-Quarter Loss After Investment, Asset Write-Downs”, The Wall Street Journal , October 17, 2001. https://www.wsj.com/articles/SB1003237924744857040. (go back)

10 Dylan Tokar and Paul J. Davies, “Wirecard Red Flags Should Have Prompted Earlier Response, Former Executive Says” The Wall Street Journal , February 8, 2021. https://www.wsj.com/articles/wirecard-red-flags-should-have-prompted-earlier-response-former-execu tive-says-11612780200. (go back)

11 Corporate BoardMember , supra . (go back)

12 See Peregrine, “Why Enron Remains Relevant”, Harvard Law School Forum on Corporate Governance, December 2, 2016. (go back)

13 Corporate BoardMember , supra. (go back)

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How the Enron Scandal Changed American Business Forever

It’s the kind of historic anniversary few people really want to remember.

In early December 2001, innovative energy company Enron Corporation, a darling of Wall Street investors with $63.4 billion in assets, went bust. It was the largest bankruptcy in U.S. history. Some of the corporation’s executives, including the CEO and chief financial officer, went to prison for fraud and other offenses. Shareholders hit the company with a $40 billion lawsuit, and the company’s auditor, Arthur Andersen, ceased doing business after losing many of its clients.

It was also a black mark on the U.S. stock market. At the time, most investors didn’t see the prospect of massive financial fraud as a real risk when buying U.S.-listed stocks. “U.S. markets had long been the gold standard in transparency and compliance,” says Jack Ablin, founding partner at Cresset Capital and a veteran of financial markets. “That was a real one-two punch on credibility. That was a watershed for the U.S. public.”

The company’s collapse sent ripples through the financial system, with the government introducing a set of stringent regulations for auditors, accountants and senior executives, huge requirements for record keeping, and criminal penalties for securities laws violations. In turn, that has led in part to less choice for U.S. stock investors, and lower participation in stock ownership by individuals.

In other words, it was the little guy who suffered over the last two decades.

Americans lost trust in the stock market

The collapse of Enron gave many average Americans pause about investing. After all, if a giant like Enron could collapse, what investments could they trust? A significant number of Americans have foregone participating in the tremendous stock market gains seen over the last two decades. In 2020, a little more than half of the population (55%) owned stocks directly or through savings vehicles such as 401Ks and IRAs. That’s down from 60% in the year 2000, according to the Survey of Consumer Finances from the U.S. Federal Reserve.

That could have had a large financial impact on some folks. For instance, an investment of $1,000 in the S&P 500 at the beginning of 2000 would recently have been worth $4,710, including reinvested dividends. Wealthier people, who often employ professionals to handle their investments, were more likely to stick with their stocks, while middle class and poorer people couldn’t take the risk. Without doubt this drop in stock market participation has contributed to the growing levels of wealth inequality across the U.S.

It became harder for companies to IPO

While lack of trust in the market is a direct consequence of Enron’s mega fraud, the indirect consequences of government actions also seem to have hurt Main Street USA.

Immediately following the bankruptcy, Congress worked on the Sarbanes-Oxley legislation, which was meant to hold senior executives responsible for listed company financial statements. CEOs and CFOs are now held personally accountable for the truth of what goes on the income statement and balance sheet. The bill passed in 2002 and has been with us since. But it has also drawn harsh criticisms.

“The most important political response was Sarbanes-Oxley,” says Steve Hanke, professor of applied economics at Johns Hopkins University. “It was unnecessary, and it was harmful.”

In many ways, the legislation wasn’t needed because the Justice Department and the Securities Exchange Commission already had the powers to prosecute executives who cooked the financial books or at a minimum were less than transparent with the truth, Hanke says.

The direct result of the legislation was that public companies got dumped with a load of bureaucratic form-filling, and executives would be less likely to take on entrepreneurial risks, Hanke says. There is also much ambiguity in the law about what is or what isn’t allowed and what are the ultimate consequences of non-compliance. “You don’t know what you are facing in terms of penalties, so you back off of everything risky,” he says.

Quickly, that meant the stock market underwent two significant changes. First, fewer companies are listed now than since the 1970s. In 1996, during the dot-com bubble, there were 8,090 companies listed on stock exchanges in the U.S., according to data from the World Bank. That figure had fallen to 4,266 by 2019.

That drop was partially a reflection of the regulatory burden of companies wishing to go public, experts say. “It costs a lot of money to employ the securities attorneys needed for Sarbanes-Oxley,” says Robert Wright, a senior fellow at the American Institute of Economic Research and an economic historian. “Clearly, fewer companies can afford to meet all these requirements.”

Companies now wait under they are far larger before going public than they did before the Sarbanes-Oxley rules were introduced. Yahoo! went public with a market capitalization of $848 million in April 1996, and in 1995 Netscape got a valuation of $2.9 billion. Compare that to the $82 billion IPO valuation for ride share company Uber in 2019, or Facebook $104 billion IPO value in 2012.

Now, companies grow through investments that don’t require a public market listing and that don’t involve heavy bureaucratic costs. Instead, startups go to venture capital firms or private equity. The recent rise in the use of Special Acquisition Corporations (SPACs) is seen by some as a relatively easy way to skirt some of the burdensome regulations of listing stocks. However, SPACs do nothing to reduce ongoing costs or burden of complying with the Sarbanes-Oxley rules.

But when companies stay private longer, they spend more time without the public accountability required of listed companies. Former blood testing company Theranos famously remained private in a move some theorized was to avoid publicizing internal data. Because of the high barriers Sarbanes-Oxley placed on going public, the business world is now littered with large, private companies that don’t have to reveal their inner workings.

Delaying going public also affects Main Street because most individual investors cannot buy shares in companies that aren’t public. They haven’t been able to share in the profits from the speedy early-stage corporate growth that is typically seen in companies like Facebook and Uber.

Put simply, the Sarbanes-Oxley regulations have chased away some investing opportunities from the public market to the private ones. And in doing so have excluded small investors from participating—and gaining.

“Now smaller investors are shut out and all the big economic profits go to venture capitalists and the like,” Wright says. That, in many ways, is the legacy of Enron.

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The Enron Scandal (2001)

Both of these buildings in downtown Houston, 1400 Smith Street and 1500 Louisiana Street, were formerly occupied by Enron. A ugust 2021 marked the 20 th anniversary of arguably the most notorious corporate-accounting scandal of all time. It may not have been the biggest in dollar terms, or even the most severe in terms of criminality and personnel held culpable, but the Enron Corp. scandal of 2001 remains perhaps the most impactful of all time. One of the largest companies in the United States collapsed virtually overnight, with the fallout of its malfeasance being billions of dollars stolen, thousands of jobs wiped out, dozens of criminal convictions and even one incident of suicide.

Indeed, when Enron filed for bankruptcy protection on December 2, 2001, it was the largest company to do so in US history until that point in time. It was also once the world’s largest energy-trading company, with a market value of up to $68 billion, before its collapse destroyed thousands of jobs and more than $2 billion in pension plans. The shockwaves the scandal sent across capital markets were seismic, shaking investor confidence to its core and changing the corporate and regulatory landscapes forever.

Jeffrey Keith Skilling was CEO of Enron Corporation at the time of the Enron scandal.

Enron was born in 1985 as a result of the merger between Houston Natural Gas Company and InterNorth Inc., with the chief executive officer (CEO) of Houston, Kenneth Lay, taking the reins of the newly formed entity. By 1990, Lay had hired Jeffrey K. (Jeff) Skilling, a partner at consulting firm McKinsey, which at the time was advising Enron. Two years later, Skilling had created a new accounting technique called mark-to-market (MTM) accounting, which was granted formal approval by the U.S. Securities and Exchange Commission (SEC) in 1992.

MTM accounting enables a company to adjust the value of its balance-sheet assets from their historical value to the current fair market value (FMV), and thus means that income can be calculated as an estimate of the present value of net future cash flow. Should a contract be worth $100 million over the coming 10 years, for instance, MTM accounting would enable a company to write $100 million in its books on the day the contract was signed, irrespective of whether the deal ultimately matched expectations. As such, Enron was able to inflate its present-day worth through its financial statements, substantially over and above what it had actually earned, and thus obfuscate the truth about its business performance.

This was perhaps no more clearly illustrated than when Enron Broadband Services, a subsidiary of Enron, partnered with Blockbuster in July 2000 in a 20-year deal to sell movie-on-demand services through its broadband network. In the pre-Netflix era, the prospect of delivering movies to people’s computers or televisions via broadband was a new and exciting one. And using MTM accounting meant that Enron could book all 20 years of forward projections from the deal—in this case, $110 million of estimated profit—to its financial statements for the mid-year 2000.

But the partnership ended up being terminated after movie studios expressed their opposition to Blockbuster providing such services. The failed deal and Blockbuster’s withdrawal, however, did not stop Enron from continuing to claim future profits and thus sell shares of the company at hugely inflated prices, despite the deal resulting in a loss. Arguably, this was the first major incident to kick off the external scrutiny into Enron’s dealings and its questionable MTM practices.

Eventually, the unit CEO, Joseph Hirko, and vice presidents F. Scott Yeager and Rex Shelby were charged with conspiracy, fraud, insider trading and money laundering related to those practices. And Kevin Howard, the former chief financial officer (CFO), and Michael W. Krautz, a former senior director of accounting, of Enron Broadband Services were charged with conspiracy and fraud tied to the fabrication of earnings stemming from the failed Blockbuster deal.

The company also used accounting tricks to misclassify loan transactions as revenues just before quarterly financial-reporting dates. For instance, they entered into a deal with Merrill Lynch in which the US bank bought Nigerian barges with a buyback guarantee from Enron just before its earnings deadline. Enron misreported this bridge loan as a true sale before buying the barges back a few months later. Merrill Lynch was eventually held culpable in November for its role in assisting Enron in its accounting fraud, with some of the bank’s executives spending almost a year in prison.

Special purpose entities (SPEs) played a significant role in Enron’s misdeeds. Dubbed as the “Raptors”, these SPEs were created by the company—specifically by CFO Andrew Fastow with the apparent blessing of Skilling, Lay and the board of directors—to protect itself against MTM losses from its equity investments. Once these stocks began performing poorly, Enron “sold” them into the Raptors—LJM Cayman. L.P. (LJM1) and LJM2 Co-Investment L.P. (LJM2)—to shore up the appearance of its financial statements. In other words, LJM1 and LJM2 were created purely for the purpose of acting as the external equity investor required for the SPEs being used by Enron.

Fastow stated much of this when he testified before the U.S. Congress in the aftermath of the scandal and also confirmed that he himself stood to “benefit greatly from the partnerships”; indeed, he ended up pocketing some $45 million in the profit from his activity. In January 2004, he pleaded guilty to two counts of fraud, agreed to a prison term of up to 10 years and forfeited $24 million. “I was being a hero for Enron,” he said repeatedly during the testimony. “We were using this to inflate our earnings.”

According to the US government, Enron’s board also approved moving an affiliated company, Whitewing, off the books while guaranteeing its debt with $1.4 billion in Enron’s stock and helping it obtain funding to purchase Enron’s assets. “From the Raptor transactions, and numerous others described in the Powers Report, Congressional testimony, and newspaper reports, Enron may have paid out well over $300 million—in the form of cash, investments, and Enron stock—to advisors and SPE equity holders in order to sustain its network of off–balance sheet financing entities,” noted The CPA Journal in 2003. “By comparison, the Financial Accounting Foundation spent just $22 million to generate and maintain its FASB [Financial Accounting Standards Board] and GASB [Government Accounting Standards Board] standards-setting programs. As a result, it is not difficult to see how determined companies can run rings around GAAP [generally accepted accounting principles], exploiting technicalities and loopholes to create financial statements that even the most sophisticated investors cannot understand.”

In terms of Enron’s path towards bankruptcy, the failed Blockbuster deal kicked off a gradually expanding wave of scrutiny into the company’s accounts from the financial press. The Texas Journal ran a story in September 2000 about the shortfalls and lack of transparency surrounding the MTM accounting techniques being increasingly adopted by the energy industry. The following March, the Fortune article “Is Enron Overpriced?” questioned the company’s stock valuation and posited that investors were unaware of how exactly Enron made money, while concerns voiced by the article’s author, Bethany McLean, were dismissed by Skilling when she tried to discuss her findings with him before publishing the article. And perhaps most infamously, on a conference call with Wall Street analyst Richard Grubman who pressed him into explaining more about Enron’s accounting practices, Skilling retorted, “Well uh…. Thank you very much, we appreciate it…. Asshole.” The response was met with considerable astonishment from the public.

By late October, following mounting complaints from analysts over the opacity of Enron’s financial statements, ratings agency Moody’s had lowered Enron’s credit rating to just two levels above junk status. A few days later, it was revealed to the public that the SEC had begun a formal investigation into Enron and its dealings with “related parties”.

By late November 2001, Enron’s stock price had plunged to less than $1 per share, in stark contrast to its mid-2000 peak of $90.75. The company was estimated to have $23 billion in liabilities from both outstanding debts and guaranteed loans, raising speculation that it would have to declare bankruptcy. Enron Europe, the holding company for Enron’s operations in Continental Europe, was the first to do so on November 30, a day before the board voted unanimously to file for Chapter 11 protection for the rest of the company.

At $63.4 billion in total assets, Enron’s was the largest corporate bankruptcy in US history until the WorldCom scandal just one year later. Around 4,000 jobs were lost, and almost two-thirds of the 15,000 employees’ savings plans that depended on Enron stock, which had been purchased at $83 at the start of the year, became worthless.

Additional fallout from the scandal was most directly suffered by Enron’s accounting firm, Arthur Andersen, which earned $52 million in audit and consulting fees in 2000, more than one-quarter of total audit fees generated by the company’s Houston office clients. Andersen was accused of failing to apply sufficient standards during its audits of Enron’s books and conducting itself in a way to simply receive its fees without sufficiently examining Enron’s accounting practices.

“When confronted by evidence of Enron’s high-risk accounting, all of the Board members interviewed by the Subcommittee pointed out that Enron’s auditor, Andersen, had given the company a clean audit opinion each year,” the US Senate found . “None recalled any occasion on which Andersen had expressed any objection to a particular transaction or accounting practice at Enron, despite evidence indicating that, internally at Andersen, concerns about Enron’s accounting were commonplace. But a failure by Andersen to object does not preclude a finding that the Enron Board, with Andersen’s concurrence, knowingly allowed Enron to use high risk accounting and failed in its fiduciary duty to ensure the company engaged in responsible financial reporting.”

Sherron Watkins (left), Vice President of Corporate Development for the Enron Corporation, Skilling attorney Bruce Hiler (middle), and Jeffrey Skilling (right), former CEO of Enron, during the Senate Commerce hearing on the company’s bankruptcy | Photo Credit: Ferrell, Scott J – Library of Congress

It was eventually revealed that several conflicts of interest arose between Andersen and Enron. For example, Andersen’s Houston office, which conducted the audits, had the power to overrule any criticism levelled at Enron’s accounting practices by Andersen’s Chicago partner. It was also discovered that Enron’s management had applied considerable pressure on Andersen’s auditors to meet its earnings expectations. For instance, it would briefly hire other accounting companies to conduct some accounting tasks and thus give the impression that it would replace Andersen. The shredding of almost 30,000 e-mails and other files after Enron’s malpractice was made public also raised suspicion of widespread collusion between the two parties.

Ultimately, Andersen’s involvement with Enron caused the accounting firm to break up, again leading to thousands of job losses. “The evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enron’s financial statements, or its obligation to bring to the attention of Enron’s Board (or the Audit and Compliance Committee) concerns about Enron’s internal contracts over the related-party transactions,” according to the (William C.) Powers Committee, which was appointed by Enron’s board to review its accounting practices in October 2001.

The 2002 enactment of the Sarbanes-Oxley Act did strengthen the oversight of accountants; reduced the potential for conflicts of interests faced by auditors, specifically by barring them from providing various consulting services to audit clients; and enhanced the SEC’s enforcement tools.

But it wasn’t until February 2004 that the SEC finally indicted Skilling, charging him with “violating, and aiding and abetting violations of, the antifraud, lying to auditors, periodic reporting, books and records, and internal controls provisions of the federal securities laws”.

“In this scandal, as in others, we are by now all too familiar with executives who bask in the attention that follows the appearance of corporate success, but who then shout their ignorance when the appearance gives way to the reality of corruption,” Stephen M. Cutler, director of the SEC’s Enforcement Division, said at the time. “Let there be no mistake that today’s enforcement action against Mr. Skilling places accountability exactly where it belongs.”

A federal jury in 2006 convicted him on 19 out of 28 criminal counts, including fraud, conspiracy and insider trading. He was sentenced to 24 years in prison and ordered to forfeit $45 million. Lay was convicted of all six counts of securities and wire fraud for which he had been tried, but he died in July 2006 before serving his sentence of potentially up to 45 years behind bars.

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The Fall of Enron

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In 1999, Enron was the #1 company in innovation and quality of management. Less than two years later, it filed for bankruptcy in one of the most portent fraud cases of the decade. The story of…

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In 1999, Enron was the #1 company in innovation and quality of management. Less than two years later, it filed for bankruptcy in one of the most portent fraud cases of the decade. The story of Enron's rise and fall tells a lot about manipulation of accounting and regulatory standards and about the disregard of ethics and law in pursuit of money and excellence. Against the backdrop of the company's history and main players, the case explains the law-bending tactics used by Enron's management and partners, eventually leading to speculations and the resignation of then-CEO Jeff Skilling. The stock price crash and resulting bankruptcy are also discussed, and the profile ends with the main findings of the ensuing SEC investigation. This case is included in Module 3 of the course Business Thought & Action.

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After discussing this case study, students will be able to:

1.) Describe the corporate history of Enron from its founding until its bankruptcy.

2.) Assess how the company's corporate governance model contributed to the company's eventual failure.

Mar 17, 2010

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Business Ethics

Geographies:

United States

Industries:

Energy and natural resources sector

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What Was Enron?

Understanding enron, the enron scandal.

Mark-to-Market Accounting

What Happened to Enron

The Role of Enron's CEO

The Legacy of Enron

The bottom line.

Company Profiles
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What Was Enron? What Happened and Who Was Responsible

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Investopedia / Daniel Fishel

Enron was an energy-trading and utility company based in Houston, Texas, that perpetrated one of the biggest accounting frauds in history. Enron's executives employed accounting practices that falsely inflated the company's revenues and, for a time, made it the seventh-largest corporation in the United States. Once the fraud came to light, the company quickly unraveled, filing for Chapter 11 bankruptcy in December 2001.

Key Takeaways

Enron was an energy company that began to trade extensively in energy derivatives markets.
The company hid massive trading losses, ultimately leading to one of the largest accounting scandals and bankruptcy in recent history.
Enron executives used fraudulent accounting practices to inflate the company's revenues and hide debt in its subsidiaries.
The SEC, credit rating agencies, and investment banks were also accused of negligence—and, in some cases, outright deception—that enabled the fraud.
As a result of Enron, Congress passed the Sarbanes-Oxley Act to hold corporate executives more accountable for their company's financial statements.

Enron was an energy company formed in 1986 following a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. After the merger, Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chair.

Lay quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices. In 1990, Lay created the Enron Finance Corporation and appointed Jeffrey Skilling, whose work as a McKinsey & Company consultant had impressed Lay, to head the new corporation. Skilling was then one of the youngest partners at McKinsey.

Enron provided a variety of energy and utility services around the world. Its company divided operations in several major departments, including:

Enron Online : In late 1999, Enron built its web-based system to enhance customer functionality and market reach.
Wholesale Services : Enron offered various energy delivery solutions, with its most robust industry being natural gas. In North America, Enron claimed to deliver almost double the amount of electricity compared to its second tier of competition.
Energy Services : Enron's retail unit provided energy around the world, including in Europe, where it expanded retail operations in 2001.
Broadband Services : Enron provided logistical service solutions between content providers and last-mile energy distributors.
Transportation Services : Enron developed an innovative, efficient pipeline operation to network capabilities and operate pooling points to connect to third parties.

However, by leveraging special purpose vehicles, special purpose entities, mark-to-market accounting, and financial reporting loopholes, Enron became one of the most successful companies in the world. Upon discovery of the fraud, the company subsequently collapsed. Enron shares traded as high as $90.75 before the fraud was discovered but plummeted to around $0.26 in the sell-off after it was revealed.

The former Wall Street darling quickly became a symbol of modern corporate crime. Enron was one of the first big-name accounting scandals, but uncovered frauds at other companies such as WorldCom and Tyco International soon followed.

Before coming to light, Enron was internally fabricating financial records and falsifying the success of its company. Though the entity did achieve operational success during the 1990s, the company's misdeeds were finally exposed in 2001.

Pre-Scandal

Leading up to the turn of the millennium, Enron's business appeared to be thriving. The company became the largest natural gas provider in North America in 1992, and the company launched EnronOnline, its trading website allowing for better contract management just months before 2000. The company also rapidly expanded into international markets, led by the 1998 merger with Wessex Water.

Enron's stock price mostly followed the S&P 500 for most of the 1990's. However, expectations for the company began to soar. In 1999, the company's stock increased 56%. In 2000, it increased an additional 87%. Both returns widely beat broad market returns, and the company soon traded at a 70x price-earnings ratio.

Early Signs of Trouble

In February 2001, Kenneth Lay stepped down as Chief Executive Officer and was replaced by Jeffrey Skilling. A little more than six months later, Skilling stepped down as CEO in August 2001, with Lay taking over the role again.

Around this time, Enron Broadband reported massive losses. Lay revealed in the company's Q2 2001 earnings report that "...in contrast to our extremely strong energy results, this was a difficult quarter in our broadband businesses." In this quarter, the Broadband Services department reported a financial loss of $102 million.

Also, around this time, Lay sold 93,000 shares of Enron stock for roughly $2 million while telling employees via e-mail to continue buying the stock and predicting significantly higher stock prices. In total, Lay was eventually found to have sold over 350,000 Enron shares for total proceeds greater than $20 million.

During this time, Sherron Watkins had expressed concerns regarding Enron's accounting practices. A Vice President for Enron, she wrote an anonymous letter to Lay expressing her concerns. Watkins and Lay eventually met to discuss the matters, in which Watkins delivered a six-page report detailing her concerns. The concerns were presented to an outside law firm in addition to Enron's accounting firm; both agreed there were no issues to be found.

By October 2001, Enron had reported a third quarter loss of $618 million. Enron announced it would need to restate its financial statements from 1997 to 2000 to correct accounting violations.

Enron's $63.4 billion bankruptcy was the biggest on record at the time.

On Nov. 28, 2001, credit rating agencies reduced Enron's credit rating to junk status, effectively solidifying the company's path to bankruptcy. On the same day, Dynegy, a fellow energy company Enron was attempting to merge with, decided to nix all future conversations and opted against any merger agreement. By the end of the day, Enron's stock price had dropped to $0.61.

Enron Europe was the first domino, filing for bankruptcy after close of business on Nov. 30. The rest of Enron followed suit on Dec. 2. Early the following year, Enron dismissed Arthur Andersen as its auditor , citing that the auditor had yielded advice to shred evidence and destroy documents.

In 2006, the company sold its last business, Prisma Energy. The next year, the company changed its name to Enron Creditors Recovery Corporation with the intention of repaying any remaining creditors and open liabilities as part of the bankruptcy process.

Post Bankruptcy/Criminal Charges

After emerging from bankruptcy in 2004, the new board of directors sued 11 financial institutions involved in helping conceal the fraudulent business practices of Enron executives. Enron collected nearly $7.2 billion from these financial institutions as part of legal settlements. The banks included the Royal Bank of Scotland, Deutsche Bank, and Citigroup.

Kenneth Lay pleaded not guilty to eleven criminal charges. He was convicted of six counts of securities and wire fraud and was subject to a maximum of 45 years in prison. However, Lay died on July 5, 2006, before sentencing was to occur.

Jeff Skilling was convicted on 19 of the 28 counts of securities fraud he was charged with, in addition to other charges of insider trading. He was sentenced to 24 years and four months in prison, though the U.S. Department of Justice reached a deal with Skilling in 2013. The deal resulted in 10 years being cut off of his sentence.

Andy Fastow and his wife, Lea, pleaded guilty to charges against them, including money laundering, insider trading, fraud, and conspiracy. Fastow was sentenced to 10 years without parole to testify against other Enron executives. Fastow has since been released from prison.

Causes of the Enron Scandal

Enron went to great lengths to enhance its financial statements, hide its fraudulent activity, and report complex organizational structures to both confuse investors and conceal facts. The causes of the Enron scandal include but are not limited to the factors below.

Special Purpose Vehicles

Enron devised a complex organizational structure leveraging special purpose vehicles (or special purpose entities). These entities would "transact" with Enron, allowing Enron to borrow money without disclosing the funds as debt on their balance sheet.

SPVs provide a legitimate strategy that allows companies to temporarily shield a primary company by having a sponsoring company possess assets. Then, the sponsor company can theoretically secure cheaper debt than the primary company (assuming the primary company may have credit issues). There are also legal protection and taxation benefits to this structure.

The primary issue with Enron was the lack of transparency surrounding the use of SPVs. The company would transfer its own stock to the SPV in exchange for cash or a note receivable. The SPV would then use the stock to hedge an asset against Enron's balance sheet. Once the company's stock started losing its value, it no longer provided sufficient collateral that could be exploited by being carried by an SPV.

Inaccurate Financial Reporting Practices

Enron inaccurately depicted many contracts or relationships with customers. By collaborating with external parties such as its auditing firm, it was able to record transactions incorrectly, not only in accordance with GAAP but also not in accord with agreed-upon contracts.

For example, Enron recorded one-time sales as recurring revenue. In addition, the company would intentionally maintain an expired deal or contract through a specific period to avoid recording a write-off during a given period.

Poorly Constructed Compensation Agreements

Many of Enron's financial incentive agreements with employees were driven by short-term sales and quantities of deals closed (without consideration for the long-term validity of the deal). In addition, many incentives did not factor in the actual cash flow from the sale. Employees also received compensation tied to the success of the company's stock price, while upper management often received large bonuses tied to success in financial markets.

Part of this issue was the rapid rise of Enron's equity success. On Dec. 31, 1999, the stock closed at $44.38. Just three months later, it closed on March 31, 2000 at $74.88. With the stock hitting $90 by the end of 2000, the massive profits some employees received only fueled further interest in obtaining equity positions in the company.

Lack of Independent Oversight

Many external parties learned about Enron's fraudulent practices, but their financial involvement with the company likely caused them not to intervene. Enron's accounting firm, Arthur Andersen, received many jobs and financial compensation in return for their services.

Investment bankers collected fees from Enron's financial deals. Buy-side analysts were often compensated to promote specific ratings in exchange for stronger relationships between Enron and those institutions.

Unrealistic Market Expectations

Both Enron Energy Services and Enron Broadband were poised to be successful due to the emergence of the internet and heightened retail demand. However, Enron's over-optimism resulted in the company over-promising online services and timelines that were simply unrealistic.

Poor Corporate Governance

The ultimate downfall of Enron was the result of overall poor corporate leadership and corporate governance . Former Vice President of Corporate Development Sherron Watkins is noted for speaking out about various financial treatments as they were occurring. However, top management and executives intentionally disregarded and ignored concerns. This tone from the top set the precedent across accounting, finance, sales, and operations.

In the early 1990s, Enron was the largest seller of natural gas in North America. Ten years later, the company no longer existed due to its accounting scandal.

The Role of Mark-to-Market Accounting

One additional cause of the Enron collapse was mark-to-market accounting. Mark-to-market accounting is a method of evaluating a long-term contract using fair market value. At any point, the long-term contract or asset could fluctuate in value; in this case, the reporting company would simply "mark" its financial records up or down to reflect the prevailing market value .

There are two conceptual issues with mark-to-market accounting, both of which Enron took advantage of. First, mark-to-market accounting relies very heavily on management estimation. Consider long-term, complex contracts requiring the international distribution of several forms of energy. Because these contracts were not standardized, it was easy for Enron to artificially inflate the value of the contract because it was difficult to determine the market value appropriately.

Second, mark-to-market accounting requires companies to periodically evaluate the value and likelihood that revenue will be collected. Should companies fail to continually evaluate the value of the contract, it may easily overstate the expected revenue to be collected.

For Enron, mark-to-market accounting allowed the firm to recognize its multi-year contracts upfront and report 100% of income in the year the agreement was signed, not when the service would be provided or cash collected. This form of accounting allowed Enron to report unrealized gains that inflated its income statement, allowing the company to appear much more profitable than it was.

The Enron bankruptcy, at $63.4 billion in assets, was the largest on record at the time. The company's collapse shook the financial markets and nearly crippled the energy industry. While high-level executives at the company concocted the fraudulent accounting schemes, financial and legal experts maintained that they would never have gotten away with it without outside assistance. The Securities and Exchange Commission (SEC), credit rating agencies, and investment banks were all accused of having a role in enabling Enron's fraud.

Initially, much of the finger-pointing was directed at the SEC, which the U.S. Senate found complicit for its systemic and catastrophic failure of oversight. The Senate's investigation determined that had the SEC reviewed any of Enron's post-1997 annual reports, it would have seen the red flags and possibly prevented the enormous losses suffered by employees and investors.

The credit rating agencies were found to be equally complicit in their failure to conduct proper due diligence before issuing an investment-grade rating on Enron's bonds just before its bankruptcy filing. Meanwhile, the investment banks—through manipulation or outright deception—had helped Enron receive positive reports from stock analysts, which promoted its shares and brought billions of dollars of investment into the company. It was a quid pro quo in which Enron paid the investment banks millions of dollars for their services in return for their backing.

Enron reported total company revenue of:

$13.2 billion in 1996
$20.3 billion in 1997
$31.2 billion in 1998
$40.1 billion in 1999
$100.8 billion in 2000

The Role of Enron's CEO

By the time Enron started to collapse, Jeffrey Skilling was the firm's CEO. One of Skilling's key contributions to the scandal was to transition Enron's accounting from a traditional historical cost accounting method to mark-to-market accounting, for which the company received official SEC approval in 1992.

Skilling advised the firm's accountants to transfer debt off Enron's balance sheet to create an artificial distance between the debt and the company that incurred it. Enron continued to use these accounting tricks to keep its debt hidden by transferring it to its subsidiaries on paper. Despite this, the company continued to recognize revenue earned by these subsidiaries. As such, the general public and, most importantly, shareholders were led to believe that Enron was doing better than it actually was despite the severe violation of GAAP rules.

Skilling abruptly quit in August 2001 after less than a year as chief executive—four months before the Enron scandal unraveled. According to reports, his resignation stunned Wall Street analysts and raised suspicions despite his assurances that his departure had "nothing to do with Enron."

Skilling and Kenneth Lay were tried and found guilty of fraud and conspiracy in 2006. Other executives plead guilty. Lay died shortly after his conviction, and Skilling served twelve years, by far the longest sentence of any of the Enron defendants.

In the wake of the Enron scandal, the term " Enronomics " came to describe creative and often fraudulent accounting techniques that involve a parent company making artificial, paper-only transactions with its subsidiaries to hide losses the parent company has suffered through other business activities.

Parent company Enron had hidden its debt by transferring it (on paper) to wholly-owned subsidiaries —many of which were named after Star Wars characters—but it still recognized revenue from the subsidiaries, giving the impression that Enron was performing much better than it was.

Another term inspired by Enron's demise was "Enroned," slang for having been negatively affected by senior management's inappropriate actions or decisions. Being "Enroned" can happen to any stakeholder, such as employees, shareholders, or suppliers. For example, if someone lost their job because their employer was shut down due to illegal activities they had nothing to do with, they have been "Enroned."

As a result of Enron, lawmakers put several new protective measures in place. One was the Sarbanes-Oxley Act of 2002, which enhances corporate transparency and criminalizes financial manipulation. The Financial Accounting Standards Board (FASB) rules were also strengthened to curtail the use of questionable accounting practices, and corporate boards were required to take on more responsibility as management watchdogs.

What Did Enron Do That Was So Unethical?

Enron used special purpose entities to hide debt and mark-to-market accounting to overstate revenue. In addition, it ignored internal advisement against these practices, knowing that its publicly disclosed financial position was incorrect.

How Big was Enron?

With shares trading for around $90/each, Enron was once worth about $70 billion. Leading up to its bankruptcy, the company employed over 20,000 employees. The company also reported over $100 billion of company-wide net revenue (though this figure has since been determined to be incorrect).

Who Was Responsible for the Collapse of Enron?

Several key executive team members are often noted as being responsible for the fall of Enron. The executives include Kenneth Lay (founder and former Chief Executive Officer), Jeffrey Skilling (former Chief Executive officer replacing Lay), and Andrew Fastow (former Chief Financial Officer).

Does Enron Exist Today?

As a result of its financial scandal, Enron ended its bankruptcy in 2004. The name of the entity officially changed to Enron Creditors Recovery Corp., and the company's assets were liquidated and reorganized as part of the bankruptcy plan. Its last business, Prisma Energy, was sold in 2006.

At the time, Enron's collapse was the biggest corporate bankruptcy ever to hit the financial world (since then, the failures of WorldCom, Lehman Brothers, and Washington Mutual have surpassed it). The Enron scandal drew attention to accounting and corporate fraud. Its shareholders lost tens of billions of dollars in the years leading up to its bankruptcy, and its employees lost billions more in pension benefits. Increased regulation and oversight have been enacted to help prevent corporate scandals of Enron's magnitude.

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Page 56.

University of Chicago. " Enron Annual Report 2000 ."

Wall Street Journal. " Enron Announces Acquisition of Wessex Water for $2.2 Billion ."

University of Missouri, Kansas City. " Enron Historical Stock Price ."

The New York Times. " Enron Chairman Kenneth Lay Resigns, Company Says ."

University of Chicago. " Enron Reports Second Quarter Earnings ."

U.S. Securities and Exchange Commission. " SEC Charges Kenneth L. Lay, Enron's Former Chairman and Chief Executive Officer, with Fraud and Insider Trading ."

U.S. Securities and Exchange Commission. " Form 10-Q, 9/30/2001, Enron Corp. "

GovInfo. " Enron and the Credit Rating Agencies ."

United States Bankruptcy Court. " Enron Corp. Bankruptcy Information ."

Blackstone. " Enron Announces Proposed Sale of Prisma Energy International Inc. "

GovInfo. " Enron Creditors Recovery Corp ."

JournalNow. " Judge OKs Billions to Enron Shareholders ."

United States Department of Justice. "Federal Jury Convicts Former Enron Chief Executives Ken Lay, Jeff Skilling on Fraud, Conspiracy and Related Charges ."

Federal Bureau of Investigation. " Former Enron Chief Financial Officer Andrew Fastow Pleads Guilty to Commit Securities and Wire Fraud, Agrees to Cooperate with Enron Investigation ."

University of North Carolina. " Enron Whistleblower Shares Lessons on Corporate Integrity ."

George Benston. " The Quality of Corporate Financial Statements and Their Auditors Before and After Enron ."

The New York Times. " Jeffrey Skilling, Former Enron Chief, Released After 12 Years in Prison ."

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PROFESSIONAL ISSUES

The Rise and Fall of Enron

When a company looks too good to be true, it usually is..

Management Accounting
Enterprise Risk Management
Forensic Services
Accounting & Reporting

If you’re like most, you’ve been astonished, disillusioned and angered as you learned of the meteoric rise and fall of Enron Corp. Remember the company’s television commercial of not so long ago, ending with the reverberating phrase, “Ask why, why, why?” That question is now on everyone’s lips. The Enron case is a dream for academics who conduct research and teach. For those currently or formerly involved with the company, such as creditors, auditors, the SEC and accounting regulators, it’s a nightmare that will continue for a long time.

Formal investigations of Enron are now under way, headed by the company’s board, the SEC, the Justice Department and Congress. The exact causes and details of the disaster may not be known for months. The purpose of this article is to summarize preliminary observations about the collapse, as well as changes in financial reporting, auditing and corporate governance that are being proposed in response by Big Five accounting firms, the AICPA and the SEC.

IN A WAY IT'S SIMPLE, IN A WAY IT'S NOT

On the surface, the motives and attitudes behind decisions and events leading to Enron’s eventual downfall appear simple enough: individual and collective greed born in an atmosphere of market euphoria and corporate arrogance. Hardly anyone—the company, its employees, analysts or individual investors—wanted to believe the company was too good to be true. So, for a while, hardly anyone did. Many kept on buying the stock, the corporate mantra and the dream. In the meantime, the company made many high-risk deals, some of which were outside the company’s typical asset risk control process. Many went sour in the early months of 2001 as Enron’s stock price and debt rating imploded because of loss of investor and creditor trust. Methods the company used to disclose (or creatively obscure) its complicated financial dealings were erroneous and, in the view of some, downright deceptive. The company’s lack of transparency in reporting its financial affairs, followed by financial restatements disclosing billions of dollars of omitted liabilities and losses, contributed to its demise. The whole affair happened under the watchful eye of Arthur Andersen LLP, which kept a whole floor of auditors assigned at Enron year-round.

THE BEGINNING PRESAGES THE END

In 1985, after federal deregulation of natural gas pipelines, Enron was born from the merger of Houston Natural Gas and InterNorth, a Nebraska pipeline company. In the process of the merger, Enron incurred massive debt and, as the result of deregulation, no longer had exclusive rights to its pipelines. In order to survive, the company had to come up with a new and innovative business strategy to generate profits and cash flow. Kenneth Lay, CEO, hired McKinsey & Co. to assist in developing Enron’s business strategy. It assigned a young consultant named Jeffrey Skilling to the engagement. Skilling, who had a background in banking and asset and liability management, proposed a revolutionary solution to Enron’s credit, cash and profit woes in the gas pipeline business: create a “gas bank” in which Enron would buy gas from a network of suppliers and sell it to a network of consumers, contractually guaranteeing both the supply and the price, charging fees for the transactions and assuming the associated risks. Thanks to the young consultant, the company created both a new product and a new paradigm for the industry—the energy derivative.

Lay was so impressed with Skilling’s genius that he created a new division in 1990 called Enron Finance Corp. and hired Skilling to run it. Under Skilling’s leadership, Enron Finance Corp. soon dominated the market for natural gas contracts, with more contacts, more access to supplies and more customers than any of its competitors. With its market power, Enron could predict future prices with great accuracy, thereby guaranteeing superior profits.

THE BEST, THE BRIGHTEST AND THE DREADED PRC

Skilling began to change the corporate culture of Enron to match the company’s transformed image as a trading business. He set out on a quest to hire the best and brightest traders, recruiting associates from the top MBA schools in the country and competing with the largest and most prestigious investment banks for talent. In exchange for grueling schedules, Enron pampered its associates with a long list of corporate perks, including concierge services and a company gym. Skilling rewarded production with merit-based bonuses that had no cap, permitting traders to “eat what they killed.”

One of Skilling’s earliest hires in 1990 was Andrew Fastow, a 29-year-old Kellogg MBA who had been working on leveraged buyouts and other complicated deals at Continental Illinois Bank in Chicago. Fastow became Skilling’s protg in the same way Skilling had become Lay’s. Fastow moved swiftly through the ranks and was promoted to chief financial officer in 1998. As Skilling oversaw the building of the company’s vast trading operation, Fastow oversaw its financing by ever more complicated means.

As Enron’s reputation with the outside world grew, the internal culture apparently began to take a darker tone. Skilling instituted the performance review committee (PRC), which became known as the harshest employee-ranking system in the country. It was known as the “360-degree review” based on the values of Enron—respect, integrity, communication and excellence (RICE). However, associates came to feel that the only real performance measure was the amount of profits they could produce. In order to achieve top ratings, everyone in the organization became instantly motivated to “do deals” and post earnings. Employees were regularly rated on a scale of 1 to 5, with 5s usually being fired within six months. The lower an employee’s PRC score, the closer he or she got to Skilling, and the higher the score, the closer he or she got to being shown the door. Skilling’s division was known for replacing up to 15% of its workforce every year. Fierce internal competition prevailed and immediate gratification was prized above long-term potential. Paranoia flourished and trading contracts began to contain highly restrictive confidentiality clauses. Secrecy became the order of the day for many of the company’s trading contracts, as well as its disclosures.

HOW HIGH THEY FLY

Coincidentally, but not inconsequentially, the U.S. economy during the 1990s was experiencing the longest bull market in its history. Enron’s corporate leadership, Lay excluded, comprised mostly young people who had never experienced an extended bear market. New investment opportunities were opening up everywhere, including markets in energy futures. Wall Street demanded double-digit growth from practically every venture, and Enron was determined to deliver.

In 1996 Skilling became Enron’s chief operating officer. He convinced Lay the gas bank model could be applied to the market for electric energy as well. Skilling and Lay traveled widely across the country, selling the concept to the heads of power companies and to energy regulators. The company became a major political player in the United States, lobbying for deregulation of electric utilities. In 1997 Enron acquired electric utility company Portland General Electric Corp. for about $2 billion. By the end of that year, Skilling had developed the division by then known as Enron Capital and Trade Resources into the nation’s largest wholesale buyer and seller of natural gas and electricity. Revenue grew to $7 billion from $2 billion, and the number of employees in the division skyrocketed to more than 2,000 from 200. Using the same concept that had been so successful with the gas bank, they were ready to create a market for anything that anyone was willing to trade: futures contracts in coal, paper, steel, water and even weather.

Perhaps Enron’s most exciting development in the eyes of the financial world was the creation of Enron Online (EOL) in October 1999. EOL, an electronic commodities trading Web site, was significant for at least two reasons. First, Enron was a counterparty to every transaction conducted on the platform. Traders received extremely valuable information regarding the “long” and “short” parties to each trade as well as the products’ prices in real-time. Second, given that Enron was either a buyer or a seller in every transaction, credit risk management was crucial and Enron’s credit was the cornerstone that gave the energy community the confidence that EOL provided a safe transaction environment. EOL became an overnight success, handling $335 billion in online commodity trades in 2000.

The world of technology opened up the Internet, and the IPO market for technology and broadband communications companies started to take off. In January 2000 Enron announced an ambitious plan to build a high-speed broadband telecommunications network and to trade network capacity, or bandwidth, in the same way it traded electricity or natural gas. In July of that year Enron and Blockbuster announced a deal to provide video on demand to customers throughout the world via high-speed Internet lines. As Enron poured hundreds of millions into broadband with very little return, Wall Street rewarded the strategy with as much as $40 on the stock price—a factor that would have to be discounted later when the broadband bubble burst. In August 2000 Enron’s stock hit an all-time high of $90.56, and the company was being touted by Fortune and other business publications as one of the most admired and innovative companies in the world.

THE ROLE OF MARK-TO-MARKET ACCOUNTING

Enron incorporated “mark-to-market accounting” for the energy trading business in the mid-1990s and used it on an unprecedented scale for its trading transactions. Under mark-to-market rules, whenever companies have outstanding energy-related or other derivative contracts (either assets or liabilities) on their balance sheets at the end of a particular quarter, they must adjust them to fair market value, booking unrealized gains or losses to the income statement of the period. A difficulty with application of these rules in accounting for long-term futures contracts in commodities such as gas is that there are often no quoted prices upon which to base valuations. Companies having these types of derivative instruments are free to develop and use discretionary valuation models based on their own assumptions and methods.

The Financial Accounting Standards Board’s (FASB) emerging issues task force has debated the subject of how to value and disclose energy-related contracts for several years. It has been able to conclude only that a one-size-fits-all approach will not work and that to require companies to disclose all of the assumptions and estimates underlying earnings would produce disclosures that were so voluminous they would be of little value. For a company such as Enron, under continuous pressure to beat earnings estimates, it is possible that valuation estimates might have considerably overstated earnings. Furthermore, unrealized trading gains accounted for slightly more than half of the company’s $1.41 billion reported pretax profit for 2000 and about one-third of its reported pretax profit for 1999.

CAPITALISM AT WORK

In the latter part of the 1990s, companies such as Dynegy, Duke Energy, El Paso and Williams began following Enron’s lead. Enron’s competitive advantage, as well as its huge profit margins, had begun to erode by the end of 2000. Each new market entrant’s successes squeezed Enron’s profit margins further. It ran with increasing leverage, thus becoming more like a hedge fund than a trading company. Meanwhile, energy prices began to fall in the first quarter of 2001 and the world economy headed into a recession, thus dampening energy market volatility and reducing the opportunity for the large, rapid trading gains that had formerly made Enron so profitable. Deals, especially in the finance division, were done at a rapid pace without much regard to whether they aligned with the strategic goals of the company or whether they complied with the company’s risk management policies. As one knowledgeable Enron employee put it: “Good deal vs. bad deal? Didn’t matter. If it had a positive net present value (NPV) it could get done. Sometimes positive NPV didn’t even matter in the name of strategic significance.” Enron’s foundations were developing cracks and Skilling’s house of paper built on the stilts of trust had begun to crumble.

RELATED PARTIES AND COMPLEX SPECIAL PURPOSE ENTITIES

In order to satisfy Moody’s and Standard & Poor’s credit rating agencies, Enron had to make sure the company’s leverage ratios were within acceptable ranges. Fastow continually lobbied the ratings agencies to raise Enron’s credit rating, apparently to no avail. That notwithstanding, there were other ways to lower the company’s debt ratio. Reducing hard assets while earning increasing paper profits served to increase Enron’s return on assets (ROA) and reduce its debt-to-total-assets ratio, making the company more attractive to credit rating agencies and investors.

Enron, like many other companies, used “special purpose entities” (SPEs) to access capital or hedge risk. By using SPEs such as limited partnerships with outside parties, a company is permitted to increase leverage and ROA without having to report debt on its balance sheet. The company contributes hard assets and related debt to an SPE in exchange for an interest. The SPE then borrows large sums of money from a financial institution to purchase assets or conduct other business without the debt or assets showing up on the company’s financial statements. The company can also sell leveraged assets to the SPE and book a profit. To avoid classification of the SPE as a subsidiary (thereby forcing the entity to include the SPE’s financial position and results of operations in its financial statements), FASB guidelines require that only 3% of the SPE be owned by an outside investor.

Under Fastow’s leadership, Enron took the use of SPEs to new heights of complexity and sophistication, capitalizing them with not only a variety of hard assets and liabilities, but also extremely complex derivative financial instruments, its own restricted stock, rights to acquire its stock and related liabilities. As its financial dealings became more complicated, the company apparently also used SPEs to “park” troubled assets that were falling in value, such as certain overseas energy facilities, the broadband operation or stock in companies that had been spun off to the public. Transferring these assets to SPEs meant their losses would be kept off Enron’s books. To compensate partnership investors for downside risk, Enron promised issuance of additional shares of its stock. As the value of the assets in these partnerships fell, Enron began to incur larger and larger obligations to issue its own stock later down the road. Compounding the problem toward the end was the precipitous fall in the value of Enron stock. Enron conducted business through thousands of SPEs. The most controversial of them were LJM Cayman LP and LJM2 Co-Investment LP, run by Fastow himself. From 1999 through July 2001, these entities paid Fastow more than $30 million in management fees, far more than his Enron salary, supposedly with the approval of top management and Enron’s board of directors. In turn, the LJM partnerships invested in another group of SPEs, known as the Raptor vehicles, which were designed in part to hedge an Enron investment in a bankrupt broadband company, Rhythm NetConnections. As part of the capitalization of the Raptor entities, Enron issued common stock in exchange for a note receivable of $1.2 billion. Enron increased notes receivable and shareholders’ equity to reflect this transaction, which appears to violate generally accepted accounting principles. Additionally, Enron failed to consolidate the LJM and Raptor SPEs into their financial statements when subsequent information revealed they should have been consolidated.

OBSCURE DISCLOSURES REVEALED

A very confusing footnote in Enron’s 2000 financial statements described the above transactions. Douglas Carmichael, the Wollman Distinguished Professor of Accounting at Baruch College in New York City, told the Wall Street Journal in November of 2001 that most people would be hard pressed to understand the effects of these disclosures on the financial statements, casting doubt on both the quality of the company’s earnings as well as the business purpose of the transaction. By April 2001 other skeptics arrived on the scene. A number of analysts questioned the lack of transparency of Enron’s disclosures. One analyst was quoted as saying, “The notes just don’t make sense, and we read notes for a living.” Skilling was very quick to reply with arrogant comments and, in one case, even called an analyst a derogatory name. What Skilling and Fastow apparently underestimated was that, because of such actions, the market was beginning to perceive the company with greater and greater skepticism, thus eroding its trust and the company’s reputation.

IT ALL COMES TUMBLING DOWN

In February 2001 Lay announced his retirement and named Skilling president and CEO of Enron. In February Skilling held the company’s annual conference with analysts, bragging that the stock (then valued around $80) should be trading at around $126 per share.

In March Enron and Blockbuster announced the cancellation of their video-on-demand deal. By that time the stock had fallen to the mid-$60s. Throughout the spring and summer, risky deals Enron had made in underperforming investments of various kinds began to unravel, causing it to suffer a huge cash shortfall. Senior management, which had been voting with its feet since August 2000, selling Enron stock in the bull market, continued to exit, collectively hundreds of millions of dollars richer for the experience. On August 14, just six months after being named CEO, Skilling himself resigned, citing “personal reasons.” The stock price slipped below $40 that week and, except for a brief recovery in early October after the sale of Portland General, continued its slide to below $30 a share.

Also in August, in an internal memorandum to Lay, a company vice-president, Sherron Watkins, described her reservations about the lack of disclosure of the substance of the related party transactions with the SPEs run by Fastow. She concluded the memo by stating her fear that the company might “implode under a series of accounting scandals.” Lay notified the company’s attorneys, Vinson & Elkins, as well as the audit partner at Enron’s auditing firm, Arthur Andersen LLP, so the matter could be investigated further. The proverbial “ship” of Enron had struck the iceberg that would eventually sink it.

On October 16 Enron announced its first quarterly loss in more than four years after taking charges of $1 billion on poorly performing businesses. The company terminated the Raptor hedging arrangements which, if they had continued, would have resulted in its issuing 58 million Enron shares to offset the company’s private equity losses, severely diluting earnings. It also disclosed the reversal of the $1.2 billion entry to assets and equities it had made as a result of dealings with these arrangements. It was this disclosure that got the SEC’s attention.

On October 17 the company announced it had changed plan administrators for its employees’ 401(k) pension plan, thus by law locking their investments for a period of 30 days and preventing workers from selling their Enron stock. The company contends this decision had in fact been made months earlier. However true that might be, the timing of the decision certainly has raised suspicions.

On October 22 Enron announced the SEC was looking into the related party transactions between Enron and the partnerships owned by Fastow, who was fired two days later. On November 8 Enron announced a restatement of its financial statements back to 1997 to reflect consolidation of the SPEs it had omitted, as well as to book Andersen’s recommended adjustments from those years, which the company had previously “deemed immaterial.” This restatement resulted in another $591 million in losses over the four years as well as an additional $628 million in liabilities as of the end of 2000. The equity markets immediately reacted to the restatement, driving the stock price to less than $10 a share. One analyst’s report stated the company had burned through $5 billion in cash in 50 days.

A merger agreement with smaller cross-town competitor Dynegy was announced on November 9, but rescinded by Dynegy on November 28 on the basis of Enron’s lack of full disclosure of its off-balance-sheet debt, downgrading Enron’s rating to junk status. On November 30 the stock closed at an astonishing 26 cents a share. The company filed for bankruptcy protection on December 2.

THE AFTERMATH

Unquestionably, the Enron implosion has wreaked more havoc on the accounting profession than any other case in U.S. history. Critics in the media, Congress and elsewhere are calling into question not only the adequacy of U.S. disclosure practices but also the integrity of the independent audit process. The general public still questions how CPA firms can maintain audit independence while at the same time engaging in consulting work, often for fees that dwarf those of the audit. Companies that deal in special purpose entities and complex financial instruments similar to Enron’s have suffered significant declines in their stock prices. The scandal threatens to undermine confidence in financial markets in the United States and abroad.

In a characteristic move, the SEC and the public accounting profession have been among the first to respond to the Enron crisis. Unfortunately, and sadly reminiscent of financial disasters in the 1970s and 1980s, this response will likely be viewed by investors, creditors, lawmakers and employees of Enron as “too little, too late.”

In an “op-ed” piece for the Wall Street Journal on December 11, SEC Chairman Harvey Pitt called the current outdated reporting and financial disclosure system the financial “perfect storm.” He stated that under the current quarterly and annual reporting system, information is often stale on arrival and mandated financial disclosures are often “arcane and impenetrable.” To reassure investors and restore confidence in financial reporting, Pitt called for a joint response from the public and private sectors that included, among other things,

A system of “current” disclosures, supplementing and updating quarterly and annual information with disclosure of material information on a real-time basis.
Public company disclosure of significant current “trend” and “evaluative” data in addition to historical information.
Identification of “most critical accounting principles” by all public companies in their annual reports.
More timely and responsive accounting standard setting on the part of the private sector.
An environment of cooperation between the SEC and registrants that encourages public companies and their auditors to seek advice on disclosure issues in advance.
An effective and transparent system of self-regulation for the accounting profession, subject to SEC’s rigorous, but nonduplicative, oversight.
More proactive oversight by audit committees who understand financial accounting principles as well as how they are applied.

The CEOs of the Big Five accounting firms made a joint statement on December 4 committing to develop improved guidance on disclosure of related party transactions, SPEs and market risks for derivatives including energy contracts for the 2001 reporting period. In addition, the Big Five called for modernization of the financial reporting system in the United States to make it more timely and relevant, including more nonfinancial information on entity performance. They also vowed to streamline the accounting standard-setting process to make it more responsive to the rapid changes that occur in a technology-driven economy.

Since the Enron debacle, the AICPA has been engaged in significant damage control measures to restore confidence in the profession, displaying the banner “Enron: The AICPA, the Profession, and the Public Interest” on its Web site. It has announced the imminent issuance of an exposure draft on a new audit standard on fraud (the third in five years), providing more specific guidance than currently found in SAS no. 82, Consideration of Fraud in a Financial Statement Audit . The Institute has also promised a revised standard on reviews of quarterly financial statements, as well as the issuance, in the second quarter of 2002, of an exposure draft of a standard to improve the audit process. These standards had already been on the drawing board as part of the AICPA’s response to the report of the Blue Ribbon Panel on Audit Effectiveness, issued in 2000.

In late December the AICPA issued a tool kit for auditors to use in identifying and auditing related party transactions. While it breaks no new ground, the tool kit provides, in one place, an overview of the accounting and auditing literature, SEC requirements and best practice guidance concerning related party transactions. It also includes checklists and other tools for auditors to use in gathering evidence and disclosing related party transactions.

In January the AICPA board of directors announced that it would cooperate fully with the SEC’s proposal for new rules for the peer review and disciplinary process for CPA firms of SEC registrants. The new system would be managed by a board, a majority of which would be public members, enhancing the peer review process for the largest firms and requiring more rigorous and continuous monitoring. The staff of the new board would administer the reviews. In protest, the Public Oversight Board informed Pitt that it would terminate its existence in March 2002, leaving the future peer review process in a state of uncertainty. The SEC and the AICPA are now engaged in talks with the POB to reassure the board it will continue to be a vital part of the peer review process in the future.

The AICPA has also approved a resolution to support prohibitions that would prevent audit firms from performing systems design and implementation as well as internal audit outsourcing for public audit clients. While asserting that it does not believe prohibition of these services will make audits more effective or prevent financial failures, the board has stated it feels the move is necessary to restore public confidence in the profession. These prohibitions were at the center of the controversy last year between the profession and the SEC under the direction of former Chairman Arthur Levitt. Big Five CPA firms and the AICPA lobbied heavily and prevailed in that controversy, winning the right to retain these services and being required only to disclose their fees.

The impact of Enron is now being felt at the highest levels of government as legislators engage in endless debate and accusation, quarreling over the influence of money in politics. The GAO has requested that the White House disclose documents concerning appointments to President George W. Bush’s Task Force on Energy, chaired by Vice-President Dick Cheney, former CEO of Halliburton. The White House has refused, and the GAO has filed suit, the first of its kind in history. Congressional investigations are expected to continue well into 2002 and beyond. Lawmakers are expected to investigate not only disclosure practices at Enron, but for all public companies, concerning SPEs, related party transactions and use of “mark-to-market” accounting.

Kenneth Lay resigned as Enron’s CEO, under pressure from creditor groups. Lay, Skilling and Fastow still have much to explain. In addition, Enron’s board of directors, and especially the audit committee, will be in the “hot seat” and rightfully so.

The Justice Department opened a criminal investigation and formed a national task force made up of federal prosecutors in Houston, San Francisco, New York and several other cities to investigate the possibility of fraud in the company’s dealings. Interestingly, to illustrate how far-reaching Enron’s ties are to government and political sources at all levels, U.S. Attorney General John Ashcroft, as well as his entire Houston office, disqualified themselves from the investigation because of either political, economic or family ties.

It appears that 2002 is shaping up to be a year of unprecedented changes for a profession that is already coping with an identity crisis.

WHERE WERE THE AUDITORS?

Arthur Andersen LLP, after settling two other massive lawsuits earlier in 2001, is preparing for a storm of litigation as well as a possible criminal investigation in the wake of the Enron collapse. Enron was the firm’s second-largest client. Andersen, who had the job not only of Enron’s external but also its internal audits for the years in question, kept a staff on permanent assignment at Enron’s offices. Many of Enron’s internal accountants, CFOs and controllers were former Andersen executives. Because of these relationships, as well as Andersen’s extensive concurrent consulting practice, members of Congress, the press and others are calling Andersen’s audit independence into question. Indeed, they are using the case to raise doubts about the credibility of the audit process for all Big Five firms who do such work.

So far, Andersen has acknowledged its role in the fiasco, while defending its accounting and auditing practices. In a Wall Street Journal editorial on December 4, as well as in testimony before Congress the following week, Joseph Berardino, CEO, was forthright in his views. He committed the firm to full cooperation in the investigations as well as to a leadership role in potential solutions.

Enron dismissed Andersen as its auditor on January 17, 2002, citing document destruction and lack of guidance on accounting policy issues as the reasons. Andersen countered with the contention that in its mind the relationship had terminated on December 2, 2001, the day the firm filed for Chapter 11 bankruptcy protection.

The fact that Andersen is no longer officially associated with Enron will, unfortunately, have little impact on forces now in place that may, in the eyes of some, determine the firm’s very future. Andersen is now under formal investigation by the SEC as well as various committees of both the U.S. Senate and House of Representatives of the U.S. Congress. To make matters worse for it, and to the astonishment of many, Andersen admitted it destroyed perhaps thousands of documents and electronic files related to the engagement, in accordance with “firm policy,” supposedly before the SEC issued a subpoena for them. The firm’s lawyers issued an internal memorandum on October 12 reminding employees of the firm’s document retention and destruction policies. The firm fired David B. Duncan, partner in charge of the Enron engagement, placed four other partners on leave and replaced the entire management team of the Houston office. Duncan invoked his Fifth Amendment rights against self-incrimination at a congressional hearing in January. Several other Andersen partners testified that Duncan and his staff acted in violation of firm policy. However, in view of the timing of the October 12 memorandum, Congress and the press are questioning whether the decision to shred documents extended farther up the chain of command. Andersen has suspended its firm policy for retention of records and asked former U.S. Senator John Danforth to conduct a comprehensive review of the firm’s records management policy and to recommend improvements.

In a move to bolster its image, Andersen also has retained former Federal Reserve Chairman Paul Volcker to lead an outside board that will advise it in making “fundamental change” in its audit process. Other members of the board include P. Roy Vagelos, former chairman and CEO of Merck & Co., and Charles A. Bowsher, current chairman of the Public Oversight Board, which disbanded in March. Volcker also named a seven-member advisory panel made up of prominent corporate and accounting executives that will review proposed reforms to the firm’s audit process.

Hindsight is so clear that it sometimes belies the complexity of the problem. Although fraud has not yet been proven to be a factor in Enron’s misstatements, some of the classic risk factors associated with management fraud outlined in SAS no. 82 are evident in the Enron case. Those include management characteristics, industry conditions and operating characteristics of the company. Although written five years ago, the list almost looks as if it was excerpted from Enron’s case:

Unduly aggressive earnings targets and management bonus compensation based on those targets.
Excessive interest by management in maintaining stock price or earnings trend through the use of unusually aggressive accounting practices.
Management setting unduly aggressive financial targets and expectations for operating personnel.
Inability to generate sufficient cash flow from operations while reporting earnings and earnings growth.
Assets, liabilities, revenues or expenses based on significant estimates that involve unusually subjective judgments such as…reliability of financial instruments.
Significant related party transactions.

These factors are common threads in the tapestry that is described of the environment leading to fraud. They were incorporated into SAS no. 82 on the basis of research into fraud cases of the 1970s and 1980s in the hope that auditors would learn from the past. Andersen will have to explain when and how it identified these factors, as well as how it responded and how it communicated with Enron’s board about them.

More important, Andersen will have to explain why it delayed notifying the SEC after learning of the internal Enron memo warning of problems. In addition, it will have to explain why the Houston office destroyed the thousands of documents related to the Enron audits for 1997 through 2000. Only time will tell, but it appears the firm is in serious trouble. In the end, and also characteristic of cases like this, the chief parties likely to benefit from this process are the attorneys.

THE HUMAN FACTOR

The Enron story has produced many victims, the most tragic of which is a former vice-chairman of the company who committed suicide, apparently in connection with his role in the scandal. Another 4,500 individuals have seen their careers ended abruptly by the reckless acts of a few. Enron’s core values of respect, integrity, communication and excellence stand in satirical contrast to allegations now being made public. Personally, I had referred several of our best and brightest accounting, finance and MBA graduates to Enron, hoping they could gain valuable experience from seeing things done right. These included a very bright training consultant who had lost her job in 2000 with a Houston consulting firm as a result of a reduction in force. She has lost her second job in 18 months through no fault of her own. Other former students still hanging on at Enron face an uncertain future as the company fights for survival.

The old saying goes, “Lessons learned hard are learned best.” Some former Enron employees are embittered by the way they have been treated by the company that was once “the best in the business.” Others disagree. In the words of one of my former students who is still hanging on: “Just for the record, my time and experience at Enron have been nothing short of fantastic. I could not have asked for a better place to be or better people to work with. Please, though, remember this: Never take customer and employee confidence for granted. That confidence is easy to lose and tough—to impossible—to regain.”

C. WILLIAM THOMAS, CPA, Ph.D. , is the J.E. Bush Professor of Accounting in the Hankamer School of Business at Baylor University in Waco. Mr. Thomas can be reached at [email protected] . This article originally appeared in the March/April 2002 issue of Today’s CPA , published by the Texas Society of CPAs.

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Solutions, Causes, & Conclusion: Enron Case Study

Welcome to our The Fall of Enron case study! Here, you will find the scandal timeline, company background, and a comprehensive conclusion. Enron case study will also reveal who was involved in the company’s downfall and how it could’ve been avoided.

Enron Case Study Introduction

Agency problem is one of the major challenges that shareholders face in their effort to maximize wealth through investment. One source of agency problems is associated with the existence of conflicts of interest. In an effort to increase their earnings, firms’ management teams engage in unethical practices such as financial irregularities. Additionally, they also implement operational strategies that aim at maximizing their firms’ profitability rather than the shareholders’ wealth.

Therefore, to better illustrate how the operational strategies implemented by firms’ management teams can cause a firm to collapse, this paper will evaluate causes, solutions, and conclusion of Enron scandal. More focus goes to the company background, cultural environment and the implemented management control. The paper also conducts an analysis of Enron’s ineffectiveness in implementing a strong organizational culture and its inefficient management control system. In conclusion, Enron case study will provide recommendations for Enron scandal.

Enron Case Study Background

The case illustrates the rise and collapse of Enron Corporation. Some of the salient features evident in the case include:

Factors that contributed to the rise of the company – These factors are clearly illustrated and explained. The case makes it evident that Enron’s collapse was due to inefficient control by the company’s Chief Executive Officer, Jeff Skilling.
The leadership style adopted by Jeff Skilling – Leadership style stands out as the major factor that contributed towards the emergence of an inefficient organizational culture.
Establishment of a “new economy”- Skilling laid more emphasis on transforming the firm from being an “old economy” to being a “new economy”. However, the leadership style he adopted had a negative impact on the firm’s effort to achieve its goal.
Management control system – The case cites inefficiency in controlling the activities of the employees, which comes out as a major cause that significantly contributed towards the firm’s failure.

Company attributes

Enron Corporation was energy and commodities trading company, which was formed in 1985 by Kenneth Lay. Its headquarters were located in Houston, in the US. The firm owned the most extensive natural gas pipeline in the US. In a quest to maximize its profitability, the firm ventured into the international market. In addition to its energy business, Enron also positioned itself as a giant with regard to water and wastewater management having ventured into the industry in 1998.

Upon its market entry, the firm gained global recognition courtesy of its strategic move with regard to its adoption of the “new economy” strategy. Enron’s management team appreciated the importance of diversification in an effort to maximize profitability. Consequently, the firm established numerous divisions.

Some of these divisions included online marketplace, transportation, wholesale, and broadband services. The firm’s decision to incorporate the concept of product and service diversification emanated from its founders’ focus on steering it towards maximizing the shareholders’ value.

Business strategy

The success of a firm depends on the effectiveness with which it formulates and implements business strategies. In the course of its operation, Enron adopted a business strategy that focused on attaining a high rate of expansion. Consequently, Enron incorporated a number of business strategies, which included internationalization and formation of mergers and acquisitions.

The firm’s success in the international market emanated from its ability to implement strategic practices such as acquisitions. For example, in 1987, Enron acquired Zond Corporation, a leader in wind-power, which provided an opportunity to venture into the renewable energy sector. The firm was very effective in venturing into the international market. In its internationalization strategy, one source of the firm’s success was its ability to formulate and implement effective international marketing campaigns.

Industry analysis using Porter’s five forces

Understanding industry characteristic is paramount in a firm’s efforts to formulate and implement competitive strategies. The porter’s model is one of the frameworks that are suitable in analyzing the intensity of competition, buyer and supplier bargaining power, degree of rivalry, and threat of entry of a particular industry.

The industry was experiencing an increment in threat of entry due to its profitability potential. New firms especially firms dealing in production of renewable energy were considering the possibility of venturing into the industry to exploit the presented profitability. The threat of entry was minimal given that there were minimal legal barriers. The emergence of renewable forms of energy significantly increased the threat of substitute.

Consumers were switching to renewable forms of energy. The intensity of competition led to an increment in the degree of industry rivalry. The various alternatives with regard to forms of energy significantly increased the buyers’ power. This aspect emanated from the fact that they could switch at a minimal cost. On the other hand, the suppliers’ bargaining power was low due to the large number of suppliers.

The Fall of Enron Case Study: SWOT Analysis

Pipeline infrastructure -The firm established an elaborate natural gas pipeline network in the United States. The firm’s name attained a relatively high credibility given that it ranked 7 th on the Fortune 500.

Positive reputation -In the course of its operation, Enron managed to attain and sustain positive reputation. Its strength also emanated from the fact that it had attained a monopolistic advantage over its competitors emanating from its large size. The firm achieved this goal by positioning itself as the largest energy provider in the US.

Human capital pool- A f irm’s ability to attain high competitive advantage relative to its competitors is directly impacted by the quality of its human capital. In its operation, Enron had been very effective in enhancing its employees’ skills, abilities, knowledge, and capabilities by undertaking comprehensive training and development.

Innovation- Enron’s management team appreciated the fact that it operated in a very dynamic industry. Consequently, it laid great emphasis on innovation in an effort to thrive. Its innovation ability enabled Enron to shift from natural gas and energy transportation to being a trading company. The firm specifically focused on other areas such as pulp and paper production, coal, steel, and communication business lines.

Marketing and value delivery- Since its establishment, Enron had been committed towards meeting the customers’ needs. Its ability to identify and deliver customer values played a significant role in enabling Enron to attain an optimal market position.

Failed board of directors- The firm’s board of directors did not execute its oversight role effectively, which stands out clearly in the face of its inability to monitor the firm’s operations through its committees. Additionally, the firm’s board of directors failed in enhancing moral and ethical practices within the firm. As a result, its auditors and employees engaged in unethical practices such as deceit.

Conflict of interest- The firm’s weakness also stands out given the inability of the management team to control conflicts of interest that occurred in various transactions that the firm engaged in during its existence. This aspect pushed the firm into great losses due to the persistent fraud, which further necessitated the firm’s collapse.

Opportunities

Public reputation -In the course of its operation, Enron developed a strong public reputation, which presents an opportunity that the firm could have exploited in the course of its operation. Consumers associated Enron with its ability to provide quality energy. Consequently, Enron could have exploited such public perception to expand its pipeline and other businesses. Additionally, Enron could have exploited the move by the government to deregulate the energy industry by venturing in other energy sectors. For example, the firm should have considered the possibility of venturing into production of clean energy. This move would have played a significant role in dealing with climate change challenges of the 21 st century and thus the firm’s reputation would have improved significantly.

Formation of mergers and acquisitions – Considering the prevailing economic environment, Enron should have improved its competitive advantage by seeking reputable firms in the industry to form mergers and acquisitions. Some of the potential partners that the firm should have focused on included firms dealing in production of clean energy. In the course of its operation, Enron gained sufficient experience informing mergers and acquisitions.

Terrorist threat – The threat of terrorism had become real to firms in different economic sectors. Terrorists were increasingly targeting major infrastructure in the US such as energy plants in an effort to sabotage the country’s economy. Therefore, the extensive natural gas pipeline that Enron had developed in the US could have attracted terrorists, and such an occurrence could have a significant impact on Enron’s operation.

Economic crisis- Due to the high rate of globalization, the US could not shield itself from the occurrence of another economic recession. The occurrence of a recession could have directly affected Enron because it derived a significant proportion of its revenue from household consumption.

Competition – In the course of its operation, Enron faced competition challenges emanating from the numerous firms in the US energy industry. The intense competition significantly increased the degree of rivalry within the industry. Consequently, most firms in the industry focused at formulating and implementing strategies that enhanced their ability to increase their market share. One of the strategies that the industry players were focusing on entails research and development.

Organizational culture

An organization’s culture has a significant impact on how its employees act. This aspect arises from the fact that the culture nurtured by a particular organization affects its traditions and customers coupled with how employees execute their duties and responsibilities. Firms develop their culture over time. Upon his entry into the company, Jeff Skilling intended to transform the company’s culture into a “New Economy”, and to achieve this goal, he focused on transforming the company into becoming an exemplary intellectual capital firm that would greatly delight the shareholders and stakeholders.

Consequently, Enron developed a culture that was characterized by intense regulation. This move significantly contributed towards the firm’s collapse. The firm’s management team believed that the culture it developed would foster its innovativeness and capacity to adapt.

Consequently, the firm recruited the most talented employees mostly composed of new university graduates such as MBA holders. The decision to recruit employees of such caliber hinged on the management teams’ emphasis on entrepreneurial thinking and risk taking, which made the firm’s managers to become overconfident.

Enron nurtured an aggressive culture that led to a high rate of employee turnover. This scenario arose from the fact that the firm laid more emphasis on attaining short-term results. The firm’s management team formulated an employee evaluation program that was conducted after every six months. The objective of the evaluation was to enhance the integrity and creativity amongst the employees.

However, this move stressed most of the employees thus reducing their operational efficiency. Employees who succeeded in attaining the set targets received extensive monetary rewards such as salary increments, stock options, and bonuses. Skilling’s focus on development of such culture did not succeed. Instead, a culture of arrogance, fierce internal competition, and extreme decentralization became the norm.

The firm’s manager was mainly concerned with transforming the institution into a postmodern, hyper-flexible, and a firm that continuously re-invents in order to align with changes in the external business environment. According to Skilling’s opinion, this would enable the firm to increase its profitability. Conversely, the ever-changing characteristic of the firm made employees to perceive a significant decline in their job security.

Due to its extensive expansion, Enron ventured into unfamiliar territories. The inexperience of the firm’s executives significantly contributed towards the occurrence of mistakes.

Additionally, the management team’s emphasis on generation of ideas from the employees led to accumulation of information, which the firm could not process adequately. Its over-emphasis on risk taking made the firm to ignore the costs associated with such risks. Additionally, putting pressure on the employees to be creative stimulated most employees to take shortcuts, which were in most cases unethical.

The firm’s employees laid more emphasis on creativity because it attracted great rewards compared to integrity. This aspect led to the occurrence of agency problem between shareholders and managers. Employees were mainly concerned with their personal welfare rather than attaining the shareholders’ wealth maximization goal.

Enron Case Study Problems and Key Issues

The case illustrates a number of problems and key issues that Enron experienced in the course of its operation. One of the major problems evidenced in the case touches on the accounting system used by the firm.

Enron adopted an aggressive accounting style whereby the accounting officers inflated figures in the firm’s financial statements. Additionally, special partnerships were formed with the objective of defrauding the firm. The partnerships rendered the process of accounting very complicated. The accounting officer did not record the actual values in the firm’s accounting books.

The records were made to look attractive, which was not the case. The management team engaged in fraudulent reporting by manipulating the firm’s revenue and earnings in order to sustain the firm’s credit rating. Consequently, most investors perceived the firm as a solid and reliable investment partner. The auditors colluded with the management team in return of huge financial gains.

Approximately, the auditors and consultants earned between $25 million and $27 million in audit and consulting fees. In the course of executing its oversight duties, Enron ignored the firm’s financial capacity, which made its shares to rise significantly during the 1990s.

Enron relied on the “mark to Market” accounting system, which enabled it to succeed in adjusting the value of its stocks and shares by reflecting the prevailing market value. By using this method, Enron comfortably reported its expected future earnings as current earnings.

Therefore, Enron disregarded its codes of ethics, which is based on integrity, respect, excellence, and communication. The existence of conflict of interest between managers and shareholders comes out clearly given the fact that the executive mainly focused on maximizing their earnings. In August 2001, the company Chief Executive Officer Jeff Skilling resigned from the company and immediately disposed off his stocks, which were valued at more than $33 million.

In addition to the accounting fraud, another key issue that is evident in the case study relates to the firm’s overdependence on making deals. Despite the fact that Enron had developed a professional risk assessment and control committee, the committee did not execute its duties effectively.

For example, the committee was reluctant to reject projects that were evidently risky. Its inability to execute this role was necessitated by the fact that the management team mainly focused on making deals that would contribute to increment in the firm’s cash flows, hence necessitating the firm’s ability to attain high growth.

Additionally, the committee was reluctant to express its opinion regarding illegal businesses and practices that the firm was undertaking. This scenario arose from the fact that making such opinions would herald their career’s death. The firm’s management team rewarded blind loyalty to employees and quashed those who portrayed dissent.

Enron situation fits perfectly in the theory of planned behavior. The theory explains that there exist reasons behind the occurrence of a particular situation.

It asserts that unethical practices such as corruption mainly hinge on specific values and intent. Enron’s employees mainly focused on engaging themselves in extreme competitive actions and favored unethical practices in order to achieve their desired operational efficiency. The behavior thrived because the employees observed the optimal treatment to individuals who engaged in shortcuts to attain the desired level of creativity.

Enron Scandal Conclusion and Recommendations

In summary, the fraud in Enron Corporation was a result of failure in the firm’s leadership system, management control, and ineffective organizational culture. Its focus on positioning itself as a “new economy” stimulated employees to engage in unfair activities in order to achieve the desired objective.

Additionally, the management team developed a culture that focused on attainment of results rather than nurturing integrity. Consequently, employees engaged in unethical practices and disregarded the codes of ethics implemented by the firm. Therefore, to deal with these challenges, we suggest the following recommendations for Enron scandal.

Enron should have adopted a progressive-adoptive culture. This culture focuses on generation of new ideas and openness to new ideas. However, it does not force employees to implement the ideas hence it does not enhance unhealthy competition. It would also have been important for the firm to consider nurturing a community-oriented culture, which mainly seeks to ensure a high level of collaboration and cooperation amongst employees. Adoption of such cultures would have played an important role in providing employees with direction.
To ensure effective reporting, Enron should have incorporated accrual method of reporting to ensure accurate description of the company’s value.
With regard to control issues, the firm should have adopted a more current control system by reviewing its policies, procedures, and rules. The policies and procedures should have focused on nurturing integrity and ethics. The firm should have remained strict in implementing ethical policies and procedures to refrain employees from unethical behavior.

Action plan on how to implement the recommendations and the expected time duration

Chicago (A-D)
Chicago (N-B)

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Bibliography

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Lessons from the Enron Scandal

Markkula Center for Applied Ethics
Focus Areas
Business Ethics
Business Ethics Resources

Kirk Hanson, executive director of the Markkula Center for Applied Ethics, was interviewed about Enron by Atsushi Nakayama, a reporter for the Japanese newspaper Nikkei.

On March 5, 2002, Kirk Hanson, executive director of the Markkula Center for Applied Ethics, was interviewed about Enron by Atsushi Nakayama, a reporter for the Japanese newspaper Nikkei . Their Q & A appears below:

Nakayama: What do you think are the most important lessons to be learned from the Enron scandal?

Hanson: The Enron scandal is the most significant corporate collapse in the United States since the failure of many savings and loan banks during the 1980s. This scandal demonstrates the need for significant reforms in accounting and corporate governance in the United States, as well as for a close look at the ethical quality of the culture of business generally and of business corporations in the United States.

N: Why did this happen?

H: There are many causes of the Enron collapse. Among them are the conflict of interest between the two roles played by Arthur Andersen, as auditor but also as consultant to Enron; the lack of attention shown by members of the Enron board of directors to the off-books financial entities with which Enron did business; and the lack of truthfulness by management about the health of the company and its business operations. In some ways, the culture of Enron was the primary cause of the collapse. 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. When some of their business and trading ventures began to perform poorly, they tried to cover up their own failures.

N: Why didn't the company's directors protect the employees and investors?

H: The board of directors was not attentive to the nature of the off-books entities created by Enron, nor to their own obligations to monitor those entities once they were approved. The board did not pay attention to the employees because most directors in the United States do not consider this their responsibility. They consider themselves representatives of the shareholders only, and not of the employees. However, in this case they did not even represent the shareholders well-and particularly not the employees who were shareholders.

N: Why didn't anyone stop Skilling, Lay and Fastow?

H: Jeffrey Skilling and Andrew Fastow changed the business strategy and corporate culture of Enron. In the process, they appeared to make Enron very innovative and very profitable. When the stock is rising and the shareholders are getting rich, there is little incentive for the board of directors and the investment community to question the executives very closely. The board is at fault for permitting the suspension of Enron's own code of conduct to permit the conflicts of interest inherent in the off-books corporations controlled by Fastow. A few analysts recommended their clients stay out of Enron, but not many.

N: Could you tell me how the corporate governance should be changed?

H: I do not think the rules of corporate governance will be changed in significant ways. But boards of directors need to pay closer attention to the behavior of management and the way the company is making money. In too many American companies, board members are expected to approve what management proposes-or to resign. It must become acceptable and mandatory to question management closely. There is little chance the U.S. governance rules will be changed to make boards responsible to the employees as well as to the shareholders. However, board members would be foolish not to pay more attention to how employees and customers and business partners are treated. These greatly affect the long-term value of the shareholders' investment.

N: Don't you think this scandal damaged the new economy's fundamental system?

H: Enron is a prominent example of a "new economy" company. Kenneth Lay and Jeffrey Skilling claimed that Enron was the most innovative company in the United States and at times tried to intimidate reporters or analysts who questioned their strategy. In the new economy, new kinds of companies have been created. Enron's collapse will encourage investors, analysts, reporters, and employees to ask "old economy" questions about these new economy companies: How does this company make money? Can it sustain this strategy over the long term? How do those who work in and with this company feel about it? The new economy has lost some of its appeal after the collapse of many dot.com companies and of Enron.

N: Can we believe analysts' strong "buy" recommendations from now on?

H: Many have questioned the overly optimistic "buy" recommendations analysts have issued in recent years, fearing they had conflicts of interest because of the underwriting business their firms did for dot.coms or because of the investment industry culture which rewarded analysts who were bullish on the new economy. I think there will be much closer scrutiny of analysts' recommendations in the months and years ahead, and a close look at the conflicts of interest of individual analysts. Analysts who are always bullish will be less likely to be believed.

N: What reforms should Congress, the SEC, and others institute post-Enron?

H: I believe accounting regulations should be altered to prohibit ownership of both auditing and consulting services by the same accounting firm. Accounting firms are already moving to sever their consulting businesses. The SEC should probably adopt additional disclosure requirements. Various regulators should tighten requirements for directors to be vigilant and provide protections for whistleblowers who bring improper behavior to public attention. But, in the final analysis, the solution to an Enron-type scandal lies in the attentiveness of directors and in the truthfulness and integrity of executives. Clever individuals will always find ways to conceal information or to engage in fraud.

N: How can credibility be recovered with investors?

H: U.S. firms and foreign firms listed on U.S. stock exchanges will need to demonstrate that they have eliminated all off-books accounts which distort the public's understanding of the financial health of the organization. They may need to pledge that they will not suspend the company's code of conduct, or at least report to the public when they do. Finally, every company will need to demonstrate that its board of directors is vigorous, vigilant, and that its procedures will enable it to uncover any questionable behavior. Companies may need to adopt a set of "governance best practices" to regain the trust of the market.

N: Some say Enron's collapse was caused by its stock options system. Do you think the executive compensation system should be reformed, and if so, how?

H: The stock option system is not itself the problem. Excessive stock options and excessive corporate compensation give corporate executives too many incentives to manipulate the financial accounts and the stock price of the company. When huge cash or options bonuses are dependent upon achievement of one or a few narrowly defined profit or growth goals, the temptation to manipulate the numbers to get the rewards will be too great. The problem is not the stock option system but the excessive compensation given to executives in the United States, particularly compared to the salaries of regular employees of the company. U.S. companies should look more like Japanese companies in the ratio of the salaries of top executives to those of regular employees.

N: Will stock prices continue to be down because the investors' faith has been shaken? The other day the blue chips like GE and IBM had to reassure investors about the strength of their financial controls.

H: I believe the stock prices of new economy companies will continue to show an "Enron effect" for many months to come. Until an individual company convinces the market that it has rid itself of any questionable practices and has improved its governance systems, it will not be evaluated fully.

N: Don't you think this kind of scandal will be a bad influence on the U.S. economy, which is recovering from recession?

H: Enron has clearly done some damage to the U.S. economy, but it will not hold up recovery from the current recession. The fundamental health of the U.S. economy is strong and now getting stronger. Some individual new economy companies will have depressed stock prices for some time, but they, too, will recover as they demonstrate that they are prepared to prevent Enron-like behavior.

N: You mentioned in Newsweek magazine that Enron will become the morality play of the new economy. Could you give me a more concrete idea what you mean by this?

H: I do believe Enron will be the morality play of the new economy. It will teach executives and the American public the most important ethics lessons of this decade. Among these lessons are:

You make money in the new economy in the same ways you make money in the old economy - by providing goods or services that have real value.

Financial cleverness is no substitute for a good corporate strategy.

The arrogance of corporate executives who claim they are the best and the brightest, "the most innovative," and who present themselves as superstars should be a "red flag" for investors, directors and the public.

Executives who are paid too much can think they are above the rules and can be tempted to cut ethical corners to retain their wealth and perquisites.

Government regulations and rules need to be updated for the new economy, not relaxed and eliminated.

McCombs School of Business

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Case Study UT Star Icon

Selling Enron

Following the deregulation of electricity markets in California, private energy company Enron profited greatly, but at a dire cost.

In the late 1990s, the state of California deregulated many of its electricity markets, opening them up to private sector energy companies. Enron Corporation had long lobbied for deregulation of such markets and would likely have profited greatly had California’s experiment succeeded and become a model for other states.

Enron CEO Ken Lay wrote a public statement saying that Enron “believes in conducting business affairs in accordance with the highest ethical standards… your recognition of our ethical standards allows Enron employees to work with you via arm’s length transactions and avoids potentially embarrassing and unethical situations.” At the same time, Tim Belden, a key Enron employee in its energy trading group, noticed that California’s “complex set of rules…are prone to gaming.”

According to Bethany McLean and Peter Elkind, authors of The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron:

“In one scheme, Enron submitted a schedule reflecting demand that wasn’t there… Another was a variation of the Silverpeak experiment: Enron filed imaginary transmission schedules in order to get paid to alleviate congestion that didn’t really exist… Get Shorty was a strategy that involved selling power and other services that Enron did not have for use as reserves…”

Some Enron employees admitted that their schemes were “kind of squirrelly,” but used them because they were profitable. The impact on customers was clear: electricity prices rose and rolling blackouts occurred. Enron’s profits, however, quadrupled. An Enron lawyer later wrote that the Enron traders did not think “they did anything wrong.” Another employee admitted, “The attitude was, ‘play by your own rules.’ …The energy markets were new, immature, unsupervised. We took pride in getting around the rules.”

In October 2001, Enron’s unethical and illegal business practices became public knowledge. Enron’s stock prices plummeted, and the company filed for bankruptcy in December 2001.

Discussion Questions

1. How did Enron’s CEO and employees frame their business model? How did differences in their framing affect their actions?

2. How might framing affect people’s approaches to business conduct? Explain your reasoning.

3. Can you think of other framing tactics used by different businesses? How does framing affect the products they sell and the actions of their consumers?

4. How do you react to the following recorded conversation between two Enron employees? What does it tell us about framing, if anything?

Greg: “It’s all how well you can weave these lies together, Shari. Shari: I feel like I’m being corrupted now. Greg: No, this is marketing. Shari: OK.”

5. The Enron scandal affected the lives of many employees who had no responsibility in Enron’s framing tactics. If you were a new employee starting your career at Enron and you learned of the framing tactics in this case study, what would you do? Why?

Bibliography

Conspiracy of Fools: A True Story http://www.worldcat.org/title/conspiracy-of-fools-a-true-story/oclc/57192973

Enron: The Rise and Fall http://www.worldcat.org/title/enron-the-rise-and-fall/oclc/50549063

Sidetracked: Why Our Decisions Get Derailed, and How We Can Stick to the Plan http://www.worldcat.org/title/sidetracked-why-our-decisions-get-derailed-and-how-we-can-stick-to-the-plan/oclc/807028907

The Ethical Executive: Becoming Aware of the Root Causes of Unethical Behavior: 45 Psychological Traps that Every One of Us Falls Prey To http://www.worldcat.org/title/ethical-executive-becoming-aware-of-the-root-causes-of-unethical-behavior-45-psychological-traps-that-every-one-of-us-falls-prey-to/oclc/225875973

Experimental Ethics: Toward an Empirical Moral Philosophy http://www.worldcat.org/title/experimental-ethics-toward-an-empirical-moral-philosophy/oclc/881387881

The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron http://www.worldcat.org/title/smartest-guys-in-the-room-the-amazing-rise-and-scandalous-fall-of-enron/oclc/52418094

I Survived Enron http://www.bloomberg.com/bw/stories/2006-02-05/i-survived-enron

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JOLE 2023 Special Issue
Editorial Staff
20th Anniversary Issue

Enron’s Ethical Collapse: Lessons for Leadership Educators

Craig Johnson 10.12806/V2/I1/C2

Craig Johnson Professor of Communication Arts Department of Communication

George Fox University 414 Meridian St.

Newberg, OR 97132

(503) 554-2610

[email protected]

Top officials at Enron abused their power and privileges, manipulated information, engaged in inconsistent treatment of internal and external constituencies, put their own interests above those of their employees and the public, and failed to exercise proper oversight or shoulder responsibility for ethical failings. Followers were all too quick to follow their example. Therefore, implications for teaching leadership ethics include, educators must: (a) share some of the blame for what happened at Enron, (b) integrate ethics into the rest of the curriculum, (c) highlight the responsibilities of both leaders and followers, (d) address both individual and contextual variables that encourage corruption, (e) recognize the importance of trust and credibility in the leader-follower relationship, and (f) hold followers as well as leaders accountable for ethical misdeeds.

Introduction

Enron’s bankruptcy filing in November 2001 marked the beginning of an unprecedented wave of corporate scandals. Officials at Tyco, WorldCom, ImClone, Global Crossing, Adelphia, AOL Time Warner, Quest, and Charter Communications joined Enron executives as targets of SEC probes, congressional hearings, stockholder lawsuits, and criminal indictments. Enron’s troubles, which had been center stage, were soon pushed to the background by subsequent revelations of corporate wrongdoing.

More recent instances of corporate corruption should not diminish the importance of Enron as a case study in moral failure. Enron collapsed in large part because of the unethical practices of its executives. Examining the ethical shortcomings of Enron’s leaders, as well as the factors that contributed to their misbehaviors, can provide important insights into how to address the topic of ethics in the leadership classroom.

Moral Failure at the Top

Events leading up to Enron’s bankruptcy have been chronicled in a host of magazine articles as well as in such books as Anatomy of Greed (Cruver, 2002), Enron: The Rise and Fall (Fox, 2003), What Went Wrong at Enron (Fusaro & Miller, 2002), The Enron Collapse (Barresveld, 2002), and Pipe Dreams (Bryce, 2002). The company’s collapse was ultimately triggered by failed investments in overseas ventures and the unraveling of a series of dubious limited partnerships called Special Purpose Entities (SPEs). These SPEs , backed by Enron stock and illegally run by company insiders, were designed to keep debt off the firm’s balance sheets and helped prop up its share price. However, when the firm’s stock price began to slide, the company was unable to back its guarantees. In addition to charges related to shady partnerships, Enron stands accused of:

borrowing from subsidiaries with no intent to repay the loans (Wilke, 2002, August 5).
avoiding federal taxes even though some of its subsidiaries, like Portland General Electric, collected tax payments from customers (Manning & Hill, 2002).
contributing to the California energy crisis by manipulating electricity prices (Fusaro & Miller, 2002; Manning, 2002).
bribing foreign officials to secure contracts in India, Ghana and other countries (Wilke, 2002, August 7).
immediately claiming profits for long term projects that would eventually lose money (Hill, Chaffin, & Fidler, 2002).
switching account balances immediately before quarterly reports to boost apparent earnings (Cruver, 2002).
manipulating federal energy policy (Duffy, 2002; Duffy & Dickerson, 2002).

Much of the blame for what happened at Enron (nicknamed the “Crooked E” for its tilted Capital E logo) can be laid at the feet of company founder Kenneth Lay, his successor Jeffrey Skilling, chief financial officer Andrew Fastow, and Fastow’s top assistant Michael Kopper. Each failed to meet important ethical challenges or dilemmas of leadership (Johnson, 2001). Their failures included:

Abuse of Power

Both Lay and Skilling could wield power ruthlessly. The position of vice-chair was known as the “ejector seat” because so many occupants were removed from the position when they took issue with Lay or appeared to be a threat to his power. Skilling, for his part, eliminated corporate rivals and intimidated subordinates. Abdication of power was also a problem at Enron. At times, managers did not appear to understand what employees were doing or how the business (which was literally creating new markets) operated. Board members also failed to exercise proper oversight and rarely challenged management

decisions. Many were selected by CEO Kenneth Lay and did business with the firm or represented non-profits that received large contributions from Enron (Associated Press, 2002; Cruver, 2002).

Excess Privilege

Excess typified top management at Enron. Lay, who began life modestly as the son of a Baptist preacher turned chicken salesman, once told a friend, “I don’t want to be rich, I want to be world-class rich” (Cruver, 2002, p. 23). At another point he joked that he had given wife Linda a $2 million decorating budget for a new home in Houston which she promptly exceeded (Gruley & Smith, 2002). The couple borrowed $75 million from the firm that they repaid in stock. Linda Lay fanned the flames of resentment among employees when she broke into tears on the Today Show to claim that the family was broke. This was despite the fact that the Lays owned over 20 properties worth over $30 million (Eisenberg, 2002).

During Enron’s heyday, some of the perks filtered down to followers as well. Workers enjoyed such benefits as lavish Christmas parties, aerobic classes, free taxi rides, refreshments, and the services of a concierge ( Enron excess , 2002; How Enron let down its employees , 2002).

Enron officials manipulated information to protect their interests and to deceive the public, although the extent of their deception is still to be determined. Both executives and board members claim that they were unaware of the extent of the company’s off-the-books partnerships created and operated by Fastow and Kopper (Eisenberg, 2002). However, both Skilling and Lay were warned that the company’s accounting tactics were suspect (Duffy, 2002). The Senate Permanent Subcommittee on Investigations, which investigated the company’s downfall, concluded, “Much that was wrong with Enron was known to the board” (Associated Press, 2002). Board members specifically waived the conflict of interest clause in the company’s code of ethics that would have prevented the formation of the most troublesome special partnerships (Cruver, 2002).

Employees were quick to follow the lead of top company officials. They hid expenses, claimed nonexistent profits, deceived energy regulators and so on.

Inconsistent Treatment of Internal and External Constituencies

Enron’s relationships with both employees and outsiders were marked by gross inconsistencies. Average workers were forced to vest their retirement plans in Enron stock and then, during the crucial period when the stock was in free fall, were blocked from selling their shares. Top executives, on the other hand, were able to unload their shares as they wished. Five-hundred officials received “retention bonuses” totaling $55 million at the same time laid off workers received only a fraction of the severance pay they had been promised (Barreveld, 2002).

Enron treated its friends royally. In particular, the company used political donations to gain preferential treatment from government agencies. Kenneth Lay was the top contributor to the Bush campaign and officials made significant donations to both Democratic and Republican members of the House and Senate. In return, the company was able to nominate friendly candidates for the Security Exchange Commission (SEC) and the Federal Energy Regulatory Commission (FERC). Federal officials intervened with foreign governments to promote Enron projects, and company representatives played a major role in setting federal energy policy that favored deregulation of additional energy markets (Fox, 2003). Anyone perceived as unfriendly to Enron’s interests could expect retribution, however. In one instance, Lay withdrew an underwriting deal to pressure Merrill Lynch into firing an analyst who had downgraded Enron stock (Smith & Raghaven, 2002). Skilling called one analyst an “asshole” when he questioned the company’s performance during a conference call (Cruver, 2002).

Misplaced and Broken Loyalties

Enron officials put their loyalty to themselves above those of everyone else with a stake in the company’s fate — stock holders, business partners, rate payers, local communities, foreign governments, and so on. They also betrayed the trust of those who worked for them. Employees apparently believed in the company and in Lay’s optimistic pronouncements. In August 2001, for example, he declared “I have never felt better about the prospects for the company” (Cruver, 2003, p. 91). In late September, just weeks before the company collapsed, he encouraged employees to “talk up the stock” because “the company is fundamentally sound” (Fox, 2003, p. 252). These exhortations came even as he was unloading his own shares. The sense of betrayal experienced by Enron employees only added to the pain of losing their jobs and retirement savings.

Irresponsible Behavior

Enron officials acted irresponsibly by failing to take needed action, failing to exercise proper oversight, and failing to shoulder responsibility for the ethical miscues of their organization. CEO Lay downplayed warnings of financial improprieties and some board members did not understand the numbers or the company’s operations. Too often company managers left employees to their own devices, encouraging them to make their numbers by any means possible. After the collapse, no one stepped forward to accept blame for what happened. Lay and Fastow claimed Fifth Amendment privileges against self-incrimination when called before congressional committees; Skilling testified but claimed he had no knowledge of illegal activity.

The unethical behavior of Enron’s leaders appears to be the product of both individual and situational factors. Greed was the primary motivator of both managers and their subordinates at Enron (Cruver, 2002). Optimistic earnings

reports, hidden losses and other tactics were all designed to keep the stock price artificially high. Lofty stock values justified generous salaries and perks, deflected unwanted scrutiny, and allowed insiders to profit from their stock options. Greed was not limited to top Enron executives, however. Meeting earnings targets triggered large bonuses for managers throughout the firm, bonuses that were sometimes larger than employees’ salaries. Rising stock prices and extravagant rewards made it easier for followers as well as leaders to overlook shortcomings in the company’s ethics and business model.

Hubris was also a major character flaw at the Crooked E, a fact reflected in the company banner that declared: FROM THE WORLD’S LEADING ENERGY COMPANY — TO THE WORLD’S LEADING COMPANY (Cruver, 2002, p.

3). Skilling, who lacked the social and communication skills of Ken Lay, best exemplifies the haughty spirit of many Enron officials. At the height of the California energy crisis he joked that the only difference between the Titanic and the state of California was that “when the Titanic went down, the lights were on” (Fusaro & Miller, 2002. p. 122).

Even the so-called “heroes” of the Enron debacle failed to demonstrate enough virtue to delay or to prevent the company’s collapse. Former company treasurer Clifford Baxter complained about Fastow’s financial wheeling and dealing, but then retired without going public with his complaints. Vice-president of corporate development Sherry Watkins outlined her concerns about the firm’s questionable financial practices in a letter and in a meeting with Lay ( A Hero , 2002). Later she discussed the same issues with an audit partner at Anderson. While these are commendable acts, in her letter she recommended quiet clean up of the problems rather than public disclosure. She stopped short of talking to the press, the SEC and other outside agencies when her attempts at internal reform failed (Zellner, 2002).

The destructive power of individual greed and pride was magnified by Enron’s corporate culture that encouraged creativity and risk taking. Employees invented a host of new commodity products which earned Enron top ranking six straight years on Fortune magazine’s list of most innovative companies (Fusaro & Miller, 2002). Ken Lay was fond of telling the story of how Enron employees in London started its on-line trading business (which later carried a quarter of the world’s energy trades) without the blessing or knowledge of corporate headquarters in Houston (Stewart, 2001). The cost of freedom, however, was pressure to produce that created a climate of fear. Enron’s atmosphere was similar to that of an elite law firm where talented young associates scramble to make partner (Fusaro & Miller, 2002).

Adding to the stress was the organization’s “rank and yank” evaluation system. Every six months 15% of all employees were ranked in the lowest category and then had a few weeks to find another position in the company or be let go (Cruver, 2002). Workers in the next two higher categories were put on notice that

they were in danger of falling into the lowest quadrant during the subsequent review. This system (a harsher variant of one used at many companies) encouraged cutthroat competition and silenced dissent. Followers were afraid to question unethical and or illegal practices for fear of losing their jobs. Instead, they were rewarded for their unthinking loyalty to their managers (who ranked their performance) and the company as a whole (Fusaro & Miller, 2002).

Lack of controls, combined with an intense, competitive, results-driven culture made it easier to ignore the company’s code of ethics which specifically prohibited conflicts of interest like those found in the SPEs and to seek results at any cost (Hill, Chaffin, & Fidler, 2002). Anderson auditors signed off on its questionable financial transactions for fear of losing lucrative auditing and consulting contracts with Enron.

Enron was also a victim of larger social and cultural factors. Publicly traded firms in the United States are judged by their quarterly earnings reports. Obsession with short-term results encourages executives to do whatever they can to meet these expectations. Enron’s explosive growth took place during the economic boom of the 90s. All the major stock indices soared and billions were wasted on Internet start-ups that never had a realistic chance to make a profit. During this period the Cult of the CEO emerged. Business leaders achieved rock star status, gracing the covers of national magazines and best selling biographies (Elliott & Schroth, 2002, p. 125). In this heady climate, government regulators and investors felt little need to study the operations or finances of apparently successful companies led by business superstars. The recent spate of corporate scandals and the accompanying market crash may be the penalty that society must pay for the excesses and inattention of the last decade.

Implications for Leadership Educators

The lessons of Enron extend beyond the accounting and market reforms instituted in the wake of the scandal. Leadership educators can gain important insights about how to treat the topic of ethics in the classroom from the moral shortcomings of Enron’s top executives. The pedagogical implications of Enron include:

Educators Must Share Some of the Blame

Academics find it easy to distance themselves from the sins of Enron. The college and university classroom seems a world away from the high flying, gun slinging mentality of the former energy giant. Few professors can begin to comprehend the level of privilege and influence enjoyed by the company’s C level executives.

Those who study and teach ethics believe that they would exhibit the virtues that Lay, Skilling, and Fastow seemed to lack.

Disassociating oneself from Enron may be comforting, but this maneuver conveniently overlooks the fact educators must shoulder at least some of the blame for the company’s moral failure (Kavanaugh, 2002). As college graduates, Enron managers undoubtedly enrolled in leadership and ethics courses. Many were also products of Harvard and other top MBA programs. Followers armed with bachelor and masters degrees served as willing soldiers in the army of public relations experts who helped the company maintain its veneer of profitability, lobby government official, and attack its critics. What Enron’s top leaders, lower level managers, and front line employees learned in university classrooms was not enough to prevent ethical tragedy.

Strive for Ethical Integration

Enron is a classic example of a company whose ethical pronouncements were “decoupled” from the rest of its operations (Weaver, Trevino, & Cochran 1999). The key values of the company were respect, integrity, communications, and excellence. Enron also had an extensive code of ethics. Unfortunately, these values and policies had little impact on how Lay, Skilling, and their underlings did business. By the time of its collapse in 2001, the company had been manipulating its books and misleading investors for several years.

Unfortunately, the teaching of ethics, like the practice of ethics at Enron, is typically decoupled from the rest of the curriculum. Discussions of ethics often stand alone, limited to a single unit or to one course in the entire leadership curriculum. Further, the placement of ethical material also diminishes its importance. Ethics units and text chapters sometimes appear to be an afterthought, introduced at the end of a course or book and therefore likely to be eliminated if the professor falls behind during the quarter or semester. To be effective, ethical considerations should be part of every unit, class, and set of readings.

Highlight Leadership and Followership Duties and Responsibilities

Many students study leadership in hopes of achieving the kind of heroic stature that, until recently, they saw reflected in press reports about famous business figures and other prominent leaders. Power, perks, financial security, and recognition all seem to come with an executive title. Instructors cater to this motivation when they act as cheerleaders for prominent business leaders like Jack Welch or Kenneth Lay. They overlook the fact that the same qualities and strategies so often praised in business and other leadership literature can lead to disaster. Enron is a case in point. The company’s leaders did many things right according to the leadership and management literature. Lay and his colleagues had a clear vision and values, pursued excellence, and fostered an extraordinary degree of creativity and innovation. Sadly, their vision was unrealistic, their stated values took back seat to unstated ones (e. g., make the deal at whatever the cost and generate constant profits and growth), and their drive for innovation led them into a host of unprofitable markets that even their management team did not

completely understand. Followers also lost sight of their personal values as well as their commitment to society.

Altruism is a universal value that is particularly important to leaders who, by virtue of their roles, are to exercise influence on behalf of others. Leaders cannot articulate the concerns of followers unless they first understand their needs (Kanungo & Mendoca, 1996). Leaders driven by altruism pursue organizational goals rather than personal achievement and are more likely to give power away. Leaders seeking self-benefit focus on personal achievements, and control followers through coercion and reward.

Communitarianism emphasizes the need for individual and corporate responsibility (Etzioni, 1993). Citizens and institutions have obligations to the larger community. When making decisions, leaders and followers must look beyond the immediate interests of themselves and their organizations to the needs of the local community and society as a whole.

Servant leadership is a model that puts the needs of followers first (Greenleaf, 1977; Spears, 1998). Servant leaders continually ask themselves what would be best for their constituents and measure their success by the progress of their followers. Driven by a concern for people, they seek to treat others fairly and recognize that they hold their positions in stewardship for others.

Address Both Individual and Contextual Variables

Training can help individuals develop sensitivity to moral issues and improve ethical reasoning skills (Rest, 1993). To prevent future Enrons, faculty must help current and future leaders and followers equip themselves with the values, principles, and skills they need to make reasoned moral choices. Nonetheless, an individual focus does not address organizational forces – group culture, high forced turnover, reward system – that played a significant role in Enron’s moral failures. In addition, society’s fixation on short term profits and daily market moves also increased the pressure to manipulate results and to hide financial bad news.

What organizational controls should be put on innovation?
How can employees be rewarded in a way that promotes ethical behavior?
What are the dysfunctional consequences of the rank and yank evaluation system?
What are reasonable limits on executive compensation?
What is a corporate board’s role in overseeing the operations of an organization?
What should be the composition of a board’s membership?
How should the performance of companies be judged?
How can society develop a long-term perspective on financial results?

Recognize the Importance of Credibility

Since Aristotle, scholars have examined the factors that make a source believable to an audience, an interest based on the strong correlation between credibility and influence (Hackman & Johnson, 2001, chap. 6). The Enron debacle and subsequent scandals demonstrate that credibility, specifically trustworthiness, is more important than ever. Stock values declined nearly 40% from market highs in July1998 due largely to investors’ loss of confidence in the integrity of publicly held corporations. Employees are increasingly skeptical as well. A 2002 survey by the Ethics Resource Center found that 43% of respondents believed that their bosses fail to model integrity and felt pressure to compromise their own ethical standards at work (Wee, 2002). Modern technology, which enables the rapid, worldwide dissemination of information, makes credibility more important now than in the time of Plato and Aristotle. Leadership faculty need to help students consider not only how credibility is built and maintained, but also how trust is destroyed and at what cost to individuals and organizations.

Followers are Also Accountable

Lay, Skilling, Fastow and other high level executives deserve most of the blame for what went wrong at Enron. It was they who created the company’s culture, approved dubious partnerships, attacked critics, and, in the end, abandoned employees while enriching themselves. Nevertheless, followers, ranging from second tier officials down to receptionists and mailroom clerks, share some of the blame. Many willingly bought into the get rich quick mentality of the Crooked E. During the company’s 15 years of rapid growth, few stopped to question the company’s tactics. They were “bought off” by the generous perks and the thrill of being part of one of the most sophisticated and innovative companies in the world. The constant threat of termination undoubtedly convinced others to keep their doubts to themselves and to support their bosses.

According to Chaleff (1995), courage – the willingness to accept a higher level of risk – is the most important virtue for organizational followers. Such courage was sorely lacking at Enron. Few had the courage to challenge authority. Few had the courage to leave when faced with ethical violations. Apparently no member of the firm had the courage to bring the misbehavior of Lay and his subordinates to the attention of the public before the crisis erupted (Cruver, 2002).

Unfortunately, cowardice is not limited to Enron. Nearly two-thirds of those who witness ethical violations in their companies refuse to report them, believing that reporting problems would not do any good ( Chief Executive , 2002). The final lesson of Enron, then, is that both instructors and students have the responsibility to confront moral failure whenever and wherever it appears, regardless of whether they function in a leadership or in a followership role.

In summary, top officials at Enron abused their power and privileges. They manipulated information while engaging in inconsistent treatment of internal and external constituencies. These leaders put their own interests above those of their employees and the public, and failed to exercise proper oversight or shoulder responsibility for ethical failings. Sadly, the followers were all too quick to follow their example.

Numerous implications for teaching leadership ethics can be gleaned from the Eron situation. Educators must share some of the blame for what happened at Enron. It is important to integrate ethics into the rest of the curriculum.

Leadership educators need to highlight the responsibilities of both leaders and followers along with addressing both individual and contextual variables that encourage corruption. The importance of trust and credibility in the leader- follower relationship must be recognized. And, finally, educators must hold followers as well as leaders accountable for ethical misdeeds.

Associated Press (2002, July 7). Report: Enron board aided collapse. Retrieved August 8, 2002 from http://www.msnbc.com/news/777112.asp.

Barreveld, D. J. (2002). The Enron collapse: Creative accounting, wrong economics or criminal acts? San Jose, CA: Writers Club Press.

Bryce, R., (2002). Pipe dreams: Greed, ego, and the death of Enron . New York: Public Affairs.

Chaleff, I. (1995). The courageous follower . San Francisco: Berett-Koehler.

Chief Executive of San Diego shuttle company assails corporate chicanery. (2002, July 14). San Diego Union-Tribune . Retrieved July 16, 2002 from Newspaper Source.

Cruver, B. (2002). Anatomy of greed: The unshredded truth from an Enron insider . New York: Carroll & Graf.

Duffy, M. (2002, January 28). What did they know and when did they now it?

Time , pp. 16-22.

Duffy, M., & Dickerson, J. F. (2002, February 4). Enron spoils the party. Time,

Eisenberg, D. (2002, February 21). Ignorant & Poor? Time , pp. 37-39.

Elliott, A. L, & Schroth, R. J. (2002). How companies lie: Why Enron is just the tip of the iceberg . New York: Crown Business.

“Enron’s excess” (2002, March 2). Newsweek . Retrieved August 8, 2002 from http://www.msnbc.com/news/718379.asp.

Etzioni, A. (1993). The spirit of community: The reinvention of American society . New York: Touchstone.

Fox, L. (2003). Enron: The rise and fall . New York: John Wiley & Sons.

Fusaro, P. C., & Miller, R. M. (2002). What went wrong at Enron . Hoboken, NJ: John Wiley & Sons.

Greenleaf, R. (1977). Servant leadership . New York: Paulist Press.

Gruley, B., & Smith, R. (2002, April 26). Kenneth Lay—disaster? Wall Street Journal , pp. A1, A5.

Hackman, M. Z., & Johnson, C. E. (2001). Leadership: A communication Perspective . Prospect Heights, IL: Waveland Press.

“How Enron let down its employees.” BBC News . Retrieved August 8, 2002, from http://news.bbc.co.uk/1/hi/business/17677633.stm.

Hill, A., Chaffin, J., & Fidler, S. (2002, February 3). Enron: Virtual company, virtual profits. The Financial Times. Retrieved August 8, 2002 from http://specials.ft.com/enron/FT3648VA9XC.html.

Johnson, C. E. (2001). Meeting the ethical challenges of leadership: Casting light or shadow . Thousand Oaks, CA: Sage.

Kanungo, R. N., & Mendoca, M. (1996). Ethical dimensions of leadership . Thousand Oaks, CA: Sage.

Kavanaugh, J. F. (2002, February 25). Capitalist conscience. America , p. 17. Retrieved July 16, 2002 from Academic Search Premiere.

Manning, J. (2002, October 18). Former Enron trader pleads guilty. The Oregonian , pp A1, A11.

Manning, J., & Hill, G. K. (2002, February 3). Enron pockets PGE’s tax payments. The Oregonian , pp. A1, A7.

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Approaches to moral development (pp. 201-211). New York:Teachers College Press.

Smith, R., & Raghavan, A. (2002, July 30). Feds eye Merrill’s Enron deals. The Wall Street Journal . Retrieved August 8, 2002 from htt p://www.msnbc.com/news/787517.asp.

Spears, L. (1998). Introduction: Tracing the growing impact of servant leadership. In L. C. Spears (Ed.), Insights on leadership (pp. 1-12). New York: John

Stewart, T. A. (2001, December 5). Two lessons from the Enron Debacle.

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Wee, H. (2002, April 4). Corporate ethics: Right makes might. Business Week Online . Retrieved July 16, 2002, from Academic Search Premier.

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An earlier version of this paper was presented at the 2002 National Communication Association convention, New Orleans, LA.

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Case Study: Enron

Background

Once the seventh largest company in America, Enron was formed in 1985 when InterNorth acquired Houston Natural Gas. The company branched into many non-energy-related fields over the next several years, including such areas as Internet bandwidth, risk management, and weather derivatives (a type of weather insurance for seasonal businesses). Although their core business remained in the transmission and distribution of power , their phenomenal growth was occurring through their other interests. Fortune Magazine selected Enron as "America's most innovative company" for six straight years from 1996 to 2001. Then came the investigations into their complex network of off-shore partnerships and accounting practices.

How the Fraud Happened

The Enron fraud case is extremely complex. Some say Enron's demise is rooted in the fact that in 1992, Jeff Skilling, then president of Enron's trading operations, convinced federal regulators to permit Enron to use an accounting method known as "mark to market." This was a technique that was previously only used by brokerage and trading companies. With mark to market accounting, the price or value of a security is recorded on a daily basis to calculate profits and losses. Using this method allowed Enron to count projected earnings from long-term energy contracts as current income. This was money that might not be collected for many years. It is thought that this technique was used to inflate revenue numbers by manipulating projections for future revenue.

Use of this technique (as well as some of Enron's other questionable practices) made it difficult to see how Enron was really making money. The numbers were on the books so the stock prices remained high, but Enron wasn't paying high taxes. Robert Hermann, the company's general tax counsel at the time, was told by Skilling that their accounting method allowed Enron to make money and grow without bringing in a lot of taxable cash.

Enron had been buying any new venture that looked promising as a new profit center. Their acquisitions were growing exponentially. Enron had also been forming off balance sheet entities (LJM, LJM2, and others) to move debt off of the balance sheet and transfer risk for their other business ventures. These SPEs were also established to keep Enron's credit rating high, which was very important in their fields of business. Because the executives believed Enron's long-term stock values would remain high, they looked for ways to use the company's stock to hedge its investments in these other entities. They did this through a complex arrangement of special purpose entities they called the Raptors. The Raptors were established to cover their losses if the stocks in their start-up businesses fell.

When the telecom industry suffered its first downturn, Enron suffered as well. Business analysts began trying to unravel the source of Enron's money. The Raptors would collapse if Enron stock fell below a certain point, because they were ultimately backed only by Enron stock. Accounting rules required an independent investor in order for a hedge to work, but Enron used one of their SPEs.

The deals were so complex that no one could really determine what was legal and what wasn't. Eventually, the house of cards began falling. When Enron's stock began to decline, the Raptors began to decline as well. On August 14, 2001, Enron's CEO, Jeff Skilling, resigned due to "family issues." This shocked both the industry and Enron employees. Enron chairman Ken Lay stepped in as CEO.

In the next section we'll look at how the fraud was discovered.

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Organizations need to beware of 'institutional parasites,' study says

by City University London

Organizations that fail to identify or swiftly expel "institutional parasites" risk long-term damage, academics from British and Finnish business schools have warned.

In a paper published in Academy of Management Review , they argue that the increasingly complex and opaque nature of many organizations provides fertile ground for institutional parasites, such as suppliers or other key external partners and employees.

Dr. Jukka Rintamäki from Finland's Aalto University School of Business, Dr. Simon Parker from Nottingham University Business School and Professor Andre Spicer, Professor of Organisational Behaviour at Bayes Business School (formerly Cass), City, University of London, analyzed existing research and a range of case studies.

They cite accountancy firms that collude in falsification of accounts (such as Arthur Andersen's oversight of collapsed energy giant Enron) and specialist ESG firms that guarantee positive outcomes from human rights and sustainability audits of clients' supply chains.

The authors used a model developed by Dr. Rintamaki to explore how the parasites form and proliferate—and how they can be challenged effectively.

The parasitical action can initially benefit both the institutional parasite and the host organization, they conclude. The parasite is more likely to win contracts by guaranteeing positive conclusions, while the latter may pay less tax or have lower supply chain costs.

The more complex and opaque the institutional environment, the more parasites can remain undetected or without their negative impact being obvious, the paper says.

Dr. Rintamäki said, "Institutions identify and act against obvious threats but it is the insidious ones that can fell them. A leech that is visibly draining blood from a body will be quickly removed. An internal parasite, such as a roundworm, can cause significant harm to the host human before they realize they have a problem and seek medical attention and treatment."

Partly due to the initially mutually beneficial nature of much parasitical activity, leaders can engage in willful blindness—or fail to clearly identify and challenge the parasites. That can foster more parasites—and ultimately lead to significant harm, including the collapse of the organization.

Even when seeking to manage or remove the parasitical activity, leaders can actually exacerbate the problem, the authors warn.

Some leaders or industry watchdogs or legislators react with new policies, rules and guidance. Ironically, such measures can nurture the very environment in which parasites thrive by increasing complexity and opacity. The organization is also focusing on process and administrative actions rather than its core functions—risking inefficiencies and reputational damage.

The authors urge leaders to instead act boldly—"reforming" the institution in ways that improve transparency and reinforce its core purpose and principles. Regulators and lawmakers responding to exposure of wrongdoing should also embrace that approach and aim to improve the identification of parasitical actors.

Often an organization that has drifted too far from the principles and practices that made it successful in the first place must change to maintain or regain success, Dr. Parker said.

"Complexity is the key driver of institutional parasitism and as organizations grow it is more difficult for leaders to be aware of emerging problems across many sites or partner organizations. It's also a fact of life that there is sometimes a gap between what we claim about ourselves and what we do—and that can apply, for example, to monitoring of suppliers."

Professor Spicer said, "In modern life medical science and public health regulations have removed many parasites and other risks to our biological health from our daily lives. Simultaneously, however, our increasingly complex working environments have fostered the conditions where institutional parasites flourish. We have all worked with 'slackers' and with people who sometimes cut corners or sail close to the wind ethically. Our concept of institutional parasites goes well beyond that."

Dr. Parker added, "It's understandable that the first response to a parasitical threat is adding yet more pages to bulging staff manuals or supplier contracts. However, leaders should instead focus on stripping back the complexity and looking at the core functions, purpose and expectations of their organization. Ironically, sometimes such change allows leaders to maintain a form of the status quo."

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The Enron Scandal (2001)

Further Viewing

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About The Authors

Paul M. Healy

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The Fall of Enron (TN)

Profile of Enron: The Rise and Fall

Learning Objectives

What Was Enron?

What Happened to Enron

The Legacy of Enron

What Was Enron? What Happened and Who Was Responsible

Key Takeaways

Pre-Scandal

Early Signs of Trouble

Post Bankruptcy/Criminal Charges

Causes of the Enron Scandal

Special Purpose Vehicles

Inaccurate Financial Reporting Practices

Poorly Constructed Compensation Agreements

Lack of Independent Oversight

Unrealistic Market Expectations

Poor Corporate Governance

The Role of Mark-to-Market Accounting

The Role of Enron's CEO

What Did Enron Do That Was So Unethical?

How Big was Enron?

Who Was Responsible for the Collapse of Enron?

Does Enron Exist Today?

The Rise and Fall of Enron

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Solutions, Causes, & Conclusion: Enron Case Study

Enron Case Study Introduction

Enron Case Study Background

Company attributes

Business strategy

Industry analysis using Porter’s five forces

The Fall of Enron Case Study: SWOT Analysis

Opportunities

Organizational culture

Enron Case Study Problems and Key Issues

Enron Scandal Conclusion and Recommendations

Lessons from the Enron Scandal

Selling Enron

Discussion Questions

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Enron’s Ethical Collapse: Lessons for Leadership Educators

Introduction

Moral Failure at the Top

Abuse of Power

Excess Privilege

Inconsistent Treatment of Internal and External Constituencies

Misplaced and Broken Loyalties

Irresponsible Behavior

Implications for Leadership Educators

Educators Must Share Some of the Blame

Strive for Ethical Integration

Highlight Leadership and Followership Duties and Responsibilities

Address Both Individual and Contextual Variables

Recognize the Importance of Credibility

Followers are Also Accountable

How Cooking the Books Works

Case Study: Enron

How the Fraud Happened

Organizations need to beware of 'institutional parasites,' study says