Case Study on Enrons Fall

Course No : MBA 513

Course Title : (Business Ethics)
Submitted to,
Muhammad Shariat llah, !h"
East #est ni$ersit%
Submitted b%,
&unu Sar'er
(" No: )*1)+)+,5+*-3
East #est ni$ersit%
"ate: )-
th
.une )*1/
*
1
SUMMERY OF THE CASE STUDY
Enron 0as 1amous throu2hout the business 0orld and 0as 'no0n as an
inno$ator, technolo2% 3o0erhouse, and a cor3oration 0ith no 1ear4 The
sudden 1all o1 Enron in the end o1 )**1 shattered not 5ust the business 0orld
but also the li$es o1 their em3lo%ees and the 3eo3le 0ho belie$ed that their
soar to 2reatness 0as 2enuine4 Their colla3se 0as 1ollo0ed b% a series o1
re$elations on ho0 the% mani3ulated their success4
Enron shoc'ed the 0orld 1rom bein2 6America7s most inno$ati$e com3an%8 to
America9s bi22est cor3orate ban'ru3tc% at its time4 At its 3ea', Enron 0as
America9s se$enth lar2est cor3oration4 Enron 2a$e the illusion that it 0as a
stead% com3an% 0ith 2ood re$enue but that 0as not the case, a lar2e 3art o1
Enron7s 3ro1its 0ere made o1 3a3er4 This 0as made 3ossible b% master1ull%
desi2ned accountin2 and morall% :uestionable acts b% traders and
e;ecuti$es4 "ee3 debt and sur1acin2 in1ormation about hidin2 losses 2a$e
the com3an% bi2 3roblems and in the late )**1 Enron declared ban'ru3tc%
under Cha3ter 11 o1 the nited States Ban'ru3tc% Code4
The Enron scandal, re$ealed in <ctober )**1, e$entuall% led to the
ban'ru3tc% o1 the Enron Cor3oration, an American ener2% com3an% based in
=ouston, Te;as, and the de 1acto dissolution o1 Arthur Andersen, 0hich 0as
one o1 the 1i$e lar2est audit and accountanc% 3artnershi3s in the 0orld4 (n
addition to bein2 the lar2est ban'ru3tc% reor2ani>ation in American histor% at
that time, Enron 0as attributed as the bi22est audit 1ailure4
Enron 0as 1ormed in 1,?5 b% @enneth Aa% a1ter mer2in2 =ouston Natural
Bas and (nterNorth4 Se$eral %ears later, 0hen .e11re% S'illin2 0as hired, he
de$elo3ed a sta11 o1 e;ecuti$es that, b% the use o1 accountin2 loo3holes,
s3ecial 3ur3ose entities, and 3oor 1inancial re3ortin2, 0ere able to hide
billions o1 dollars in debt 1rom 1ailed deals and 3ro5ects4 Chie1 Cinancial
<11icer Andre0 Casto0 and other e;ecuti$es not onl% misled Enron9s board
o1 directors and audit committee on hi2h+ris' accountin2 3ractices, but also
3ressured Andersen to i2nore the issues4
Enron shareholders 1iled a D/* billion la0suit a1ter the com3an%9s stoc'
3rice, 0hich achie$ed a hi2h o1 SD,*4-5 3er share in mid+)***, 3lummeted
to less than D1 b% the end o1 No$ember )**14 The 4S4 Securities and
E;chan2e Commission (SEC) be2an an in$esti2ation, and ri$al =ouston
)
com3etitor "%ne2% o11ered to 3urchase the com3an% at a $er% lo0 3rice4 The
deal 1ailed, and on "ecember ), )**1, Enron 1iled 1or ban'ru3tc% under
Cha3ter 11 o1 the nited States Ban'ru3tc% Code4 Enron9s DE34/ billion in
assets made it the lar2est cor3orate ban'ru3tc% in 4S4 histor% until
#orldCom9s ban'ru3tc% the ne;t %ear4
Man% e;ecuti$es at Enron 0ere indicted 1or a $ariet% o1 char2es and 0ere
later sentenced to 3rison4 Enron9s auditor, Arthur Andersen, 0as 1ound 2uilt%
in a nited States "istrict Court, but b% the time the rulin2 0as o$erturned at
the 4S4 Su3reme Court, the com3an% had lost the ma5orit% o1 its customers
and had closed4 Em3lo%ees and shareholders recei$ed limited returns in
la0suits, des3ite losin2 billions in 3ensions and stoc' 3rices4 As a
conse:uence o1 the scandal, ne0 re2ulations and le2islation 0ere enacted
to e;3and the accurac% o1 1inancial re3ortin2 1or 3ublic com3anies4 <ne
3iece o1 le2islation, the Sarbanes+<;le% Act, increased 3enalties 1or
destro%in2, alterin2, or 1abricatin2 records in 1ederal in$esti2ations or 1or
attem3tin2 to de1raud shareholders4 The act also increased the
accountabilit% o1 auditin2 1irms to remain unbiased and inde3endent o1 their
clients4
3
Question 1 :
Wat are te syste!i"# "or$orate and indi%idual eti"al
issues rise &y tis "ase'
Ans(er :
(n the case o1 Sl$er% and the choolate industr% contains s%temetic, cor3orate
and indi$idual ethical issues in man% di11erent 0a%s4 Aoo'in2 at the
economical re3ercussions, it 0ould not be lo2ical to do business 0ith these
countries considerin2 that close to hal1 o1 the 0orlds chocolate is made 1rom
cocoa beans that are 2ro0n in the ($or% Coast and Bhana4 (1 0e re1used to
do business 0ith these countries the ost o1 these 2oods 0ould be un+
a11ordable to consumers4 (n a 3olitical as3ect, 0e tend to be the leaders the
moment 0e sto3 doin2 business 0ith these indi$iduals man% other countries
0ill 1ollo0 alon2 or $is $ersaF those countries 0ho re1use to do to sto3 doin2
business 0ith them mi2ht then sto3 doin2 business 0ith us4 The last
s%stematic issue raised is le2al4 As stated in the article sla$er% on the 1arms
is in ille2al in the ($or% Coast4 #hether it is or ho0 0ell the la0s are en1orced
is 1or the most 3art out o1 our control4
1) Te Syste!ati" *ssues:
(t is common 'no0led2e that Enron is ar2uabl% to bi22est cor3orate colla3se
in recent histor%4 (t is not common 'no0led2e, ho0e$er, 0hat e;actl%
ha33ened 0ithin Enron that lead to its demise4 @enneth Aa% 1ounded Enron
in 1,?5 0hen he con1i2ured the mer2in2 o1 t0o natural 2as com3anies4
Enron continued to 2ro0 b% ac:uisition, leadin2 to lar2e amounts o1 debt4
Aa% hired .e11er% S'illin2 in 1,?, to head the com3an%7s 1inance de3artment4
The com3an%, it 0as re$ealed, had made about a do>en G3artnershi3sG 0ith
com3anies it had created, and it used those 3artnershi3s to hide hu2e debts
and hea$% losses on its tradin2 businesses4 At the same time, Arthur
Andersen, the com3an% that audited Enron9s boo's, at best ne2lected to
reco2ni>e the com3an%9s 3roblems4 At 0orst, in$esti2ators no0 sa%, the
auditor 0as com3licit in 3er3etratin2 one o1 the bi22est 1rauds in cor3orate
histor%4
Auditin+ *ssues
Cederal securities la0 re:uires that the accountin2 statements o1 3ublicl%
traded cor3orations be certi1ied b% an inde3endent auditor4 Enron7s outside
/
audits ha$e recei$ed much attention4 #hile e;ternal audits do not 3re$ent
cor3orations 1rom ma'in2 1inancial mista'es, let alone ban'ru3tc%, 3roblems
0ith recent Enron audits ma% ha$e contributed to both the ra3id rise and the
shar3 1all in its stoc' 3rice4 <utside in$estors, includin2 1inancial institutions,
ma% ha$e been misled about the cor3oration7s net income (0hich 0as
subse:uentl% restated) and contin2ent liabilities (0hich 0ere 1ar lar2er than
2enerall% 'no0n)4 The auditor, Arthur Andersen, has admitted some
mista'es4 Andersen 1ired the 3artner in char2e o1 Enron audits on .anuar%
15, )**), and Enron dismissed Andersen on .anuar% 1-4 <ne issue is
0hether Andersen7s e;tensi$e consultin2 0or' 1or Enron ma% ha$e
com3romised its 5ud2ment in determinin2 the nature, timin2, and e;tent o1
audit 3rocedures and in as'in2 that re$isions be made to 1inancial
statements, 0hich are the res3onsibilit% o1 Enron7s mana2ement4 Huestions
ha$e also been as'ed about Andersen destro%in2 documents and e+mails
related to its audits4 <$ersi2ht o1 auditors has 3rimaril% rested 0ith the
American (nstitute o1 Certi1ied !ublic Accountants (a non2o$ernmental trade
2rou3) and state boards o1 accountanc%4 <n .anuar% 1-, )**), the Chairman
o1 the Securities and E;chan2e Commission (SEC) 3ro3osed a ne0
o$ersi2ht board that 0ould be res3onsible 1or disci3linar% actions4
A""ountin+ *ssues
The Enron contro$ers% in$ol$es se$eral accountin2 issues4 <ne concerns
the rules 2o$ernin2 0hether the 1inancial statements o1 s3ecial 3ur3ose
entities (S!Es) established b% a cor3oration should be consolidated 0ith the
cor3oration7s 1inancial statementsF 1or certain S!E 3artnershi3s at issue,
consolidation is not re:uired i1 amon2 other thin2s an inde3endent third 3art%
in$ests as little as 3I o1 the ca3ital, a threshold some consider too lo04 A
second issue concerns the latitude allo0ed in $aluin2 deri$ati$es, 3articularl%
none;chan2e traded ener2% contracts4 Third, there are calls 1or im3ro$ed
disclosure, either in notes to 1inancial statements or a mana2ement
discussion and anal%sis, es3eciall% 1or 1inancial arran2ements in$ol$in2
contin2ent liabilities4 Accountin2 standards 1or cor3orations are set b% the
Cinancial Accountin2 Standards Board (CASB), a non2o$ernmental entit%,
thou2h there are also SEC re:uirements4 (The SEC has statutor% authorit%
to set accountin2 standards 1or 1irms that sell securities to the 3ublic4)
,ension *ssues
Ai'e man% com3anies, Enron s3onsors a retirement 3lan J a 6/*1(')8 J 1or
its em3lo%ees to 0hich the% can contribute a 3ortion o1 their 3a% on a ta;+
de1erred basis4 As o1 "ecember 31, )***, E)I o1 the assets held in the
5
cor3oration7s /*1(') retirement 3lan consisted o1 Enron stoc'4 Man%
indi$idual Enron em3lo%ees held e$en lar2er 3ercenta2es o1 Enron stoc' in
their /*1(') accounts4 Shares o1 Enron, 0hich in .anuar% )**1 traded 1or
more than D?*Kshare, 0ere 0orth less than -* cents in .anuar% )**)4
Conse:uentl%, the com3an%7s ban'ru3tc% has substantiall% reduced the
$alue o1 its em3lo%ees7 retirement accounts4 The losses su11ered b%
3artici3ants in the Enron Cor3oration7s /*1(') 3lan ha$e 3rom3ted :uestions
about the la0s and re2ulations that 2o$ern these 3lans4 Should there be a
limit on the amount o1 em3lo%er stoc' that a /*1(') 3lan can holdL Should
com3anies be allo0ed to restrict the sale o1 stoc' that the% contribute to the
3lansL Should the 2uarantees that the !ension Bene1it Buarantee
Cor3oration e;tends to traditional 6de1ined bene1it8 3lans also a33l% to
/*1(')7sL
Se"urities Analyst *ssues
Securities anal%sts em3lo%ed b% in$estment ban's 3ro$ide research and
ma'e 6bu%,8 6sell,8 or 6hold8 recommendations 1or the use o1 their sales sta11s
and their in$estor clients4 These recommendations are 0idel% circulated and
are relied u3on b% man% in$estors throu2hout the mar'ets4 Anal%st su33ort
0as crucial to Enron because it re:uired constant in1usions o1 1undin2 1rom
the 1inancial mar'ets4 <n No$ember ),, )**1, a1ter Enron7s stoc' had 1allen
,,I 1rom its hi2h, and a1ter ratin2 a2encies had do0n2raded its debt to
65un' bond8status, onl% t0o o1 11 ma5or 1irm anal%sts rated its stoc' a 6sell48
This 3er1ormance added to concerns that 0ere raised in )*** in the 0a'e o1
the 6dot4com8 stoc' crash4 (s anal%st ob5ecti$it% com3romised b% 3ressure to
a$oid alienatin2 lucrati$e in$estment ban'in2 clientsL Are re2ulations
needed to re:uire disclosure o1 anal%sts7 3ersonal holdin2s or their
em3lo%ers7 dealin2s 0ith the 1irms the% co$er, or to 3rohibit the lin'in2 o1
anal%st 3a% to in$estment ban'in2 3ro1itsL Should anal%sts7 3er1ormance and
:uali1ications be monitored b% the SEC or b% a sel1+re2ulator% or2ani>ation
such as the National Association o1 Securities "ealers (NAS")L
Deri%ati%es *ssues
The core o1 Enron7s business a33ears to ha$e been dealin2 in deri$ati$e
contracts based on the 3rices o1 oil, 2as, electricit% and other $ariables4 Cor
e;am3le, Enron sold lon2+term contracts to sell ener2% at 1i;ed 3rices4 These
contracts allo0 the bu%ers to a$oid, or hed2e, the ris's that increases (or
dro3s) in ener2% 3rices 3osed to their businesses4 Since the mar'ets in
0hich Enron traded are lar2el% unre2ulated, 0ith no re3ortin2 re:uirements,
little in1ormation is a$ailable about the e;tent or 3ro1itabilit% o1 Enron7s
E
deri$ati$es acti$ities4 "id Enron earn mone% 1rom dealer commissions and
s3reads, or 0as it acti$el% s3eculatin2 on 1uture 3rice trendsL S3eculati$e
losses in deri$ati$es, 3erha3s mas'ed b% 6creati$e8 accountin2, could ha$e
contributed to the 1irm7s do0n1all4 <n the other hand, the tradin2 o3erations
ma% ha$e been 3ro1itable and trouble1ree, and Enron7s 1inancial di11iculties
the result o1 other unrelated o3erations4 Enron7s colla3se raises the issue o1
su3er$ision o1 unre2ulated deri$ati$es mar'ets4 #ould it be use1ul i1
re2ulators had more in1ormation about the 3ort1olios and ris' e;3osures o1
ma5or dealers in deri$ati$esL Althou2h Enron7s ban'ru3tc% a33ears to ha$e
had little im3act on ener2% su33lies and 3rices, a similar dealer 1ailure in the
1uture mi2ht dama2e the dealer7s tradin2 3artners and its lenders, and mi2ht
set o11 0ides3read disru3tions in 1inancial andKor real commodit% mar'ets4
-) Te Cor$orate *ssues :
=eal% and !ale3u 0rite that a 0ell+1unctionin2 ca3ital mar'et Gcreates
a33ro3riate lin'a2es o1 in1ormation, incenti$es, and 2o$ernance bet0een
mana2ers and in$estors4 This 3rocess is su33osed to be carried out throu2h
a net0or' o1 intermediaries that include assurance 3ro1essionals such as
e;ternal auditorsF and internal 2o$ernance a2ents such as cor3orate
boards4G <n 3a3er, Enron had a model board o1 directors com3risin2
3redominantl% o1 outsiders 0ith si2ni1icant o0nershi3 sta'es and a talented
audit committee4 (n its )*** re$ie0 o1 best cor3orate boards, Chief
Executive included Enron amon2 its 1i$e best boards4 E$en 0ith its com3le;
cor3orate 2o$ernance and net0or' o1 intermediaries, Enron 0as still able to
Gattract lar2e sums o1 ca3ital to 1und a :uestionable business model, conceal
its true 3er1ormance throu2h a series o1 accountin2 and 1inancin2
maneu$ers, and h%3e its stoc' to unsustainable le$els4G
E.e"uti%e "o!$ensation
Althou2h Enron9s com3ensation and 3er1ormance mana2ement s%stem 0as
desi2ned to retain and re0ard its most $aluable em3lo%ees, the s%stem
contributed to a d%s1unctional cor3orate culture that became obsessed 0ith
short+term earnin2s to ma;imi>e bonuses4 Em3lo%ees constantl% tried to
start deals, o1ten disre2ardin2 the :ualit% o1 cash 1lo0 or 3ro1its, in order to
2et a better ratin2 1or their 3er1ormance re$ie04 Additionall%, accountin2
results 0ere recorded as soon as 3ossible to 'ee3 u3 0ith the com3an%9s
stoc' 3rice4 This 3ractice hel3ed ensure deal+ma'ers and e;ecuti$es
recei$ed lar2e cash bonuses and stoc' o3tions4
-
Ris/ !ana+e!ent
Be1ore its scandal, Enron 0as lauded 1or its so3histicated 1inancial ris'
mana2ement tools4 &is' mana2ement 0as crucial to Enron not onl% because
o1 its re2ulator% en$ironment, but also because o1 its business 3lan4 Enron
established lon2+term 1i;ed commitments 0hich needed to be hed2ed to
3re3are 1or the in$ariable 1luctuation o1 1uture ener2% 3rices4 Enron9s
ban'ru3tc% do0n1all 0as attributed to its rec'less use o1 deri$ati$es and
s3ecial 3ur3ose entities4 B% hed2in2 its ris's 0ith s3ecial 3ur3ose entities
0hich it o0ned, Enron retained the ris's associated 0ith the transactions4
This arran2ement had Enron im3lementin2 hed2es 0ith itsel14
Eti"al and $oliti"al analyses
Commentators attributed the mismana2ement behind Enron7s 1all to a $ariet%
o1 ethical and 3olitical+economic causes4 Ethical e;3lanations centered on
e;ecuti$e 2reed and hubris, a lac' o1 cor3orate social res3onsibilit%, situation
ethics, and 2et+it+done business 3ra2matism4

!olitical+economic
e;3lanations cited 3ost+1,-*s dere2ulation, and inade:uate sta11 and
1undin2 1or re2ulator% o$ersi2ht4

A more libertarian anal%sis maintained that
Enron7s colla3se resulted 1rom the com3an%7s reliance on 3olitical lobb%in2,
rent+see'in2, and the 2amin2 o1 re2ulations4
0) Te *ndi%idual *ssues :
<n the sur1ace, the moti$es and attitudes behind decisions and e$ents
leadin2 to Enron7s e$entual do0n1all a33ear sim3le enou2h: indi$idual and
collecti$e 2reed born in an atmos3here o1 mar'et eu3horia and cor3orate
arro2ance4
Artur Andersen
Arthur Andersen 0as char2ed 0ith and 1ound 2uilt% o1 obstruction o1 5ustice
1or shreddin2 the thousands o1 documents and deletin2 e+mails and
com3an% 1iles that tied the 1irm to its audit o1 Enron4 Althou2h onl% a small
number o1 Arthur Andersen9s em3lo%ees 0ere in$ol$ed 0ith the scandal, the
1irm 0as e11ecti$el% 3ut out o1 businessF the SEC is not allo0ed to acce3t
audits 1rom con$icted 1elons4 The com3an% surrendered its C!A license on
Au2ust 31, )**), and ?5,*** em3lo%ees lost their 5obs4 The con$iction 0as
later o$erturned b% the 4S4 Su3reme Court due to the 5ur% not bein2
3ro3erl% instructed on the char2e a2ainst Andersen4
M15*N
The Su3reme Court
?
rulin2 theoreticall% le1t Andersen 1ree to resume o3erations4 =o0e$er, the
dama2e to the Andersen name has been so 2reat that it has not returned as
a $iable business e$en on a limited scale4
E!$loyees and sareolders
Enron9s head:uarters in "o0nto0n =ouston 0as leased 1rom a consortium
o1 ban's 0ho had bou2ht the 3ro3ert% 1or D)?5 million in the 1,,*s4 (t 0as
sold 1or D5545 million, 5ust be1ore Enron mo$ed out in )**/4 Enron9s
shareholders lost D-/ billion in the 1our %ears be1ore the com3an%9s
ban'ru3tc% (D/* to D/5 billion 0as attributed to 1raud)4 As Enron had nearl%
DE- billion that it o0ed creditors, em3lo%ees and shareholders recei$ed
limited, i1 an%, assistance aside 1rom se$erance 1rom Enron4 To 3a% its
creditors, Enron held auctions to sell assets includin2 art, 3hoto2ra3hs, lo2o
si2ns, and its 3i3elines4
Ca$italis! at Wor/
(n the latter 3art o1 the 1,,*s, com3anies such as "%ne2%, "u'e Ener2%, El
!aso and #illiams be2an 1ollo0in2 Enron7s lead4 Enron7s com3etiti$e
ad$anta2e, as 0ell as its hu2e 3ro1it mar2ins, had be2un to erode b% the end
o1 )***4 Each ne0 mar'et entrant7s successes s:uee>ed Enron7s 3ro1it
mar2ins 1urther4 (t ran 0ith increasin2 le$era2e, thus becomin2 more li'e a
hed2e 1und than a tradin2 com3an%4 Mean0hile, ener2% 3rices be2an to 1all
in the 1irst :uarter o1 )**1 and the 0orld econom% headed into a recession,
thus dam3enin2 ener2% mar'et $olatilit% and reducin2 the o33ortunit% 1or the
lar2e, ra3id tradin2 2ains that had 1ormerl% made Enron so 3ro1itable4 "eals,
es3eciall% in the 1inance di$ision, 0ere done at a ra3id 3ace 0ithout much
re2ard to 0hether the% ali2ned 0ith the strate2ic 2oals o1 the com3an% or
0hether the% com3lied 0ith the com3an%7s ris' mana2ement 3olicies4 As one
'no0led2eable Enron em3lo%ee 3ut it: 6Bood deal $s4 bad dealL "idn7t
matter4 (1 it had a 3ositi$e net 3resent $alue (N!O) it could 2et done4
Sometimes 3ositi$e N!O didn7t e$en matter in the name o1 strate2ic
si2ni1icance48 Enron7s 1oundations 0ere de$elo3in2 crac's and S'illin27s
house o1 3a3er built on the stilts o1 trust had be2un to crumble4
Related ,arties 1 Co!$le. S$e"ial ,ur$ose Entities
(n order to satis1% Mood%7s and Standard P !oor7s credit ratin2 a2encies,
Enron had to ma'e sure the com3an%7s le$era2e ratios 0ere 0ithin
acce3table ran2es4 Casto0 continuall% lobbied the ratin2s a2encies to raise
,
Enron7s credit ratin2, a33arentl% to no a$ail4 That not0ithstandin2, there 0ere
other 0a%s to lo0er the com3an%7s debt ratio4 &educin2 hard assets 0hile
earnin2 increasin2 3a3er 3ro1its ser$ed to increase Enron7s return on assets
(&<A) and reduce its debt+to+total+assets ratio, ma'in2 the com3an% more
attracti$e to credit ratin2 a2encies and in$estors4
Enron, li'e man% other com3anies, used 6s3ecial 3ur3ose entities8 (S!Es) to
access ca3ital or hed2e ris'4 B% usin2 S!Es such as limited 3artnershi3s
0ith outside 3arties, a com3an% is 3ermitted to increase le$era2e and &<A
0ithout ha$in2 to re3ort debt on its balance sheet4 The com3an% contributes
hard assets and related debt to an S!E in e;chan2e 1or an interest4 The
S!E then borro0s lar2e sums o1 mone% 1rom a 1inancial institution to
3urchase assets or conduct other business 0ithout the debt or assets
sho0in2 u3 on the com3an%7s 1inancial statements4 The com3an% can also
sell le$era2ed assets to the S!E and boo' a 3ro1it4 To a$oid classi1ication o1
the S!E as a subsidiar% (thereb% 1orcin2 the entit% to include the S!E7s
1inancial 3osition and results o1 o3erations in its 1inancial statements), CASB
2uidelines re:uire that onl% 3I o1 the S!E be o0ned b% an outside in$estor4
Te Hu!an Fa"tor
The Enron stor% has 3roduced man% $ictims, the most tra2ic o1 0hich is a
1ormer $ice+chairman o1 the com3an% 0ho committed suicide, a33arentl% in
connection 0ith his role in the scandal4 Another /,5** indi$iduals ha$e seen
their careers ended abru3tl% b% the rec'less acts o1 a 1e04 Enron7s core
$alues o1 res3ect, inte2rit%, communication and e;cellence stand in satirical
contrast to alle2ations no0 bein2 made 3ublic4 !ersonall%, ( had re1erred
se$eral o1 our best and bri2htest accountin2, 1inance and MBA 2raduates to
Enron, ho3in2 the% could 2ain $aluable e;3erience 1rom seein2 thin2s done
ri2ht4 These included a $er% bri2ht trainin2 consultant 0ho had lost her 5ob in
)*** 0ith a =ouston consultin2 1irm as a result o1 a reduction in 1orce4 She
has lost her second 5ob in 1? months throu2h no 1ault o1 her o0n4 <ther
1ormer students still han2in2 on at Enron 1ace an uncertain 1uture as the
com3an% 1i2hts 1or sur$i$al4
1*
Question -
*2 te %alue o2 Enrons sto"/ ad not 2allen# te s$e"ial
$ur$ose entities $era$s "ould a%e "ontinued to o$erate
inde2initely) Su$$ose tat Enrons sto"/ did not 2all# and
su$$ose tat its a""ountin+ adered to te letter# i2 not te
s$irit# o2 3AA, rules) *n tat "ase# in your %ie(# (as tere
anytin+ (ron+ (it (at Enron did'
Ans(er :
Enron9s com3le; 1inancial statements 0ere con1usin2 to shareholders and
anal%sts4 (n addition, its com3le; business model and unethical 3ractices
re:uired that the com3an% use accountin2 limitations to misre3resent
earnin2s and modi1% the balance sheet to indicate 1a$orable 3er1ormance4
The combination o1 these issues later resulted in the ban'ru3tc% o1 the
com3an%, and the ma5orit% o1 them 0ere 3er3etuated b% the indirect
'no0led2e or direct actions o1 Aa%, .e11re% S'illin2, Andre0 Casto0, and
other e;ecuti$es4 Aa% ser$ed as the chairman o1 the com3an% in its last 1e0
%ears, and a33ro$ed o1 the actions o1 S'illin2 and Casto0 althou2h he did
not al0a%s in:uire about the details4 S'illin2 constantl% 1ocused on meetin2
#all Street e;3ectations, ad$ocated the use o1 mar'+to+mar'et accountin2
(accountin2 based on mar'et $alue, 0hich 0as then in1lated) and 3ressured
Enron e;ecuti$es to 1ind ne0 0a%s to hide its debt4 Casto0 and other
e;ecuti$es G444created o11+balance+sheet $ehicles, com3le; 1inancin2
structures, and deals so be0ilderin2 that 1e0 3eo3le could understand
them4G
Re%enue re"o+nition
Enron and other ener2% su33liers earned 3ro1its b% 3ro$idin2 ser$ices such
as 0holesale tradin2 and ris' mana2ement in addition to buildin2 and
maintainin2 electric 3o0er 3lants, natural 2as 3i3elines, stora2e, and
3rocessin2 1acilities4 #hen acce3tin2 the ris' o1 bu%in2 and sellin2 3roducts,
merchants are allo0ed to re3ort the sellin2 3rice as re$enues and the
3roducts9 costs as cost o1 2oods sold4 (n contrast, an Ga2entG 3ro$ides a
ser$ice to the customer, but does not ta'e the same ris's as merchants 1or
bu%in2 and sellin24 Ser$ice 3ro$iders, 0hen classi1ied as a2ents, are able to
re3ort tradin2 and bro'era2e 1ees as re$enue, althou2h not 1or the 1ull $alue
o1 the transaction4
11
Althou2h tradin2 com3anies such as Boldman Sachs and Merrill A%nch used
the con$entional Ga2ent modelG 1or re3ortin2 re$enue (0here onl% the tradin2
or bro'era2e 1ee 0ould be re3orted as re$enue), Enron instead elected to
re3ort the entire $alue o1 each o1 its trades as re$enue4 This Gmerchant
modelG 0as considered much more a22ressi$e in the accountin2
inter3retation than the a2ent model4 Enron9s method o1 re3ortin2 in1lated
tradin2 re$enue 0as later ado3ted b% other com3anies in the ener2% tradin2
industr% in an attem3t to sta% com3etiti$e 0ith the com3an%9s lar2e increase
in re$enue4 <ther ener2% com3anies such as "u'e Ener2%, &eliant Ener2%,
and "%ne2% 5oined Enron in the 0ealthiest 5* o1 the Fortune 5** mainl% due
to their ado3tion o1 the same tradin2 re$enue accountin2 as Enron4
Mar/4to4!ar/et a""ountin+
(n Enron9s natural 2as business, the accountin2 had been 1airl%
strai2ht1or0ard: in each time 3eriod, the com3an% listed actual costs o1
su33l%in2 the 2as and actual re$enues recei$ed 1rom sellin2 it4 =o0e$er,
0hen S'illin2 5oined the com3an%, he demanded that the tradin2 business
ado3t mar'+to+mar'et accountin2, citin2 that it 0ould re3resent G444 true
economic $alue4G Enron became the 1irst non+1inancial com3an% to use the
method to account 1or its com3le; lon2+term contracts4 Mar'+to+mar'et
accountin2 re:uires that once a lon2+term contract 0as si2ned, income is
estimated as the 3resent $alue o1 net 1uture cash 1lo04 <1ten, the $iabilit% o1
these contracts and their related costs 0ere di11icult to estimate4 "ue to the
lar2e discre3ancies o1 attem3tin2 to match 3ro1its and cash, in$estors 0ere
t%3icall% 2i$en 1alse or misleadin2 re3orts4 #hile usin2 the method, income
1rom 3ro5ects could be recorded, althou2h the% mi2ht not ha$e e$er recei$ed
the mone%, and in turn increasin2 1inancial earnin2s on the boo's4 =o0e$er,
in 1uture %ears, the 3ro1its could not be included, so ne0 and additional
income had to be included 1rom more 3ro5ects to de$elo3 additional 2ro0th
to a33ease in$estors4 As one Enron com3etitor stated, G(1 %ou accelerate
%our income, then %ou ha$e to 'ee3 doin2 more and more deals to sho0 the
same or risin2 income4G "es3ite 3otential 3it1alls, the 4S4 Securities and
E;chan2e Commission (SEC) a33ro$ed the accountin2 method 1or Enron in
its tradin2 o1 natural 2as 1utures contracts on .anuar% 3*, 1,,)4 =o0e$er,
Enron later e;3anded its use to other areas in the com3an% to hel3 it meet
#all Street 3ro5ections4
1)
O224te45alan"e4Seet Finan"in+
Enron had a 2reat arra% o1 1orei2n assets such as 3o0er3lants and 3i3elines
that 0ere not doin2 as 0ell 1inanciall% as the com3an% ho3ed and counted
on in its accountin24 Enron set u3 a subsidiar% in 1,,- called #hite0in24
#hite0in2 0as created to 3urchase the under3er1ormin2 Enron assets4
#hite0in2 0as then to sell o11 the under3er1ormin2 assets4 As a subsidiar%
the 1inancial state o1 #hite0in2 0ould sho0 u3 in the accounts 1or its 3arent
com3an% Enron4 (n 1,,, Enron sold o11 sli2htl% more than hal1 o1 #hite0in2
so it 0ould not be treated as a subsidiar% in the accounts o1 Enron4
#hite0in2 0as created to bu% the under3er1ormin2 assets 1rom Enron at a
2enerous 3rice, a 3rice hi2her than it could sell those assets 1or4 So
#hite0in2 0as destined to ta'e losses on its assets ac:uired 1rom Enron4 (n
order 1or Enron to 1ind bu%ers 1or the hal1 share in #hite0in2 it had to a2ree
to com3ensate #hite0in2 1or an% losses on its sale o1 the under3er1ormin2
assets 0ith shares o1 Enron stoc'4 A 2rou3 o1 in$estment ban'ers 0as 1ound
to ac:uire the hal1 share o1 #hite0in24
13
Question 0
Wi# in your 6ud+!ent# (as !orally res$onsi&le 2or te
"olla$se o2 Enron'
Ans(er :
This :estion in$esti2ates the 0ea'nesses o1 Enron7s cor3orate 2o$ernance
structures, 0ea'nesses that lead to the colla3se o1 the com3an%4
<$erall, 3oor cor3orate 2o$ernance and a dishonest culture that
nurtured serious con1licts o1 interests and unethical beha$iour in Enron
are identi1ied as si2ni1icant 1indin2s in this 3a3er4 Enron7s ethics code
0as based on res3ect, inte2rit%, communication, and e;cellence4 These
$alues 0ere described as 1ollo0s:
Res$e"t4 #e treat others as 0e 0ould li'e to be treated oursel$es4
#e do not tolerate abusi$e or disres3ect1ul treatment4 &uthlessness,
callousness and arro2ance don7t belon2 here4
*nte+rity4 #e 0or' 0ith customers and 3ros3ects o3enl%, honestl%
and sincerel%4 #hen 0e sa% 0e 0ill do somethin2, 0e 0ill do itF 0hen
0e sa% 0e cannot or 0ill not do somethin2, then 0e 0on7t do it4
Co!!uni"ation4 #e ha$e an obli2ation to communicate4 =ere 0e
ta'e the time to tal' 0ith one another 4 4 4 and to listen4 #e belie$e
that in1ormation is meant to mo$e and that in1ormation mo$es 3eo3le4
E."ellen"e4 #e are satis1ied 0ith nothin2 less than the $er% best in
e$er%thin2 0e do4 #e 0ill continue to raise the bar 1or e$er%one4 The
2reat 1un here 0ill be 1or all o1 us to disco$er 5ust ho0 2ood 0e can
reall% be4
Bi$en this code o1 conduct and @en Aa%7s 3ro1essed commitment to
business ethics, ho0 could Enron ha$e colla3sed so dramaticall%, 2oin2 1rom
re3orted re$enues o1 D1*1 billion in )*** and a33ro;imatel% D1/* billion
durin2 the 1irst three :uarters o1 )**1 to declarin2 ban'ru3tc% in "ecember
)**1L The ans0er to this :uestion seems to be rooted in a combination o1
the 1ailure o1 to3 leadershi3, a cor3orate culture that su33orted unethical
beha$ior, and the com3licit% o1 the in$estment ban'in2 communit%4
Man% 1actors a11ected Enron9s sur2e to the to3 and its sudden 1all4 (n this
re3ort 0e 0ill discuss and 3resent 0hat 0e thin' 0ere the main reasons o1
their rise and 1all4
1/
A""ountin+ ,ro&le!s
The con$entional 0isdom is that it 0as Ginno$ati$eG accountin2 3ractices and
their conse:uences that started the tide o1 losses that brou2ht the ener2%
2iant do0n4 Enron colla3sed not so much because it had 2otten too bi2, but
because it 0as 3ercei$ed to be much bi22er than it reall% 0as in the 1irst
3lace4 B% decentrali>in2 its o3erations into numerous subsidiaries and shell
cor3orations, Enron 0as able to hide hu2e deri$ati$e losses that 0ould ha$e
halted its 2ro0th much sooner i1 0idel% understood4 !ublicl% traded
cor3orations are re:uired to ma'e their 1inancial statements 3ublic, but
Enron9s 1inances 0ere an im3enetrable ma>e o1 care1ull% cra1ted ima2inar%
transactions bet0een itsel1 and its subsidiaries that mas'ed its true 1inancial
state4 (n other 0ords, losses 0ere held o11 the boo' b% subsidiar%
com3anies, 0hile assets 0ere stated4
Fallout Fro! Fraud
Ta'en at its 0ord, this ros% scenario made the com3an% the darlin2 o1 #all
Street, and it 0as able to borro0 almost endlessl% and e;3and into e+
commerce and other :uestionable $entures4 (ts stoc' literall% soared, 0hich
made em3lo%ee com3ensation and 3ensions in the 1orm o1 stoc' o3tions
seem $er% attracti$e4 But 0hat 0ere alread% considered accountin2 3ractices
on the ed2e o1 acce3table standards 0ere e$entuall% re$ealed to be outri2ht
1raudulent4 The dis2race dro$e so much business a0a% 1rom and created
such liabilit% 1or accountin2 1irm Arthur Anderson that it 0as itsel1 1orced out
o1 business4 B% this time, thou2h, the true $alue o1 the com3an% had been
re$ealed and the stoc' 3rice colla3sed, lea$in2 em3lo%ees 0ith 0orthless
o3tions and 3ension 3ac'a2es4 <1 course, e;ecuti$es that understood the
real 3icture sold their shares in ad$ance o1 the colla3sed and 0alt>ed a0a%
0ith billions4
Mana+e!ent Culture
<1 course, the Enron 1iasco did not ha33en b% accident4 (t 0as 1acilitated b%
a cor3orate culture that encoura2ed 2reed and 1raud, as e;em3li1ied b% the
ener2% traders 0ho e;torted Cali1ornia ener2% consumers4 &ather than 1ocus
on creatin2 real $alue, mana2ement9s onl% 2oal 0as in maintainin2 the
a33earance o1 $alue, and there1ore a risin2 stoc' 3rice4 This 0as
e;acerbated b% a 1iercel% com3etiti$e cor3orate culture that re0arded results
at an% cost4 Some di$isions o1 Enron re3laced as much as 15 3ercent o1 its
15
0or' 1orce annuall%, lea$in2 em3lo%ees to scramble 1or an% ad$anta2e the%
could 1ind to 5usti1% their continued em3lo%ment4
,re2erential Treat!ent
#hile the internal inte2rit% o1 the com3an% remained thusl% challen2ed, the
1acade 0as the e;act o33osite4 The com3an% le$era2ed 3olitical connections
in both the Clinton and Bush administrations, as 0ell as on #all Street, 1or
3re1erential treatment and the air o1 le2itimac% that allo0ed it to 3er3etrate its
1rauds4 (n this conte;t, the accountin2 3ractices 0idel% considered the cause
o1 the Enron colla3se can be seen as 5ust a s%m3tom o1 a lar2er
mana2ement culture that e;em3li1ied the dar' side o1 American ca3italism4
Co!$li"ity o2 te *n%est!ent 5an/in+ Co!!unity
Accordin2 to in$esti2ati$e re3orters McAean and El'ind, 6<ne o1 the most
sordid as3ects o1 the Enron scandal is the com3licit% o1 so man% hi2hl%
re2arded #all Street 1irms8 in enablin2 Enron7s 1raud as 0ell as bein2
3artners to it4 (ncluded amon2 these 1irms 0ere .4!4 Mor2an, Citi2rou3, and
Merrill A%nch4 This com3licit% occurred throu2h the use o1 prepays, 0hich
0ere basicall% loans that Enron boo'ed as o3eratin2 cash 1lo04 Enron
secured ne0 3re3a%s to 3a% o11 e;istin2 ones and to su33ort ra3idl%
e;3andin2 in$estments in ne0 businesses4
E$ilo+ue
The Enron Code o1 Ethics and its 1oundational $alues o1 res3ect, inte2rit%,
communication, and e;cellence ob$iousl% did little to hel3 create an ethical
en$ironment at the com3an%4 The 1ull e;tent and e;3lanation o1 Enron7s
ethical colla3se is %et to be determined as le2al 3roceedin2s continue4
Courteen other Enron em3lo%eesQman% hi2h le$elQha$e 3led 2uilt% to
$arious char2esF 1) o1 these are a0aitin2 sentencin2, 0hile the other t0o,
one o1 0hom is Andre0 Casto07s s3ouse, ha$e recei$ed 3rison sentences o1
at least one %ear4 .uries ha$e con$icted 1i$e indi$iduals o1 1raud, as 0ell as
Arthur Andersen, the accountin2 1irm hired b% Enron that shared
res3onsibilit% 1or the com3an%7s 1raudulent accountin2 statements4
Enrons To$ 7eadersi$
(n the a1termath o1 Enron7s ban'ru3tc% 1ilin2, numerous Enron e;ecuti$es
0ere char2ed 0ith criminal acts, includin2 1raud, mone% launderin2, and
insider tradin24 Cor e;am3le, Ben Blisan, Enron7s 1ormer treasurer, 0as
char2ed 0ith t0o+do>en counts o1 mone% launderin2, 1raud, and cons3irac%4
1E
Blisan 3led 2uilt% to one count o1 cons3irac% to commit 1raud and recei$ed a
3rison term, three %ears o1 3ost+3rison su3er$ision, and 1inancial 3enalties o1
more than D1 million4 "urin2 the 3lea ne2otiations, Blisan described Enron
as a 6house o1 cards48
Andre0 Casto0, .e11 S'illin2, and @en Aa% are amon2 the most notable to3+
le$el e;ecuti$es im3licated in the colla3se o1 Enron7s 6house o1 cards48
Andre0 Casto0, 1ormer Enron chie1 1inancial o11icer (CC<), 1aced ,? counts
o1 mone% launderin2, 1raud, and cons3irac% in connection 0ith the im3ro3er
3artnershi3s he ran, 0hich included a Bra>ilian 3o0er 3lant 3ro5ect and a
Ni2erian 3o0er 3lant 3ro5ect that 0as aided b% Merrill A%nch, an in$estment
ban'in2 1irm4 Casto0 3led 2uilt% to one char2e o1 cons3irac% to commit 0ire
1raud and one char2e o1 cons3irac% to commit 0ire and securities 1raud4 =e
a2reed to a 3rison term o1 1* %ears and the 1or1eiture o1 D),4? million4 .e11
S'illin2 0as indicted on 35 counts o1 0ire 1raud, securities 1raud, cons3irac%,
ma'in2 1alse statements on 1inancial re3orts, and insider tradin24 @en Aa%
0as indicted on 11 criminal counts o1 1raud and ma'in2 misleadin2
statements4 Both S'illin2 and Aa% 3led not 2uilt% and are a0aitin2 trial4

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