The fall of Enron

17th February 2012

The Causes (1/3)

A complex Business model
1) The Extension of trading activities Divestments from heavy assets Extension to trading of other commodities (increase of volatility) Extensive use of derivatives and financial instruments 2) Expansion in many deregulated markets and in the construction of energy-assets business This complex model lead to the stretching of the limits of accounting

The Causes (2/3)

The accounting issues
1) Mark-to-market accounting Estimation of the cost of contract fulfillment was highly subjective 2) The special purpose entities (SPEs) Problem of transparency to cover their debts and increase their revenues Off balance sheet liabilities

The Causes (3/3)

Those issues were not detected because of problems of Governance
1. Top Management level Compensation system that focused on short term performance CEO is also Chairman of the Board 2. Audit Committee Few short meetings that covered too many points 3. External Auditors Problem of independence (auditors too close with the firm )

Cadbury Code of Best Practices

Problems related to the Cadbury Code Presence of executives directors on the Board which hampered the ability of the Board to oversee partially the management A concentration of power in one person (here CEO/Chairman is a unique person), no strong independent element on the Board The majority of the board is not free from any business or relationship which could interfere with the exercise of their independent judgment. (several members were CEO of energy companies or related to Enron) Board members are also members of other committees (Audit, Compensation) this lead to lack of independence and control of those committees

Cadbury Code of Best Practices

Complexity of the business model and the structure of the company so the Board could have had difficulties in presenting an understandable assessment of the companys position. Connivance between the board and the external auditors (long standing relationships, personal interests) Effectiveness of the system of internal control in question (many internal auditing controls outsourced to Andersen).

Recommendations
Enhance independence between the various stakeholders Separate Chairman / CEO Rotation of external auditors Separation of consulting / auditing services Enhance the compensation system Remuneration of directors should not be linked with the stocks performance More control over the remuneration system

Recommendations
More transparency in the accounting system Problem of the off balance liabilities Problem of the mark to market cash flows valuation