Enron Research Paper Final PDF

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Enron Scandal Research Paper. Brief summary, impact of the scandals and alternative solutions...

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Executive Summary Enron, from being one of America’s most innovative companies, is now a no longer existing energy production and commodities trading company which found itself at the centre of one of corporate America's biggest scandals. Through severe accounting malpractices, Enron’s corruption scandal resulted in a loss of 20,000 jobs and $70 billion in shareholder value. This report helps provide an understanding of the organizational factors that facilitated such corruption. Jeff Skilling, Enron’s CEO, created an extreme performance culture that prioritized stock price performance without regards for the means. His survival of the fittest tactics were reflected in his PRC policies or Performance Review Committees. Due to Enron’s malpractices and intention to deceive, individuals that were unwilling to engage in unethical practices received poor performance reviews and were effectively forced out of the company. Individuals failed to raise concerns through the available control structures because they feared that the Performance Review Committee would be used to end their career at Enron. Enron also highlights failure of external oversight measures as auditors failed to hold Enron accountable due to conflicts of interest and regulators let accounting irregularities go unnoticed due to industry deregulation. The sudden fall of Enron came as a shock to the public as it affected the lives of investors, stakeholders, and the lives of thousands employees as well. This paper provides a brief history of the company, numerous ethical dilemma and actions of the Executive that led to the collapse of the company. It will also discuss the impacts of the scandal and possible alternative actions to be taken to prevent this from happening again in the future.

Brief History of Enron Enron began its life as an interstate pipeline company in 1985 following a merger between Houston Natural Gas Co. and Omaha-based InterNorth Inc. In the early 1990s, Kenneth Lay initiated the selling of electricity on the free market and right after a legislation deregulating the sale of natural gas has been approved by the US Congress which gave Enron the opportunity to sell their energy at higher prices which leads to the increase of their revenue. From then, Enron began moving into new fields and became known throughout the business world as America’s most innovative company. It was also listed as the seventh largest company in the United States which made the company more appealing to top graduates out of the best universities in America hence, giving the company more competence. Aside from the company’s great success financially, it is also regarded as an excellent corporate citizen committed to excellence in corporate governance. However, this is only at first glance. Enron gave the illusion that its great success was genuine but this is not the real situation because many of Enron's debts and losses that the company suffered were not reported in the financial statements. The company’s failure in 2001 represents the largest corporate scandal in history. What led to the Ethical Dilemma? Company executives and managers play a significant role that directly influences the ethical direction of the company. The executives allowed themselves to be driven by acts that would benefit themselves rather than what would truly benefit the company as a whole. The Enron scandal involves both illegal and unethical activities which are caused by unethical behaviour on behalf of executive management allowed by a lack of transparency and failure on the part of external auditing. Although Enron has code of ethics, executives and managers did not

observe this and did not provide a good example for employees to follow but instead it encouraged them to follow their lead and do whatever it takes to generate profits. Mark to market Accounting The mark to market accounting is one of the various methods of deception used by Enron to hide the real situation in the company. This method allowed them to include in their accounting future estimated income even though money was not yet received which caused investors to rely on this misleading information because of the deviations in estimations. This allowed them to estimate profits on an asset built without considering what the market would be in the future. Enron Culture Enron has been described as having a culture wherein everyone is very competitive to the point that they will do everything just to close a deal. This is because of the bonuses and incentives in the form of cash or stock options that is given right after they closed a deal regardless of the outcome of the deal. This mentality made everyone in the work place very competitive. Another factor that contributed to the competitiveness of the employees in Enron is the performance evaluation process for all Enron employees wherein they have to perform well because if they aren’t good enough they had to pack their things because they will lose their job anytime soon. This made the employees more aggressive. Enron’s bonus program encouraged the use of non-standard accounting practices. Consequently, employees adopted and complied with the culture demanded by the company’s leaders.

Special Purpose Entity The use of Special Purpose Entity is one of the methods of deception used by Enron to appear more profitable than it really was. Supposedly, Special Purpose Entities are legal entities which are created in order to achieve a specific or temporary task but Andrew Fastow used this in order to hide its debts and overestimate its capital. He created several SPEs to which Enron transferred its substantial debt in order to conceal the current and true situation in the company. Stakeholders and Obligations If there are persons that would greatly be affected by an organization’s decision, these would be the stakeholders which comprises of the stockholders, employees, investors, etc. Stakeholders refer to persons who have interest in the company. It also refers to someone who can contribute to the company’s growth and success or who benefits from its success. These various stakeholders differ in their responsibilities and level of involvement in a business. Stockholders amd Investors The role of stockholders and investors are to provide the capital necessary for the growth and expansion of the company. They have the responsibility of setting the strategic direction that will guide the company’s management. As stockholders, they have the responsibility in addressing environmental concerns and workplace issues surrounding the company. As an owner of the company, they also have the responsibility of encouraging corporate social responsibility. In the case of Enron, this is what the stockholders of Enron failed to do. They did not pay attention to the company’s corporate responsibility performance. They failed to oversee the proper management of the company. They did not even address the problems and

raise objections to the actions and decisions relating to the management of Enron. They only focus their attention on what they think will matter that will affect the company’s performance over a short period of time and for them, social and environmental issues are quite insignificant. Employees Top management may set the overall strategic direction for the company, but it is the responsibility of the employees to carry out assigned tasks to achieve the company’s objectives. They must be able to work efficiently and effectively as the company’s success depends on them. Without them, the company would not be able to generate profits. They also have the responsibility to adhere to the rules and regulations of the company. In the case of the Enron scandal, the employees did everything they can just to comply with the level of performance demanded to them to the point that they even use inappropriate accounting practices. Consequently, they were able to adopt the culture demanded by the company’s leaders. Impact of the Scandal The collapse of Enron has affected several parties which include the stockholders, employees, customers and suppliers, communities and also the United States as a whole. Thousands of employees lost their job and their retirement savings. Stockholders also lost their investment as Enron’s stock drop rapidly. The sudden fall of Enron came as a shock to the public as it not only affected the lives of the stakeholders, but it also affected the economy as a whole. The energy industry was also greatly affected. Of all the impact of the scandal, the most destructive part would be the damage done to people’s trust in business and their leaders.

Relevant Accounting Ethics Standards Involved in the Situation Lack of integity Lack of integrity is one of the root causes of the sudden fall of Enron. Because of the lack of truthfulness by management about the financial health of the company and its business operations, Enron suffered greatly. Commitment of fraud by the management Enron used various methods of deception in order to hide the real situation of the company. They manipulate the financial statements to create an illusion that they are healthy and prosperous than it actually is. This is to protect their interest and to deceive the public. Some executives were more concern for their self-interests than those of the company. Because many executives like Lay, Skilling and Fastow used their position for their self-enrichment, corruption existed which lead to the sudden fall of Enron. Inappropriate accounting practices Enron made used of special purpose entity and mark to market accounting in order to appear more profitable than it really was and to cover up their losses. These methods allowed them to include in their accounting future income even though money was not yet received and these also allowed them to conceal its debts and overestimate its capital. The Causes of Enron’s Bankruptcy The ENRON Scandal is probably the largest bankruptcy reorganization in American history at that time and undoubtedly is the biggest audit failure. The auditing system of the

company failed to serve its purpose in the detection of fraudulent activities and used off-balance sheet vehicles to take on large amounts of debt and fabricate earnings. There are many causes regarding the collapse of the company. Among them are the lack of truthfulness by management about the health of the company, the senior executives believed Enron had to be the best at everything it did and they had to protect their reputations and their compensation as the most successful executives in the U.S. There is no evidence when Enron’s CEO told the employees that the stock would probably rise and that he disclosed that he was selling stock. Only the investigation surrounding Enron’s bankruptcy enabled shareholders to learn of the CEO stock sell-off; the conflict of interest, Arthur Andersen played the two roles being the auditor but also as consultant to Enron; Enron managers manipulated the intent and purpose of using Special Purpose Entities (SPE’s) by using them as vehicles to transfer debts outside of the company and would not show up on the balance sheet and manipulate the parent company’s reported revenues and earnings; and the use of the Mark to Market (MTM) accounting method. In order to keep appeasing the investors to create a consistent profiting situation in the company, Enron traders were pressured to forecast high future cash flows and low discount rate on the long-term contract with Enron. Forced Ranking Distribution Scheme This is a rating system used by companies to evaluate their employees. The system requires the managers to evaluate each individual, and rank them into one of three categories. In the case of Enron, this scheme created negativity amongst employees as they became more and more greedy.

The basic method to prevent this kind of scheme behavior, at micro and macro level will be simply to not implement this scheme. If this has been implemented, the company should see to it that this scheme is positively motivating the employees to perform better. Accounting and Auditing Issues It has been required by the federal securities law that the accounting statements of publicly traded corporations be certified by an independent auditor. Enron’s auditor, Arthur Andersen, made improper accounting practices and was actively involved in devising complex financial structures and transactions that facilitated deception. Several methods of deception were used by Enron such as special purpose entity and mark to market accounting in order to carry out its objective of gaining profit without considering appropriate accounting practices. They did not prepare true and fair balance sheets and cash flow statements. The Enron scandal involves both illegal and unethical activities which are caused by unethical behavior on behalf of executive management allowed by a lack of transparency and failure on the part of external auditing. Possible Alternatives That Can Be Done  Require audit committee member professional expertise and independence  Adopt new and effective corporate culture to change company’s perspective  Keep every financial statement updated and in a proper way  Transparency in accounting procedures and practices  Appropriate regulation in the areas of securities fraud, insider trading  Accounting standards must be principle-based, not rule-based

Course of Action Auditing should be separate from consulting functions. Eliminate the use of various methods of deception such as the mark to market accounting and special purpose entity and adopt a new and effective accounting practice which would provide a fair and accurate disclosure of financial statements. Conclusion By studying the history of the Enron organization, I have come to know that there is lack of information. The information provided by the management is completely wrong as they showed the results according to their desires and get high bonuses on this. To prevent this problem happen in future, there should be a system, which will provide transparent reports to the stakeholders. They must look more closely at the relationship between auditors, managers and the company audit committee. Investors should be fully aware of the company financial position and the accounting policies used by the company. There should be no hidden information from the stakeholders. Effective business communication plays a vital role in the business success. With the enforcement of the Sarbanes-Oxley Act, organization will be able to identify internal weaknesses, develop new policies and procedures, and have a more compliant culture within the organization.

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