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Enron's directors were promoting integrity, honesty and excellence in the workplace; however its focus on internal competitiveness completely obstructed these values. How do you expect to achieve integrity and honesty in your employees when the performance appraisal system pushes them to backstab their peers and to deceive management? The case study states that, the 'rank and yank' performance appraisal system incentivised employees to purposely rank their peers with low scores in order to progress their own career advancement, which in our opinion obstructed excellence and promoted individuality. In our view, excellence in an organisation can be only achieved when everyone is vigorously working towards the overall interests of the organisation instead of their own interests, and this is exactly what Enron failed to promote. The nature of the performance appraisal system awarded employees who were not playing by the rules, and this resulted in 'survival of the fittest' attitude in the workplace. Based on our assumptions, this 'survival of the fittest' attitude encouraged some of the employees to willingly engage themselves in fraudulent activities in order to satisfy their own selfish needs. This permeated the lower levels of the organisational structure with fraud and highly contributed to Enron's financial problems which thereafter led Enron to its bankruptcy.
It is also important to note that, Enron's performance appraisal system set very harsh punishments in regards to poor performance. We assume that, such draconian standards diminished employee loyalty towards the management and encouraged employees to hide issues that might potentially harm the organisation, this abolished the existence of effective communications within Enron and it ultimately led to Enron's demise. It is very important for an organisation to have effective internal communications, which is why an organisation is called 'organisation' i.e. a group of people who are working together in order to achieve a common objective. When there is lack of communication, an organisation can't function properly, and this is exactly what happened to Enron. Enron's management instilled fear in its employees, and this resulted in lack of loyalty and crucial issues being hidden and left unresolved. Subsequently these unresolved issues gradually piled up and this gave rise to disastrous financial consequences.
Enron's culture of constant innovation also led to over-expansion. Some employees in Enron thought that nearly anything could be turned into a financial product, and more than often these new financial products spawned their own operations. Because of this constant growth, Enron's network of operations became overly complex and there was no time to establish tight internal controls, and this made these operations more prone to material misstatements and/or fraud.
Enron's culture valued risk taking. Willingness to take risks is certainly a very good value to possess, however if this value is exercised without any consideration in respect of the possible consequences, it transforms into ignorance. In organisational environment Ignorance can lead to very adverse consequences. This is exactly what happened to Enron, the case study implies that, Enron's directors thought that no matter how high a risk is it can be undertaken without the occurrence of any consequences. This ignorance greatly contributed to Enron's demise. For example, the inability to recognise the potential consequences regarding the risky transactions with SPEs single handily destroyed Enron's cash flows.
All in all, Enron's directors supposedly valued integrity, honesty and excellence; however these values were only a facade which was used to create a positive image for the public. The fraudulent actions of Enron's directors permeated all levels of the organisation with fraud. Enron's corporate culture didn't encourage maximising profits for the shareholders, instead it highly incentivised to act in your own interests and to break the codes of ethics and law in doing so. In practice such an ideology wouldn't go well with a firm's shareholders and it can be seen that it certainly didn't go well with Enron's.
In our opinion Enron's bankers, auditors and attorneys did contribute to Enron's demise.
When talking about Enron's demise, it is impossible not to mention Arthur Andersen's role in it. In our understanding, Andersen's auditors knowingly contributed to the deception of potential shareholders by providing biest audit opinions that were untrue of Enron's true financial position.
Andersen's main duty was to formulate an independent opinion for shareholders as to whether Enron's financial statements give true and fair view. But how can an auditor stay independent from the audit client if one sells consulting services worth of $50 million to the same client? We assume that, the importance of business opportunities with Enron influenced Andersen's auditors to ignore the questionable accounting practices which were exercised to avoid consolidation of huge amounts of debt and to significantly overstate revenues. In our opinion, Enron's demise could have been prevented, if Andersen's auditors would have acted with objectivity and have had questioned these practices, or even stopped Enron from exercising them by issuing a qualified audit opinion.
Andersen's reputation diminished a lot of criticisms targeted towards Enron's questionable dealings with SPEs, and this only further contributed to Enron's demise. Andersen's unqualified reports acted as some sort of stamp of approval for Enron's questionable dealings and enabled Enron to practice these unlawful dealings for a substantial amount of time without any real consequences. This enabled Enron's favourable financial picture to become solely dependent on the success in these dealings, thus any difficulties in these dealings would cause Enron's favourable financial position to go into shambles, which is exactly what happened.
It is important to note that, auditors are permitted to issue letters of recommendations for the purpose of highlighting weaknesses in client's internal controls and to provide an advice on how to improve upon such weaknesses before they result in material misstatements and fraud. By looking at the amount of consultancy fees and Andersen's lack of objectivity and independence, it seems that Andersen's auditors failed to provide a substantial advice on such issues, but instead focused on provision of commercial advices. By doing this, the auditing firm failed to identify the critical risk areas associated with the complexity of Enron's operations. These operations were significant risk areas, since where there is complexity it is much easier for fraud to go by unnoticed e.g. Andersen didn't mind the complex partnerships with SPEs, which were to blame for massive amounts of hidden debt and overstated revenues, and ultimately Enron's demise.
Even though Enron's bankers Merrill Lynch escaped the scandal without facing any criminal charges by keeping an innocent position regarding its involvement in Enron's ordeals, its engagement with Enron was very suspicious and is presumed by many to have directly contributed to Enron's demise.
Enron's greediness influenced it to engage in aggressive accounting practices that seemed legal only on the surface but in reality allowed Enron to manipulate its financial statements. These manipulations allowed Enron to fraudulently raise the confidence of potential investors, and Merrill Lynch was suspected to be actively engaged in these ordeals. This completely erodes the firm's innocent position in respect of the scandal and Enron's demise, since manipulation of financial statements was one of the main reasons for Enron's downfall. For example, Merrill Lynch wilfully and knowingly helped Enron to carry out the Nigerian barges deal which allowed Enron to fraudulently misrepresent its revenues by $12 million.
Merrill Lynch's innocent position is further worsened by the replacement of the research analyst whose coverage of Enron displeased Enron's directors. This researcher was probably dismissed because his report on Enron reported a credit rating representative of Enron's true financial position. The replacement researcher once more overstated Enron's credit rating. Enron's ability to constantly maintain incredible credit ratings for substantial amounts of time raised public suspicions, which led to investigations that uncovered firm's true financial position. From this passage it can be seen that, Enron's size often allowed it to bully its bankers, and the inability of these bankers to resist Enron's bullying resulted in suspiciously high credit ratings that instead of rising shareholder confidence gradually diminished it.
The legality of Enron's aggressive accounting practices were constantly under public scrutiny. Enron's law firm Vinson and Elkins diminished any scrutiny regarding these practices by approving their legality. This enabled Enron to exercise these accounting practices without the existence of any legal boundaries, and this freedom eventually led to Enron's demise.
Additionally, Vinson and Elkins was suspected to have helped Enron to carry out its dealings with SPEs. It is stated by the case study that, if it wasn't for Vinson and Elkin's opinion letters many of these fraudulent dealings with SPEs would be impossible to carry out. SPE's were entities that were used by Enron to keep its debt off the balance sheet and to fraudulently overstate its revenues. Enron's excessive dealings with these entities resulted in a very favourable financial picture, however this bubble eventually burst and Enron was faced with catastrophic financial consequences.
Enron's CFO Fastow was behind the partnerships that were used to fraudulently keep Enron's debts off its balance sheet and to hugely overstate its profits. These partnerships appeared to be separate legal entities, but in reality they were under the absolute rule of Enron. Enron ordered these partnerships to borrow money and to use these borrowings to buy Enron's assets; this allowed Enron to obtain debt without any consolidation in the balance sheet and to report healthy cash flows. Enron had to finance these entities when they were unable to pay off these debts, and this was where the problems began arise, which ultimately led to Enron's bankruptcy. Enron financed these entities with its stock, thus it meant that Enron's ability to finance these entities very much depended on its stock price. Once Enron's stock price fell down it was unable to assist the debts of SPEs' with its stock alone and it had to resort to cash. This resulted in huge amounts of negative cash flows because the outstanding debts in partnerships had accumulated to very large amounts, in fact the case study states, that these partnerships held some $1 billion in Enron debt. The reported negative cash flows severely damaged shareholder confidence and this resulted in lack of investments and Enron's collapse.
Additionally we believe that, Fastow's dealings adversely affected Enron's culture. Personal benefits that Fastow fraudulently gained from these partnerships were valued in millions of dollars; it is possible that this encouraged Fastow's peers and underlings to follow his lead. This resulted in even greater accumulation of material misstatements, which only further contributed to Enron's financial problems.