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The spectacular rise and fall of Enron was the most massive financial scandal to rock corporate America in the last decade. Much has been written about its collapse and impact on the American economic landscape from various economic, accounting and legal perspectives. Yet, the most important lesson that can be learnt from the Enron debacle is that it is a cautionary tale of how unbridled greed and a complete absence of morals and ethics can destroy even the largest of businesses. This report examines how a lack of ethics led to the downfall of Enron and how the crisis might have been averted had there been good corporate governance.
Before we do that, let us review the facts of the case. Enron was an energy company headquartered in Texas. Under the stewardship of its CEO Kenneth Lay, the company experienced a meteoric rise and by 2001 it became one of the top global Fortune 500 companies. Everything that Enron touched seemed to turn into gold. Apart from its core activity as an energy provider, the company diversified into other areas like energy futures and Internet trade. Profits seemed to rise unstoppably from quarter to quarter, as did Enron's stock price. At one point it was touted as the company of the future and some went so far as to predict that Enron would create a new business model and conquer the world.
Yet, behind this wonderful façade lay the company's true sordid nature. Enron engaged in so many unethical and illegal dealings that it took years to unravel the full extent of its wrongdoings. For one, many of its partnerships turned out to be hoaxes as they were companies formed by Enron executives and not external parties. Hence, the sale or purchases of these companies were no more than intra-company transactions which Enron made to seem like legitimate sales. Profits from these sales were made to inflate actual financial results which actually amounted to losses. Enron was a generous contributor to President Bush's 2000 election campaign and once he was elected, the company used its political clout to lobby for its futures activities.
Enron also engaged in illegal manipulations of electricity prices and it had traders who bought kilowatts of electricity in parts of America which were lower and sold them in areas where it was higher. The power crisis in California was largely due to Enron which purposely cut off supply and charged customers higher to restore it. Furthermore, its involvements in energy futures and volatile technology stocks caused great financial losses which Enron concealed by creating false partnership firms which absorbed these losses so that they would not appear on Enron's financial statements. These false partnerships were funded by Enron stocks and the problem did not manifest as long as stock prices were high. But when Enron's stock prices fell, these losses were unsustainable and the company engaged in ever more complex and fraudulent accounting practices to hide these losses to shareholders.
As losses mounted and as the stock price tumbled, the company's leadership scrambled for damage control. They even resorted to their powerful friends in Washington who wisely turned them down. Desperate, Enron courted another energy company, Dyenergy, with the promise of a merger but the deal fell through when the other company discovered the truth. Finally, straddled with massive debts that were payable within days, the company was faced with no choice but file for bankruptcy on 1 December 2001.
It was an inglorious end for a company that promised to become the world's greatest. The aftermath of Enron's demise were numerous and severe. It brought down the venerable audit firm Arthur Andersen which was charged with colluding with Enron to conceal financial irregularities. This also brought about a massive public outrage and mistrust of the auditing profession in general and on corporate America. Over a decade of deregulations beginning with President Reagen were brought to a screeching halt as lawmakers questioned the wisdom of allowing companies do as they please. Consequently, the Sarbanes Oxley Act was enacted to promote greater corporate governance in America but the law has met with modest success and is widely criticized as a stop gap measure and an impediment on efficiency. As for Enron itself, the company's employees all lost their jobs and pension funds. A few top executives were charged but Kenneth Lay escaped trial by dying of a heart attack. Even after almost a decade, there is no full closure and corporations still fail to learn the lessons from Enron's egregious errors.
Two questions come to mind when we think of Enron. Firstly, what caused the company's management to act in such a grossly unethical manner and secondly, could greater corporate governance at Enron have averted this disaster? Let us examine them one by one. Ethics can be defined as a philosophy that covers good living and proper conduct. Business ethics is a branch of ethics that studies the moral and ethical problems in a business context (DeGeorge, 2006). It is a broad category which encompasses ethics of accounting information, human resource management, sales and marketing, intellectual property, knowledge and skills, international business ethics and the ethics of economic systems.
Enron clearly demonstrates many breaches of ethics on so many levels. One is the exploitation of information asymmetry. In a capitalist market, all participants should be given free and equal access to do business (Friedman, 2005). Yet the market has some inherent weaknesses which are exploited by businesses. Some of these are acceptable like temporary monopolies created by the use of patents or competitive advantage due to certain expertise. However, some businesses exploit situations where one side of a transaction has insider information that the other party does not. This is called information asymmetry. One form of exploitation of information asymmetry is insider trading, which is strictly against the law. Enron was aware of information asymmetries and profited when it dabbled in the energy futures market.
Another breach of ethics is the failure to fulfill Enron's fiduciary duty to its shareholders. Fiduciary refers to acting in the best interest of the other party and the management of a company has a fiduciary duty to its shareholder. Yet, Enron's top management abdicated from this role and acted in a way that demonstrated conflicting interests. In addition, disclosure of accounting was not made in good faith as there were many instances of concealment and even outright fraud. Profits were inflated and massive losses went unreported, all for the sake of keeping stock prices high. Arthur Andersen, the firm's auditors were also party responsible for approving financial statements that did not reflect a true and fair view of the company.
It is obvious that Enron was a case with an absence of ethics and a lack of corporate governance. The question is, would greater corporate governance have averted disaster? Corporate governance can be defined as the set of processes, policies, customs, laws and institutions affecting the way a corporation is administered, directed or controlled (Kim et al, 2004). Corporate governance also encompasses the relationship between the many stakeholders involved and the goals for which the enterprise is governed. Good corporate governance includes principles like trust, honesty, openness, performance orientation, responsibility and accounting, mutual respect and commitment to the company.
One of the components of good corporate governance is the rights and equitable treatment of stockholders. Stockholders rights should be respected and the company should assist stockholders to exercise their rights by effectively communicating material information and encouraging stockholders to participate in the annual general meeting. In Enron's case stockholders were not only left in the dark but were given false information about profits.
The role and responsibilities of the board of directors must be defined clearly. The board must be sufficiently sized and members should have the necessary level of commitment to discharge their duties and responsibilities. Board members should have an understanding of the various business issues at stake and review management performance. Enron's board members lacked the required breadth of knowledge and experience and many were cronies of top management and acted little more than rubber stamps.
Corporate governance also includes proper disclosure and transparency. Generally, people tend to associate corporate governance with this alone, although it covers much more. Companies should make public the responsibilities and roles of the board of directors. Material information should be disclosed in a timely manner in a way that is understood by all. The financial statements should be prepared in accordance to the law and accounting standards, and also be independently verified by an auditor. Had Enron exercised this aspect of corporate governance, its wrongdoings would have been detected much earlier and not escalated to gigantic proportions.
Another aspect of corporate governance that has the most direct bearing to Enron's case is integrity and ethical behavior. Good ethical conduct should flow from the top to the bottom. If top executives act unethically, subordinates cannot be expected to act otherwise. A Code of conduct should have been developed by Enron for its directors and executives. The code should contain guidelines on ethical and responsible decision making. For this purpose, a good compliance and ethics program should be designed to minimize the risk of entering questionable ethical and legal waters (Kim et al, 2007).
A good compliance and ethics program should be properly designed. It must be viewed in relation to the business functions or units in terms of responsibility and accountability. Care must be taken to ensure compliance, though it is challenging. This exercise should be viewed as an opportunity to promote operational excellence across the entire company and serve as a catalyst for performance improvement. Effective risk management occurs when the company complies with regulatory requirements and its policies are formulated to achieve this purpose. Checking and doing maintenance with compliance is not just to appease regulators, it is one of the most important ways for an organization to act in an ethical manner, support the firm's long-term prosperity, and preserve and protect its values. A good whistle blowing program is essential and whistleblowers should be protected. Enron's whistleblowers were vilified and threatened and this should not happen in a firm with good corporate governance.
While effective program design is important, effective program implementation is equally important. Perhaps the implementation stage is the most difficult aspect of the program as this is when most failures happen. Stakeholder engagement is essential for successful implementation. By cooperating, compliance and ethics officers, the board of directors and top management can contribute to ensure the improvement of the organization's compliance practices and the overall success of the company's strategy. The board should demonstrate leadership and the company should foster a corporate culture that places a sense of responsibility and accountability among all its members.
In conclusion, Enron's collapse was a disaster that should not have happened. In hindsight, it is easy for us to fault the company's greedy and unethical management and to suggest ways in which the crisis could have been averted. Yet, Enron did collapse, and all we can do is to learn from its mistakes. Unfortunately, people have very short memories and a tendency to assume that bad things can never happen to them. Enron should have been a turning point which heralded a new era of greater corporate governance and responsibility. Instead, it was the start of the gradual decline of corporate America which witnessed the collapse of major insurance companies, financial institutions, the housing market and the stock market by the end of 2009. In the end, we should ask ourselves, have we learnt anything?