Enron was formed in 1985 under the chairman Kenneth Lay by merging the natural gas pipeline companies of Houston Natural Gas and InterNorth. It was the natural gas company and with the passage of time it became the major petrochemical and energy trader in USA and started generating high revenues. In 1999, Enron moved its operations online to improve its contracts trading business in natural gas, electricity, crude oil, petrochemicals and plastics. To achieve further growth, Enron diversified its business into steel, shipping, coal, pulp, metal, paper, and broadband services across the globe. By December 31, 2000, the price of Enron's stock was $83.13 and its market capitalization exceeded to $60 billion, which is 70 times of earnings and six times of book value. When Enron was at its peak, its reporting revenues were $80 billion and profits were of $1 billion. Through this marvelous growing business stock market was having high expectations about Enron future prospects. Enron was rated as a most innovative and largest company in America in Fortune's Companies survey for consecutive six years.
Identification of scandal:
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The sudden resignation of Enron Vice-Chairman Clifford Baxter in May of 2001 and subsequent resignation of CEO Jeffrey Skilling in August of 2001 was the first indication of Enron having troubles. They both were retired for undisclosed personal reasons. On Oct16, 2001, Enron has announced to taking a $544 million after-tax-charge against the earnings and a reduction in shareholder equity by $1.2 billion due to related transactions with LJM partnership. LJM was partnership managed and partially owned by Enron's CFO, Andrew Fastow, which provided Enron with a partner for the purchase and sell of assets as well as an instrument to hedge risk. Less than a month later Enron announced that it would be restating its earnings from 1997 through 2001 because of accounting errors relating to transactions with another Fastow partnership, LJM Cayman, and Chewco Investments, which was managed by Michael Kopper who was the managing director of Enron's global finance unit. Such restatements sparked a formal investigation by the Security Exchange Commission into Enron's partnerships. Enron's disclose that their CFO Mr. Fastow was paid in excess of $30 million for the management of LJM partnership. Due to these statement investors' confidence in Enron has been crushed. Enron's debt rating rapidly decreases and one month later, on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code.
Reason of Bankruptcy:
When Jeffrey Skilling was hired as a CEO, he developed a staff of executives in the way that they can take the advantage of accounting loopholes, special purpose entities, and poor financial reporting, which have made them able to hide billions of dollars debt from failed deals and projects. CFO Andrew Fastow and other executives has not only misled Enron's BODs and audit committee on high-risk accounting practices, but also forced the Andersen to ignore these issues.
Enron's complex financial statements were confusing to shareholders and analysts which makes Enron to misrepresent its earning on the balance sheet to show the good performance. The primary focus for Enron's accounting and financial transactions were to keep reporting income and cash flows up, asset values inflated, and liabilities off the books. The combination of these issues later resulted in the bankruptcy of the company, and the majority of them were due to the indirect knowledge or direct actions of Lay, Jeffrey Skilling, Andrew Fastow, and other executives. Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen, which was one of the five largest auditing companies. In addition to being the largest bankruptcy organization in American history at that time, Enron was also attributed as the biggest audit failure. Shareholders has lost $11 billion, when Enron's stock price which was US$90 per share during the middle of 2000 decreased to at less than $1 by the end of Nov, 2001. The U.S. Security Exchange Commission began an investigation against Enron and on Dec 2, 2001, Enron filed for bankruptcy under the Chapter 11 of the U.S. Bankruptcy Code. At that time Enron's was having $63.4 billion in assets which made it the largest corporate bankruptcy in U.S. history until WorldCom's bankruptcy. Many of the senior executives were sent to prison and employees lost even their pensions.
2. Does Enron scandal is related to corporate governance? How?
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Enron scandal was the best example to the failure of corporate governance. The failure of the Enron has thrown up several questions about the effectiveness of contemporary accounting, auditing and corporate governance practices. To be a part of good governance there are several practices that are important for the success of organization, some them were totally ignored in the case of Enron.
i. Equally distribution of roles and responsibilities among executive:
The good practice of corporate governance is to separate the roles and responsibilities of Chairman of the Board and the CEO. The Chairman is the head of the Board and CEO is the in charge of entire management. If any one person holds the both positions than there will be too much power and work to control that will leads to the dilution of the board. In case of Enron, when the CEO has resigned then Kenneth Lay was holding both the position as a Chairman and CEO which was the symbol of poor corporate governance.
ii. Audit committee:
The audit committee is the most important aspects of corporate governance. It supervises the financial reporting process, monitoring the financial policies and procedures of the organization. The audit committee is also responsible to brings loopholes to the attention of the full board. It was consider as one of the fault of Enron that the audit committee failed to focus in its roles and responsibilities. The Board of Enron has assigned the Audit and Compliance Committee only to reviewing the transactions not to monitor the lapses in their transactions which was the major laps of corporate governance and ultimately it has leaded the Enron towards bankruptcy.
iii. Open and Transparent system:
Good governance plays very important role in any organization. It can help the organization to become open to all the stakeholders. Good governance entails that the directors have to maintain their independence in the board, will not use their power to get self benefited and do not avoid the conflicts of interests. If we analyzed the condition of Enron, the company had created a good practice but in the way the board has behaved, they compromised their independence and they have suffered from serious conflicts of interests. Enron's complex financial statements were also confusing to shareholders and analysts and they were unable to give the transparent reporting which was also the failure of corporate governance in Enron.
iv. Disclosure of relevant and material matters:
The flow of information is an important aspect of any organization and it is considered as one of the important factors in terms of good corporate governance. It's the duty of board to disclose different important information and data in timely manner, in order to perform their roles and responsibilities properly. In the situation of Enron, the directors were ignoring to expose the dark deals of excusing themselves of the liability. The board had denied disclosing the important information that will serve as a key reason of behind any particular action.
Poor corporate governance in Enron weaken its potential and that lead to the financial difficulties and reporting errors in transactions and ultimately various unexpected statements from the Enron leads to its bankruptcy.
3. Did Enron do the ethical practices to its stakeholders? Explain?
In an organization, the functions of the operations management department should consist of ethical values, integrity, competence and clear accountability. But Enron did not abide by these functions which led to its bankruptcy. We may say that the company's employees lacked Enron ethics. Organizations should make ethics part of corporate culture. Employees should be trained to believe that success is possible by being ethical. Enron was very unethical with its stakeholders.
i. A corporation does not belong only to the shareholders. To maintain the long term sustainability of the corporation, it must have long-term close relationships not only with employees but also with customers, suppliers, clients and the local community in which the business is operating. The interests of stakeholders are also need to be taken in account by the management of the organization which is considered as a public concern. In Enron these ethical practices were ignored. They did not meet their obligations to stakeholders. The sudden collapse in the market value of this corporate has had major problem for all of its stakeholders.
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ii. Decisions that an individuals and corporations make often have multiple effects. Sometime individual decision makers underestimate the consequences that may happen from their decision. When the BODs of organization do not take under account the future consequences then the serious hazards results happens. Many decision makers involved with Enron would have been served all stakeholders better if they had considered the consequences associated with their decisions.
iii. While million dollar deals are being transacted every day, the common stakeholder is powerless in any decision that may ultimately affect his or her future. Of course no one would have invested in Enron stock if the truth was told and of course some would have invested in other places, but Enron did lie and these people did lose their money, retirements, etc which was one of the examples of unethical practices.
The Enron scandal has opened the eyes of many on the ethical issues that businessmen and women face every day. The men and women that had any stake in this company were badly affected. With no sign of hope the families had to move on. If Enron's senior leadership would have let independent researchers conduct a survey of their operations, this research will help in identifying the risk of real defections while also guided the business leaders to make the right decisions for their shareholders, customers, employees, and the community which will be the true sign of ethical practices.