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Only months before Enron Corp.'s bankruptcy filing in December 2001, the firm was widely regarded as one of the most innovative, fastest growing, and best managed businesses in the United States. With the swift collapse, shareholders, including thousands of Enron workers who held company stock in their 401(k) retirement accounts, lost tens of billions of dollars. Investigations of wrongdoing may take years to conclude, but Enron's failure already raises financial oversight issues with wider applications. Why didn't the watchdogs bark? This report briefly examines the accounting system that failed to provide a clear picture of the firm's true condition, the independent auditors and board members who were unwilling to challenge Enron's management, the Wall Street stock analysts and bond rates who missed the trouble ahead, the rules governing employer stock in company pension plans, and the unregulated energy derivatives trading that was the core of Enron's business. The report will be updated regularly as further reliable information about Enron's downfall - which is now extremely limited - becomes available.
Enron, once the world's largest energy company, was ranked number seven by Fortune magazine in April 2001 in Fortune's ranking by market capitalization of the five hundred largest corporations in the United States. On December 2, 2001, Enron filed for bankruptcy.
It has become increasingly evident that corporate failure of the magnitude of Enron causes serious economic, political, and social dislocation.
The Security exchange act seeks to improve the quality of the information disclosed and to help make a company's financial statements 'transparent', i.e., more easily understood by the investing public
Enron Corporation was an American energy company based in the Enron Complex in texas. Before its bankruptcy in late 2001, Enron employed approximately 22,000 staff and was one of the world's leading electricity, natural gas, communications and pulp and paper companies, with claimed revenues of nearly $101 billion in 2000. Fortune named Enron "America's Most Innovative Company" for six consecutive years. At the end of 2001, it was revealed that its reported financial condition was sustained substantially by institutionalized, systematic, and creatively planned accounting fraud, known as the "Enron scandal". Enron has since become a popular symbol of willful corporate fraud and corruption.
Dynegy Inc. is one of the world's top energy merchants. Through its global energy delivery network and marketing, trading and risk management capabilities, Dynegy provides innovative solutions to customers in North America, the United Kingdom and Continental Europe.
Despite all the checks and balances provided for in the U.S. corporate governance system as discussed above, Enron collapsed under the burden of its accounting scandals, just as its accountant Sherron Watkins warned in internal memos to the CEO Kenneth Lay and its external auditors, in August 2002 (Hamburger and Brown 2002). The Enron case exemplifies the great harm an accounting scandal and a large corporate bankruptcy can wreak upon society and its members.
Every leader is expected to act in good faith and in the best interests of the company. The director, in exercising his or her duties, is expected to exercise skill and diligence. A director may be sued for the failure to take reasonable care, or for a breach of duty of care to the firm, in circumstances where it can be shown that he or she failed to exercise due care. If it can be shown that a director was knowingly a party to conducting the firm's business in a reckless manner, the Courts may make the director personally liable for any harm caused to the firm.
It is a structured approach to transitioning individuals, teams, and organizations from a current state to a desired future state. It is an organizational process aimed at empowering employees to accept and embrace changes in their current business environment. In project management, change management refers to a project management process where changes to a project are formally introduced and approved.
Examples of Organizational Change
Changing the attitudes and behaviors of personnel
"Hard" elements are easier to define or identify and management can directly influence them: These are strategy statements; organization charts and reporting lines; and formal processes and IT systems.
"Soft" elements, on the other hand, can be more difficult to describe, and are less tangible and more influenced by culture. However, these soft elements are as important as the hard elements if the organization is going to be successful.
The way the model is presented in Figure 1 below depicts the interdependency of the elements and indicates how a change in one affects all the others.
Strategy: the plan devised to maintain and build competitive advantage over the competition.
Structure: the way the organization is structured and who reports to whom.
Systems: the daily activities and procedures that staff members engage in to get the job done.
Shared Values: called "superordinate goals" when the model was first developed, these are the core values of the company that are evidenced in the corporate culture and the general work ethic.
Style: the style of leadership adopted.
Staff: the employees and their general capabilities.
Skills: the actual skills and competencies of the employees working for the company.
Social Impact of the Enron Bankruptcy
As the value of Enron stock plunged in value, many Enron employees lost their jobs and nearly all of their retirement savings. To make matters worse, many of these employees were restricted from selling their stock even as the stock price declined in value, while senior officers of the firm were able to sell their Enron stock without similar restrictions (Schultz 2002). The issues of restricting stock sales and the percentage of stock held in individual 401(K) plans are some of the many troubling issues to emerge from the Enron crisis.
The steep financial losses and loss of jobs is not limited to the employees of Enron. (Dugan It is noteworthy that similar indictments have not yet been issued for the top managers at Enron.
The sharp and sudden decline in the value of Enron stock adversely affected the retirement savings of thousands of ordinary Americans who had no direct connection with the firm. Many Americans invest their retirement savings in mutual funds and especially in index funds because of their relative safety and reliable performance. Enron was a member of the Standard and Poors (S&P) 500 Index until November 29, 2001. To the extent index funds reduced their. There were also many other actively managed portfolios, including those of many university foundations (such as the investment portfolio of the University of California), which had substantial exposure to Enron.
Enron if they did not properly understand how the firm made the profits it reported. The social impact of this failure in fiduciary responsibility is reflected in the millions of dollars lost in Enron stock investments by individual and institutional investors. Many of Enron's trading partners such as Citigroup and J.P. Morgan also suffered steep losses because of the Enron collapse and within days of the Enron bankruptcy filing provided the public and their stakeholders with preliminary estimates of their Enron exposure.
Causes and Consequences of Multiple Failures
The failure of Enron was a result of a combined failure on several fronts. It was a failure of the high-risk, asset light business and financial strategy pursued by Enron presumably under the advisement of its business consultants, McKinsey and Company. The Wall Street Journal reports that McKinsey and Company, in an internal document, praised Enron's use of "off balance sheet funds using institutional investment money [which] fostered its securitization skills and granted it access to capital at below the hurdle rates of major oil companies" (Hwang 2002, B1). If Enron's balance sheet had contained a greater proportion of tangible and especially fixed assets with stable market values, the market value of the firm may not have collapsed as it did, and the fixed assets could have been sold to meet its financial obligations.
There are many levels of blame in this corporate crisis. Enron's top managers are clearly responsible for poor business decisions and mismanagement of the corporation. Decisions that individuals and corporations make often have multiple, systemic effects. Often, individual decision makers underestimate the consequences that follow from their decisions. When the governing bodies of corporations do not understand, or take account of all future consequences, serious moral hazards result. Messick and Bazerman (1996) argue that potential consequences are often ignored because of five possible biases: ignoring low probability events, limiting the search for stakeholders, ignoring the possibility that the public will find out, discounting the future, and undervaluing collective outcomes. It now appears that Enron management and the Board maintained all of the five biases to some extent. The many decision makers involved with Enron would have better served all stakeholders if they had considered the full spectrum of consequences associated with their decisions (Messick and Bazerman 1996, p.3).
Enron's collapse also might have been averted had there been a truly independent and objective review of its financial statements by its auditors
Enron could not have succeeded without the cooperation and support of its bankers and trading partners who helped finance its operations. Some Enron bankers (e.g., JP Morgan) helped finance Enron's elaborate strategy of tax avoidance. Consequently, Enron did not report a tax liability or pay any income taxes for several years (Sapsford and Raghavan 2002.) The trading and financing scheme Enron had with its banker and trading partner, J.P. Morgan, was initially financially rewarding to the banker,
The stock research that Wall Street analysts publish and provide to their clients and/or to the public must be independent, fair, and unbiased.
The impact of a positive recommendation given by Wall Street should not be underestimated. Prior academic research in finance has shown that upgrades and downgrades by Wall Street clearly influence investor enthusiasm for individual stocks. It also has a significant impact on the market value of a firm (Glascock, Davidson, and Henderson 1987; Zaima and McCarthy 1988; Hand, Holthausen, and Leftwich 1992; Goh and Ederington 1993; Elayan, Maris, and Young 1996; Liu, Seyyed, and Smith 1999; Kliger and Sarig 2000).
Reforms Following the Enron Collapse
The collapse of Enron and the economic and emotional impact it continues to have on thousands of ordinary Americans, Enron and Andersen employees, and investors demonstrates the widespread impact a major business failure can have on society.
Following the collapse of Enron, Senators Corzine and Boxer proposed a twenty percent limit for any one stock that can be invested in any single 401(K) plan. In addition, President Bush called for the creation of a task force to identify methods to strengthen American's retirement security. This task force, composed of Commerce, Labor, and Treasury Department members, will closely examine the potential problems related to employer's restrictions on portfolio diversification and employees' sale of stock. They will also research whether employees get proper investment advice regarding their retirement plans and whether the government has adequate tools to protect workers' pensions (Chen 2002).
In addition to the federal government's proposals, many institutional investors, including the many mutual funds that lost money by holding Enron in their stock portfolios, are pressing firms to adopt conflict-of-interest policies that would prevent a firm's auditors from doing non-audit work for their client. The Enron auditors maintain they do not believe their non-auditing fees compromised their auditor independence (Solomon 2002). A recent unpublished study by DeFond, Raghunandan, and Subramanyam (2002) also finds no significant association between the ratio of audit to non-audit fees paid and the likelihood of an auditor issuing a going concern opinion." (Gentile 2002, p.1).
The fallout of the Enron crisis may be a period of greater regulation over a broad range of issues ranging from regulation of utilities to regulation of accounting standards. There is no doubt that this corporate collapse will increase the debate concerning the deregulation of public utilities and other related industries. Yetmar, Cooper, and Frank (1998) acknowledge that the auditing profession has inherent conflicts between the public interest and the interests of the client, which create the possibility for a variety of problems
The collapse of Enron stock, its financial restatements, and the subsequent disclosures made by its auditors have shaken the faith of the investing public in the entire accounting industry with particular concern for the role of auditors and the reliability of their financial disclosures (Andreczak 2001) is "outmoded and incomprehensibleâ€¦ and driven by a system of disclosure to avoid liability rather than to inform investors" (Schroeder 2002a).
The Enron case has focused public attention on the distance that must be necessarily maintained between business and government. Even the perception of government culpability in the Enron case has shaken the American public's faith in the impartiality of government. While it is clear that Enron's financial contributions to both parties did not win the firm its requested bailout from the White House in October 2001, it is possible that the firm's management was able to influence government policy to its advantage in prior years. While no improprieties have been proved to date, the media has raised many questions about the relationship between Enron and the government (Wilke 2002). The Enron case has heightened public awareness of the need for distance between business and government while at the same time sparking debate about when regulation is necessary.
The complete story of Enron is yet to be fully told and the case will likely be discussed and debated in courtrooms and classrooms of business schools for many years to come. The story of Enron is replete with numerous instances of conflict of interest in the present system of corporate governance. The failure of Enron demonstrates the vital role business plays in American society and therefore underscores the importance of good governance in business. It also reinforces the multiplicity of stake-holders that any large corporation must consider in its decision making processes.
Apart from the obvious social impact of financial losses created by the Enron collapse, the social impact of the crisis of confidence that this incident has created in capital markets is greatly troubling. As a result of the Enron collapse the public currently has less confidence in the management of large corporations, in the independence of auditors, in corporate accounting and reporting practices, in Wall Street analysts, in mutual fund and pension fund managers, in the SEC and in the government. This lack of confidence is reflected in our currently weak financial markets. Investor perception of reality and facts is as important as the facts themselves when investors make their assessments of firms. Investor perception of wrongdoing in the Enron case has had a depressing effect on the stock market and the U.S. economy even though no wrongdoing has yet been proven. The multiplier effect of this crisis in confidence cannot be taken lightly. Its result, among other things, is a more difficult environment for business and government. While the task of effectively managing a company the size and scope of Enron is daunting, there is an ethical obligation to make every effort to manage these firms by reviewing all the consequences of the decisions they make. There is the potential that some social good will eventually emerge from this business failure as government, business, and employees come together to reform the systemic flaws that the Enron crisis illuminated.
Enron's investments in high-tech companies soared in value after initial public offerings, resulting in significant gains that were recognized in Enron's income statement. Managers reasonably anticipated these stock prices would fall and that the stock price declines would lead to large losses being reported on the income statement. Management wanted to hedge against these potential losses. When no counterparties for the hedge could be found, the CFO created SPEs to be the counterparties for the derivative transactions Enron desired. The SPEs were not consolidated with Enron, which was critical for the SPE strategy to be effective.