Enron Collapse: Where It Went Wrong
Enron was an American energy company based in Texas that was beloved by the media and shareholders alike. There have been postmortem examinations performed by the Securities and Exchange Commission following the bankruptcy of the company as a result of massive fraudulent accounting practices. The ineffective corporate governance structure as well as the “tone at the top” which allowed this fraudulent activity is among the main causes that led to the company’s collapse.
Governance systems exist to ensure that a firm’s management act in the best interests of its shareholders. The US Securities and Exchange Commission (SEC) define corporate governance in its Code of Corporate Governance for Publicly Listed Companies as “the system of stewardship and control to guide organizations in fulfilling their long-term economic, moral, legal and social obligations towards their stakeholders” (SEC). The structure is to use controls, procedures, and other mechanisms to ensure that actions and behavior of employees and managers are ethical and adhere to a company’s value system. The four pillars of corporate governance are accountability, fairness, transparency, and independence. Setting an appropriate tone at the top is also integral to a solid system of corporate governance. Enron failed to set a proper tone at the top and failed in each of the four pillars of governance.
Enron’s tone at the top did not set an ethical example for the rest of the organization with executives working on behalf of their own self-interests and greed. Executives were primarily focused on their own short term interests, not the long-term health of the company. Executives and managers focused on ensuring that the price per share remained high in the short term and personal gains from meeting those goals. An example of this is when executives discovered two traders had misappropriated company assets; falsified accounting records, and recklessly gambled large amounts of company assets, the traders weren’t fired or disciplined. Rather, Enron encouraged this behavior of their based on the returns on those assets. A large contributing factor to perpetuating this results based culture was that Enron’s practice of ranking employee’s production and culling the least productive fifteen percent created a culture of extreme competitiveness and discouraged employees from disagreeing with their superiors or questioning decisions.
Enron operated to maximize profits at the detriment of the public which it served. An example of this follows the deregulation of California’s energy industry. Enron not only took advantage of electricity shortages and forced blackouts to drive higher prices as suppliers, company traders actually worked to manufacture shortages to further increase prices. Enron consistently recorded false or misleading profits and hid losses and liabilities. Top executives encouraged employees to invest in Enron stock, assuring employees that rumors of financial struggles and questionable practices were false as the executives sold off personal shares in anticipation of a price crash. Many innocent employees invested their entire futures in this company and lost everything because executives were not transparent with their own trades.
In regards to the pillar of independence in corporate governance, a large component of Enron’s fraud was the creation of other companies to create profit and hide losses and risky investments. Segregation of duties and independence issues existed with these special purpose entities (SPEs). Special purpose entities are supposed to be legally separate businesses that absorb the risks of corporations. The appeals of SPEs are that the assets of these entities are protected in the event that the corporation becomes insolvent. A large majority of the transactions that were questionable from an ethical standpoint stem from the use of Special Purpose Entities. The illegal and unethical methods in which these entities were used to raise capital whilst hiding relevant debt as well as the fraudulent manipulation of financials allowed the executives of the organization to benefit. The reasons why the company utilized these entities as they did are clear to anyone looking back on this as a case study, and that the lack of any corporate governance and proper oversight allowed these issues to fester are why Enron is such as landmark example of corporate corruption and fraud decades after the fact.
The Chief Financial Officer, Andrew Fastow as well as other employees used Enron stock as collateral to finance the Special Purpose Entities and for their own personal loans. Overall, Enron executives made money at the expense of company employees and shareholders, the groups whose interest executives are hired to protect. The company had a culture of indulgent and lavish spending and paired this with lack of controls to prevent fraud or limit excessive risk. Top management insisted they were unaware of the specifics of financial details, yet played both the employee and the investor in multimillion-dollar deals, “enriching themselves through the use of structured financing techniques” and bankrupting the company in the process. Employees were rewarded when Enron was able to report high profits and were incentivized to do anything to game the ratios and ensure that the company was profitable on paper.
Competition and disregard for others was pervasive in Enron’s culture. The company rewarded innovation and punished employees deemed weak. A system called “rank and yank” created an evaluation system for employees. Founder and Chairman Ken Lay terminated and transferred employees “on a whim,” instilling fear in employees that discouraged challenging the decisions of leaders and rewarded loyalists. Enron’s culture of prioritizing profits ahead of people directly drove employees to operate unethically. The ruthlessness of the executive team, coupled with the tone that they set, led to the company’s collapse.