Enron

The Enron scandal has far-reaching political and financial implications. In just 15 years, Enron grew from nowhere to be America's seventh largest company, employing 21,000 staff in more than 40 countries. But the firm's success turned out to have involved an elaborate scam. Enron lied about its profits and stands accused of a range of shady dealings, including concealing debts so they didn't show up in the company's accounts. As the depth of the deception unfolded, investors and creditors retreated, forcing the firm into Chapter 11 bankruptcy in December. More than six months after a criminal inquiry was announced, the guilty parties have still not been brought to justice. Leaders Leadership is critical to the creation and maintenance of culture; there is a constant interplay between culture and leadership. Leaders create the mechanisms for cultural embedding and reinforcement. Cultural norms arise and change because of what leaders tend to focus their attention on, their reactions to crises, their role modeling, and their recruitment strategies. Referring to Enron, the major mistake made by leaders are as follows: Compensation Programs As in most other U. S. companies, Enron’s management was heavily compensated using stock options. Heavy use of stock option awards linked to short-term stock price may explain the focus of Enron’s management on creating expectations of rapid growth and its efforts to puff up reported earnings to meet Wall Street’s expectations. The stated intent of stock options is to align the interests of management with shareholders. But most programs award sizable option grants based on short-term accounting performance, and there are typically few requirements for managers to hold stock purchased through option programs for the long term. The experience of Enron, along with many other firms in the last few years, raises the possibility that stock compensation programs as currently designed can motivate managers to make decisions that pump up short-term stock performance, but fail to create medium- or long-term value (Hall and Knox, 2002). Dishonestly concealed debt and overstated earnings. Management t Enron Corp. admitted it overstated earnings for nearly five years. In an SEC filing, Enron said financial statements from 1997 through the third quarter of 2001 â€Å"should not be relied upon, and that outside businesses run by Enron officials during that period should have been included in the company's earnings reports. As a result, Enron is reducing earnings for those years by $586 million, from $2. 89 billion to $2. 31 billion. The company also acknowledged that part of earnings came from deals with partnerships controlled by recently sacked CFO Andrew Fastow. These transactions are already being investigated by the Securities and Exchange Commission. Enron said these deals enabled Fastow to earn more than $30 million. Enron also conceded that three entities run by company officials should have been included in its financial statements, based on generally accepted accounting principles. In addition, the company revised its debt upward in each year from 1997 to 2000. As a result, Enron's debt at the end of 2000 was $10. 86 billion, $628 million more than previously reported. Enron’s Performance Review System. PRC featured two basic motivational forces – fear and greed. Skilling wanted to keep only â€Å"the very best,† meaning those who produced their profit and volume target– so every six months one or two out of every ten employees were dismissed. In pitting employees against each other, the rank-and rank System acted to stress the imagined weaknesses of individuals and to obfuscate organizational problems. In sum, this led to an erosion of employee confidence in their own perceptions and, most crucially, to further compliance with the organization’s leaders in a way that strengthened conformist behavior. In practice, the PRC system worked to encourage â€Å"entourages† or â€Å"fiefdoms† (Dallas 2003) of loyal employees who gravitated towards powerful players for protection. The PRC was a powerful mechanism for preventing the emergence of subcultures running counter to the organizational tone set by Enron’s hierarchy. Members of the Risk Management and Assessment Group who reviewed the terms and conditions of deals (and who were largely inexperienced recent MBA graduates) as well as internal auditors, were fearful of retaliation in the PRC from persons whose deals they were reviewing (Chaffin and Fidler 2002; Dallas 2003). At best, control was compliance-based, seldom encouraging employees to follow either the letter or the intent of laws (Dallas 2003). This punitive environment brought the consequences of dissent sharply into focus. Enron’s culture has been characterized as â€Å"ruthless and reckless †¦ lavish rewards on those who played the game, while persecuting those who raised objections† (Chaffin and Fidler 2002, 4-5). Led by Skilling’s cavalier attitude to rules, top management conveyed the impression that all that mattered was for employees to book profits. In sum, this led to an erosion of employees’ confidence in their own perceptions and, most crucially, to further compliance with the organization’s leaders in a way that strengthened conformist behavior. Former employees have noted how â€Å"loyalty required a sort of group think† (Chaffin and Fidler 2002, 2) and â€Å"that you had to ‘keep drinking the Enron water’† (Stephens and Behr 2002, 2). A myth of smooth, flawless operations was perpetuated with problems â€Å"papered over† (McLean 2001, 58). The net effect of the rank-and-yank system was to decrease the likelihood that employees would raise objections to any illegal or unethical behavior of powerful players. The competitiveness the PRC created was exacerbated by Enron’s bonus regime. As one insider put it, â€Å"sure, the culture at Enron was treacherous, but that was the point† (Swartz and Watkins 2003, 56). Ultimately, the overestimation of profits and underestimation of costs was endemic to the organization. The cheat on debt and financial report lead to character erosion which destroys the image of this company and loss of business and social standing. The harsh policy alliance the relationship between managers and ordinary workers, make well-intentioned employees were inhibited from doing the right thing. Board Board of Directors in Enron’s collapse concluded that the firm had developed a pervasive culture of deception (Senate Subcommittee 2002). As such it was designed and operating at the level of connivance. CEO Lay used direct force to fire any possible successor with whom he disagreed and either he or other top Enron managers used indirect force to deceive and manipulate employees and other stakeholders for top executive advantage. Whatever standard operating procedures were developed at the level of conformance were honored only to the extent that they did not infringe upon executive perks or interfere with top executives exercising a type of feudal control over internal subjects. When external compliance threatened to restrict Enron corporate prerogatives, aggressive tactics to reduce or liminate regulatory standards were routinely employed. The extent and degree to which illegal non-compliance was the cultural norm at Enron will be determined in the courts. Enron did not reach the commitment level; it never democratized its power structures so that employee and community input could shape strategic direction or restrain executive perks. For all intents and purposes, the work culture of Enron was that of a moral jungle where abuse of power dominated principled economic democratic norms; it was a moral powder keg ready to explode. (1) Fiduciary Failure.  The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the United States, by allowing Enron to engage in high risk accounting, inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. The Board witnessed numerous indications of questionable practices by Enron management over several years, but chose to ignore them to the detriment of Enron shareholders, employees and business associates. 2) High Risk Accounting. The Enron Board of Directors knowingly allowed Enron to engage in high risk accounting practices. (3) Inappropriate Conflicts of Interest. Despite clear conflicts of interest, the Enron Board of Directors approved an unprecedented arrangement allowing Enron’s Chief Financial Officer to establish and operate the LJM private equity funds which transacted business with Enron and profited at Enron’s expense.  The Board exercised inadequate oversight of LJM transaction and compensation controls and failed to protect Enron shareholders from unfair dealing. (4) Extensive Undisclosed Off-The-Books Activity. The Enron Board of Directors knowingly allowed Enron to conduct billions of dollars in off-the-books activity to make its financial condition appear better than it was and failed to ensure adequate public disclosure of material off-the-books liabilities that contributed to Enron’s collapse. (5) Excessive Compensation.  The Enron Board of Directors approved excessive compensation for company executives, failed to monitor the cumulative cash drain caused by Enron’s 2000 annual bonus and performance unit plans, and failed to monitor or halt abuse by Board Chairman and Chief Executive Officer Kenneth Lay of a company-financed, multi-million dollar, personal credit line. (6) Lack of Independence. The independence of the Enron Board of Directors was compromised by financial ties between the company and certain Board members. The Board also failed to ensure the independence of the company’s auditor, allowing Andersen to provide internal audit and consulting services while serving as Enron’s Outside Accountants/Auditors Andersen's auditors were pressured by Enron's management to defer recognizing the charges from the special purpose entities as their credit risks became clear. Since the entities would never return a profit, accounting guidelines required that Enron should take a write-off, where the value of the entity was removed from the balance sheet at a loss. To pressure Andersen into meeting Enron's earnings expectations, Enron would occasionally allow accounting firms Ernst & Young or PricewaterhouseCoopers to complete accounting tasks to create the illusion of hiring a new firm to replace Andersen. Although Andersen was equipped with internal controls to protect against conflicted incentives of local partners, they failed to prevent conflict of interest. Revelations concerning Andersen's overall performance led to the break-up of the firm, and to the following assessment by the Powers Committee (appointed by Enron's board to look into the firm's accounting in October 2001): â€Å"The evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enron's financial statements, or its obligation to bring to the attention of Enron's Board (or the Audit and Compliance Committee) concerns about Enron's internal contracts over the related-party transactions†. Ethical Code/Process Enron senior management gets a failing grade on truth and disclosure. The purpose of ethics is to enable recognition of how a particular situation will be perceived. At a certain level, it hardly matters what the courts decide. Enron is bankrupt—which is what happened to the company and its officers before a single day in court. But no company engaging in similar practices can derive encouragement for any suits that might be terminated in Enron’s favor. The damage to company reputation through a negative perception of corporate ethics has already been done. Enron’s top managers chose stakeholder deception and short-term financial gains for themselves, which destroyed their personal, and business reputations and their social standing. They all risk criminal and civil prosecution that could lead to imprisonment and/or bankruptcy. Board members were similarly negligent by failing to provide sufficient oversight and restraint to top management excesses, thereby further harming investor and public interests (Senate Subcommittee 2002). Individual and institutional investors lost millions of dollars because they were misinformed about the firm’s financial performance reality through questionable accounting practices (Lorenzetti 2002). Employees were deceived about the firm’s actual financial condition and deprived of the freedom to diversify their retirement portfolios; they had to stand by helplessly while their retirement savings evaporated at the same time that top managers cashed in on their lucrative stock options (Jacobius and Anand 2001). The government was also harmed because America’s political tradition of chartering only corporations that serve the public good was violated by an utter lack of economic democratic protections from the massive public stakeholder harms caused by aristocratic abuses of power that benefited select wealthy elite.