Why pick Enron? The answer is that Enron is a well-documented story and we can apply our method with the great advantage of retrospection to show ho

Introduction

Why pick Enron? The answer is that Enron is a well-documented story and we can apply our method with the great advantage of retrospection to show how the end result could have been predicted. It is also a good example to illustrate how ethics drives culture which in turn pushes the ethical boundaries and is a key influence on all the four other key elements of good corporate governance.

History of Enron

Enron was created in 1986 by Ken Lay to take advantage of the opening he saw coming out of the deregulation of the natural gas industry in the USA. What started as a pipelines company was transformed by the vision of a McKinsey consultant, Jeff Skilling, who had the idea of applying models used in the financial services industry to the deregulated gas industry.

He persuaded Enron to set up a Gas Bank through which buyers and sellers of natural gas could transact with each other via a regulator (Enron) whose contractual arrangements would provide both parties with reliability and predictability regarding pricing and delivery. Enron duly recruited him to run this business and he rapidly built up a major gas trading operation through the early nineties.

During this time Enron was extending its pipeline operations into a wider power supply business, initially in the USA and then on an international scale, completing a large plant at Teesside in the UK and contracting to build a huge plant near Mumbai in India. In due course it had deals all around the globe, from South America to China. The hard driving expansion of Enrons power business worldwide created a global reputation for Enron.

Skillings vision was to transform Enron into a giant, asset-light operation, trading power generally and his next target was trading electricity. Lay was lobbying Washington hard to deregulate electricity supply and in anticipation he and Skilling took Enron into California, buying a power plant on the west coast.

Enrons national reputation rested on the rapid expansion of its domestic business and its steadily growing revenue and earnings from trading. So, on the back of his track record, Skilling was appointed Chief Operating Officer by Ken Lay and he then embarked upon transforming the whole of Enron to reflect his vision.

Observing the dotcom boom, Skilling decided Enron could create a business based on a broadband network which could supply and trade bandwidth and he set out to build this at a great pace.

However, the experiment in deregulation in California didnt work well and in due course was reversed with recriminations all round. Moreover, the international business expansion wasnt underpinned by adequate administration and many of the contracts later turned bad.

So, Enron then took the decision to build on its international presence by becoming a global leader in the water industry and bought a big water company in the UK, following it up with a big deal in Argentina.

At this point, around 2000, Enrons reputation was still riding high and Lay and Skilling were looked up to as visionary thinkers and top business leaders.

However, as we see elsewhere in this case study, the rapid expansion had run well ahead of Enrons ability to fund it, and to address the problem, it had secretly created a complex web of off-balance sheet financing vehicles. These, unwisely, were ultimately secured, and hence dependent, on Enrons rapidly rising share price.

Also, its hard driving culture was underpinned by incentive schemes which promised, and delivered, huge rewards in compensation packages to outstanding performers. The result was that, to achieve results, aggressive accounting policies were introduced from an early stage. In particular, the use of mark to market valuation on contracts produced artificially large earnings, disguising for some years underlying poor profitability in major parts of the business.

This, of course, meant that Enron was not generating adequate cashflow, while spending extravagantly on expansion, and eventually it blew up suddenly and dramatically. Colleagues of this author who met Lay and had dealings with Enron confirm that there was skepticism in the market about Enrons profitability and its cash position. Suspicions grew that Enrons earnings had been manipulated and in late summer 2001 it emerged that its Chief Finance Officer had privately made himself rich at Enrons expense through the off-balance sheet vehicles. About this time the dotcom boom ended suddenly and for Enron, this coincided with the international power business going radically wrong, the broadband business having to be shut down, the water business collapsing and the electricity services business getting into serious trouble in California. Enrons share price started to slide and Skilling, appointed Chief Executive Officer in January 2001, resigned in August.

Enrons share price then rapidly declined, triggering repayment clauses in the financing vehicles which Enron couldnt handle. Its credit rating went to junk status, which caused the share price to collapse and triggered further crystallizing of debt obligations. Banks refused further finance, suppliers refused to supply and customers stopped buying.

At the beginning of December 2001, Enron filed for the biggest bankruptcy the USA had yet seen.

This, in turn, took down one of the largest accounting firms in the world, Arthur Andersen, which was deemed to have so compromised its professional standards in its dealings with its client Enron that it was in many ways complicit in Enrons criminal behavior.

Ethical Assessment

Enron didnt start out as an unethical business. As we have seen in this case study, what introduced the virus was the pursuit of personal wealth via very rapid growth. This led to the introduction of quite extreme incentive schemes to attract and motivate very bright and driven people, which, in turn, led to an unhealthy focus on short term earnings.

The next step was, naturally, to look at how earnings could be massaged to achieve the aggressive revenue and earnings targets. Since the massaged figures for growth in earnings still left a shortfall in cash, Enron quickly maxed out on its borrowing abilities.

But issuing more equity would have hurt the share price, on which most of the incentives were based. So, schemes had to be created to produce funding secretly and this funding had to be hidden. In this way, an amoral and unethical culture developed in Enron in which customers, suppliers and even colleagues were misled and exploited to achieve targets. And the top management, who were rewarding themselves with these same incentive schemes, boasted that a pure, market-driven ethos was propelling Enron to greatness and deluded themselves that this equated to ethical behavior. Lay even lectured the California authorities, whom Enron was cheating, that Enron was a model of business ethics.

Finally, the respected Arthur Andersen allowed greed for fees to over-rule the strong business ethics tradition of its founder and caused it to succumb to bending and suspending its professional standards, with fatal results.

Impact on Corporate Governance

Our five Rules of Good Corporate Governance start with the need for an ethical culture. Having established that Enrons culture became progressively more deficient in this regard, lets consider briefly the impact of this failure in business ethics on the other Rules.

Clear goal shared by all key Stakeholders

Lay and, particularly Skilling, engendered in all the staff of Enron the goal of driving up the share price to the virtual exclusion of all else. The goal of achieving a long-term satisfaction from a stable customer base took a distant second place to signing up deals. In California, the customers were deliberately exploited by the traders to the maximum extent their ingenuity could achieve. Even internally, the Chief Finance Officers funding scheme was designed to make him rich at his employers expense.

Strategic Management

As a McKinsey consultant specializing in strategy, Skilling had a very clear vision, at least initially, of what he wanted Enron to achieve. However, he wasnt interested in management per se and allowed operational management to wither. But his vision of a huge trading enterprise wasnt carried down to the next level of developing and implementing practical business plans, as evidenced by his crazy launch into broadband, a field in which he had no personal knowledge or experience and in which Enron had almost no capability or likelihood of raising the funds required to implement the project

Organizational failure at Delivery

Skilling became COO on the departure of a very tough and experienced predecessor. Even at that point, Enron had been expanding at a rate which outran its ability to set up appropriate and adequate administrative systems and controls. Added to which it had always been short of funds. Skillings lack of interest in operational management meant that on his appointment at COO, he made a poor situation much worse by making bad managerial appointments. His focus on rapid growth incentivized by very generous compensation schemes, and with inadequate spending controls, created a totally dysfunctional organization.

Transparency and Accountability

From the early stages, Enrons focus on earnings and share price growth and the related financial incentives led to a necessary lack of transparency as the figures were fiddled. One could argue that Enron felt very much accountable to their shareholders for delivering consistent above average growth in Enrons market capitalization. However, this growth was achieved by subterfuge and deception. Certainly, the dealings in California were as far from transparent as it was possible to be.

Conclusion

The flaws in Enron should have been spotted from early on, and indeed were periodically commented on by various observers from the early nineties onward. If independent ethical and corporate governance surveys had been conducted by independent parties they would have highlighted the growing problems.

One would conclude from this survey in June 2000 that:

neither customers, suppliers, financiers nor local communities rated Enrons morality in terms of business ethics

customers and local communities thought they were breaking regulations

customers and suppliers thought they were probably bending their own rules

customers, shareholders, suppliers, financiers and local communities thought they were not truly honest.

It is clear with the benefit of hindsight that what started out as an imaginative and ground- breaking idea, which transformed the natural gas supply industry, rapidly evolved into a megalomaniac vision of creating a world-leading company. Intellectual self-confidence mutated into contempt for traditional business models and created an environment in which top management became divorced from reality. The obsessive focus on driving the share price obscured the lack of basic controls and benchmarks and the progressive dishonesty in generating revenue and earnings figures in order to deceive the stock market led to the management deceiving themselves about the true situation.

Right up to nearly the end, Enron complied with all its regulatory requirements. The failings in these regulations led directly to Sarbanes-Oxley. But all the extra reporting in Sar-Box Act didnt prevent the global financial meltdown in 2008 as the banks gamed the regulatory system.

BUSN1203

Management, People, and Organizations

Assignment 2- Ethics Case Study

Name Student ID

Contents

Introduction

Social Responsibility Strategy.

Ethical View.

Stakeholders

Internal stake holders ..External stake holders.

Conclusion

References...

Appendix

Exchange Case studies with your partner and answer the following questions. Once you have finished provide feedback to your partner.

Format:

Is there:

a cover pageTable of Contents

Introduction

Separate headings for each question Social responsibility, ethical viewpoint, stakeholders

Conclusions

References:

How many references have been included?

Do the references intext match the final reference list?

Are the references listed A-Z?

Has the Harvard system been used?

Appendix:

Does this include an Ethical checklist?

Whos viewpoint was used? E.g. CEOs/ CFOs/ employees

Do you agree with the options provided?

Social Responsibility Strategy

Is a Social Responsibility Strategy identified?

Has it been defined?

Are examples provided of how Enron aligns with this strategy?

Ethical viewpoint

Is an ethical viewpoint identified?

Has it been defined?

Do you agree with how Enron would be viewed from this strategy?

Stakeholders

Have relevant stakeholders been identified?

How many?

Has the affect on them been stated accurately?