The bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the disintegration of Arthur Andersen was exposed in October 2001. At that time, Enron was a big audit failure company which fell down too fast. Through this paper, the purpose is to analyze the reasons and aspects that took the firm up to this point, by no applying positively the organizational policies and the Code of Conducts. The Scandal of Enron To review the Scandal of Enron in deep and have a better understanding of what happened, it is important to know about the company’s history and analyze some of the events that led to fell down too fast. After a union between Houston Natural Gas Co. and Omaha-based InterNorth Inc. Enron was created in 1985. Soon after, Kenneth Lay – the chief executive officer (CEO) of Houston Natural Gas- became Enron’s CEO and chairman who rebranded Enron into an energy trader and provider. Also, in 1990 Kenneth Lay created the Enron Finance Corp. At this time, in the earliest 1990’s was in course the liberalism and nonintervention of the energy markets, when the United States congress accepted a legislation that deregulated the sale of natural gas, being this the factor that permitted companies like Enron took advantage to place bets and speculate on future prices (Segal, T. 2018).
In the late 1990s, the Enron company was recognized as one of the most innovative corporations, its annual earnings were around $9 billion in 1995 to above $100 billion in 2000. They kept constructing power plants and operating gas lines, but the principal reason why they were well-known was their extraordinary trading business. Which in addition to ordering and vending gas and electricity futures, appears the creation of new markets (commodities) for broadcast time for advertisers, weather futures, and Internet bandwidth as some of the different projects they had (Yuhao, L. 2010). Where the company was trying to explore any possibility that drives to grow revenues at any cost. In the same year, Jeffery Skilling joined Enron, and in 1997 was selected as the company’s Chief Executive Officer. He claimed the need to change the accounting system from a straightforward were Enron had listed actual revenue and costs of supplying and selling gas to the mark-to-market accounting system (Pavel, T. & Encontro, M. 2012). In order to explain this, is relevant to be familiar with the concepts mentioned above, thus according to the definition given on INVESTOPEDIA (2018), Mark-to-market (MTM) is a measure of the fair value of accounts that can change over time, such as assets and liabilities. Which means that all the estimations made at Enron were created based on the upcoming net value of the cash flow, even though the money was not yet received.
For instance, when the Executive Skilling, had in possession material of nonpublic information including the Enron’s performance and the failure of its business, he took advantage of that by selling Enron’s stocks at the inflated values. From April 2000 to September 2001, Skilling sold over one million shares that generated unlawful earnings of around $63 million (U.S. Securities and Exchange Commission, 2004). Hence, the unethical and illegal decisions soon started to reflect its bad results, causing a lot chaos and the beginning of the company’s destruction. Certainty, Enron was a big blossoming business that change and left a mark in the history; where sadly a considerable amount of people loses their jobs, or event worst their money. In addition, to cover all the mess up caused already, appears a major player in Enron’s scandal, Arthur Andersen LLP and partner David B. Duncan who supervised the accounts and accounting practices at Enron. Despite the irregularities they found on Enron’s statements, Arthur Andersen stamped his approval and signed off the corporate reports. Nonetheless, in April 2001 many analysts started to demand transparency and explanation of all the movements the company had done without showing in public the appropriate financial statements (Segal, T. 2018).
In fact, this relationship is also another factor that helped the company hide its frauds, such as keeping huge debts off balance sheets. Central problems It is evident that the Enron Scandal involves a lot of factors which should be covering in order to explain what really happens, but at this point, the concentration will be only on the most relevant facts by implementing a framework of Ethics. The legal and regulatory structure, the internal policies to manage employees’ compensation (organizational design & strategic decision making), the power to hire their own auditors (allies), the financial disclosure mechanisms and the unethical performance, were some of the reasons why first of all the company was allowing to take advantage of its shareholders and secondly was led to bankruptcy. Problems Definition In the following paragraphs, the purpose is to find the appropriate facts to explain all the problems mentioned above and the proper ways to give them possible solutions. Based on a study made by Dennis, Martin, & Kirk (2002) at Santa Clara University, which states that back in that time the current laws & Security and Exchange Commission (SEC) regulations allowed firms like Arthur Andersen to deliver consulting services without specific tools. That would have helped them with the measurement of Enron’s performance. Here the legal and controlling system’s fallacy was exposed, since the two companies (Enron & Anderson) were able to hide, lied and override the social rules, by mistreating the real information to all the parties involved.
For instance, when Enron announced bankruptcy, they had $13.1 billion in debt on its books, $18.1 billion on its subsidiary’s books, and an estimated $20 billion more off the balance sheets (Zellner, W. 2001). Although, previous to the fall of Enron and their auditors, Arthur Andersen, were safety actions in place to protect the investors and the public as a whole. These safety measures included Generally Accepted Accounting Principles (GAAP), Generally Accepted Auditing Standards (GAAS), Statements on Auditing Standards (SAS), and all professional ethics. The use of GAAP by accountants is standard protocol (Todd, S. 2001). Which were not enough to prevent the inappropriate actions effectuated by them. Secondly, are the internal policies to manage employees’ compensation (organizational design & strategic decision making), to explore this issue further, the Enron’s compensation policies are the most important thing to look at based on that in many plans it seemed to be innovative with best practices, but payments were closely connected to shareholder value, and employees had a significant portion of their compensation at risk. Furthermore, Enron’s audit committee was state of the art allowing the committee to retain other accountants, consultants, or lawyers, as it deemed appropriate. (Gillan, S. & Martin, J. 2007). In mid-2000 the stock price of the company fell from $90 per share to less than $1, taking with it the value of Enron employees’ 401’k pensions, which were mainly tied to the company stock (Peter, B.2016) Table 1: CEO compensation during 2000: Enron and peers In this table clearly can be analyzed the Enron’s CEO, Kenneth Lay, and peer firms’ compensation during 2000 (section A) and the sample of investment banks (section B). There is a high total pay packages where Lay’s total compensation is one of them, and it was parallel to the investment banks, although somewhat less incentive-based. The company enforced a program that provided directors with incentives (bonus) to rise earnings and the company’s stock price (Gillan, S. & Martin, J. 2007).
In effect, after seeing all of this is hard to believe that they did not manipulate the earnings to achieve those bonuses, based that those could be obtain on performance. Third, the power to hire their own auditors (allies), this again is a conflict of interest built into the legal system because the auditor has an incentive not to question an unfavorable or negative report on the company that is paying. Thus, is appropriate to cite here the Special Purpose Entity (SPE), which are legal entities that are created only to accomplish an explicit or provisional task. With the purpose to handle assets either by funding or by risk management (Pavel, T. & Encontro, M. 2012). In Enron’s case the Special Purpose Entities were not only used to avoid the traditional accounting resolutions but also, they could hide obligations (debts). But this foundational statement that the SEC can differ on private entities as the first and primary control against massive corporate wrongdoing, proved terribly wrong in the case of Enron (Financial oversight of Enron, 2002). Similarly, Enron was subject to external sources of authority like market pressures, oversight by government regulators, and oversight by private entities including auditors, equity analysts, and credit rating agencies (Financial oversight of Enron, 2002) which were no aware of all the illicit transaction until the big scandal came out on 2001 leaving in evidence all the unethical performance and decisions that affect so many people. Potential and Specific Solutions Presenting general solutions to vast problems is the descriptive phrase of this paragraph, which can be driven to find the precise way to take, by implementing the managerial theories and following upgrading process. As a result, and after doing research about this, the more factual solutions:
Enforcement of the Code of Ethics by any employer or employee in the company. As all the corporations have their Code of Ethics, Enron did too, but they did not follow what they highlighted on it where the core values were: respect, integrity, communication, and excellence (Enron, Code of Ethics. 2000). The payment of incentives after a project is done or at least when the company is really profiting from that certain project. Operational risk should be reduced.
Careful selection of accounting approach and financial structures to use. look more closely at the relationship between auditors, managers and the company audit group. Minimized payment in stocks (Pavel, T. & Encontro, M. 2012).
New regulations resulted after the scandal, and the legislation designed to increase the accuracy of financial reporting for publicly traded companies (Peter, B. 2016). These new methods that are bringing positive results to the business, are always needed in any type of organization, since many changes are being experienced and will continue to be with the growing & globalized world.
The hierarchy system should be modifying and most importantly restructured (Natasha, S. 2011). Delegation among the employees according to their specialties & strengths and not hiding information of the current company status. Also, Directors could have adapted key aspects of the private-equity governance model to ensure that they achieve their oversight responsibilities.
Companies can take steps to help senior executives avoid the two sources of leadership failure at Enron: personal opportunism and flights to utopianism (Natasha, S. 2011). All of this is about communication vs people, when a person is happy doing his/her job, will exceed their limits to achieve organizational goals, but if instead, that person has no motivation the performance will be poor. Key terms and Conclusion The HBS professor Malcolm S. Salter, explained on his new book, Innovation Corrupted: The Origins and Legacy of Enron’s Collapse, a deep reflection on the present and future of business, all of them based on Enron’s scandal. Putting as an illustration, their ambition and aspiration were too wide-ranging to authority disciplined and responsible decision-making during the struggling time, that did not allow the members of the board manage the problems. Another key point is that Enron was an advanced and innovative company, and its collapse can be traced by some enormously poor diversification decisions, and poorly considered and implemented administrative practices that led, to their auto destruction.
In summary, Executives at Enron and Arthur Andersen did not think on their actions and all the disaster they could cause to people and families who trusted them, they neither have a positive impact on the accounting industry nor any industry. They set out to make as much money for themselves as quickly as possible. They were willing to do whatever it took to make that money (Todd, S. 2001). These insensitive and selfish acts led both companies to a final downfall in bankruptcy. Nevertheless, the accounting industry responded by initiating changes that would recover itself and the economy in which it exists, as it was mention before; But, even now, only with the continuous work to improve the industry and the implementation of better processes, it will tend to function effectively and shape to the fast changes. Finally, the Code of Ethics should be mandatory to act in the best interest of the company, shareholder and employees, no leaving it in consideration to the managers/executives to exercise their own business and enter arrangements. .
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