Enron Corporation was a trading company that dealt in services, energy, and commodities. Before its downfall, Enron was one of the largest companies in the United States and its share price was among the highest in the market. Financial statements showed that the company was doing relatively well. As a public trading company, it was considered a good investment and many investors were buying its shares daily. Their employees were also amongst the best paid in the country and many graduates were eagerly seeking employment with the company. However, the company’s success was short-lived (Sterling, 2002). Trouble began when the company changed its organizational structure. The company employed many new people at managerial levels and gave them autonomy in making crucial decisions, which affected the company. With the change in organizational structure, the company reward system was changed such that high performing employees were given hefty bonuses and stock options. An internal authority controlled the new reward system, but this turned to be a bad system. The people who carried out the reviews and those who were reviewed worked on the same level, and they therefore started forming alliances. Employees were ‘looking out’ for each other and the results of the reviews were skewed to the advantage of the employees. Everyone received a good review and this created a culture of dishonesty that ultimately led to the company’s failure (Dharan & Rapoport, 2004).
On December 2, 2001, the company filed for bankruptcy and this led to one of the most cited corporate litigation processes. The case revealed the accounting fraud employed by the company and demonstrated how organizational structures in a company can be a major cause of downfall. This paper will look at the company’s management, processes, and individual responsibility that led to Enron’s failure. It will further recommend on various things the company could have done to avert the downfall.
Analysis of the company management, processes, and individual responsibility in causing the downfall
The company’s earlier organizational structure was based on the theory of constructivism (Sinclair, 2005). According to the theory, people gain knowledge when they use their experiences and ideas, which they apply to better their work. This organizational structure encouraged employees to work hard and achieve more. Adoption of a new system, however, gave too much authority and power to the new managers. The new managers were in no way related to the company and, therefore, they used the new powers bestowed on them to enrich themselves (Dharan & Rapoport, 2004). They were unaware of the company’s values and norms, this led to them working with no guidance, and therefore many of the wrong things they did were not reported or they were ignored.. Because the new organizational structure rewarded top performers, many young managers employed dubious methods to get the bonuses. This led to a culture of individualism and perfectionism in the company, which resulted to its downfall (Sterling, 2002). According to Kirk Hanson during an interview with Nakayama:
There are many causes of the Enron collapse. Among them are the conflicts of interest between the two roles played by Arthur Andersen, an auditor and a consultant of Enron. The lack of attention shown by members of the Enron board of directors to the off-books financial entities with which Enron did business; and the lack of truthfulness by management about the health of the company and its business operations contributed to the company’s failure. In some ways, the culture of Enron was the primary cause of the collapse. The senior executives believed Enron had to be the best at everything it did and that they had to protect their reputations and their compensation as the most successful executives in the U.S. When some of their business and trading ventures began to perform poorly, they tried to cover up their own failures (Nakayama, 2002, p. 5).
Another thing that made the company fail was that financial statements of the company did not reflect its operations and financial position to its owners. The unethical practices in the company required it to change and misrepresent its earnings to show that the company was doing relatively well. According to Bethany and Peter, “The Enron scandal grew out of a steady accumulation of habits, values, and actions that began years before, and finally spiraled out of control” (Elkind & Bethany, 2003, p. 132). The company changed figures of income, cash flow, inflated the value of the assets, and dramatically reduced the liabilities in the books (Sterling, 2002)
The company’s executives adopted market-to-market accounting and tried their best to hide the company’s debts. This would help the company to report profits on investments even though they would later turn out to be a source of losses. Because of the large inconsistencies that were supposed to match up the profits and cash flow, investors and creditors were given reports which were wrong.One example of a deal that Enron reported as profitable when actually it was resulting into losses is the twenty-year contract with Blockbuster Video, which was entered in 2000. The agreement would have seen the company introduce an on-demand entertainment in various cities in America. After rolling out several pilot projects, the company announced estimated profit revenue of close to $100 million from the agreement. Many financial analysts were skeptical about the viability of the project and the demand for the services. When the agreement failed, Blockbuster terminated the contract, but Enron continued to recognize the expected profits from the venture in its books (Fox, 2003).
The company had also created several offshore entities that were used to plan and avoid taxes as well as raise the company’s profits. These entities gave the management and owners of the company freedom to move currency and their anonymity allowed the company to hide its massive losses. The practice of using the entities helped the company’s stock prices to rise, and the management of the company was accused of insider trading. The Chief Financial Officer of the company, Andrew Fastow, helped create these shell companies and used them to enrich himself and his friends. By the time the Enron scandal was unearthed it is claimed that he had siphoned hundreds of millions from the corporations he had worked for and their investors (Sterling, 2002).
The dubious practices in the company’s management level ultimately led to its downfall and rendered the company bankrupt. The downfall was not only a result of the improper accounting standards and alleged corruption, but also stemmed from the organizational structure that was adopted. The organizational structure that was adopted by the company can be described as very competitive and individualistic to a point where there was no teamwork in the company (Fox, 2003). It can also be described as one that promoted perfectionism and encouraged power seeking among the employees. This kind of culture in the company made the employees fearful of their superiors and forced them to become ‘yes men.’ They agreed with decisions made by their superiors and rarely made contributions or pointed out mistakes in the company (Fox, 2003).
The organizational values of the company after adoption of the new system can be summarized as one that focused on results and disregarded accounting practices and ethics. The values instilled in the employees were that profits had to be realized no matter the cost or method employed. The system was bound to fail regardless of the efforts applied to manipulate the books.
Various things should have been done differently at Enron. This should have included review of the new system and see its implications, management reporting on financial records, auditing and consultation practices, and changes needed in the Securities and Exchange Commission and auditing requirements of companies.
The organizational structure that was adopted by the company should have been replaced or reverted to the older one after it was noticed that it was changing the values and norms of the company. Unlike the old system that focused on the workers learning and applying their knowledge to improve their work, the new system focused on an employee being perfect and this led to some of the workers being over ambitious to a point of committing felonies to get the desired results. The employees should have been encouraged to work as a team and the goals set should have been realistic and achievable. An external authority should have been involved during the review of the employees. The external authority would have worked with the internal authority, and this would have made the reviews to be honest and fair. The culture of individualism and “looking out for each other” would not have sufficed. The new members of the management should not have been given autonomy and authority to carry out transactions on behalf of the company without the senior management supervision. The senior management should always be the one to guide young managers and help them adapt to the company. In the case of Enron internal mismanagement led to new workers in managerial positions to lack guidance, and therefore, many of their decisions were wrong. The new young managers could also not point out the various irregularities happening for fear of being victimized and losing their work.
The management of Enron should have been more honest about the financial situation of the company. There should have been mechanisms in the company’s management that required the balance sheet report available to share holders. To avert issues like those that faced Enron, companies should thoroughly keep check on their top management. This is because if they are left to run the company without proper supervision, they might connive and cause a company to fail just like Enron. The board of directors in Enron was not attentive to the activities that happened off-books and failed to monitor them once they were approved.
In corporations and companies, no one should be given the freedom that Anderson enjoyed as an auditor and consultant of Enron. This is because with this kind of freedom, there is lack of control and the person can manipulate the books of the company just the same as Andersen. Analysts should also scrutinize companies’ books even when they are reporting huge profit. In the case of Enron Skilling and Fastow changed the organizational structure of the company and in the process made the company to look profitable and innovative. The board of directors is mandated see that companies’ code of conduct and ethics is followed. In Enron, they failed and this gave Skilling and Fastow the chance to practice impunity in the company.
There should be changes made in the Securities and Exchange Commission (SEC) and auditing practices to avoid similar cases, according to Kirk Hanson during an interview with Nakayama:
I believe accounting regulations should be altered to prohibit ownership of both auditing and consulting services by the same accounting firm. Accounting firms are already moving to sever their consulting businesses. The SEC should probably adopt additional disclosure requirements. Various regulators should tighten requirements for directors to be vigilant and provide protections for whistleblowers who bring improper behavior to public attention. But, in the final analysis, the solution to an Enron-type scandal lies in the attentiveness of directors and in the truthfulness and integrity of executives. Clever individuals will always find ways to conceal information or to engage in fraud (Nakayama, 2002, p. 17).
Dharan, B. G., & Rapoport, N. B. (2004). Enron: corporate fiascos and their implications. New York: Foundation Press.
Elkind, P., & Bethany, M. (2003). The smartest guys in the room: the amazing rise and scandalous fall of Enron. New York: Portfolio.
Fox, L. (2003). Enron: the rise and fall. New York: Wiley & Sons.
Nakayama, A. (2002). Lessons from the Enron Scandal. Santa Clara University. Web.
Sinclair, T. J. (2005). The new masters of capital: American bond rating agencies and the politics of creditworthiness. Ithaca : Cornell University Press
Sterling, T. F. (2002). The Enron scandal. New York: Nova Science Publishers.