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The Collapse of Enron

Aakash Khandelwal (2012IPG-001)Arun Pant (2012IPG-019)Fatehyaab Alam (2015MBA-13)Rohit Nimiya (2012IPG-078)

ABV - Indian Institute of Information Technology and Management, Gwalior

BY –

* All the images in this document are obtained from google images

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The Enron Story• Employed approximately 20,000 staff.• One of the world's major electricity, natural gas, communications, and pulp and paper

companies.• Revenues of nearly $101 Billion.• Named Enron "America's Most Innovative Company" for six consecutive years by Fortune

BroadbandShipping / freightStreaming mediaWater and wastewaterPrincipal InvestmentsRisk management for Commodities etc.

PetrochemicalsPlasticsPowerPulp and paperSteelWeather Risk ManagementOil and LNG transportation

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Smartest Guys in the Room• Inflate earnings using Mark to Market Accounting.“Technique used when trading securities where you measure the value of a security based on its current market value, instead of its book value.”

The company would build an asset, such as a power plant, and immediately claim the projected profit on its books, even though it hadn't made one dime from it. If the revenue from the power plant were less than the projected amount, instead of taking the loss, the company would then transfer these assets to an off-the-books corporation, where the loss would go unreported.

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Smartest Guys in the Room

• $30 million of self dealings by the chief financial officer• $700 million of net earnings disappeared• $1.2 billion shareholders equity disappeared• Over $4 billion in hidden liabilitiesCorporate Governance: In 1999, Enron’s board waived conflict of interest rules to allow CFO Andrew Fastow to create private partnership to do business with the firm.Enron’s 401(k) pension scheme: Almost 62% of this pension scheme was Enron’s stock which crashed drastically from over $80 in early 2001 to a mere few cents by the end of the same year. Relationship with Bankers: Enron was lucrative Investment Banking (IB) business for the banks. In exchange of the potential profits from IB services, the banks had lend money to Enron and promote it’s derivatives and securities.

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“I am incredibly nervous that we will implode in a wave of accounting scandals. My eight years of Enron work history will be worth nothing on my résumé, the business world will consider the past successes as nothing but an elaborate accounting hoax. Skilling is resigning now for ''personal reasons'' but I would think he wasn't having fun, looked down the road and knew this stuff was unfixable and would rather abandon ship now than resign in shame in two years.”

Letter from Sherron S. Watkins, a vice president for corporate development at Enron to Kenneth L. Lay, the chairman of the Enron Corporation, after Jeffrey K. Skilling resigned unexpectedly as chief executive on Aug. 14 2001

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The Disaster Stock

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Internal Stakeholders

• Senior executives Kenneth Lay – Chairperson and CEO. Died before his sentencing. Jeffrey Skilling – Former CEO. Sentence reduced from 24 years to

14years. Andrew Fastow – CFO. Sentenced to 6 years in prison.

• Employees 20,000 employees lost jobs. $2 billion in pension fund lost. $85 million were compensated.

• Shareholders $40 billion lost in stocks.

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External Stakeholders

• Creditors JP Morgan Chase, Credit Suisse, Citigroup and other investors were

paid by auction of company's assets after bankruptcy.• Auditor

Reputation of auditing firm Arthur Anderson was so server damaged that the organization had to be dissolved.

• Residents of California Faced power blackouts and increased cost of electricity.

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Factors Leading to Collapse of Enron

• Poor Corporate Governance Board of directors permitted poor business decisions and unethical

behavior of top managers to go unchecked. Audit and compliance committee failed to assure correctness of

financial statements. The board voted to suspend code of ethics allowing Fastow to go

unethical.• Compensation and Reward System

Rank and Yank system Compensation was largely in form of stocks. This led to incentivizing

employees to artificially inflate stock prices.

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Factors Leading to Collapse of Enron

• Corporate Culture Aggressive competition to deliver results. High risk taking was appreciated. Money symbolized success.

• Inadequate Ethics Infrastructure Board occasionally voted to suspend code of ethics to allow for off-the-

book partnerships. There were conflict of interest at many managerial positions within the

company. The ethics committee did nothing to address those

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Ethical and Moral Issues at Enron

• Activities at Enron are not in sync with deontological or utilitarian school of ethics. No ethical justification can be provided.

• Multiple conflict of interests existed in organization, which were unaddressed:

Andrew Fastow – Enron vs. companies that he owned. Lay and Skilling – Maximizing shareholders wealth vs. maximizing their

own wealth• Large scale participation of employees in unethical activities

can be explained by Milgram’s Experiment.

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Milgram’s Experiment

• People are ready to do unethical things if they are pressurized/ encouraged by an authority to do so.

• Senior management at Enron motivated employees not to pay attention to rules and regulations and only focus on making profits, leading to building of unethical culture in company.

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Aftermath of Collapse

• Immediate and Massive Lay-offs• Life-long Savings reduced to ‘0’• $70 billion Worth of Market Value Lost• Unprecedented Major Write-downs on Bad Loans• Suits, Trials and Unwrapping• Big Five became Big 4

Code of Ethics Violated at Will.

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Pyramid of Social Responsibility

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The scandal made the authorities realize the importance of ethics and importance of INTERNAL CONTROL in business enterprises. It also helped understand the real meaning of Shareholder’s Wealth Maximization and the boundaries within which this key objective is to be achieved. Enron’s opaque financial statements and records helped conceal the true and sordid fate of it’s investor’s money.

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Sarbanes-Oxley Act

• The Enron scandal was certainly enough to show the American public and its representatives in Congress that new compliance standards for public accounting and auditing were needed. Enron was one of the biggest and, it was thought, one of the most financially sound companies in the U.S.

• In response to what was widely seen as collusion by Enron's accountants, The Arthur Andersen firm, in Enron's fraudulent behavior, SOX also changes the way corporate boards deal with their financial auditors.

• All companies, according to SOX, must provide a year-end, report about the internal controls they have in place and the effectiveness of those internal controls.

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Sarbanes-Oxley Act

• Sarbanes-Oxley, or SOX, is a federal law that is a comprehensive reform of business practices. 

• This act set new standards for public accounting firms, corporate management, and corporate boards of directors.

• Features - • Greater Oversight of Accounting Practices• Increased independence of auditors and analysts• Increased Penalties for Corporate Crime• Tighter Controls on Insider Activity

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Learnings for Future

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Learnings for Future

• Corporate Managers• Identify the role that can be played in resolving conflict of interests.• Intervene in cases of malpractices if it comes under one’s purview.• Report instances of fraud/deceit to subsequent higher levels of

hierarchy.• Grow on genuine and sustainable foundations.• Avoid too much risk and excessive competitive attitude.

Don’t take the pill that can’t be swallowed.

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Learnings for Future

• Stakeholders• Keep weighing the options.• Be decisive while considering the pros and cons.• Have multiple eggs in the basket.• Don’t out rightly ignore the alarm bells.• Profits and responsibility goes hand-in-hand.

Be prepared for any eventuality.Nothing is infallible.

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Learnings for Future

• Policy Makers• Regular review of existing policies.• Identify and plug possible loopholes.• Extra caution if exceptions are being made.• National policies are for national interests.• Appeasement often ends in adversity.• “A stitch in time saves nine.”

Act if one smells the rat.

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Thank you!