Examining a Business Failure
January 3, 20111
Dr. Donald Wicker
Examining a Business Failure
Once touted as a prosperous and highly successful corporation, Enron sold natural gas and electricity, energy and other commodities and provided risk management and financial services to clients worldwide. Enron imploded as a result of poor managerial decisions, greed, collusion, lack of effective oversight and inaccurate financial reporting. The failure of Enron resulted in the loss of jobs, incomes and pensions for thousands of employees, the incarceration of several company executives, and the collapse of the well known accounting firm Arthur Anderson. The objective of this paper is to examine the failure of this former energy industry star to identify the parties involved and the factors affecting the organizational behavior involved in the demise of this company.
Enron Culture of Mismanagement
Enron was based in Houston, Texas and was founded in July 1985 by the merger of InterNorth of Omaha in Nebraska, and Houston natural gas. In 1994, the company started selling electricity, and in 1995, it entered the European energy market. By the middle of 2001 it employed about 30,000 people globally. Spearheading the rapid growth and success of the company was Ken Lay, Enron??™s Chairman and Chief Executive Officer, Jeff Skilling, company President, and Andrew Fastow, Chief Financial Officer. Ken Lay made it a point to employ only those individuals who shared his vision of success at all costs. The pinnacle of success was measured by the number of deals made and the amount of money the company made. The basic rule of thumb was to make money and profits any way possible. The corporate culture appeared to be that of a ???take no prisoners??? approach. In general its senior management had developed enormous arrogance due to early business successes (Chandra, 2003). This sentiment is echoed by Malcolm Gladswell who New Yorker magazine article he wrote on July 22, 2002, claimed Enron was a Narcissistic Corporation,??? defined as taking more credit for success than it deserved, not acknowledging responsibility for failure and lacking disciplined management (Maccoby, 2002). Chandra went on to say that the tone for such arrogance was set at the top and filtered it way through the lower levels of the organization, eventually becoming the culture of Enron. This narcissistic mindset is illustrated in a January 2001 interview Jeff Skilling had with Bethany McLean, a staff reporter for Fortune magazine. In the article written by McLean, Skilling stated ???I??™ve never been unsuccessful at business or work??¦ever!???
Enron??™s lack of effective managerial oversight was made possible by a lasses-faire style of management. Top management provided much latitude in the way executives were allowed to pursue ventures that ensured corporate success and financial prosperity for Enron and in the process left them alone to conclude those transactions.
???No one in management accepted primary responsibility for oversight; the controls were not executed properly; and there were structural defects in those controls that became apparent over time.
??¦..No one in management stepped forward to address the issues as they arose, or to bring the apparent problems to the Board??™s attention??? (Powers, 2002, p. 10).
In short as long as a deal ended in success no one cared and managers were too afraid to question or second guess senior executives. This was evident in the fact that in order to achieve top ratings all employees were expected to be motivated to ???do deals??? and post profits. Employees were rated on what was known as a ???360-degree review???. This was a program instituted by Jeff Skilling. The program rated employees based on the values of Enron that were respect, integrity, communication, and excellence (RICE). Employees were rated on a scale of one to five with employees having ratings of five fired within six months. As a result of this harsh ratings system there was a certain degree of paranoia and survivors of the rating system made questionable deals, and developed arrogance, thereby not fearing the consequences of their dubious and sleight-of-hand business conduct.
Collusion and Deceit
The goal of Enron??™s dubious business practices was to keep reported income and cash flows up, asset values inflated, and debts and liabilities off the books. Enron went to extensive lengths to highlight the great financial gains and profits the company made while taking equal measures to hide its losses by means of ???shell??? companies or special purpose entities (SPE). According to the report compiled by the International Swaps and Derivatives Association meeting held in Berlin on April 17, 2002, Enron demonstrated a failure of corporate governance, in which internal control mechanisms were short-circuited by conflicts of interest that enriched certain managers at the expense of shareholders. The report went to say that Enron??™s actions were undertaken to mislead the market by creating the appearance of greater credit worthiness and financial stability than was in fact the case. Most SPE??™s were shells to borrow money from banks and others and the participants knew the facts behind the facade (ISDA, 2002). Two of the more notable SPE??™s used by Enron were Chewco and JEDI that were used to transfer and hide debt and business losses from investors, creditors and regulators, and for business hedging. The use of SPE??™s resulted in inaccurate financial reporting and unjustified and illegal financial earnings for certain Enron executives. Chief Financial officer Andrew Fastow was able to mislead and pressure the board of directors and audit committee on high-risk accounting practices and convince accounting firm Arthur Anderson to overlook and ignore accounting irregularities.
The accounting firm of Arthur Anderson, Enron??™s auditor was eventually indicted and accused of being unethical in the way it processed financial information provided by Enron. The company was also indicted for obstruction of government for its part in destroying thousands of financial documents that could have been used to bolster a criminal case against itself and Enron. In fact a conflict of interest existed because Arthur Anderson not only handled the financial reporting for Enron but also the auditing as well. The result of Arthur Anderson??™s affiliation with Enron was the downfall of the once prestigious accounting firm. Well known and powerful clients abandoned the firm and thousands of employees lost their jobs.
To prevent other Enron type debacle organizations must adopt a proactive approach to business dealings and transactions to demonstrate transparency in the way business is conducted. In the Enron incident a distinct lack of attention was demonstrated by the board of directors to the off-books financial entities with whom Enron did business. The board failed to oversee the SPE??™s created by Skilling and Fastow because as they saw it, these companies were creating large profits for Enron. Passage of the Sarbanes-Oxley Act placed corporate executives and board members in the ???crosshairs??? with regard to having direct knowledge of company financials. Top executives no longer have the luxury of claiming innocence by means of not knowing the financial condition of their company. The indictment of Arthur Anderson proved that there should be a distinct separation between internal and external auditing functions. No company should be allowed to perform both functions when performing accounting duties. There needs to be increased disclosure of financial relationships of top executives and board members of publicly traded companies. The public has a right to know who stands to profit from business dealings between corporate executives and subsidiary companies. Do board members have any financial ties to ???splinter??? or ???spin off??? companies Boards of directors need to be cognizant of established codes of ethics and be held accountable for breaches of such codes. These boards must be able to examine proposed business models and come to a proper conclusion regarding the legality and propriety of the suggested course of business and then take proper measures in either recommending or overturning the business venture.
When the amount of money an individual makes is tied directly to the amount of business he or she can generate for a company as was the case of Enron, there is a tendency to play fast and loose with the rules. By taking advantage of financial loopholes, establishing shell SPE??™s to inflate profits and hide liabilities and having the accounting firm of Arthur Anderson handling internal and external company audits, Enron could dupe shareholders and creditors while providing generous salaries for top executives. Enron??™s board knowingly allowed the company to move at least $27 billion off the balance sheet, thus precipitating the decline and eventual collapse of the company (Choo, 2005). Ultimately the final cost was the downfall of two major companies and the loss of countless millions of dollars for once loyal employees and shareholders.
Chandra, G. (2003). The Enron implosion and it lessons. Journal of Management Research, 3(2), 98-111.
Choo, C. W. (2005). Information failures and organizational disasters. MITSloan Management Review, 46(3), 8-10.
Maccoby, M. (2002, December). Learning the wrong lessons from Enron et al. Retrieved December 30, 2010 from http://proquest.umi.com.ezproxy.apollolibrary.com
Powers, W. Jr. (2002). Report of the Special Investigations Committee [of Enron], Enron Corporation, February 1, 2002.
Enron: Corporate failure, market success. International Swaps and Derivatives Association 17th Annual General Meeting, Berlin, April 17, 2002
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