Enron is a poster child for shareholder wealth destruction and bad behavior. This case describes the company’s strategy, internal and external governance to allow students to understand why the company failed. The case raises several interesting questions. What was the role of accounting improprieties in Enron’s failure? What roles were played by strategic failures, the company’s culture and internal governance? Why did the firm’s auditors and board fail to foresee the problems at the company in time to save it?
Why was Enron such an admired company prior to 2000?
Before the year 2000, Skilling had initiated a new model and new product of the industry that was the energy derivative. Enron Finance Corp, which was a new division formed in 1990, soon dominated the natural gas contract market. Having this power in the market, the company was capable of predicting the prices of the future with almost great accuracy. By 1997, the company had acquired an electric utility company, the Portland General Corporation. Skilling developed another new division, which was Enron Capital and Trade Resources which grew to become the largest buyer as well as the nation of the nation of electricity and natural gas. By 1999, Enron Online had been created and by the next year, the company stock was at an all-time high at the price of $90.56.
Enron at that time was considered to be one of the most innovative companies in the country. The company has built a gas line, power plants and was well known for the unique style of trading business. The company was widely involved in the buying and selling of the future contracts of both electricity and gas, and it also created a new market for its oddball commodities. Another reason for the high admiration for Enron had been its high compensation given to the employees. The company also gave big bonuses for good performances. The corporate culture rewarded innovative ideas of its employees (Thomas, 2002).
Why did the company fail?
Enron made partnerships with its own internally created companies and used these companies to manipulate and mask huge losses and debts that it had on the trading business. Another major reason for its failure was its market-to-market accounting. Enron would use estimated profits and recognize these profits in the statements even when the company had incurred a loss in reality.
The accounting method, compensation system, Special Purpose Entities, and the internal auditing were the main reasons for the failure of Enron. The mark-to-market accounting which required the company to project and provide a forecast for its projects caused them to recognize their unearned profits. These projects, in reality, yielded financial losses which are never recognized. It enabled them to fake the financial health of the company, deceiving their investors into a healthy company outlook. The SPEs were used for the understatement of the liabilities and the overstatement of the equities. The company used these for the sole purpose of corruption. Enron stock was used for hedging of the private companies which caused the greatest conflict of interests. Executives were taking ownership in these SPEs and taking out the money. The fraud was realized after the asset write-down started and the company started to show everything it had been deceived (Thomas, 2002).
Why were the company’s internal checks and balances and incentive systems unable to prevent its demise?
The internal checks and balances of the company Enron were looked after to some extent by Arthur Anderson LLP, which was responsible for the internal bookkeeping which helped in distortion of the division of responsibilities which Enron had to use to guarantee the honesty in their reporting of financial information. Other than this, many of the executives of Enron moved from Arthur Anderson to Enron. It caused the lines to get blurred between the corporate management and the independent external auditor. The internal controls of Enron were inadequate, and the contingent liabilities were never disclosed, leading to weak internal check systems (Stevenson & Gerth, 2002).
Why did the external auditors and the board fail to prevent Enron’s failure?
Anderson audited the books of Enron and neglected its responsibility to disclose the discretions and unethical doings of the company. Anderson as the external auditor validated the problematic and manipulated financial statements of the company. The company also witnessed having a relationship with Enron. It caused them to have low motivation for exposing themselves to publicly and destroy one of their largest clients (Abelson & Glater, 2002). Even after surpassing the need for the composition of the Board, Enron failed. The main reason was that things were kept from the board’s knowledge.
References
Abelson, R., & Glater, J. D. (2002). Enron’s Collapse: The Auditors; Who’s Keeping the Accountants Accountable? Retrieved from https://www.nytimes.com/2002/01/15/business/enron-s-collapse-the-auditors-who-s-keeping-the-accountants-accountable.html
Stevenson, R. W., & Gerth, J. (2002, September 10). Enron’s Collapse: The System; Web of Safeguards Failed as Enron Fell. Retrieved from https://www.nytimes.com/2002/01/20/us/enron-s-collapse-the-system-web-of-safeguards-failed-as-enron-fell.html
Thomas, C. W. (2002, April 1). The Rise and Fall of Enron. Retrieved from https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html
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