Introduction:
Corporate governance is one of the most dynamic as well as the central aspect of any business. Governance refers to steering. It implies that corporate governance involves the directing of the business as compared to its control. Corporate governance has become the topic of academic research increasingly because of its impact on the health of the economic system. It has been long ignored as a potentially important development for a nation’s economy. The 1990s wave of corporate fraud in the US has long been attributed to the weakness of corporate governance. The most recent global financial crisis of 2009 was also found to be triggered by the failure of the subprime mortgages increasing the interest of academics around the globe in corporate governance frameworks in the financial sector. The strong corporate governance framework is needed to be developed for the maintenance of investor confidence, protection of stakeholders’ rights, and attraction of foreign direct investments. This paper, in particular, looks at the collapse of Enron and analyzes its core in the context of its effort to look healthier than its actual assets were. It is dedicated to analyzing if the corporate governance framework of shareholder wealth maximization were found to become a weakness in the Enron case or its strength. Corporate governance importance for the corporate success of the business and its social welfare cannot be overstated. The massive corporate collapse resulting from the weak corporate governance systems have highlighted the immediate need for improvement and reforms in the corporate governance frameworks on an international level. In the presence of cases similar to Enron, countries have reacted by pre-empting similar events. The Sarbanes Oxley Act 2002 was one of these immediate reactions. Similarly, the Higgs Report and the Smith Report account for similar reactions in the UK (Eriksson, 2003). Consequently, the failure of Enron shows the importance of corporate governance in the prevention of such failures.
Enron Collapse:
With every economic expansion, an investment is brought forward which is treated by people as being the catalyst for breaking the iron law of return and risk (big returns are equal to big risks). The 1920s made the investment in common stocks with margin. The 1960s came with the Nifty Fifty stocks. The 1970s brought commodities whose prices were expected to rise forever. The 1970s were marked by the junk bond and then came 1990s, which brought the new-economy stocks. Then came Enron.
Enron had been flying high. The stocks of Enron have been peaked by touching ninety dollars in 2000 in August. It was then the seventh largest firm in America regarding market capitalization. Fortune Magazine ranked it as one of the most highly innovative companies in America in the last five years. When it fell, it was also ranked first in many aspects. It was the largest company who went into bankruptcy reorganization in the history of America. Similarly, the stock of Enron fell to sixty cents a share because of its company, being the biggest financial fraud victim of the history and also of the biggest failure of audit as well. Major market correction occurred in the latter two months growing worry for the financial reports similar to Enron. The increased insecurity is increasingly raising the risk premiums and depressing the stock prices. IN between of all this, the greater victims were still its stockholders and employees, more specifically its employees who were also its stockholders. Around 4000 of these were laid off before filing for bankruptcy by the company. However, still, all faced the realization of locking down of their 401 K plans which were 60% invested in the stock of Enron (Adams, 2003).
Corporate failures like the ones of Enron are considered to be an example of future business regulations. Enron with its failure raised concerns on the future of the mandatory disclosure system, accounting profession’s regulations, and most importantly the internal corporate governance systems. The reaction of the Enron case was started even before the end of 2001 with bills presented in the Senate for limitation for companies on the dedication of retirement plans to its securities to ten to twenty percent (Dibra, 2016).
Corporate Governance Shock with Enron Failure:
During the 1990s, corporate self-regulation was widely spread and had reached the highest of evolutionary success because of the proliferating practices and institutional monitoring. However, the case of Enron showed the failure from legerdemain which can often be controlled. The reality of Enron defied any explanation – the $700 million of earnings disappearing in smoke, $30 million of self-deals by the chief financial officer, $4 billion written in hidden liabilities, $1.2 billion in equity erased and all from a company which was exemplified. The reason for this happening in a corporate governance framework which was envied by the world is important to be identified. Only hidden skullduggery or concealed regulatory defects can answer such reasons. With more investigation, the concealed skullduggery found more evidence. The investigations showed principals being considered as rouges expelled by the business community. A study found that the collapse of Enron was already wrought in the framework of corporate governance as much as the success of General Electric lies with Jack Welch. Enron similarly like the General Electric followed the wealth maximization of shareholder model. It also followed most innovative plans like General Electric. The collapse was accounted for more mundane reasons. It was because of the behavioral biases of the managers of successful entrepreneurs. These managers lacked practice and overemphasized the upside. These managers were pursuing short-term heroic goals which their business could never deliver. Their pursuit of shareholder value had caused them to become risk-prone and encouraged them to engage in the manipulation of earnings, levered speculation, and hiding of critical information.
The collapse of Enron showed that the corporate governance system takes considerable risks for the sake of innovation and economizing of enforcement costs. The managers of the Enron exploited the system by taking advantage of the slack it offers to the successful actors. These principals, although they did not disclose everything, did disclose enough to make the monitoring bodies notice that their earnings were soft, and their liabilities understated. It is a commonplace in business today. It has become normal in the pursuit of shareholder wealth maximization (Bratton, 2002).
Theory of Shareholder Value:
The theory of shareholder wealth maximization, however, tells an entirely different story. As per the academics, the shareholder value in the context of the management is defined as those practices which enhance productivity. Productivity here means the concentrations on core competencies and return of the free cash flow to shareholders, prompt restructure of the dysfunctional operations and the compensation schemes aligning the incentives (Cuong, 2011). However, in transition between theory and practice is the set of instructions which diffuses the norm. This norm, which is informed by the shareholders, as well as the official economy, becomes more capacious as it takes on the darker side (Swanpoel, 2018). For the equity investors, it is evident that the maximum shareholder value does not mean patient investment. On the contrary, it means the obsession with short-term numeric goals. Consequently, for the managers, it means more than just investment and disinvestment (Laplume et al., 2008). It means the proper management of the reported figure as compared to the demanded figure of shareholder values by the shareholders. The dedication of Enron to this norm is presented in the 2000 Annual Report in which it considered itself as laser-focused on the earnings per share (Koen, 2005).
Concerns over Governance Standards:
The Enron case forces the business community to face a discomforting fact. IT is that even if all the academics proclaim that the governance standards are rising, it cannot deny that some of these have declined. Specifically, this may include the ones regarding the shareholder value. Enron is in the only case. The accounting restatements lowering their last stated earnings had averaged at 49 companies per year from 1990 to 1997. It rose to 156 by 2000.the line between what is appropriate and what is not has dissolved under the pressure of producing the shareholder value. The further exploitation and expansion of this gray area have become a routine aspect (Lazonick & O’Sullivan, 2000).
The Monitoring Model of Enron’s Corporate Governance:
The Enron board is rightfully evidenced for wrong direction and monitoring of the LJM transactions. However, it also shows that the Enron board had followed the book. Because of the self-detailing aspect of the transactions the Board needed ongoing monitoring of the managers which had the interests of Enron. Furthermore, the Audit Committee was expected to review the transactions on a yearly basis actively. It was found that the middle management was also actively participating in the concealment of the information perceived as negative (Page, 2001). The Power Report consisted of one review on the expectation of plaintiff contemplating a lawsuit against Enron. The facts of the case of Enron have also given a disturbing signal that Enron stumbled in the end while it was following a good governance practice book. It raised questions about why the system of corporate governance along with its gatekeepers and monitors has failed to provide friction for the execution and formulation of such strategy to cause enough changes. Aggressive monitoring might have been successful in the containment of this recklessness and ultimately saving of the company (Gospel & Pendleton, 2003). It points out a finger, not only to the lower officers but also the outside directors and the governing model of corporate governance (Kester, 1992).
The monitoring model of a company provides an objective and process-based system. It gives the company the opportunity to put up highly qualified directors, the majority on the board, and integrate it into its decision-making structure as one major participant. On the level of the mandate, it only needs the board for making through the motions of making considered judgments. It cannot make the subjective inquiry into the quality for judgment which is brought to be beard (Maher & Andersson, 1999).
Concerns over Compliance with Audit Committee:
In considering an example of compliance with the preceding rules, the Enron 2001 proxy statement of 2001 is an example. The audit committee met five times in 2000 with inside managers and outside auditors responsible for internal controls and accounting. Despite the reviews, the formal recommendation of the audited financial had failed and consequently the committee process as well.
With the progression of the 1990s, darker colors appeared. It raised concerns over the fabulous wealth generated from the liberal stock options and stock prices rises. The shareholder value maximization at this time came out to act out in the bubble stock market. It expanded the bubble based on the short-term norm of numerical goals stemming from the trading and economics of sober fundamental value maximizations by management scientists and investors. This increased pressure on the managers from the short-term maximization of the marketplace (Klarsfeld, 2016). It all came down with Enron in which the pressure for maximizing the shareholder value and the culture of winning has combined drawn a firm into the risk-prone state of decision making (Hanson, 2002).
Three strong lessons can be deduced from the collapse of Enron. Firstly, Enron had collapsed in the same way as the banks have collapsed in the days before the deposit insurance. Secondly, it shows that the seventh largest firm in the country preaching the highly of the market discipline turned out to be the weakest ships of cooperation of the outside auditors, outside directors and institutional investors showing the limits of the self-regulation and market incentives. Thirdly, the suspicion of the accumulation of significant assets within the liability of corporate organization in which the responsibility is diluted among the members of a group was found rationales (Corplaw Admin, 2013).
At the end of the 20th century, many thought that the Anglo-American system of the corporate governance is performing effectively, and the analysts claimed that convergence would surely emerge internationally around it. The crisis of US companies questioned this claim. Then the collapse of Enron can be deduced to certain distinct positions (Noorderhaven et al., 2015). Firstly, it can be said that the current system of corporate governance is working. As shown, these scandals might be the reason to be more confident in investments in America. The second position can be that the corporate governance of Enron showed serious failures which can be tracked to the conflicts of interest regarding auditors and its board members. It is one of the positions which shaped the formation of the Sarbanes Oxley Act (Deakin & Konzelmann, 2003).
The third position shows a different explanation. It shows that the entire business plan of Enron was following the shareholder value system. This focus on the short-term stock price increments was one of the main reasons for its downfall. This third explanation goes into the heart of the matter and shows how the Enron case has given rise to concerns over corporate governance models (Smith, 2003).
Studies investigating the relationship between the stock prices and the shareholder value, and the sustainability of the economy have shown concern over the blind pursuit of shareholder value (Lazonick & O’Sullivan, 2000).
Conclusion:
Corporate governance is the arrangement through which a company serves and represents the interest of its investors. It includes everything and anything from the boards of the company to its executive compensations’ schemes to the laws for bankruptcy.
The system of checks and balances which aids the corporate governance systems required to function effectively. Consequently, the case of Enron showcases the required functions of the audit non-executive directors, ethicality of the management and disclosures. Many of the American corporate governance systems are designed to encourage the managers to take appropriate risks. These risks if not taken appropriately can be catastrophic for the company. Similarly, the competitive nature of the markets can also induce the managers to take inappropriate risks. The emphasis on the profits and the shareholder value as the principal constituency of the manager has an upside in the form of appropriate focus for decision making. However, this limitation of the scope of corporate law has abetted to the excesses of the 1990s.
The voices claiming for increased supervision by the capital markets (Dore, 2006) i.e. corporate governance can be shown the facts of financial crises to show that shareholder value is a wood way.
Indeed, the corporate governance frameworks cannot prevent any unethicality of the top management. However, it can at least act for detection of such activity before it is too late. Thus, it can be said that the analysis of the case of Enron has shown that corporate governance systems can be vulnerable to exploitation and to weaknesses of the corporate governance system that is similar.
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